Completing the Tests in the Sales and
Collection Cycle: Accounts Receivable
Designing Tests of Details of Balances
• Audit Risk Model
• Thus need to consider
– Inherent risk
– Control risk
– Detection risk
– Audit risk
Accounts Receivable-2
Types of Audit Tests and Audit Risk Model
Sufficient Appropriate
Audit Evidence
Audit Risk
=
=
Risk Assessment Procedures
Inherent Risk
+
Procedures to understand
internal control
+
x
Control Risk
Test of control
+
x
Analytical Procedures
+
Detection Risk
Test of details
Accounts Receivable-3
The Audit of Accounts Receivable
Set materiality.
Assess Audit Risk for A/R.
Conduct analytical procedures for
planning purposes
Assess Control Risk for sales and
collections cycle
Identify assertions where
substantive testing is insufficient,
and/or there is risk of material
misstatement
Design and perform test of control.
Assess control risk
Design and perform analytical
procedures as substantive tests for
accounts receivable balance.
The type of audit procedures?
What is the sample size?
Items to be selected?
Timing – when to do the procedures?
Design tests of accounts receivable
balance to satisfy balance-related
audit objectives.
Accounts Receivable-4
Effects of Inherent and Control Risks
High Inherent or
Control Risk
Greater chance of
missing material
misstatement
Thus a lot of
substantive
testing
Low Inherent or
Control Risk
Material
misstatement will
be caught by the
system
Thus substantive
testing can be
reduced, but not
eliminated
Accounts Receivable-5
Materiality Considerations
• Accounts receivable may be one of the largest
amounts on the balance sheet.
• Sales and accounts receivable balances are normally
significant.
Accounts Receivable-6
Inherent Risk Considerations
• Inherent risk tends to be moderate to low for all
assertions
– What are the risk associated with Accounts Receivable?
– High risk areas:
Accounts Receivable-7
Balance-Related Audit Objectives
• Help auditor decide appropriate audit evidence
– Accounts receivable exist
– Accounts receivable are owned and have not been sold or discounted
– There are no unrecorded accounts receivables
– Stated at NRV
– Accounts receivable are appropriately recorded and disclosed
• Properly classified
• Aged trial balance agrees with the general ledger
• Accounts receivable are recorded in the correct period
Accounts Receivable-8
Disclosure-Related Audit Objectives
• Presentation and disclosure in the financial statements
– Accounts receivable transactions actually occurred
– Accounts receivable are amounts collectible by the client
– Disclosures for accounts receivables are fully included
– Accounts receivable in the financial statements are materially correct
– Shown at amounts that are collectible
– Correctly shown as current and long-term
– Both financial and non-financial is clearly disclosed
Accounts Receivable-9
Relationship Between Transaction-Related and Balance-Related Audit Objectives
Accounts Receivable Balance-Related
Audit Objectives
x
Completeness
x
Accuracy
x
Classification
x
Posting and
summarization
x
Timing
Cash Receipts
x
Occurrence
Completeness
Accuracy
Classification
Posting and
summarization
Timing
Cut-off
Detail Tie-in
Classification
Valuation
Accuracy
Occurrence
Completeness
Sales
Rights
and Obligations
TransactionRelated Audit
Objectives
Existence
Class of
Transactions
x
x
x
x
x
x
Accounts Receivable-10
• Occurrence transaction-related audit objective for
sales and the Existence balance-related audit
objective
– For sales, the audit objective occurrence shows that
– For accounts receivable, the audit object of existence shows
that
– From the point of control risk
• If auditor concludes that control risk over sales is low
– Also, by performing accounts receivable confirmations
Accounts Receivable-11
• Completeness transaction-related audit objective for
cash receipts and the Existence balance-related audit
objective
– For cash receipts the audit objective completeness shows
that
– For accounts receivable the audit object shows that
– From the point of control risk
• If auditor concludes that control risk over cash receipts is low
– Thus by performing subsequent payments
Accounts Receivable-12
Analytical Procedures
• Analytical procedures are important
• But remember that analytical procedures are used
during three main phases of the audit:
1. Planning
2. As part of substantive testing
3. As part of completing the audit engagement
Accounts Receivable-13
Using Analytical Review to Target
Detailed Tests
• Helpful analyses could include comparing:
–
–
–
–
–
–
–
Sales by month
Sales returns and allowances
Individual customer balances
Bad debt expense to gross sales
Number of days in A/R
Aging categories
Allowance for uncollectible accounts
• To what would these items be compared?
• What is the auditor looking for?
Accounts Receivable-14
The Audit Objective and the Audit Procedure
• Existence and accuracy:
– Confirm accounts receivable balances
– performing alternative procedures for discrepancies and
non-replies.
