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Module 003 - Substantive Tests of Receivables and Sales
Module 003 - Substantive Tests of Receivables and Sales
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Substantive Tests of Receivables and Sales
Course Module
Assertions:
I. Existence and occurrence
Audit Objectives:
A. To determine that receivables exist and represent bona fide obligations owed to the
company as of the statement of financial position date.
Audit Procedures:
1. Perform a receivable confirmation on a sample year-end trade receivables.
2. Obtain a schedule of aged trade accounts receivable and notes receivable schedule
and reconcile to ledgers.
3. Examine the underlying documentation such as purchase order, dispatch
documentation, duplicate sales invoice, etc.
4. Inspect notes on hand.
5. Examine the customer’s account and customer correspondence to assess whether the
balance outstanding represents specific invoices and confirm their validity.
Assertions:
II. Completeness
Audit Objectives:
B. To determine that all transactions relative to receivables have been recorded in the
proper accounting period.
Audit Procedures:
6. Test cutoff of sales and sales returns to determine whether receivables are recorded
in the proper accounting period.
7. Trace a sample of shipping documentation to sales invoices and into the sale and
receivables’ ledger.
8. Review material subsequent year invoices, credit notes and adjustment and ensure
that they are recorded correctly in the line relevant financial period.
Assertions:
III. Rights and obligations
Audit Objectives:
C. To determine that the company has a legal right to all accounts receivables at the
balance sheet date.
Audit Procedures:
9. Review bank confirmation for any liens on receivables.
10. Make inquiries of management, review loan agreement and review board minutes for
any evidence of receivables being sold or factor.
Assertions:
IV. Valuation and Allocation
Audit Objectives:
Applied Auditing
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Substantive Tests of Receivables and Sales
Assertions:
V. Presentation and Disclosure
Audit Objectives:
E. To determine that receivables are properly presented and classifies in the statement
of financial position.
Audit Procedures:
17. Read the disclosure notes relevant to receivables in the draft financial statements and
review for understandability.
18. Obtain written client representations regarding pledge, discount or assignment of
receivable, and about related-party receivables (officers, directors and other related
parties).
Course Module
The auditor should test footings, cross footings and aging especially those
accounts classifies as current and those shown as past due. These accounts
should be traced to the subsidiary ledgers.
Figure 3.1 illustrates the working papers for accounts receivable while figure
3.2 shows the working paper for notes receivable.
Figure 3.1 Accounts Receivable Aging Schedule
South Grand Incorporated
Accounts Receivable - Aging Schedule
December 31, 2018
Source: Cabrera, M.E. (2017) Applied Auditing. Manila: GIC Enterprises & Company, Incorporated
(Chapter 10 – Substantive Tests of Receivables and Sales)
C Confirmed by maker
Confirmation replies on separate file
Traced to the general ledger
I Inspected promissory note
ˆ Computations verified
Source: Cabrera, M.E. (2017) Applied Auditing. Manila: GIC Enterprises & Company, Incorporated
(Chapter 10 – Substantive Tests of Receivables and Sales)
Course Module
Figure 3.3 Positive Form of Accounts Receivable Confirmation Request
South Grand Incorporated
178B V. Luna Avenue
Manila City
Dear Sirs:
The correctness of the balance of your account payable to us as shown below and
on the enclosed statement at December 31, 2018. If the amount is not in agreement
with your records at that date, please provide any information which will aid our
auditors in reconciling the difference.
Your prompt return of this form in the enclosed stamped envelope is essential to
the completion of the auditors’ examination of our financial statements and will be
appreciated.
THIS IS NOT A REQUEST FOR PAYMENT, BUT MERELY FOR CONFIRMATION OF YOUR ACCOUNT
The statement of out account showing a balance of P50,000 due to South Grand
Incorporated at December 31, 2018 is correct except as noted below:
Jackson Trading
Exceptions: None________________________________________________________________________________________
____________________________________________________________________________________________________________
____________________________________________________________________________________________________________
On the other hand, in a negative confirmation, the recipient is requested to reply only
when the recipient disagrees with the stated amount. In the event that the customer
fails to reply, the account balance indicated in the confirmation request is regarded
as a correct response even though the debtor may have ignored it.
Negative Confirmation is less expensive than positive confirmation, because there
will be no second confirmation request and no follow-up procedures. This method is
used when:
a) The auditor has assessed the risk of material misstatement as low and has
obtained sufficient evidence regarding the design and operating
effectiveness of controls.
