Completing the Tests in the
Sales and Collection Cycle:
Accounts Receivable
Chapter 16
©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley
15 - 1
Learning Objective 1
Describe the methodology
for designing tests of details
of balances using the
audit risk model.
Accounts Receivable BalanceRelated Audit Objectives
Accuracy
Realizable
value
Existence
Classification
Rights and
obligations
Completeness
Cutoff
Detail tie-in
Methodology for Designing Tests of
Balances – Accounts Receivable
Identify client business risks
affecting sales and collection
cycle and set audit risk (ch. 8).
Set tolerable misstatement for A/R and assess
inherent risk for sales and collection cycle (ch. 9).
Potential FR – improper rev recognition (ch. 11)
Assess control risk for sales
and collection cycle (ch. 10).
Methodology for Designing Tests of
Balances – Accounts Receivable
Design and perform tests of
controls and substantive tests
of transactions for sales and
collection cycle (ch. 14 and 15).
Design and perform analytical
procedures for sales and collection
cycle balances (e.g., sales, BDE) (ch. 8 and 16).
Methodology for Designing Tests of
Balances – Accounts Receivable
Design tests of details of Audit procedures/staffing
accounts receivable balance Sample size/budget
to satisfy balance-related
Items to select
audit objectives.
Timing
Occurrence
Completeness
Accuracy
Classification
Timing
Posting/Summary ×
×
×
×
×
×
Rights
Cutoff
Realizable
value
Classification
Accuracy
Sales ↓
Completeness
Transaction-Related
Audit Objectives
Existence
Accounts Receivable
Balance-Related
Audit Objectives →
Detail tie-in
Relationship Between Sales and Accounts
Receivable: dr. A/R (inc), cr. Sales (inc)
Occurrence
Completeness
Accuracy
Classification
Timing
Posting/Summary ×
×
×
×
×
×
Rights
Cutoff
Realizable
value
Classification
Accuracy
Cash receipts
Completeness
Transaction-Related
Audit Objectives
Existence
Accounts Receivable
Balance-Related
Audit Objectives
Detail tie-in
Relationship Between Collections and Accounts
Receivable: dr. cash (inc), cr. A/R (dec)
Say what???
Recording a cash receipt that did not occur
(cash – occurrence violation) violates
completeness objective for A/R – there is an
open A/R not in the accounting records
(A/R reduced with false j/e).
 Failure to record a cash receipt (cash –
completeness violation) means violation of
existence for A/R – A/R should be reduced –
does not exist.

Learning Objective 2
Design and perform analytical
procedures for accounts in the
sales and collection cycle.
Analytical Procedures for the
Sales and Collection Cycle
Gross margin percentage with previous years
Sales by month over time
Sales returns and allowances as a percentage
of gross sales with previous years
Sales growth vs. related NFM growth
Analytical Procedures for the
Sales and Collection Cycle
Individual customer A/R balances over a stated amount
Bad debt expense as a percentage of gross sales
Days that accounts receivable are outstanding
Analytical Procedures for the
Sales and Collection Cycle
Aging category as a percentage of receivables
Allowance for uncollectible accounts
as a percentage of accounts receivable
Charge-off of uncollectible accounts
as a percentage of total accounts receivable
Selected Comparative
Information
Percent
2008 Change
(000) 08-07
Sales
144.3 9.4
Gross margin
39.8 9.3
Accounts receivable 20.2 7.4
Bad debt expense
3.3 (2.9)
Total assets
61.4 (7.0)
Net earnings
5.7 21.3
Number of accounts
receivable
258
16.7
2007
(000)
132.0
36.4
18.8
3.4
66.0
4.7
221
Percent
Change
07-06
6.5
7.1
13.9
9.7
8.0
38.2
5.7
2006
(000)
124.0
34.0
16.5
3.1
61.1
3.4
209
Analytical Procedures
Sales and Collection Cycle
2008
27.8%
.9%
2.3%
Gross margin/net sales
Sales R&A/gross sales
Bad debt expense/net sales
Allowance for uncollectible
accounts/accounts receivable 6.1%
Number of days receivables
outstanding
51.5
Net accounts receivable/
current assets
37.2%
2007
27.7%
.9%
2.6%
2006
27.5%
.8%
2.4%
8.2%
8.4%
52.3
51.2
38.6%
36.0%
Analytical Procedures for Gross
Margin: Sales – CGS / Sales
Hardwood
Softwood
Plywood
Gross Margin Percent
2008
2007
Client Industry
Client Industry
36.3
32.4
36.4
32.5
23.9
22.0
20.3
22.1
40.3
50.1
44.2
54.3
Learning Objective 3
Design and perform tests of
details of balances for accounts
receivable for each balancerelated audit objective.