Accounts Receivable-15
• Rights and obligations:
– Could also say the ownership of the asset
– But what is done about pledged or factored accounts
receivable?
Accounts Receivable-16
• Valuation:
– What is the important valuation account in relation to
accounts receivable?
– Thus pertinent procedures for valuation?
Accounts Receivable-17
• Completeness:
• Classification:
Accounts Receivable-18
• Cut-off:
– Select the last 40 sales transactions from the current year’s
sales journal and the first 40 from the subsequent year’s
• Detail tie-in:
– Foot the customer master file
• Presentation and disclosure:
– Ensure full and complete disclosure in the financial
statements
Accounts Receivable-19
The Power of Confirmations
• A very important audit procedure
– McKesson & Robbins 1937
• Useful for existence
• A/R confirmations come in two forms:
– Negative
– Positive
Accounts Receivable-20
Positive vs. Negative Confirmations
• Positive confirmations
– A more reliable form of evidence for A/R
– if not answered
• When are they used?
– Individual balances are
– And/or
.
Accounts Receivable-21
ABC Company Letterhead
ABC Company
1234 Main Street
Winnipeg, Manitoba
R3R 3R3
15 January, 201Y
To Whom it May Concern:
Please examine the accompanying statement carefully and either confirm its correctness or report any differences directly to our
auditors
Black & White, LLP
P.O. Box 789
Hamilton, Ontario
L8C 2H5
Your prompt attention to this request will be appreciated. An stamped envelope is enclosed for your reply.
Sincerely,
……………………………………
Jean Fellows, Controller
Confirmation
The balance receivable from us for $2,987.50 as of December 31, 201X is correct except as noted below:
___________________________________________________________________________________________________________
___________________________________________________________________________________________________________
___________________________________________________________________________________________________________
ABC Company
Date ……………………………………….
By …………………………………………..
Accounts Receivable-22
• Negative confirmations
– Failure to reply
• Negative confirmation requires a response only if there is a
discrepancy.
• When are they used?
Accounts Receivable-23
ABC Company Letterhead
ABC Company
1234 Main Street
Winnipeg, Manitoba
R3R 3R3
15 January, 201Y
To Whom it May Concern:
Please examine the accompanying statement. If it does NOT agree with your records, please report any differences directly to our
auditors
Black & White, LLP
P.O. Box 789
Hamilton, Ontario
L8C 2H5
Your prompt attention to this request will be appreciated. An stamped envelope is enclosed for your reply. Please do not send your
payments to the auditors.
Sincerely,
……………………………………
Jean Fellows, Controller
Differences
___________________________________________________________________________________________________________
___________________________________________________________________________________________________________
___________________________________________________________________________________________________________
ABC Company
Date ……………………………………….
By …………………………………………..
Accounts Receivable-24
Controlling and Managing the
Confirmation Process
Look at the following points:
1. Controlling the sending of confirmations
2. Procedures for those accounts the client does not want
confirmed
3. Handling returned confirmations
4. Timing of alternative procedures and second requests
Accounts Receivable-25
1. Controlling the Sending of Confirmations
• The client may assist in preparing the confirmations
• If the client stuffs and stamps the envelopes
• Return envelopes
Accounts Receivable-26
2. Procedures for those Accounts the Client does not want
Confirmed
• If it has been selected by the auditor
Accounts Receivable-27
3. Handling Returned Confirmations
• Confirmations should be returned directly
• Differences between the client’s records and the
confirmation reply
Accounts Receivable-28
Types of differences between client and customer
• Differences between the client records and the
confirmation could be due to:
1. Payment already made by the client
2. Goods were not received
3. Goods were returned
4. Amounts are in dispute
Accounts Receivable-29
4. Timing of alternative procedures and second requests
• Second requests can be sent
• Control of such follow-up requests
• Alternative procedures
Accounts Receivable-30
Nature of Alternative Procedures
• Review of subsequent cash receipts
• Examination of duplicate sales invoices
• Examination of shipping documentation
• Review of correspondence between the client and the customer
Accounts Receivable-31
Sampling and Accounts Receivable
• Sampling is always used to determine which
accounts receivable will be selected
• Statistical sampling could be used to select accounts
receivable for confirmation
• Or directed sampling
Accounts Receivable-32
How Does Monetary Unit Sampling Work?
Auditors use monetary unit sampling, also called probability-proportional-to-size or dollar-unit sampling, to determine the accuracy of
financial accounts. With monetary unit sampling, each dollar in a transaction is a separate sampling unit. A transaction for $40, for
example, contains 40 sampling units. Auditors usually use monetary unit sampling to sample and test accounts receivable.
Here’s an example of how monetary unit sampling works The audit client’s accounts receivable book value is $300,000, and the sample
size is set at 96 records.
