Problem 13-25, p. 446
You have been assigned to the confirmation of aged accounts receivable for the audit of Blank
Paper Company Ltd. You have tested the trial balance and selected the accounts for confirmation. Before
the confirmation requests are mailed, the controller asks to look at the accounts you intend to confirm in
order to determine whether she will permit you to send them.
She reviews the list and informs you that she does not want you to confirm six of the accounts on
your list. Two of them have credit balances, one has a zero balance, two of the other three have a fairly
small balance, and the remaining balance is highly material. The reason she gives is that she feels the
confirmations will upset these customers because they are “kind of hard to get along with.” She does not
want the credit balances confirmed because it may encourage the customers to ask for a refund.
In addition, the controller asks you to send an additional 20 confirmations to customers she has
listed for you. She does this as a means of credit collection for “those who won’t know the difference
between a public accountant and a credit collection agency.”
REQUIRED:
a. Is it acceptable for the controller to review the list of account you intend to confirm? Discuss.
b. Discuss the appropriateness of sending 20 additional confirmations to the customers.
c. If the auditor complies with the controller’s request, what additional audit work is required?
d. Assuming the auditor complies with all of the controller’s requests, what is the effect on the
auditor’s opinion?
Accounts Receivable-1
13-25 Solution
a.
Yes, it is acceptable for the controller to review the list of accounts the auditor intends to confirm. The
confirmations will be sent to the company’s customers, and the auditor must be sensitive to the client’s concern
with the treatment of their customers. At the same time, if the client refuses permission to confirm receivables,
the auditor must consider the reasonableness of the request.
b.
The auditor should be willing to perform special procedures that the client requests if the client is in agreement
that these procedures may not necessarily be considered within the scope of the auditor’s engagement. In the
case of the 20 additional confirmations that the controller requested that the auditor send, the auditor should
be willing to send the confirmations; however, these confirmations should not be considered in the evaluation of
the results of the accounts receivable confirmation sent by the auditor. It would also be reasonable for the
auditor to track the time spent on these confirmations and bill them separately.
c.
If the auditor complies with the controller’s request to eliminate six of the accounts from the confirmation, the
auditor must perform alternative procedures on the six accounts and decide whether or not this omission is
significant to the scope of her examination. If the auditor believes that the impact of omitting these accounts is
significant, she must qualify the auditor’s report to indicate the restriction of scope imposed by the client. With
respect to the additional 20 confirmations, since these are outside the scope of the audit, the auditor could
discuss the extent of the alternative procedures conducted with the client. There may not be any additional
procedures conducted, but simply mail the confirmations (unless there are significant disputes or other matters
that come to light. Then the auditor must consider their impact upon the accounts receivable balance).
d.
If the restriction with respect to not sending the confirmations is material, a qualified or denial of opinion may
be needed, if the alternative procedures do not provide satisfactory evidence.
Accounts Receivable-2
Problem 13-28, p. 447
You intend to use MUS as a part of the audit of several accounts for Roynpower Manufacturing Inc. You have
done the audit for the past several years, and there has rarely been an adjusting entry of any kind. Your audit tests
of all tests of controls for the transaction cycles were completed at an interim date, and control risk has been
assessed as low. You therefore decide to use an ARIA of 10 percent for all tests of details of balances.
You intend to use MUS in the audit of three of the most material asset balances: accounts receivable,
inventory, and marketable securities. You feel justified in using the same ARIA for each audit area because of the
low assessed control risk.
The recorded balances and related information for the three accounts are as follows:
Recorded Value
Accounts receivable
$3,600,000
Inventory
4,800,000
Marketable securities
1,600,000
$10,000,000
Net earnings before taxes for Roynpower are $2,000,000. You decide that materiality will be $100,000 for the
client
Accounts Receivable-3
The audit approach will be to determine the total sample size needed for all three accounts. A sample will be
selected from all $10 million, and the appropriate testing for a sample item will depend on whether the item is a
receivable, inventory, or marketable security. The audit conclusions will pertain to the entire $10 million, and no
conclusion will be made about the three individual accounts unless significant misstatements are found in the
sample.
