Question

Crescent City Fun Park (Crescent City), an amusement park with thrilling rides and a water park, sells tickets onsite and has a website that allows customers to purchase tickets in advance and bypass the long lines. Customers who use the website include the general public and travel agents. Both individuals and travel agents can purchase tickets online using a major credit card. Some travel agents prefer the option of using the website to purchase tickets, but rather than pay with a credit card, be billed at the end of each month. To use the billing option, a travel agent must contact a sales agent with Crescent City and complete a detailed application with at least two references. Once an application is complete, the sales manager verifies the information, contacts the references, and either approves or denies the application. If the application is approved, the sales manager decides on a credit limit for the travel agent. Terms of payment for all travel agent customers is 30 days from the invoice date.

The auditor performs tests of controls on the credit-granting process and gathers sufficient appropriate audit evidence to conclude that the process is working effectively. Credit is only granted after a thorough credit check. However, Crescent City has continual problems collecting from the larger travel agents within the 30-day period. Some of the largest travel agents regularly take 90 or more days to pay an invoice. Crescent City allows this late payment habit to continue simply because of the volume of business generated by the large travel agents. Crescent City has 398 travel agents as customers, with 42 of them representing 81% of accounts receivable.

a. Recommend which customers should be selected for further testing and why.

b. Explain when the testing of accounts receivable would take place and why.

Answer 1

(a)

The key assertions at risk for accounts receivable(A/R) are existence (do the travel agents really exist?) and valuation (are the accounts receivable valued appropriately?). The auditor is concerned about the risk of overstatement. This means that the larger A/R balances would be of most concern. The testing has revealed that rigorous credit checks are conducted before travel agents are able to purchase from the client on credit, providing some assurance that the amounts are collectible. However, the constant late payments increase the risk that accounts will not be paid, either because of financial deterioration of the travel agent or a dispute between the client and the travel agent about a particular sale.

Forty-two travel agents represent 81% of the A/R balance. A sample of the 42travel agents should be selected. Of the remaining 356 travel agents (398 total – 42 large balances), an additional sample of late-paying travel agents should be selected. Finally, a small sample of the remaining travel agents should also be selected.

(b)

There are strong controls over credit approval. If other controls over A/R and sales are also strong, the testing for existence could be carried out prior to year-end with roll-forward procedures after year-end. Testing for valuation should be carried out closer to year-end as evidence of deteriorating financial position of travel agents would be more likely to be gathered closer to year-end. Testing of subsequent receipts from travel agents (post balance date) would provide strong evidence to support A/R valuation at year-end.