In this post, we look at how to audit accounts receivable and sales. We’ll answer questions such as, “should I confirm receivables or examine subsequent receipts?” and “why assume an overstatement of revenues?”
In this post, we will cover the following:
First, let’s look at assertions. The primary relevant accounts receivable and sales assertions are:
Of these assertions, I believe—in general—existence and occurrence and valuation are most important. So, the client is asserting that the accounts receivable exist and sales balances occurred and that they are valued properly.
Accuracy comes into play if the customer has complex receivable transactions. Additionally, the cutoff assertion is often seen as relevant, especially if the client has increased incentives to inflate the receivables balance (e.g., bonuses triggered by certain income levels).
Second, think about performing your risk assessment work in lights of the relevant assertions.
As we perform walkthroughs of accounts receivable and sales, we are looking for ways that accounts receivable and sales are overstated (though they can also be understated as well). We are asking, “What can go wrong—whether intentionally or by mistake?”
In performing accounts receivable and sales walkthroughs, ask questions such as:
As we ask questions, we also inspect documents (e.g., aged receivable reports) and make observations (who is doing what?).
If controls weaknesses exist, we create audit procedures to respond to them. For example, if—during the walkthrough—we see inconsistent allowance methods, we will perform more substantive work to prove the allowance balances.
Third, consider the directional risk of accounts receivable and sales.
The directional risk for accounts receivable and sales is an overstatement. So, in performing your audit procedures, perform procedures to ensure that accounts receivables and sales are not overstated. For example, review the cutoff procedures at period-end. Be sure that no subsequent period sales are recorded in the current fiscal year.
Audit standards require that auditors review estimates for management bias. So, consider the current year allowance and bad debt write-offs in light of the prior year allowance. This retrospective review allows the auditor to see if the current estimate is fair. The threat is that management might reduce allowances to inflate earnings.
Moreover, the audit standards state there is a presumption (unless rebutted) that revenues are overstated. Again, the threat is an overstatement of income.
Fourth, think about the risks related to receivables and sales.
The main risks are:
Look for risks specific to the entity you are auditing. Risk vary from company to company.
Fifth, think about the control deficiencies noted during your walkthroughs and other risk assessment work.
In smaller entities, the following control deficiencies are common:
Sixth, now it’s time to assess your risks.
In smaller engagements, I usually assess control risk at high for each assertion. Controls must be tested to support the lower control risk assessments. Assessing risks at high is often more efficient than testing controls.
When control risk is assessed at high, inherent risk becomes the driver of the risk of material misstatement (controls risk X inherent risk = risk of material misstatement). The assertions that concern me the most are existence, occurrence, and valuation. So my RMM for these assertions is usually moderate to high.
My response to higher risk assessments is to perform certain substantive procedures: namely, receivable confirmations and tests of subsequent collections. As RMM increases I send more confirmations and examine more subsequent collections.
Additionally, I thoroughly test management’s allowance computation. I pay particular attention to uncollected amounts beyond 90 days. Uncollected amounts beyond 90 days should usually be heavily reserved. And amounts beyond 120 days should–generally–be fully reserved.
And finally, it’s time to determine your substantive procedures in light of your identified risks.
My customary audit procedures are as follows:
My accounts receivable and sales work papers frequently include the following:
In conclusion, today we looked at how to perform accounts receivable and sales risk assessment procedures, the relevant accounts receivable and sales assertions, the accounts receivable and sales risk assessments, and substantive accounts receivable and sales procedures.
If you audit accounts receivable and sales differently, please share your ideas below.
This post is a part of my series titled the Why and How of Auditing. If you’ve missed the previous series articles, click here.
Next week, we’ll look at how to audit plant, property, and equipment.
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Charles Hall is a practicing CPA and Certified Fraud Examiner. For the last thirty years, he has primarily audited governments, nonprofits, and small businesses.He is the author of The Little Book of Local Government Fraud Prevention and Preparation of Financial Statements & Compilation Engagements. He frequently speaks at continuing education events.Charles is the quality control partner for McNair, McLemore, Middlebrooks & Co. where he provides daily audit and accounting assistance to over 65 CPAs. In addition, he consults with other CPA firms, assisting them with auditing and accounting issues.
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