Chapter-Two Audit of Accounts Receivables and Sales 2.1. Sources and Nature of Accounts Receivables Receivables-included not only claim against customers arising from the sale of goods or services, but also a variety of miscellaneous claims such as loans to officers or employee, loans to subsidiaries, claims against various other firms, claims for tax refunds, and advances given to suppliers In the financial statements of most of the companies, accounts receivables and notes receivables are relatively large in amounts and auditors need to have more concern about the audit of these items during the course of audit. Auditors need to have a special attention to the presentation and disclosure of the loans to the officers, directors and subsidiary companies, as these related party transactions may benefit only the borrower rather than the lending company. 2.2. Auditors’ Objectives in auditing account receivables and sales The auditor’s objectives in the audit of accounts receivables and sales are: 2.3. Internal control over sales transactions and receivables 2.3.1. Internal control over sales transactions If the internal control over credit sales is ineffective, it may cause business much because the major revenue for the organization arises from sales only. Hence the auditor has to study and evaluate the internal control relating to the sales. This helps the auditor in determining the nature, timing and extent of his substantive procedures. Before studying and evaluating the internal control relating sales the auditor should have sufficient understanding about the business of the client. This will help the auditor in assessing the extent to which the sales transactions of the client’s business will affect the misstatement. If the internal control procedures are not satisfactory, the auditor can apply additional tests or modify the procedures according to the circumstances. The internal control relating to sales can be studied and evaluated by dividing the sales cycle into the following four segments 1. Processing orders and dispatching goods 2. Billing of customers and recoding of sales 3. Processing and recoding of receipts (This has already been discussed in chapter – 1 Audit of Cash Transactions.) 4. Follow up on Sales
2.3.2. Substantive procedures for sales transactions A. Tests of individual transactions
B. Analytical procedures
C. Examination of presentation and disclosure The auditor has to verify whether the sales have been properly classified and disclosed under appropriate heads in the financial statements in accordance with the generally accepted accounting principles 2.3.3. Internal control over accounts receivables The auditor has to verify the internal control system regarding the accounts receivable and examine
2.3.4. Substantive tests for accounts receivables The auditor has to apply the following substantive tests for accounts receivables
2.4. Audit program for receivables and sales transactions The most appropriate procedures for a particular audit will be guided by the nature of the internal controls in force and by other circumstances of the engagement. The following are the audit program for the verification of receivables and sales transactions. A. Consider the internal control for receivables and sales transactions 1. Obtain an understanding of internal control over receivables and sales transactions. To do so, auditors may prepare a written description or flow chart and complete internal control questionnaire for revenues and receivables. Some of the questions that might be asked include:
As auditors confirm their understanding of the revenues cycle, they will observe:
After auditors have obtained an understanding of the controls relating to receivables and sales, they will consider the types of misstatements of the accounts that may occur. 2. Asses control risk and design additional tests of controls for receivables and sales. Based on the understanding of the client’s internal controls over receivables, the auditors develop their planned level of assessed control risk for the various financial statements assertions. If auditors need to obtain additional evidences about operating effectiveness of the client’s controls, they may design additional tests of controls. 3. Perform additional tests of controls for those controls which the auditors plan to consider to support their planned assessed level of control risk, such as: a) Examine significant aspects of a sample of sales transactions by applying procedures such as:
b) Compare a sample of shipping documents to related sales invoices To assure that all shipments are billed, the auditors may obtain a sample of shipping documents may obtain a sample of shipping documents issued during the year and compare these to sales invoice. c) Review the uses and authorization of credit memorandum - See whether all returns and allowances should be supported by credit memorandum. -Review whether there is proper authorization of credit memorandum is practiced. d) Reconcile selected cash register tapes and sales tickets with sales journals. For cash sales auditors may compare selected daily totals in the sales journals with cash register readings or tapes. e) Test computer application controls if any. If the client company has established effective computer application controls for sales transactions, the auditors might decide to test these controls directly instead of testing a sample of sales transactions 4. Reassess control risk and modify substantive tests for receivables and sales transactions. When auditors have completed the procedures described in the preceding sections, they should reassess the extent of control risk for each financial statements assertion regarding receivables and revenues. B. Perform substantive tests of receivables and sales transactions The objective of major substantive testing procedures of Account receivables and revenue balances are given in the following table.
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