ATC f8 materials for jun08 session study systemf8 AA (int)session24 j08

SESSION 24 – TRADE RECEIVABLES OVERVIEW Objective To determine areas of risk in the audit of trade receivables To describe the procedure of confirmation by direct communication LEDGER ACCOUNTS SOURCES OF EVIDENCE “Ideas list” Examples RISKS C A P Accounting entries Control a/cs Control a/c reconciliations Individual customer a/cs Examples E R EXTERNAL CONFIRMATION [ISA 505] Evidence Need for Reliability Risk assessment Design of request Confirmation process A comprehensive audit program for receivables and prepayments is set out in Appendix and must be studied 2401 SESSION 24 – TRADE RECEIVABLES SOURCES OF EVIDENCE Example Complete the following ideas list 1.1 “Ideas list” 1.2 Examples Accounting systems ⇒ Documentation ⇒ Tangible assets ⇒ Management and employees ⇒ Customers and suppliers ⇒ Other third parties ⇒ Analytical procedures ⇒ RISKS 2.1 Examples Accounts receivable may not be recoverable if overdue liquidated/in receivership disputed (e.g over pricing/goods supplied) An accounts receivable analysis may not accurately reflect age of debtors (e.g if items are not matched in “open-item” system) Trade receivables will be overstated if estimate for bad and doubtful debtors is inadequate “Teeming and lading” – Receipts are pocketed and banking delayed until another receipt makes up the shortfall The misappropriation is disguised by incorrect posting of subsequent cash receipts or fictitious credit notes 2402 SESSION 24 – TRADE RECEIVABLES Example Trade receivables’ ledger B A $ B/f $ $ 100 Receipts B/f C $ 80 $ B/f $ 170 $75 from A $80 from B $100 from C Required: Explain how the misappropriation of receipt A could be concealed with subsequent cash receipts Solution (i) When $80 received from B – (ii) When $100 received from C – LEDGER ACCOUNTS Understanding the way in which transactions with customers are recorded is crucial to describing audit procedures 3.1 Accounting entries Relevant transactions are usually posted twice In total to a control a/c Individually to trade receivables/trade payables ledger accounts If control a/cs are maintained in the general ledger double-entries will include Dr Control a/c Cr Sales a/c Being sales Dr Cash a/c Cr Control a/c Being receipts individual a/cs are kept in memorandum 2403 SESSION 24 – TRADE RECEIVABLES If control a/cs are NOT maintained in the general double-entries will include Dr Individual customer a/c Cr Sales a/c Dr Cash a/c Cr Individual customer a/c a control a/c should be kept in memorandum 3.1.1 Books of prime entry Books of prime entry CASH BOOK RECEIPTS CASH BOOK PAYMENTS SALES DAY BOOK PURCHASES DAY BOOK JOURNAL (Similar entries will be made from the sales and purchases returns books) Ledges TRADE RECEIVABLES GENERAL DOUBLE ENTRIES 2404 TRADE PAYABLES SINGLE ENTRIES In memorandum SESSION 24 – TRADE RECEIVABLES 3.1.2 Detailed extract SALES DAY BOOK Totals Individual memo entries GENERAL LEDGER RECEIVABLES LEDGER Revenue a/c Control a/c Anderson TOTALS SHOULD AGREE Cooper Cash a/c Individual memo entries Totals CASH BOOK 3.2 Control accounts 3.2.1 Purpose To provide an internal control (also called “internal check”) over the recording of credit transactions and their subsequent settlement If all postings are correct both individually and in total ⇒ Σ individual balances in sub-ledger = balance on control a/c If errors in control a/c (kept in general ledger) ⇒ TB will not balance If errors in individual a/c (kept in memorandum) ⇒ under/(over *) receipts from customers * less likely 2405 SESSION 24 – TRADE RECEIVABLES 3.2.2 Proforma A trade receivables ledger control account may contain any or all of the following totals for the period Trade receivables ledger control a/c $ $ Balance b/f (opening trade receivables) x Cash a/c (cash book) x Sales (credit) a/c (sales day book) x Discounts allowed a/c (cash book) x Sales returns a/c (sales returns day book) x Cash a/c – dishonoured cheques (cash book) x Bad debts expense a/c (journal) x Credit notes (journal) x Trade payables ledger contra (journal) x Balance c/f † (closing trade receivables) x Bal b/f x x x † If there are not errors, this balance must be the same as the sum of the individual balances on the customers’ ledger a/cs Any difference must be reconciled 3.3 Control account reconciliations 3.3.1 Preliminary procedure Step Balance off individual a/cs (e.g in the sub-ledger) Step Extract a list of a/c balances and sum it Step Balance control a/c (e.g in general ledger) Step Investigate any difference 2406 SESSION 24 – TRADE RECEIVABLES 3.3.2 Possible reasons for difference Casting error in a book of prime entry (affects total) will give rise to an error in the control a/c Omission or duplicate posting of individual transactions Transposition errors (in individual amounts or totals) will result in errors (in the individual and control a/cs respectively) “Contra entries” (set-offs) in individual a/cs not recorded in control a/cs Commentary Contra entries may arise when a business has accounts in both the receivables and payables ledgers for the same party (i.e the business obtains supplies from a customer) Instead of exchanging cheques, the accounts are settled by setting off the smaller balance to leave a net amount owing Bad debts in individual a/cs not recorded in control a/c Casting error in balancing off a/cs (individual or total) Errors in extracting individual balances (= list) omission recording Cr balance † in trade receivables ledger as Dr recording Dr balance in trade payables ledger as Cr † It is easily assumed that all receivables should