 Hello, and welcome to the session in which we would look at a CPA simulation that deals with analytical procedures. Analytical procedures are an important component, an important part of the audit process. Why? Because you would use analytical procedures before you start the actual audit to gain an understanding of the client business and to identify areas of potential risk. You also use analytical procedures as a substantive procedure, as an audit procedure which we will illustrate in this exercise in this CPA simulation. You also use analytical procedures at the end to make sure everything makes sense. So it's an important concept for a CPA candidate or an accounting students to be familiar, to be comfortable with these analytical procedures. So in this session, what I'm going to do, we're going to look at analytical procedures specifically for the allowance for doubtful accounts. So we're going to look at this account here and perform analytical procedures to determine whether the account is fairly stated. But before we do so, we want to take a look at what type of test of controls or controls are related to the allowance for doubtful accounts. Then we will proceed and we will run analytical procedures to determine whether the account allowance for doubtful account is fairly stated. Before we proceed any further, I have a public announcement about my company farhatlectures.com. Farhat accounting lectures is a supplemental educational tool that's going to help you with your CPA exam preparation as well as your accounting courses. My CPA material is aligned with your CPA review course such as Becker, Roger, Wiley, Gleam, Miles. My accounting courses are aligned with your accounting courses broken down by chapter and topics. My resources consist of lectures, multiple choice questions, true, false questions, as well as exercises. Go ahead, start your free trial today. No obligation, no credit card required. So what type of controls or test of controls are related to the account allowance for doubtful accounts? What is allowance for doubtful account? It's the account that determine your estimate of how much your receivable will go in collectible. So how much of your account receivable account will not be collected? It's an estimate. Well, if that's the case, allowance must be a factor of how good the credit quality of your customers. If you have a good credit quality, you should not have a lot of allowance because if you sell to customers with high credit quality, well, guess what? High credit quality means they pay their bills. If you sell to customer with low credit quality, most likely they will not pay their bills. So it's a factor of that. Also, your allowance is a factor of do you approve the credit before a sale? So testing your credit approval as a form of internal control will determine your allowance for doubtful account. Who approves the credit? Is it the sales people? Because they have benefit in extending the sales to the customers. Are they approving it? Or do you have a credit manager that's independent? You have to test that as a form of internal control. Is the sale authorized? Do you have someone authorizing the sale before it's being made? That determines the allowance for doubtful account because if the sale is not authorized, that means we're selling for everyone. If we're selling for everyone, some low quality credit customer might slip in. Also, the quality of the number depending on posting and summarization. Are we posting and summarizing the accounts? In other words, are we posting the sub ledgers to the general ledgers? So when we look at a count receivable, when we look at the allowance for doubtful account, are we updating our sub ledger, then moving this to the ledger? Is our numbers correct? Also, that expense is related to allowance. So we also have to examine any internal control that are related to that expense as well, which is bad that charge offs are given here. What I am going to do now is jump to the Excel sheet and run analytical procedures to determine if this account is fairly stated. Now, let's run some analytical procedures to determine whether the allowance for doubtful account based on analytical procedures is fairly stated. The first percentage I'm going to run is the allowance of receivable as a percentage of AR allowance for doubtful account as a percentage of AR. So let's run this for both year, year, the prior year, as well as the current year. So the prior year, what I did is I took the allowance and divided it by the account receivable. The allowance represented 7.23% of the receivable. And I looked at this year using the same figures, allowance as a percentage of account receivable is 6.19 or 6.2%. What can we say? We can say somehow percentage of the allowance as a receivable went down. Well, let's look at few other figures to start to make sense out of this. I'm going to also look as a bad debt percentage of sales. So I'm going to look at bad debt, which is bad debt, which is charge offs as a percentage of sales. For year one, it was 0.98. For year two, it was 0.92. Well, also went down. So what are we saying? We are saying that our allowance as a percentage of receivable went down. We are estimating less and our charge offs went down as well. We are charging less accounts. Well, let's see what else can we learn? Well, let's examine, let's study the change in the receivable and the allowance itself as well as in the receivable. Let's look at the change in the allowance. The allowance increased by 14,717 dollars, which it makes sense. It went from 74,000 to 89,000. And as a percentage, that's a 20% increase. Well, remember allowance is related to receivable. Let's take a look at the receivable and see what happened at the receivable. From a dollar perspective, receivable increased by 410,000 approximately as a percentage receivable increased by 20%. Well, let's wait now. Let's, now we have something to look at. Here's what we're saying. Allowance went up 20%. Well, that's fine because account receivable went up. But here's what we're saying. Account receivable went up by 40%. Allowance