Design and Perform Tests of Details
of A/R Balance (Phase III)
Planned detection risk for each
objective is an auditor’s decision.
Combining the factors that determine
planned detection risk and reacting to DR is complex.
Research – better at assessment than response
Designing Tests of
Detail of Balances
Aged A/R master file / subsidiary ledger
(realizable value): BDE and Allowance
Recorded accounts receivable exist (confirm)
Existing accounts receivable are included
(completeness) – Less of a concern – covered w/
Sales (cash) ToT of completeness (existence).
Accounts receivable are accurate (confirm and ToT)
Accounts receivable are properly classified – reclassify
notes receivable, credits
Designing Tests of
Detail of Balances
Cutoff for accounts receivable is correct – ToT (timing)
The client has rights to accounts receivable:
factoring? discussions, BOD minutes
Extra: Accounts receivable and Sales presentation and
disclosures are proper – SOX: exec loans, more than
5%, Rev Recognition policy
Learning Objective 4
Obtain and evaluate accounts
receivable confirmations.
AICPA Requirements: When
confirmation NOT required
1. Accounts receivable are immaterial. OR
2. The auditor considers confirmations
ineffective evidence because response
rates will likely be inadequate or unreliable. OR
3. The combined level of inherent risk and
control risk is low (DR high) and other
substantive evidence can be accumulated to
provide sufficient evidence (ToT and AP).
MUST DOCUMENT – story time
Type of Confirmation
Positive confirmation: non responses
must be followed up.
Negative confirmation:
all: (1) many small balances (coverage) (B2C) AND
(2) IR and CR are low AND (3) high response rate to
positive confirms in PY
Timing
The most reliable evidence from
confirmations is obtained when
they are sent as close to the balance
sheet date as possible, as opposed
to confirming the accounts several
months before year-end.
Consider earnings release dates in
light of risks – can you get it done??
SEC / LAFs : 90 → 60 days
Sample Size (firm specific)
Tolerable misstatement - indirect
Inherent risk - direct
Control risk - direct
Assurance re: objectives from
other substantive tests (ToT, AP) - indirect
Type of confirmation – more with negative
Dollar A/R balance – Not “large” so typically
part of process - direct
Selection of Items
for Testing
When selecting a sample of accounts receivable
for confirmation, the auditor should be careful
to avoid being influenced by the client.
Selection of Items
for Testing
If a client tries to discourage the auditor from
sending confirmation to certain customers,
the auditor should consider the possibility
that the client is attempting to conceal
fictitious or known misstatements of
accounts receivable.
Scope limitation???? Disclaimer of opinion???
Parmalat and cash confirms, Satyam
Subsequent Cash Receipts
Follow up: Evidence of the receipt of cash subsequent
to the confirmation date includes examining
remittance advices, entries in the cash receipts
records, or perhaps even subsequent credits in
the accounts receivable master files.
Monday Morning QB: Evaluate 12/31 balance with
Post 12/31 info
Duplicate Sales Invoices
These are useful in verifying
the actual issuance of a sales
invoice and the actual date
of the billing: Cutoff
Shipping Documents
These are important in establishing
whether the shipment was actually
made (existence and completeness) and
as a test of cutoff.
End of Chapter 16
©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 15 - 31