have debit (or nil) balances However, a customer could have a credit balance (e.g if they made an advance payment) Commentary Not all errors will give rise to a difference (e.g omitting a transaction from a book of prime entry) 3.3.3 Procedure for agreeing Step Identify reasons for differences (above) Step Identify control a/c adjustments ⇒ adjust control a/c Step Adjust list of balances for errors in its make-up and extraction 2407 SESSION 24 – TRADE RECEIVABLES 3.3.4 Proforma reconciliation Trade receivables ledger control a/c $ $ These not agree therefore something has gone wrong Balance b/f x Adjustments eg dishonoured cheque x Adjustments e.g contra sales returns Balance c/f x x x x x Statement reconciling the control account to the list of balances $ Balance per list of balances Add: eg balance omitted Less: eg balance posted twice x x (x) Balance per trade receivables ledger control account x 3.4 Individual customer accounts 3.4.1 “Open-item” Balances now agree Keeps full details of all transactions that have been posted to an account There is a facility to clear (or delete) from the file all items which have been fully matched, leaving details only of those items which are still not fully matched or “open” Information is thereby retained for items requiring some processing As an entry is made the user should specify whether this is a new transaction (e.g invoice) or whether it is to be matched against an earlier transaction (e.g cash receipt) To preserve audit trails when matched items are cleared from the file, it is usual for details of the file to be printed out at regular intervals 2408 SESSION 24 – TRADE RECEIVABLES 3.4.2 “Balance (brought) forward” Usually keeps details only of the current month’s transactions Those of previous months are amalgamated to form a single balance which is b/fwd Much less detail is kept in such a file and it may be impossible to obtain an accurate or meaningful aged analysis Items may be posted without specific matching to earlier transactions with a FIFO convention usually being adopted Thus a cash receipt is set against the b/fwd (old) balance before being included in the latest period’s transactions It can become difficult to reconcile the balance on an account to separate transactions in the past EXTERNAL CONFIRMATION [ISA 505] ISA 505 External Confirmations supersedes the section in ISA 501 Additional Considerations for Specific Items relating to direct confirmation of accounts receivable The process of obtaining and evaluating a direct communication from a third party in response to a request for information affecting financial statement assertions Example Suggest matters on which it may be appropriate to seek direct confirmation Solution 2409 SESSION 24 – TRADE RECEIVABLES 4.1 Need for The factors to be considered when determining the need for external confirmations are: materiality; the assessed risk; and how other evidence will reduce audit risk to an acceptably low level The weaker internal controls (i.e the higher control risk), the more important external confirmation Confirming balances (e.g accounts receivable) on a test basis may reduce the scope of detailed tests on related transactions (e.g sales) 4.2 Reliability Received directly by the auditor from independent third parties, therefore relatively reliable However, the auditor must exercise control over confirmation requests and responses Restrictions imposed by management (e.g not to request balances from certain customers) may impair reliability 4.3 Risk assessments If assessed risk is high, the need for more substantive or persuasive evidence (e.g through direct confirmation procedures) is greater If assessed as low (e.g in respect of a loan being repaid in accordance with its terms) substantive procedures may be limited to tests of detail (e.g of the payments made) rather than through confirmation (e.g with the lender) Example Identify the financial statement assertion(s) most relevant to the external confirmation of: (a) an account receivable (b) goods held on consignment (c) an account payable 2410 SESSION 24 – TRADE RECEIVABLES Solution Account receivable Goods held on consignment Account payable 4.4 Design of request External confirmation requests should be tailored to the specific audit objective 4.4.1 Factors to be considered Financial statements assertions Prior experience Respondents (competence, competence, independence, motivation, authority or willingness to provide information, knowledge of the matter being confirmed, and objectivity) The type of information respondents will readily confirm For example, single transactions (e.g invoices) rather than overall account balance Management’s authorization to respondents to disclose information requested 2411 SESSION 24 – TRADE RECEIVABLES 4.4.2 Methods Positive 4.4.3 vs Negative Request to confirm agreement with balance shown or express disagreement Request to reply only in event of disagreement with recorded balance Preferred when high assessed risk e.g Appropriate when weak internal controls good internal controls , and suspicion of irregularity or amounts in dispute large number of small accounts numerous bookkeeping errors errors not expected Management’s request not to confirm certain information If the auditor agrees to management’s request not to confirm certain information (on valid grounds) alternative procedures should be applied to obtain sufficient appropriate evidence If management’s request is not valid the possible impact on the auditor’s report of the limitation on scope should considered Factors to be considered: the need for professional scepticism; any