 Hello and welcome to this session in which we will audit accounts receivable Accounts receivable exist as a result of sales on credit. It means when we credit sales or revenue We debit we create an account receivable So account receivable is the result of sales on credit or revenue on credit Well revenue is considered a significant risk in most audit because auditing standards require Auditors to assume to approach revenue as a specific fraud risk because revenue is one of the most important figures So when sales are made on account, we have a double entry nature of accounting Further reinforces this presumption. So anything that affects sales revenue It's going to affect account receivable and at the end of this recording I will have a grid connecting sales revenue transaction related objective to account receivable But the point I'm trying to establish here is it's an obvious point But it's worth mentioning that account receivable is related to sales revenue. Also account receivable is related to cash Why because eventually the customer will pay the cash and we will remove account receivable So this is the life of a receivable in an easy way. We sell on account We receive cash, but once what's sometime happen is some customers don't pay We have to deal with what we have to deal with Incollectible accounts also client may mistake cut off due to error or fraud and Determining the correct balance for the allowance. So this is what could happen with revenues or account receivable What could happen is you if you have two periods period one and period two You could shift account receivable back and forth or shift sales revenue and you have to deal with allowance And those could be done an error which is unintentionally or fraudulently, which is intentionally Therefore auditors may identify the risk of material misstatement related to a realizable value Balance is related objective for account receivable as a significant risk as well So we also have to be aware of the risk of the allowance because the allowance is a result of account receivable sales create account receivable account receivable Generate allowances, which is an amount that we don't expect to collect How much is that amount that amount is estimatable before we proceed any further? 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Although it's an optional step. You should always it's it's a cheap a cost effective way Not cheap cost effective way to kind of take a look at the numbers and the third method of substantive testing is test of Detailed balances, which we'll talk about more about this session and in other sessions as well So as an auditor you must gather appropriate evidence for various tests of detailed balances to satisfy The nine related audit objective there are nine related audit objective and I'm gonna go through them one by one So this is what we need to satisfy when we're auditing account receivable the first one one of nine is Detail tie-in. What does that mean? All what it means is we want we want to make sure that the sub ledgers the subsidiary Ledgers agree with the general ledger and that the aging schedule are accurate What does that mean when you have an account receivable? You might have an account receivable general ledger account for a million dollar just this is your total receivable now this Account receivable is composed of sub Receivable you're gonna have many sub accounts. Okay, you might have 500 600 thousands of customers that make up when you add them all up They will add up to a million dollars So the first thing we want to make sure is all the sub ledgers are Are at up properly and they are in and they represent the general ledger account Also, we want to make sure we have an proper aging schedule. What is the proper aging schedule? Basically looking at the account receivable and determining how how late is the payment? Is it current is it zero to 30 days late is it 30 to 60 is it 60 to 90? Why that's gonna help us with the allowance So evidence may include reconciling sub ledgers to the general ledger basically add them up Tracing individual customer account balance to the aging of to the aging schedule and verifying the mathematical accuracy of the aging schedule So that's one thing we have to do making sure that that that the all the sub ledgers are correct are aged correct And they are added up the general ledger So this is one of the objective detailed tie-in They're gonna be nine objective the second one is existence and this is one of the most important one The objective is to confirm that the account receivable actually exists the balance actually exists It's not it's not a fictitious one So evidence can be gathered through confirmation procedures such as sending positive negative confirmation to customers Review and subsequent cash receipt and inspecting sales and shipping document So this topic is very important verifying the existence and specifically confirmation We're gonna have a whole session dealing with positive negative confirmation subsequent cash receipts But the point is is the account does the account receivable actually exist? Is it real? Why because if it's not real, it's fictitious if it's fictitious It's a problem because if you have a fictitious account receivable you have a fictitious sales Remember what we said about sales sales pause a significant fraud risk completeness the objective is to ensure that all account receivable transaction are recorded now completeness is not as important as existence because as a as a company you want to make sure You have all the account receivable It's not a major issue But you companies may still perform analytical procedure and review cut-off procedure to ensure Sometime what could happen is the account receivable could be in period two Recorded it in period two, but it should be in period one. That could be a problem So that's what it's that's what's being done for now completeness is more important We're gonna see later on for accounts payable The fourth audit related objective is accuracy and this is basically an accurate no pun intended for any account The objective is to confirm that the balance is accurate Evidence may include reviewing customer contract agreement examining sales invoices for proper pricing in terms and recalculating Sales taxes and discount you want to make sure the numbers that you are showing Whatever that number is, you know 50,000 is correct is correct. Whatever that number is Classification the objective is to ensure that the account receivable balances are properly classified as either current or non-current No for a counter see well most account receivable are current you want to be expected to be paid within one year So it's not a major issue But we might have some Some to do with reviewing aging of receivable and assessing the company's credit and collection policy here But mostly AR is mostly current so you don't have to worry about this cut off The objective is to ensure that a counter seeable transaction are recorded in the proper period Here you might review sales invoices shipping document for proper dating testing the company's cut off procedures And we'll look at that later on you could also do Analytical procedures gives you an idea if there's something out of whack to identify unusual trend or fluctuation and account balance Realizable value this deals with the allowance the objective is to determine the net realizable value How much are we going to collect at the end of the day from the account receivable? That's what matter. Okay, here. We were gonna be taking AR Minus the allowance because that's what really matters. How do you determine this amount? Well, you are going to review companies Methods for estimating the allowance. How did they come up with this figure? You look at historical data what they did in prior year and what was their bad that experience evaluating current economic conditions Well, if the current economic condition is deteriorating less and less people will pay and the opposite is true Also, we would look at the credit worthiness of customers and here companies are using big data big data means they're analyzing their Customer credit to determine the allowance especially credit card company simply put realizable value looking at a Counter-seable minus the allowance