Applied Auditing
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Substantive Tests of Receivables and Sales
4. Perform analytical procedures to determine whether the receivables, sales and interest
revenue balances appear reasonable.
Performance of analytical procedures can indicate problems with the financial
records of the client, which can be investigated more thoroughly. Analytical
procedure involves the following:
a) Compare accounts receivable turnover and days outstanding in accounts
receivable with previous years’ and industry data.
b) Compare bad debt expense as a percentage of sales revenue to previous
years and industry data.
c) Compare percentage of allowance for doubtful debts to accounts receivable
to previous years and industry data.
d) Aging analysis of outstanding balances. Compare with previous year and
note any drastic changes.
e) Compare the total balance of trade receivables with that of last year.
5. Test sales and sales returns cutoff to determine whether receivables are recorded in the
proper accounting period.
The auditor usually tests the sales cutoff by examining invoices and shipping
documents for several days both before and after the year-end by tracing such
documents to the sales and account receivable records for the appropriate period.
This test of sales cutoff may occasionally be made at an interim date to check the
frequency of the company’s procedures. All substantial sales returns after the
statement of financial position date should also be reviewed carefully as they may
represent fictitious sales recorded at year-end.
Course Module
6. Review collectability of receivables and determine the adequacy of allowance for
doubtful accounts.
The auditors reviews the process that you follow to derive an allowance for doubtful
accounts. This includes a consistency comparison with the method used in the last
year, and a determination of whether the method is appropriate for client’s business
environment.
The auditor may also verify the past due accounts receivable listed in the aging
schedule that have not been paid subsequent to the statement of financial position.
Credit ratings for delinquent and unusually large accounts are determined.
REQUIRED:
1. Given the journal entry to eliminate the above account and to set up the appropriate accounts to
replace it.
Applied Auditing
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Substantive Tests of Receivables and Sales
2. Show how the various items should be reported on a current statement of financial position.
(Requirement 2)
Current assets:
Accounts receivable - trade P 312,000
Less: Allowance for doubtful accounts 80,000 P 232,000
Receivables from employees 4,400
Prepaid insurance 2,400
Investment and funds:
Notes receivable - long term 160,000
Other assets:
Special receivable - dishonored note 44,000
Current liabilities:
Accounts payable - trade 124,000
Cash dividends payable 48,000
Wages payable 4,800
Rent revenue collected in advance 3,200
Long-term liabilities:
Mortgage payable - long term 80,000
Course Module
1) Some machines have been shipped on consignment to Joey’s regular dealers. These
transactions have been recorded as ordinary sales and billed as such. As of December 31,
2018, the machines have billed and in the hands of consignees amounted to P600,000. Sales
price was determined by adding 20% to cost.
2) On December 30, 2017, two machines were shipped to a customer FOB shipping point basis.
The sale was entered in the records on January 7, 2019 when cash was received in the amount
of P19,000.
3) The inventory as of December 31, 2018 included goods sold during November 2018 for
P13,000 but returned on December 18, 2018. O entry has been made to adjust the customer’s
account for the goods returned. The goods were included at selling price which was 130% of
cost.
As auditor of Joey Manufacturing Company, what adjusting journal entries would you
recommend relative to the above findings?
Required:
As an auditor, you have to determine:
a) The appropriate balance for the Allowance Doubtful Account on December 31, 2018.
b) How Accounts Receivable would be presented on the statement of financial position on
December 31, 2018.
c) The peso effect of the year-end bad debt adjustment on the pre-tax income for 2018.
b)
Accounts receivable P 295,000
Less: Allowance for doubtful accounts (24,250)
Net accounts receivable P 270,750
c) The year-end bad debt adjustment would decrease pre-tax income P16,750 for 2018 as
shown below:
Estimated amount required in the Allowance for doubtful accounts P 24,250
Balance in the account after write-off of bad accounts but before
adjustment (P12,500 - P5,000) (7,500)
Required charge to expense P 16,750
Course Module
1) A four-month note dated November 30, 2018, from the Aeon Company, P10,000; interest
rate 16%; discounted on November 30, 2018, at 16%.
2) A draft drawn payable 30 days after date for P45,000 by the Benton Company on the
Dodge Company in favor of the Gerrand Company, endorsed to Crome Inc., on December
2, 2018 and accepted on December 4, 2018.
3) A 90-day noted dated November 1, 2018 from J.C. Cruz of P25,000, interest at 16%; the
note is for subscriptions to 250 preference shares of Crome Inc., at P100 per share.
