ATC f8 materials FF8 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 3
and must be studied

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SESSION 24 – TRADE RECEIVABLES

1

SOURCES OF EVIDENCE

Example 1
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

⇒

2

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.

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SESSION 24 – TRADE RECEIVABLES

Example 2
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 –

3

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.
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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

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TRADE
PAYABLES
SINGLE ENTRIES

In
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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

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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 1

Balance off individual a/cs (e.g. in the sub-ledger)

Step 2

Extract a list of a/c balances and sum it

Step 3

Balance control a/c (e.g. in general ledger)

Step 4

Investigate any difference

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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 1

Identify reasons for differences (above)

Step 2

Identify control a/c adjustments ⇒ adjust control a/c

Step 3

Adjust list of balances for errors in its make-up and extraction.

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SESSION 24 – TRADE RECEIVABLES

3.3.4

Proforma reconciliation
Trade receivables ledger control a/c
$

$

These do
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.

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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.

4

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 3
Suggest matters on which it may be appropriate to seek direct confirmation.

Solution

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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 4
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.

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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.

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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.
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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.

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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 5
Suggest alternative procedures which may provide sufficient appropriate audit
evidence of the existence and completion of accounts receivable.

Solution

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SESSION 24 – TRADE RECEIVABLES

4.6.5

Summary of results

An example of a standard schedule is set out in Appendix 3.

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 1 — 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

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SESSION 24 – TRADE RECEIVABLES

Solution 2 — 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 3 — 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 4 — 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 5 — 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

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