to come up with an RV. How do we come up with it? Each company is different, but this these are some techniques Eight is rights the objective is to ensure that the the account receivable is our we have the legal right to that Usually that's not an issue. It's not like inventory. It's not a significant issue It might include your review on customer contract and agreement as well as examining any documentation related to pledging or factoring of arrangement So the only issue we could have here is when we pledge a receivable pledge means we go to the bank and we We put up the receivable as a collateral if that's the case we may not have the right to it So here what we have to do we have to examine notes payable loans at the banks If there's any of these notes are related to any pledging factoring means if there's any agreement to sell those receivables Presentation also is an essential aspect of financial reporting for any account ensuring that account receivable and related disclosure Which you know sometime you want to talk about you will talk about pledging and factoring in the notes There are presented in a clear which is plain language when you present you want to have people understand it Understand it easy to follow and relevant It means it's helping the users to make a proper decision because presentation you could have the presentation But it could be so confusing that it's not helping the users Also, what we need to look at when we're auditing a Account receivable is how does internal control relate to test of balances because internal control is important First you look at the internal control. Now. The good thing is about a counter receivable internal control over sales cash receipts and Account receivable are typically strong quite effective for the majority of businesses And why because if you build someone if you're in the business you want to make sure you are properly billing the customers When the customer pay you want to post their cash payment Why two reasons one is customer satisfaction customer relationship if you if the customer sends their payment and you don't post it They're not gonna be happy about this to you want to make sure That you are billing the customers. You're not gonna do the work and not have a proper internal control to build the customers therefore the Internal control over account receivable generally speaking is quite effective in contrast in contrast to account spable And let me just kind of tell you this on a personal level think about if you owe someone money You really don't care. I mean in a sense that you let them worry about making sure you pay But if someone owes you money, you're gonna know the balance You're gonna know how much you're gonna keep up with it so one and so forth So that that that's the reason why you have a strong internal control over a counter receivable by its nature But internal control over receivable are concerned with three things Making sure that control prevent or detect embezzlement and hear what the company would do They will have segregation of duties They will have authorization and approval process physical safeguard of the assets Which is a counter receivable the books and the cash and regular reconciliation between sales and receivable Now also they want to make sure there's a control over cutoff What does cutoff mean means the AR is reported in the prior period here They want to make sure they are recording the sales in the prior period time the recording using sequential invoices this way They know when the period ends with the last invoice and they will perform What's called period and procedures all of those are internal control I'm just going over them to show you how to relate to test of detailed balances reconciling sales looking at chip and document customer Order at the end of each accounting period matching all of those and last but not least and we talked about is control Related to allowance. How do you how do you make sure your allowance is proper? It's an estimate that how it's proper you review the aging of a counter receivable You look at credit evaluation of your customers you run their credit and you determine what's going on with their credit If their credit is deteriorating assuming you have their permission to do so based on the contract Well, guess what you're gonna have might have to increase your allowance And you're gonna be one look at your collection effort If you have more people collecting you should have less allowance If you have less people if you're cutting down on the department you might have more allowance because you can't keep up Last but not least is to connect The sales and cash transaction related objective that we looked at in the prior session To the account receivable balance or that remember that dual nature because remember when you debit account receivable You credit sales or revenue then you receive the cash you debit cash you credit receivable So what we're look we're gonna look here is in this table. Look how sales transaction and cash transaction Influence influence influence account receivable. Okay, so starting with occurrence If we can if we know if we know that a sales occur if we know for a fact that sales occur if we can't check Yes, we confirm this Well, what else can we confirm? Well, if we can confirm sales We can confirm the existence of account receivable. You notice how these two how these two Exist how these two relate so if you can confirm occurrence well to a great degree You're supplementing your auditing for account receivable audit objective related balance existence If you can have assurance that you have recorded all of your account receivable Well, you have recorded all of your account If you can have insurance That all your sales are completed you would have assurance that your account receivable is completed as well If your sales is accurate Well, your account receivable is accurate accuracy related to both If you are posting and summarizing sales, then you are then the detailed Subledger to the ledger is also correct. If you're properly classifying sales, you're properly Classifying this should be under classifying not under realizable value If you are recording sales in the proper period. Well, most likely you are also recording You are also recording Account receivable in the prior period called cutoff Presentation. Well, if you are properly presenting if you are properly presenting sales, you're most likely Properly presenting account receivable again because the dual nature they go hand in hand now when it comes to cash If there is a violation of the occurrence, it's going to be affecting the completeness Why because if we let's let's go back to occurrence and existing for sales When we debit we said when we debit account receivable We credit sales So if if the if we can verify that it occur if sales occur, then we can verify the existence of Of these sales when it comes to cash If we debit cash We have to reduce account receivable If occurrence is violated if occurrence is violated, what's going to happen is this Let's assume we book a fictitious transaction that says debit cash credit account receivable What happened as a result? We reduced account receivable. We reduced account receivable So the occurrence for cash if it's incorrect, it's going to affect the completeness and account receivable However, the completeness in cash if we can verify the completeness in cash It's going to confirm the existence of account receivable So if we have all the cash debit cash credit account receivable if we have all of them now We're saying we have all of them correctly If we have all of them Then it's going to confirm the account receivable existence because when you debit cash you are going to reduce the receivable But if we have a violation of the occurrence, it's going to affect the completeness now the accuracy of cash Will affect the accuracy of account receivable posting and summarization will tie in to tie in detailed classification Will affect the classification Timing will affect the cutoff again timing and cutoff presentation of cash will affect the presentation of account receivable What should you do now go to far hat lectures and look at mcqs true false and additional resources? 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