REQUIRED
a. Evaluate the audit approach of testing all three account balances in one sample.
b. Calculate the required sample size for each of the three accounts assuming you decide that the tolerable
misstatement in each account is $100,000. (Recall that tolerable misstatement equals preliminary judgement about
materiality for MUS.)
c. How would you identify which sample item in the population to the audit for the number 4,627,817? What
audit procedures would you perform?
d. Assume you select a sample of 100 sample items for testing and you find one misstatement in inventory. The
recorded value is $987.12, and the audit value is $887.12. Calculate the misstatement bounds for the three
combined accounts, and reach the appropriate audit conclusions.
What are the factors to be used in this problem?
Estimated Population Exception Rate (EPER) = 0.00 ( as there has rarely been an adjusting entry of any kind.)
The acceptable risk of incorrect acceptance (ARIA) is equivalent to ARACR = 10%
Tolerable Misstatement for A/R = 100,000/3,600,000 = 0.028, or close to 3%
Tolerable Misstatement for Inv. = 100,000/4,800,000 = 0.021, or close to 2%
Tolerable Misstatement for M.S. = 100,000/1,600,000 = 0,063 or close to 6%
Accounts Receivable-4
Some Key Terms for Testing
Balances
Estimated Population Error
Expected Population Error Rate
•
•
•
•
A judgmental estimate based on knowledge of client.
Used to determine appropriate sample size.
Low Error => low sample size
As Expected Error approaches Tolerable misstatement, more precision is needed and larger sample size is
needed.
Acceptable Risk of Incorrect Acceptance

ARIA
•
•

The risk that the auditor is willing to take of accepting a balance as correct when the true misstatement is
greater than the tolerable misstatement.
In other words it could be materially misstated
ARIA is equivalent to ARACR
•
•
•
ARACR is the risk the auditor is willing to take of accepting a control as effective (or monetary amount as
tolerable) when the true population exception rate is greater than TER.
Again, materially misstated
ARIA is inversely related to sample size
Tolerable Misstatement

TER on the tables
•
•
The misstatement that the auditor will permit in the population before concluding that the balance is
materially misstated.
Result of auditor judgment.
Accounts Receivable-5
Estimated Population
Exception Rate (EPER)
(in percentage)
Tolerable Exception Rate (TER)
(in percentage)
2
3
4
5
6
7
8
9
10
15
20
29
46
46
46
46
46
46
46
46
61
61
61
61
61
76
76
89
116
179
19
30
30
30
30
30
30
30
30
30
30
30
30
30
40
40
40
40
50
68
14
22
22
22
22
22
22
22
22
22
22
22
22
22
22
22
22
30
30
37
5-Percent ARACR
0.00
0.25
0.50
0.75
1.00
1.25
1.50
1.75
2.00
2.25
2.50
2.75
3.00
3.25
3.50
3.75
4.00
5.00
6.00
7.00
We need 10%. On
next slide
Accounts Receivable-6
149
236
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
99
157
157
208
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
74
117
117
117
156
156
192
227
.
.
.
.
.
.
.
.
.
.
.
.
59
93
93
93
93
124
124
153
181
208
.
.
.
.
.
.
.
.
.
.
49
78
78
78
78
78
103
103
127
127
150
173
195
.
.
.
.
.
.
.
42
66
66
66
66
66
66
88
88
88
109
109
129
148
167
185
.
.
.
.
36
58
58
58
58
58
58
77
77
77
77
95
95
112
112
129
146
.
.
.
32
51
51
51
51
51
51
51
68
68
68
68
84
84
84
100
100
158
.
.
.
TER
EPER
0.00
0.25
0.50
0.75
1.00
1.25
1.50
1.75
2.00
2.25
2.50
2.75
3.00
3.25
3.50
3.75
4.00
4.50
5.00
5.50
6.00
7.00
7.50
8.00
8.50 Receivable-7
Accounts
2
3
INV
A/R
114
194
194
265
76
129
129
129
176
221
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
4
5
6
7
8
9
10
15
20
22
38
38
38
38
38
38
38
38
38
38
52
52
52
52
52
65
65
78
103
116
199
15
25
25
25
25
25
25
25
25
25
25
25
25
25
25
25
25
34
34
34
45
52
52
60
68
11
18
18
18
18
18
18
18
18
18
18
18
18
18
18
18
18
18
18
18
25
25
25
25
32
10–Percent ARACR
MS
57
96
96
96
96
132
132
166
198
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
45
77
77
77
77
77
105
105
132
132
158
209
.