4) A 60-day note dated May 3, 2018, from the National Investment Company, P30,000;
interest rate, 16%; dishonored at maturity; judgment obtained on October 10, 2018.
Collection doubtful. (No interest after maturity.)
5) A 90-day noted dated January 4, 2018, from Romeo Paz, president of Crome, P8,000 no
interest, not renewed, president confirmed.
6) A 120-day note dated September 14, 2018, from the Samson Company, P6,0000; interest
rate, 16%; note is held by bank as collateral.
When the company discounted a noted, Interest expense was debited for the discount cost
and Interest income was credited for the revenue.
Required:
a) Working papers for the Notes Receivable as of December 31, 2018.
b) All necessary audit adjustments, including entries for interest accrued and prepaid.
c) Statement of financial position presented of the notes as of December 31, 2018.
(Requirement a)
Crome Inc.
Notes Receivable
December 31, 2018
Date Interest Interest
Maker Amount REMARKS
of Note Due rate Received Accrued Earned
Aeon Discounted on
Company 11/30/18 3/20/19 16% 10,000 C 533 r 133 11/30/2018 at 16%
Benton Accepted by Dodge
Company 12/2/18 1/2/19 45,000 C Co. on 12/14/2018
Subscription
Receivable on
J.C. Cruz 11/1/18 1/20/18 16% 25,000 C 667 ˆ 667 preference shares
National Dishonored at
Investment maturity; collection
Co. 5/3/18 7/2/18 16% 30,000 C 800 ˆ 800 doubtful
Maker is President of
Crome; not paid at
maturity not
Romeo Paz 1/4/19 4/4/19 8,000 C renewed; confirmed
Samson Note held by bank as
Company 9/14/15 1/12/16 16% 6,000 C 280 ˆ 280 collateral
Balance per ledger 124,00
Add (Deduct) Adjustment
C Confirmed by maker
Applied Auditing
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Substantive Tests of Receivables and Sales
Reviewed
Prepared by: by:
Initial Date Initial Date
(Requirement b)
(Requirement c)
Course Module
Illustrative Audit Case 3.5
The following information are available from the records of Stardust Corporation:
ABC Corporation DEF Company
9/3 378 10/8 378 7/29 398 9/16 300
10/20 345 11/18 345 8/6 280
11/1 271 12/1 271
11/25 846
GHI Incorporated JKL Trading
8/1 898 9/2 898 9/16 413 10/15 200
9/14 714 12/15 500 9/20 216 10/30 200
10/18 1,206 10/29 1,105 11/30 200
11/30 904
MNO Supply PQR Dealers
7/5 660 8/7 660 8/2 247 9/16 100
8/15 1,020 10/15 1,020 9/17 22
Required:
a) Prepare an aging working paper as of December 31, 2018 making use of the following
categories: not due; past due, less than 2 months; past due, more than 2 months. Accounts
are considered past due 60 days after date of sale.
The company establishes an allowance account for uncollectible receivables equal to:
10% of accounts less than 2 months past due
30% of accounts more than 2 months past due
The rates are based on historical bad debts adjusted for current observable data on
collectiblity of Accounts receivable.
b) Determine the adjusted balance of Accounts receivable and Allowance for doubtful
accounts as of December 31, 2018.
c) Prepare the adjusting journal entries.
Stardust Corporation
Accounts Receivable - Aging Schedule
December 31, 2018
Past due
Date of Accounts Less than More than
Dr Cr
invoice not due 2 months 2 months
ABC Corporation 11/25 846 846 ˆ
DEF Company 7/29 98 98 ˆ
8/6 280 280 ˆ
378
GHI Incorporated 9/14 214 214 ˆ
10/18 1,206 1,206 ˆ
1,420
JKL Trading 9/20 29 29 ˆ
10/29 1,105 1,105 ˆ
11/30 904 904 ˆ
2,038
MNO Supply
PQR Dealers 8/2 147 147 ˆ
9/17 22 22 ˆ
169
STU Corp. (Subsidiary Co.) 12/31 5,000
XYZ Co. 12/15 (100)
Note: Accounts with credit balances as well as non-trade receivables are not aged. Reclassifying entries are
prepared to segregate them from the trade receivables.
Stardust Corporation
Allowance for Doubtful Accounts
December 31, 2018
Course Module
Balance per ledger (40.00)
Add: Provision for the year (AJE 3) 455.10
Balance as adjusted 415.10
(Requirement c)
Adjusting Journal Entries - 12/31/2018
AJE
(1) Advances to subsidiary 5,000
Accounts receivable 5,000
Course Module