1. Figure the sampling interval by dividing book value by sample size
•
(300,000/96) = 3125
2. Arrange the client’s accounts receivable in an ordered list using some sort of ordering sequence.
•
For example, you can arrange them alphabetically by customer name or numerically by customer number.
3. Pick a random number between 1 and 3,125.
•
For this method to work correctly, the random number has to be less than the sampling interval and greater than the smallest
sampling unit. Auditors usually use a random-number-generator computer program to pick the random number. The sampling
unit and sampling interval limits are programmed into the software before the task is run. In this case, say the software selects
the random number 556.
Monetary Unit Sampling Table
Customer Name
Customer Balance
Cumulative Balance
ABC Electric
$435
$435
Best Friend Cat Care
$785
$1,220
Brandy’s Grill
$1,510
$2,730
Buddy’s Gas Station
$5,000
$7,730
Sampling Item
(1) $556
(2) $556 + $3,125 = $3,681
Accounts Receivable-33
First, pick the records to test: Take the alphabetically ordered list shown in the Customer Name column, which lists every customer
balance by dollar amount, and count each dollar until getting to $556. The random number generator gives the number 556 in Step 3 in the
previous slide. The cumulative dollar amount for ABC Electric is under $556.
That shows that the first sampling item is Best Friend Cat Care, which at a cumulative total of $1,220 is the first customer in the list with a
cumulative balance over $556. Best Friend Cat Care becomes the first customer in the sample.
Secondly, select the next invoice to sample: Add the sampling interval of $3,125 to the random number of $556. This equals $3,681,
which is the next sampled item dollar amount. Brandy’s Grill at $2,730 cumulatively is under $3,681, thus Brandy’s is skipped. Buddy’s
Gas Station has the 3,681st dollar.
To pick the next sampling item: Add the sampling interval of $3,125 to the prior sampling item of $3,681, which equals $6,806, and so
on until the last name in the customer list is reached. This will give the total sample size of 96.
When sampling, misstatements are being looked for. If a selected customers invoice should have been entered for $986, for example, and
it was entered as $896, there is a misstatement. If the total misstatements exceed the tolerable level, there may be a material misstatement.
Accounts Receivable-34
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-35
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-36
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.
Accounts Receivable-37
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-38
Estimated Population
Deviation Rate (EPDR)
(in percentage)
Tolerable Exception Rate / Tolerable Misstatement
2
3
4
5
(in percentage)
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 ARIA
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
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
.
.
.
Accounts Receivable-39
EPDR
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
Tolerable
Misstatement
2
3
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
11
25
18
25
18
25
18
25
18
25
18
25
18
25
18
25
18
25
18
25
18
25
18
25
18
25
18
25
18
25
18
25
18
34
18
34
18
34
18
45
25
52
25
52
25
60
25
68
Accounts32
Receivable-40
10–Percent ARIA
114
194
194
265
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
76
129
129
129
176
221
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
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 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.
a. 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 14-9)
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 limits, not a point estimate.
Accounts Receivable-41
Generalizing Misstatements to the
Population
•
The auditor wants to determine the maximum amount of overstatements and
understatements
–
–
•
•
•
•
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% on slide 46
–
–
–
•
While still providing a sample with no misstatements
In other words, the auditor did not miss any misstatements in the sample
The percentage is between 3.8% (Note for future 2.3 + 1.5 = 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.
•
•
•
•
•
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
Accounts Receivable-42
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 on page 45, 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-43
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
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
10
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
.
.
.
.
.
.
.
.
.
.
.
.
18.1
16.4
13.2
11.0
8.3
Accounts Receivable-44
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
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
Accounts Receivable-45
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
•
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%
•
•
•
The single overstatement percentage amount for this problem is 10.% as
calculated below
Recorded
Amount
Audited
Amount
Difference
Misstatement /
Recorded
Amount
$987.12
$887.12
$100.00
10.1%
Accounts Receivable-46
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)
0.023
10,000,000
0.50
Bound Portion
2x3x4
Understatements
0
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-47
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-48
Another example
•
Assume that there are the following misstatements with a sample size of 100 and an
ARIA of 10%
Recorded
Amount
(a)
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%
Accounts Receivable-49
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
0.500
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
*
1,400
360
0.078
Initial
Misstatement
Bound
122,170
* These amounts come from the previous slide. Only overstatements.
Accounts Receivable-50
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
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
Accounts Receivable-51
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
0.038
121,900
Accounts Receivable-52
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
(4,600)
Adjusted Overstatement Bound
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
(300)
Adjusted Understatement Bound
116,900
Thus the likely misstatement is between $116,900 and 117,570. Since materiality is $100,000, more work
needs to be performed.
Accounts Receivable-53
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-54