.
.
.
.
.
.
.
.
.
.
.
.
38
64
64
64
64
64
64
88
88
88
110
132
132
153
194
.
.
.
.
.
.
.
.
.
.
32
55
55
55
55
55
55
55
75
75
75
94
94
113
113
131
149
218
.
.
.
.
.
.
.
28
48
48
48
48
48
48
48
48
65
65
65
65
82
82
98
98
130
160
.
.
.
.
.
.
25
42
42
42
42
42
42
42
42
42
58
58
58
58
73
73
73
87
115
142
182
.
.
.
.
.
.
.
Solution 13-28
a. The audit approach of testing all three account balances is acceptable. This approach is also desirable when the following conditions
are present:
• The auditor can obtain valid, reliable information to perform the required tests in all of the areas.
• Internal control for each of the three areas is comparable.
• Misstatements are expected to occur evenly over the entire population. For instance, the auditor does not expect a large
number of misstatements in accounts receivable and very few, if any, in inventory.
b. The required sample sizes if each account is tested separately are:
Account
Tolerable Misstatement as a %
Accounts receivable
Inventory
Marketable securities
n = 100,000 / 3,600,000 = 0.028
n = 100,000 / 4,800,000 = 0.021
n = 100,000 / 1,600,000 = 0.063
Approximate Sample Size
(Table)
76
114
38
c. The population would be arranged so that all accounts receivable would be first, followed by inventory and marketable securities. The
items would be identified by the cumulative totals. In the example, the number 4,627,871 would relate to an inventory item since it is
between the cumulative totals of $3,600,000 and $8,400,000. Accordingly, for this number the inventory audit procedures would be
performed.
d. The misstatement data are as follows:
Recorded Amount
(a)
Audited Amount
(b)
Difference
(c)
Misstatement /
Recorded Amount
(c/a)
$987.12
$887.12
$100.00
10.1%
Now need to extend the misstatement to the population.
Do this by calculating the Upper and Lower bounds, not a point estimate.
If the both the lower and upper misstatement bound fall below the overstatement and understatement tolerable
misstatement
amounts, accept the conclusion that the book value is not misstated by a material amount. Otherwise
Accounts
Receivable-8
conclude that the book value may be misstated by a material amount.
Generalizing Misstatements to the Population
•
The auditor wants to determine the maximum amount of overstatements and
understatements
–
–
•
•
•
•
While still providing a sample with no misstatements
In other words, the auditor did not miss any misstatements in the sample
These are the upper misstatement bound and the lower misstatement bound
Use the Upper & Lower Misstatement Limits tables for 5% or 10% ARIA and the number of
misstatements
In this example there is one misstatement and the sample size is 114
From the table at an ARIA of 10%
•
The percentage is between 3.8% (Note for future 2.3 + 1.4 = 3.8) and 3.2% (1.9 + 1.3)
– See next slide for the calculation. Calculated percentage = 3.38%
– This percentage represents both upper and lower bounds as a percentage
•
Based on this:
– At a 10% sampling risk, there are no more than 3.38% of the dollar units in the
population that are misstated.
– The auditor must make an assumption about the average percent of misstatement for
population dollars that contain a misstatement, but which the auditor has not examined.
•
•
•
•
•
Accounts Receivable-9
i.e. what is the average misstatement rate for those items that contain a misstatement
This called the Percent of Misstatement Assumption, see Slide 46
In our example the misstatement rate for one misstatement in 10.1% - see previous page.
The auditor is trying to estimate it for those misstatements not found.
