Chapter 16
Completing the Tests in the Sales and
Collection Cycle: Accounts Receivable
(See Phase III in Figure 16-1 on page 485)
Now is the time
to test the details
of balances.
Presentation Outline
I. Analytical Procedures
II. Designing Tests of Details of Balances
III. Confirmation of Accounts Receivable
IV. Sample Audit Program
I. Analytical Procedures for Accounts
Receivable
A. Analytical Procedures Defined
B. Account Receivables that Deserve Special
Attention
C. Some Typical Analytical Procedures
A. Analytical Procedures Defined
When analytical procedures
in the sales and collection
cycle uncover unusual
fluctuations, the auditor
should make additional
inquiries of client
management.
Client responses should be
critically evaluated to
determine their adequacy
and whether they are
supported by other
corroborative evidence.
B. Account Receivables that Deserve Special
Attention
 Large balances may be
overstated.
 Accounts that have been
outstanding for a long period of
time may not be collectible.
 Receivables from affiliated
companies, officers, directors,
and other related parties may
need separate disclosure.
 Significant credit balances may
need to be reclassified as a
liability.
C. Some Typical Analytical Procedures
Analytical Procedure
Possible Misstatement
Compare gross margin
percentage with previous years
(by product line).
Overstatement or
understatement of sales and
accounts receivable.
Compare sales returns and
allowances as a percentage of
gross sales with previous years
(by product line).
Overstatement or
understatement of sales
returns and allowances and
accounts receivable.
Compare bad debt expense as
a percentage of gross sales with
previous years
Uncollectible accounts
receivable that have not been
provided for.
Compare allowance for
uncollectible accounts as a
percentage of accounts
receivable with previous years.
Overstatement or
understatement of allowance
for uncollectible accounts and
bad debt expense.
II. Designing Tests of Details of Balances
A. Tie-in of Aged Trial Balance
B. Existence of Accounts Receivable
C. Completeness of Accounts Receivable
D. Accuracy of Accounts Receivable
E. Proper Classification of Account Receivable
F. Correct Cutoff of Sales and Receivables
G. Realizable Value
H. Client Rights to Accounts Receivable
I. Presentation and Disclosure of Accounts
Receivable
A. Tie-in of Aged Trial Balance
 Most tests of accounts
receivable and the allowance
for uncollectible accounts are
based on the aged trial
balance (See Figure 16-3 on
page 491)
 The aged trial balance should
be tied into the control
account on the general ledger
before other tests begin, in
order to ensure that the total
population is being tested.
B. Existence of Accounts Receivable
When customers do not
respond to confirmations,
auditors also examine
supporting documents to
verify the shipment of the
goods and evidence of
subsequent cash receipts to
determine if accounts were
collected.
These additional audit
procedures are not as
imperative when customers
respond to confirmations.
C. Completeness of Accounts Receivable
The understatement of
sales and accounts
receivable is best
uncovered by
substantive tests of
transactions for
shipments made but
not recorded, and by
analytical procedures.
D. Accuracy of Accounts Receivable
Confirmation of individual
customer accounts is the
most common test of
details for balances for
accounts receivable.
Supporting documentation
for shipments and cash
receipts can also be
examined to support
individual entries to
customer accounts.
E. Proper Classification of Accounts
Receivable
The aged trial balance can
be reviewed for material
receivables from affiliates,
officers, directors, and
other related parties. Such
balances often require
segregation from accounts
receivable and disclosure.
Significant credit balances
in accounts receivable
should be reclassified as
accounts payable.
F. Correct Cutoff of Sales and Receivables
Sales cutoff – the proper cutoff of sales can be easily
verified when a client uses sequential prenumbered shipping
documents.
Sales returns and allowances cutoff – most companies
record sales returns and allowances in the period they occur,
assuming that they occur in fairly constant amounts over
time.
Cash receipts cutoff – auditor may check to see if client is
holding the cash receipts book open, by tracing recorded
cash receipts to subsequent period bank deposits on the
bank statement. A delay of several days could indicate a
cutoff misstatement.
G. Realizable Value
 GAAP requires that accounts
receivable be stated at the
amount that will ultimately be
collected (total A/R less
allowance for doubtful
accounts).
