Question

In: Accounting

Describe the procedure (the one-side of a dual direction test, either vouching or tracing) that would...

Describe the procedure (the one-side of a dual direction test, either vouching or tracing) that would test existence of accounts receivable. Also, answer…

a. What question is being answered being answered by performing this test?

b. Is this a substantive test? Explain why or why not?

c. Is this a test of control? Explain why or why not?

Solutions

Expert Solution

Procedure for testing of existence of account receivable:

In the audit of a company  the auditors will review accounts receivable in some detail. Accounts receivable is generally the largest asset that a company has, so auditors tend to spend a considerable amount of time gaining assurance that the amount of the stated asset is reasonable. Here are some of the accounts receivable audit procedures that they may follow:

  • Trace receivable report to general ledger. The auditors will ask for a period-end accounts receivable aging report, from which they trace the grand total to the amount in the accounts receivable account in the general ledger. (If these totals do not match, you may have a journal entry somewhere in the general ledger account that should not be there)
  • Calculate the receivable report total. The auditors will add up the invoices on the accounts receivable aging report to verify that the total they traced to the general ledger is correct.
  • Investigate reconciling items. If you have journal entries in the accounts receivable account in the general ledger, the auditors will likely want to review the justification for the larger amounts. This means that these journal entries should be fully documented.
  • Test invoices listed in receivable report. The auditors will select some invoices from the accounts receivable aging report and compare them to supporting documentation to see if they were billed in the correct amounts, to the correct customers, and on the correct dates.
  • Confirm accounts receivable. A major auditor activity is to contact your customers directly and ask them to confirm the amounts of unpaid accounts receivable as of the end of the reporting period they are auditing. This is primarily for larger account balances, but may include a few random customers having smaller outstanding invoices.
  • Review cash receipts. If the auditors are unable to confirm accounts receivable, their backup auditing technique is to verify that customers have paid the invoices, for which they will want to review check copies and trace them through your bank account.
  • Assess the allowance for doubtful accounts. The auditors will review the process that you follow to derive an allowance for doubtful accounts. This will include a consistency comparison with the method used in the last year, and a determination of whether the method is appropriate for your business environment.
  • Assess bad debt write-offs. The auditors will compare the proportion of bad debt expense to sales for this year in comparison to prior years, to see if the current expense appears reasonable.
  • Review credit memos. The auditors will review a selection of the credit memos issued during the audit period to see if they were properly authorized, whether they were issued in the correct period, and whether the circumstances of their issuance may indicate other problems. They may also review credit memos issued after the period being audited, to see if they relate to transactions from within the audit period.
  • Assess bill and hold sales. If you have situations where you are billing customers for sales despite still retaining the goods on-site (known as "bill and hold"), the auditors will examine your supporting documentation to determine whether a sale has actually taken place.
  • Related party receivables. If there are any related party receivables, the auditors may review them for collectibility, as well as whether they should instead be recorded as wages or dividends, and whether they were properly authorized.

And Verification of Account receivable is both Substantive procedure & test of control because

Substantive testing is the detailed testing of transaction in order to determine Material Misstatement at assertion level. For this Auditor first performs Test of Control to determine the operating effectiveness of Controls,When Test of controls confirm the transactions may be contained Material Misstatements then Auditor will go Substantive testing to confirm transactions at detailed level.


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