This estimate significantly affects the misstatement bounds
Generalizing from the Sample to the Population
Calculating Misstatement Percentage
Sample size for inventory was 114
Actual number of deviations was 1
ARACR is 10%
From table Misstatement Percentage = between 3.8 an 3.2
Sample size of 100 = % of 3.8
Sample size of 120 = % of 3.2
Thus a sample size of 114:
100 = 3.8
114 = x
120 = 3.2
Thus (114 – 100)/(120 – 100) = (x – 3.8)/3.2 – 3.8
x = 3.38
This percentage can be used in calculating the upper and lower bounds (i.e. $ balances)
But note in our example, Part d, we are using a sample size of 100. Thus we
will use 3.8%
Accounts Receivable-10
ACTUAL NUMBER OF DEVIATIONS FOUND
SAMPLE SIZE
0
25
30
35
40
45
50
55
60
65
70
75
80
90
100
125
150
200
Accounts Receivable-11
11.3
9.5
8.2
7.2
6.4
5.8
5.3
4.9
4.5
4.2
3.9
3.7
3.3
3.0
2.4
2.0
1.5
1
17.6
14.9
12.9
11.3
10.1
9.1
8.3
7.7
7.1
6.6
6.2
5.8
5.2
4.7
3.7
3.1
2.3
2
3
4
5
6
7
8
9
5 PERCENT RISK OF OVER RELIANCE
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
19.5
.
.
.
.
.
.
.
16.9
.
.
.
.
.
.
14.9 18.3
.
.
.
.
.
13.3 16.3 19.2
.
.
.
.
12.1 14.8 17.4 19.9
.
.
.
.
11.0 13.5 15.9 18.1
.
.
.
10.1 12.4 14.6 16.7 18.8
.
.
9.4 11.5 13.5 15.5 17.4 19.3
.
8.7 10.7 12.6 14.4 16.2 18.0 19.7
8.2
7.7
6.8
6.2
4.9
4.1
3.1
10.0
9.4
8.4
7.6
6.1
5.1
3.8
11.8
11.1
9.9
8.9
7.2
6.0
4.5
13.5
12.7
11.3
10.2
8.2
6.9
5.2
15.2
14.3
12.7
11.5
9.3
7.7
5.8
16.9
15.8
14.1
12.7
10.3
8.6
6.5
18.4
17.3
15.5
14.0
11.3
9.4
7.1
20.0
18.8
16.8
15.2
12.2
10.2
7.7
10
.
.
.
.
.
.
.
.
.
.
.
.
18.1
16.4
13.2
11.0
8.3
Sample size
ACTUAL NUMBER OF DEVIATIONS FOUND
0
1
2
3
4
5
6
7
8
9
10
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
17.9
15.7
14.0
12.7
10.6
8.0
6.4
19.5
17.2
15.3
13.8
11.6
8.7
7.0
.
.
.
.
.
.
.
.
.
.
10 PERCENT RISK OF OVER RELIANCE
20
25
30
35
40
45
50
55
60
70
80
90
100
120
160
200
Accounts Receivable-12
10.9
8.8
7.4
6.4
5.6
5.0
4.5
4.1
3.8
3.2
2.8
2.5
2.3
1.9
1.4
1.1
18.1
14.7
12.4
10.7
9.4
8.4
7.6
6.9
6.3
5.4
4.8
4.3
3.8
3.2
2.4
1.9
.
19.9
16.8
14.5
12.8
11.4
10.3
9.4
8.6
7.4
6.5
5.8
5.2
4.4
3.3
2.6
.
.
.
18.1
15.9
14.2
12.9
11.7
10.8
9.3
8.3
7.3
6.6
5.5
4.1
3.3
.
.
.
.
19.0
17.0
15.4
14.0
12.9
11.1
9.7
8.7
7.8
6.6
4.9
4.0
.
.
.
.
.
19.6
17.8
16.2
14.9
12.8
11.3
10.1
9.1
7.6
5.7
4.6
.
.
.
.
.
.
.
18.4
16.9
14.6
12.8
11.4
10.3
8.6
6.5
5.2
.
.
.
.
.
.
.
.
18.8
16.2
14.3
12.7
11.5
9.6
7.2
5.8
18.6
16.6
15.0
12.5
9.5
7.6
Appropriate Percent of Misstatement Assumption
•
This is an auditor decision
–
•
Most auditors assume that it is desirable to assume 100% for both overstatements and
understatements
–
•
•
•
Highly conservative
N.B. using MUS, upper and lower misstatement bounds are used rather than maximum
likely misstatement attached to a confidence level.