implications regarding management’s integrity; the possible existence of fraud or error 4.5 Confirmation process The auditor should have control over: the selection process; sending confirmation requests; and receiving responses To minimize the risks of: sample bias; interception of requests and alteration of responses 2412 SESSION 24 – TRADE RECEIVABLES Results should be evaluated in the context of ISA 530 Audit Sampling and Other Selective Procedures 4.5.1 Constructing a sample vs Receivables If testing primarily for OVER-statement, select from receivables’ ledger (reconciled to control a/c in general ledger) Payables If testing primarily for UNDER-statement, select from “reciprocal” population (e.g suppliers identified by audit tests on purchases) Special attention to be given to - old unpaid a/cs a/cs written off during period credit/debit balances in receivables/payables nil balances a/cs paid by date of examination Audit sampling and other selective testing procedures are described in Session 19 4.5.2 Request Specially prepared form or letter or an attachment to the normal statement giving a copy of the customer’s ledger account The latter is more likely to detect error or fraud To Audit confirmation Will you please return the enclosed slip to our auditors, Messrs Pears, Cross, Brannigan & Company, of 131/133 Dutchman Avenue, indicating whether or not you agree the enclosed account by deleting the line that does not apply In the event of disagreement, please give details on the reverse of the slip A stamped addressed envelope is enclosed for your reply 2413 SESSION 24 – TRADE RECEIVABLES To: Messrs Pears, Cross, Brannigan & Company 131/133 Dutchman Avenue Audit confirmation of balance due to: Solti Potato Crisps Inc at 30 June 20X1 Please delete as necessary We confirm that the balance due from us to the above company at the above date was $ According to our records the amount due from us to the above company was $ A reconciliation of these amounts is shown below Yours faithfully 4.5.3 Replies Agree or reconcile differences 4.5.4 Non-replies Alternative audit procedures should be undertaken to provide equivalent evidence (i.e about the same financial statement assertion) Alternative procedures are usually undertaken after a making a second request Example Suggest alternative procedures which may provide sufficient appropriate audit evidence of the existence and completion of accounts receivable Solution 2414 SESSION 24 – TRADE RECEIVABLES 4.6.5 Summary of results An example of a standard schedule is set out in Appendix FOCUS You should now be able to: explain risks of misstatement associated with trade receivables; identify sources of audit evidence; appreciate and explain the importance of control a/c reconciliations; select appropriate audit procedures (including external confirmation) for inclusion in a work program (see also Appendix 3) relating to financial statement assertions concerning trade receivables EXAMPLE SOLUTIONS Solution — Sources “Ideas list” Accounting systems ⇒ “Open-item” or “balance forward” ledger Documentation ⇒ Sales orders, GDNs, invoices, credit notes, statements Tangible assets ⇒ Cash receipts (confirm recoverability) Management and employees ⇒ Sales director, Credit controller, cashier Customers and suppliers ⇒ Customer remittance advices, correspondence, direct confirmation Other third parties ⇒ Solicitor (e.g re significant claims), Liquidator/receiver (bad/doubtful debtor) Analytical procedures ⇒ Debtor days (by month), % write-offs, % estimate for doubtful debts 2415 SESSION 24 – TRADE RECEIVABLES Solution — Teeming and lading (i) When $80 received from B – allocate $75 to A and pocket difference ($5) (ii) When $100 received from C – allocate $80 to B and pocket difference ($20) Solution — Direct confirmation Account balances (receivable and payable) and their components Terms of agreements Transactions with third parties and terms thereof Bank balances and other information from bankers Inventories held by third parties (e.g in warehouses or on consignment) Loans from lenders Title deeds to property held by lawyers or banks for safe custody or as security Investments purchased from stockbrokers but not delivered by the end of the reporting period Solution — Financial statement assertions Account receivable Existence of the account as at the date specified (and accuracy of recorded accounts balances) Completeness (and cut-off between trade receivable/inventory) of recorded transactions (particularly receipts from customers) Evidence is also provided about the adequacy (or otherwise) of the system of internal controls over sales Goods held on consignment Existence Rights Account payable Obligation Completeness (i.e that there is no material unrecorded liability) Solution — Alternative procedures (trade receivables) After-date cash receipts Shipping documentation or other proof of delivery of goods to the customer Cutoff tests (on sales invoices, goods despatch and cash receipts) Customer correspondence 2416 ... file all items which have been fully matched, leaving details only of those items which are still not fully matched or “open” Information is thereby retained for items requiring some processing... entry) 3.3.3 Procedure for agreeing Step Identify reasons for differences (above) Step Identify control a/c adjustments ⇒ adjust control a/c Step Adjust list of balances for errors in its make-up... in its make-up and extraction 2407 SESSION 24 – TRADE RECEIVABLES 3.3.4 Proforma reconciliation Trade receivables ledger control a/c $ $ These not agree therefore something has gone wrong Balance