 A common method of
evaluation is to examine
noncurrent accounts on the
aged trial balance.
 The collectibility of more
current accounts must also be
assessed.
H. Client Rights to Accounts Receivable
A portion of the receivables may have been pledged as
collateral, assigned to someone else, or sold at a discount.
Customer confirmations will not uncover this since
customers are often unaware of the arrangements.
A review of the minutes, discussions with the client,
confirmation with banks, and the examination of debt
contracts may uncover such arrangements.
I. Presentation and Disclosure of Accounts Receivable
Receivables from officers
and affiliated companies
must be segregated from
accounts receivable from
customers if the amounts
are material.
Account receivable
footnote disclosure
includes information about
the pledging, discounting,
factoring, assignment of
accounts receivable, and
amounts due from related
parties.
III. Confirmation of Accounts Receivable
A. The Confirmation Requirement
B. Types of Confirmations
C. The Acceptability of Negative
Confirmations
D. Follow-up of Nonresponses to Positive
Confirmations
E. Analysis of Differences
F. Factors Affecting Sample Size
Although auditing
standards require
confirmation of
accounts receivable,
there are three
situations where they
are deemed
unnecessary.
A. The Confirmation
Requirement
Accounts receivable are
immaterial
Auditor considers
confirmations to be
ineffective evidence
because response rates
will likely be inadequate.
The combined level of
inherent risk and control
risk is low and other
substantive evidence can
be accumulated to provide
sufficient evidence.
B. Types of Confirmations
Positive Confirmations
Recipient is requested to
reply to the auditor
whether the balance of the
account is correct or
incorrect
More reliable than
negative confirmations.
See Figure 16-5 on page
498.
Negative Confirmations
Recipient is requested to
reply to the auditor only if
the balance is incorrect.
The uncertainty associated
with no response makes
them less reliable than
positive confirmation.
See Figure 16-6 on page
499.
Note: It is also common to use a combination of confirmations,
sending the positives to accounts with large balances and the
negatives to those with small balances.
C. The Acceptability of Negative
Confirmations
All three of the following
conditions must be met
before an auditor can use
negative confirmations:
 Accounts receivable is made
up of a large number of small
accounts.
 Combined assessed control
risk and inherent risk is low.
 Recipients of the
confirmations are likely to
give them adequate
consideration.
D. Follow-up of Nonresponses to Positive Confirmations
Failure of customers to respond to initial confirmations often results
in 2nd and possibly even 3rd confirmations being sent. When
positive confirmations are used, SAS 67 requires follow-up
procedures for unreturned confirmations. Alternative procedures
include:
 Examination for subsequent cash receipt of the receivable. This
approach is generally considered to be the best alternative
procedure.
 Verifying the issuance of the sales invoice and date of billing.
 Examination of shipping documents to determine if an actual
shipment occurred.
 Examining correspondence of disputed amounts between the
client and their customer.
Note: In some cases auditors will assume that nonresponses are 100
percent overstatement amounts.
E. Analysis of Differences
 Payment has already been made – customer has made a payment
before the confirmation date, but the client has not received the
payment in time for recording before the confirmation date.
 Goods have not been received – client records the sale at the date
of shipment and the customer records the acquisition when the
goods are received.
 Goods have been returned – client’s failure to record a credit
memo could result from timing differences or the improper
recording of sales returns and allowances.
 Clerical errors and disputed amounts – customer states that there
is an error in the price charged for the goods, the goods are
damaged, the proper quantity of the goods was not received, etc.
Note: The analysis of differences is important because even
immaterial errors may add up to a considerable amount when
combined with other misstatements.
F. Factors Affecting Sample Size
Tolerable misstatement
Inherent risk
Control risk
Achieved detection risk from other procedures
Type of confirmation (negative form requires
more confirmations)
IV. Sample Audit Program
See Table 16-5 on page 504
for an Illustration of an Audit
Program for Tests of Details
of Balances for the Sales and
Collection Cycle.
Summary
Analytical Procedures and Accounts
Receivable Needing Special Attention
The 9 Test of Balances Assertions
Positive and Negative Confirmation
Alternative Procedures for Lack of
Customer Responses to Positive
Confirmation.