In other words, the misstatement is likely somewhere in between the max and the min
The following example uses 50% instead of 100%
–
•
Based on judgment
What this means is that for those items the auditor has not examined and have a misstatement, it is assumed
that they are misstated 50%
The single overstatement percentage amount for this problem is 10.1% as calculated
below. Thus 50% is conservative.
Recorded Amount
(a)
Audited Amount
(b)
Difference
Misstatement /
Recorded Amount
(c/a)
$987.12
$887.12
$100.00
10.1%
Accounts Receivable-13
Note that there may be both overstatements and understatements in the population. Thus
the following tables look at the Precision Limits for both over and understatements. Also
remember that there was only one misstatement found, and this was an overstatement.
Number of
Misstatements
(1)
Upper Precision
Limit Portion
(2)
Recorded
Value
(3)
Misstatement Unit
Error Assumption (4)
Bound Portion
2x3x4
0
0.023
10,000,000
0.50
115,000
1
0.015
10,000,000
0.101
15,150
Overstatements
Upper Precision Limit
0.038
Initial Misstatement
Bound
Number of
Misstatements
(1)
130,150
Upper Precision
Limit Portion
(2)
Recorded
Value
(3)
Misstatement Unit
Error Assumption (4)
10,000,000
0.50
Bound Portion
2x3x4
Understatements
0
0.023
115,000
Upper Precision Limit
Initial Misstatement
Bound
115,000
Also remember in this example the auditor makes the assumption that the average percent of misstatement
for population dollars that contain a misstatement is a 50% misstatement unit error. These will be items that
the auditor has not examined.
Accounts Receivable-14
There must be adjustments made to the over and understatement bounds because an
understatement offsets and over statement, and vice-versa
Number of
Misstatements
Misstatement
Unit Error
Assumption
(a)
Sample Size
(b)
Recorded
Population
(c)
Point Estimate
a(c/b)
Initial Overstatement
Bound
Bounds
130,150
Understatement
Misstatements
0
Adjusted
Overstatement Bound
130,150
Initial
Understatement
Bound
115,000
Overstatement
Misstatements
1
Adjusted
Understatement
Bound
0.101
100
10,000,000
10,100
(10,100)
105,000
Thus the likely misstatement is between $105,000 and $130,050. Since materiality is $100,000, more
work needs to be done
Accounts Receivable-15
Another example
•
Assume that there are the following misstatements:
Recorded
Amount
(a)
Accounts Receivable-16
Audited Amount
(b)
Misstatement
(c)
Misstatement
Percentage
c/a
9987.12
9887.12
100.00
1.0%
3350.75
3340.75
10.00
0.3%
2167.34
2267.34
(100.00)
4.6%
65.43
64.53
0.90
1.4%
775.45
757.45
18.00
2.3%
Note in the following table, the conservative approach is to associate the lowest misstatement limit (2)
portion with the highest misstatement unit error (4) .The amount of error is thus maximized
Overstatements
Number of
Misstatements
(1)
Upper
Precision
Limit Portion
(2)
Recorded
Value
(3)
Misstatement
Unit Error
Assumption (4)
Bound Portion
2x3x4
0
0.023
10,000,000
0.50
115,000
1
0.015
10,000,000
0.023
3,450
2
0.014
10,000,000
0.014
1,960
3
0.014
10,000,000
0.010
4
0.012
10,000,000
0.003
Overstatements
Upper Precision
Limit
*
360
0.078
Initial Misstatement
Bound
* These amounts come from the previous slide. Only overstatements.
Accounts Receivable-17
1,400
122,170
Sample size
ACTUAL NUMBER OF DEVIATIONS FOUND
0
1
2
3
4
5
6
7
8
9
10
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
17.9
15.7
14.0
12.7
10.6
8.0
6.4
19.5
17.2
15.3
13.8
11.6
8.7
7.0
.
.
.
.
.
.
.
.
.
.
10 PERCENT RISK OF OVER RELIANCE
20
25
30
35
40
45
50
55
60
70
80
90
100
120
160
200
Accounts Receivable-18
10.9
8.8
7.4
6.4
5.6
5.0
4.5
4.1
3.8
3.2
2.8
2.5
2.3
1.9
1.4
1.1
18.1
14.7
12.4
10.7
9.4
8.4
7.6
6.9
6.3
5.4
4.8
4.3
3.8
3.2
2.4
1.9
.