went only up by 20%. Well, we're going to assume that we still have the same type of customers. We're not giving any other information that the quality of our customers improved. Well, what does that mean? Well, if we have the same type of customers, why did the percentage of allowance relative to account receivable went down when account receivable went down? Also allowance as a percent of receivable went down. Well, I don't see we're not giving any additional information that shows us otherwise. Now, there is a small decrease in the percentage of sales and the percentage of bad debt to sales, but that does not explain the huge increase in receivable. That's not, that's not accompanied by that the same increase in allowance. I would say if my receivable went up by 40%, given everything else is equal, the allowance should go up proportionally, unless I'm told otherwise, and I'm not told otherwise in any way, shape or form. So here's what I'm going to, here's what I'm going to say. The dollar amount went up, but the percentage went down. So the dollar amount, okay, went up substantially, but as a percentage, it went down, it went down. So we may not be booking enough allowance because here's why. If we assume that the prior year, 7.23% is the correct figure, and we have to assume this because we're going to assume the prior year is audited. And now we know from the prior year, because the whole year went by 7.2%. If this is a representative, well, guess what? If we take 7.23%, if this should be the percentage of the allowance relative to account receivable, then if we multiply this by account receivable, our allowance should be 104, approximately 104,000 rather than 89,000. So this is what we can say based on this information. What are we basing this on? Why are we saying this? Well, we are saying this based on the fact that the allowance should stay the same if you are selling to the same customers. If you are selling to the same type of customers, your allowance as a percentage of receivable should maintain its relationship, which is 7.23%. Also, as we saw, account receivable went up by 40, allowance did not keep up with it. So we can say something is not right from the numbers given. Now, what else can we examine? We can examine the aging of receivable and we want to determine what happened to those percentages. So what I'm going to do, I'm going to take each group as a percentage of the total. So simply put, zero to 30 days, I'm going to take this number divided by the total receivable to determine what is the percentage. It was 62.29% current account receivable. The prior year was 67.45. I really don't care about the current. The reason is because it's current zero to 30 days. It doesn't really tell me much. Okay? All of it tells me that the current, I have less current, I have less current balances, but it doesn't tell me that much. But let's take a look at zero to 30 to 60 days past due. Notice last year, only 15.62% of my customer, of my account receivable balance, which is my customers that did not pay their balance, were 30 to 60 days past due. Now, it's 17.68. Notice the group of 60 to 90 days, there were only 10.28. Now this group represent 11.93. And over 90 days, they were six, they represented 6.7. Now they are 8.15%. What can I say from these percentages? What I can say, what I can conclude is I have, as a percentage of receivable, more and more people are being late. They are not paying their bill. Why? Because from the aging schedule, I can tell the relative percentage is higher. The relative percentage is higher, which does not support this low allowance. 6.19 of receivable should be in the allowance or the increase in the allowance of only 20%. It doesn't support all of those. Now also what I can do, I can look at the dollar amount of the past due. Okay, I can take a look at the dollar amount. So I'm going to add all of those 30 to 60 days, 60 and over 90 days and compare the two figures. Well, for the current year, I have 544,000. That's the amount that's past due. And the prior year, it was 335,000. The increase is 208.19, which makes sense because my receivable, again, my receivable went up. My receivable went up by 40%, which is the total past due should be higher because I have more receivable. But if I compute the percentage, 208 divided by 338, so the percentage of the difference in percentage, I find out that it's almost 62%. So there was an increase in 62% of past due account and my receivable, if I'm going to say it's relative to my account receivable, my account receivable only went up by 40%. So this means I need to book more allowance. And the proper allowance, it seems if I'm going to keep up with the same percentage as the prior year, it should be 104151. So let's assume if I put 104, make an adjustment and adjust this to 104151, notice now my allowance is in basically 40%. It doesn't mean it should be 104151, but it should be at least in my opinion, 104151, given the fact that my past due account increased by 62%. I would say that I need to do further investigation unless the company that I'm auditing, they have a valid reason, the valid reason why this number should be 89245, which is only an increase in the allowance of 20%. The numbers, the analytical procedures don't support this number. I will need to do further investigation. I need to collect more evidence. I need to talk to the credit management. I need to talk to the account receivable department. There's a lot of work need to be done, but based on this number, I don't believe this number is fairly stated. And remember we said the tolerable misstatement is 10,000. It's way above 10,000 because if it should be 104, we're looking to increase this account 15,000, at least 15,000. So the account is not fairly stated. More work is needed. Once again, this is an example of analytical procedures, an important concept in your auditing exam. What should you do now? Go to far hat lectures and look at additional resources, especially analytical procedures that's going to help you understand this concept better. Good luck, study hard and stay safe.