Accounting Principles - CH 11 - Accounts/Notes Receivable and Revenue
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Sources of A/R
Claims against customers from sale of goods
Loans to officers or employees
Loans to subsidiaries
Claims against various other refunds
Claims for tax refunds
Advances to suppliers
Sources of N/R
Written promises to pay certain amounts at future dates
Notes for substantial amounts
Installment note or contract can allow seller to hold lien on goods
Audit risk significant because
Many incidences of fraud have involved overstatement of receivables and revenue
Revenue recognition may be based on complex accounting rules
Receivables and revenues are usually subject to valuation using significant accounting estimates
Internal Control over A/R and Revenue
Important because of risk of intentional misstatement of revenue
Independence of audit committee
Management establish tone at the top
Commitment to competence
Management’s philosophy and operating style
Human resource policies and practices
Internal Control over A/R and Revenue
Division of duties
•Prepare sales order
•Issue merchandise from stock
•Maintenance of control accounts
•Maintenance of customers’ ledgers
•Approval of sales returns and allowances
- •Authorization of write-offs of
- uncollectible accounts
ØCustomer purchase order
ØBill of lading
Revenue Cycle Controls
ØSegregation of duties--sales and collections
ØMatching of sales invoices and shipping documents
ØClerical accuracy checks on invoices
ØCredit approval for sales transactions
ØMailing of monthly statements
ØReconciliation of bank accounts
ØUse of control listing of cash receipts
ØUse of budgets and analysis of variances
ØControl over shipping and billing documents
ØUse of authorized credit memoranda
ØUse of chart of accounts and review of account codings
Internal Control over Notes Receivable
ØSubdivision of duties
The custodian of notes receivable should not have access to cash or to the general accounting records
The acceptance and renewal of notes be authorized in writing by a responsible official who does not have custody of notes
The write-off of defaulted notes be approved in writing by responsible officials and effective procedures adopted for subsequent follow-up of such defaulted notes
- ØLead schedules for receivables and net
- revenue and
- ØWorking papers
- Aged trial balance of A/R
- Analyses of other accounts receivable
- Analysis of notes receivable and related interest
- Analysis of allowance for doubtful accounts and notes
- Comparative analyses of revenue Documentation of internal control
- Risk analyses and audit program
Examples of tests of controls
a. Examine significant aspects of a sample of sales transactions.
b. Compare a sample of shipping documents to related sales invoices.
c. Review the use and authorization of credit memoranda.
d. Reconcile selected cash register tapes and sales tickets with sales journals.
e. Test IT application controls.
f. Examine evidence of review and approval of revenue estimates.
Perform further audit procedures—substantive procedures for receivables and revenue
1. Obtain an aged trial balance of trade accounts receivable and analyses of other accounts receivable and reconcile to ledgers.
2. Obtain analyses of notes receivable and related interest.
3. Inspect notes on hand and confirm those with holders.
4. Confirm receivables with debtors.
5. Review the year-end cutoff of sales transactions.
6. Perform analytical procedures for accounts receivable, notes receivable, and revenue.
7. Review significant year-end sales contracts for unusual terms.
8. Test the valuation of notes receivable, computation of interest income, interest receivable, and amortization of discount or premium
Details on Understanding the Client Business
ØThe types of products and services sold.
- ØThe classes and categories of the
- client’s customers.
- ØWhether the business is affected by
- seasonal or cyclical demand.
- ØTypical marketing policies for the client
- and its industry.
- ØPolicies regarding pricing, sales
- returns, discounts, extension of credit, and normal delivery and payment terms.
- ØCompensation arrangements that are based
- on recorded revenue.
- ØTypical revenue recognition principles
- used in the industry and their methods of application
Fraud Risk related to Receivables and Revenue
- ØUnderstand controls established by
- management to control risk
ØDetermine controls have been implemented
- ØRespond to risk
- lHas overall effect on audit
- lDesign of audit procedures
- lPerforming procedures to address risk of material misstatement due to management override of internal control
Confirmation of Receivables
- Receivables should be confirmed, unless:
- ØAccounts receivable are immaterial,
ØThe use of confirmations would be ineffective, or
ØThe auditors’ combined assessment of inherent and control risk is low, and audit risk can be reduced to acceptably low level with substantive tests
Types of Confirmations
Request addressed to the debtor asking for a reply
•Ordinarily sent with balances due on them
- •Blank forms – leave amount blank (used
- less frequently
“Positive” means you intend to get a response whether respondent agrees or not.
Types of Confirmations
Ask debtor to advise the auditors only if the balance shown is incorrect
•Low level of assessed risk of material misstatement and sufficient evidence on operating effectiveness of controls
•Large number of small balances
•Low exception rate is expected
- •Recipient expected to respond
Criteria for Recognition of Revenue
ØPersuasive evidence of an arrangement exists
ØDelivery has occurred or services have been rendered
ØThe seller’s price to the buyer is fixed or determinable
ØCollectability is reasonably assured
Potential Revenue Recognition Problems
ØSales with unusual right to return
ØBill and hold transactions
- ØSales using notes with unusual interest
- ØPercentage-of-completion method of
- revenue recognition
ØMultiple element agreements
Allowance for Doubtful Accounts
ØSignificant estimate made by management
- ØBest evidence of collectability is
- subsequent payment
- ØDevelop estimate and evaluate reasonableness of management estimate
- a)Compare the details of the aging of accounts receivable to prior years’ aging.
- b)Investigate the credit ratings for delinquent and unusually large accounts.
- c)Review confirmation exceptions for an indication of amounts in dispute or other clues as to possible uncollectible accounts.
- d)Summarize in a working paper those accounts whose collectability is doubtful based on the preceding procedures. List customer names, doubtful amounts, and reasons for considering these accounts doubtful.
- e)Review with the credit manager the current status of significant doubtful accounts
- f)Compute relationships, such as the number-of-days’-sales in accounts receivable and the relationship of the valuation allowance to (1) accounts receivable and (2) net credit sales
To identify related party transactions, auditors should review
lProxy and other filings with SEC or other regulatory agencies
lconflict-of-interest statements by management
lTransactions with unusual terms
lAccounting records for unusual balances or transactions particularly near year-end
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