19.9
16.8
14.5
12.8
11.4
10.3
9.4
8.6
7.4
6.5
5.8
5.2
4.4
3.3
2.6
.
.
.
18.1
15.9
14.2
12.9
11.7
10.8
9.3
8.3
7.3
6.6
5.5
4.1
3.3
.
.
.
.
19.0
17.0
15.4
14.0
12.9
11.1
9.7
8.7
7.8
6.6
4.9
4.0
.
.
.
.
.
19.6
17.8
16.2
14.9
12.8
11.3
10.1
9.1
7.6
5.7
4.6
.
.
.
.
.
.
.
18.4
16.9
14.6
12.8
11.4
10.3
8.6
6.5
5.2
.
.
.
.
.
.
.
.
18.8
16.2
14.3
12.7
11.5
9.6
7.2
5.8
18.6
16.6
15.0
12.5
9.5
7.6
Understatements
Number of
Misstatements
(1)
Upper
Precision
Limit Portion
(2)
Recorded
Value
(3)
Misstatement
Unit Error
Assumption (4)
Bound Portion
2x3x4
0
0.023
10,000,000
0.500
115,000
1
0.015
10,000,000
0.046
6,900
Understatements
Upper Precision
Limit
Initial Misstatement
Bound
Accounts Receivable-19
0.038
121,900
Offsetting Adjustments
Number of Misstatements
Misstatement Unit
Error Assumption
(a)
Sample Size
(b)
Recorded Population
(c)
Point Estimate
a(c/b)
Bounds
Initial Overstatement Bound
122,170
Understatement Misstatements
1
0.046
100
10,000,000
4,600
Adjusted Overstatement Bound
(4,600)
117,570
Initial Understatement Bound
Overstatement Misstatements
1
0.023
100
10,000,000
2,300
(2,300)
2
0.014
100
10,000,000
1,400
(1,400)
3
0.010
100
10,000,000
1,000
(1,000)
4
0.003
100
10,000,000
300
Adjusted Understatement Bound
Thus the likely misstatement is between $116,900 and 117,570. Since materiality is $100,000, more work
needs to be performed.
Accounts Receivable-20
(300)
116,900
Problem 13-19, p. 443
During his interim audit visit, Charles Ai determined that one of the subsidiary companies of
Mega Big Limited had experienced some very serious problems with respect to the credit
management and collection of trade accounts receivable. During the first six months of the year,
the accounts receivable of this subsidiary had almost doubled, the number of days’ sales in
accounts receivable had increased from 39 to 64 days, and bad-debt expense had risen sharply.
REQUIRED
Prepare an outline of the steps that should be taken to investigate the nature and causes of the
credit and collection problems. (Do not consider the possibility of fraud.)
Accounts Receivable-21
Investigation of credit and collection problems
1. Obtain:
• aged accounts receivable trial balances (current date)
• analysis of bad-debt expenses
• analysis of doubtful accounts
2. Ascertain policies in force.
3. Obtain explanations from credit manager for unfavourable results.
4. Consider the following factors:
• economic situation
• effect of competition
• sales policies
5. Identify variances in policies and procedures between subsidiary and parent company.
6. Method of granting credit: Is there an acceptable credit granting system?
• outside sources (such as trade credit agencies)
• internal sourcespayment history
• credit limits established
7. Follow-up on collections: Is there an adequate system for follow-up?
• invoices and statements mailed promptly
• aged list of accounts reviewed and old accounts contacted by reminders, advices, correspondence, etc.
8. Are records up-to-date?
9. Check compliance with procedures.
• Have there been changes?
10. Review status of overdue accounts per aged list of accounts and ascertain whether proper action has been taken.
• follow-up by credit manager
• approval of credit on specific sales
• credit limit exceededshould be cut off
• explanation of delays in payment
• perform similar analysis of accounts written off as to causes, by checking original credit approval and follow-up.
11. Accounts
Determine
that current allowance is adequate by reviewing collectibility of overdue accounts.
Receivable-22