Accounts receivable & cash balances


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Accounts receivable & cash balances

  1. 1. AUDITINGCHAPTER 11Accounts Receivable & CashBalancesByDavid N. Ricchiute
  2. 2. REVENUE/RECEIPTCYCLE Relationship assertions & audit procedures Relationship audit risk, client strategies, substantive tests Substantive tests for assertions Revenue recognition, earnings manipulation, & channel stuffing Audit sampling & accounts receivable2 Computer-assisted audit techniques GBW 8th ed. Ch. 11
  3. 3. ASSERTIONS &OBJECTIVESManagement assertions: Recorded receivables & cash balances  Exist  Include all transactions (completeness)  Represent rights of entity  Are valued appropriately  Are presented & disclosed properly3 GBW 8th ed. Ch. 11
  4. 4. OBJECTIVES &PROCEDURES:Existence/OccurrenceObjective: determine whether all recorded sales, receivables, cash balancesProcedures  Existence  Physical observation  Confirmation  Transactions occurred  Cutoff testing for proper period4 GBW 8th ed. Ch. 11
  5. 5. OBJECTIVES &PROCEDURES:CompletenessObjective: determine whether all receivables, sales, cash of period are presented in financial statementsProcedures  Examine documents  Apply analytical procedures  Cutoff bank statements, bank reconciliations, etc.5 GBW 8th ed. Ch. 11
  6. 6. OBJECTIVES &PROCEDURES:Rights/ObligationsObjective: determine whether entity has property rights to cash, accounts receivableProcedures  Examine documentation  Confirmations  Inquiries6 GBW 8th ed. Ch. 11
  7. 7. OBJECTIVES &PROCEDURES:Valuation, AllocationObjective: determine whether entity has recorded items in correct amounts, accounts, & time periodsProcedures  Confirm balances  Verify mathematical accuracy  Examine details of recording7 GBW 8th ed. Ch. 11
  8. 8. OBJECTIVES &PROCEDURES: Presentation,DisclosureObjective: determine whether recorded transactions, balances properly classified, described, disclosedProcedures  Compare presentation to GAAP  Annual updates of AICPA guidelines8 GBW 8th ed. Ch. 11
  9. 9. AUDIT RISK MODELAR = CR x IR x DR Detection risk (DR): likelihood that error could occur & not be detected Based on  Control risk (CR)  Likelihood of material error  Inherent risk (IR)  Strategies & threats9 GBW 8th ed. Ch. 11
  10. 10. DETECTION RISK DR = ____AR___ IR x CR Nature, extent, timing substantive tests  Nature: more/less persuasive tests  Extent: larger/smaller samples  Timing: balance sheet date or interim10 GBW 8th ed. Ch. 11
  11. 11. ASSERTIONS &PROCEDURESAccounts Receivable, Sales-1Valuation Verify mathematical accuracy AR  Obtain aged trial balance  Foot trial balance  Compare total AR per trial balance to general ledger11 GBW 8th ed. Ch. 11
  12. 12. ASSERTIONS &PROCEDURESAccounts Receivable, Sales-2Existence, rights, valuation Confirm year-end accounts & notes receivable with debtors  Positive: tell auditor if balance correct  Large balances, inaccuracies  Negative: tell auditor only if balance incorrect  Control adequate, small balances12 GBW 8th ed. Ch. 11
  13. 13. ASSERTIONS &PROCEDURESAccounts Receivable, Sales-3Existence or occurrence, completeness Test cutoff to determine whether sales, receivables recorded in proper period  FOB shipping point  FOB destination13 GBW 8th ed. Ch. 11
  14. 14. ASSERTIONS &PROCEDURESAccounts Receivable, Sales-4Valuation, rights Review collectibility receivables Determine adequacy allowance for doubtful accounts14 GBW 8th ed. Ch. 11
  15. 15. ASSERTIONS &PROCEDURESAccounts Receivable, Sales-5Existence or occurrence, completeness, valuation Perform analytical procedures for reasonableness of sales, receivables balances  Collections problems  Overstated sales  Understated sales15 GBW 8th ed. Ch. 11
  16. 16. ASSERTIONS &PROCEDURESAccounts Receivable, Sales-6Presentation & disclosure Review financial statements to determine  Accounts, notes receivable properly classified, described  Disclosures adequate16 GBW 8th ed. Ch. 11
  17. 17. TESTING CUTOFFSales, ReceivablesAt or around end each quarter, the former President directed his subordinates to hold IGI’s books open, to backdate invoices, shipping documents. This caused IGI to record out-of-period sales & to overstate revenue, net income end each quarter. Procedures  Trace recorded sales to shipping documents before, after end of period17 GBW 8th ed. Ch. 11
  18. 18. ASSERTIONS &PROCEDURES: Cash-1Existence, rights, valuation Confirm year end balances with all banks18 GBW 8th ed. Ch. 11
  19. 19. ASSERTIONS &PROCEDURES: Cash-2Valuation Verify mathematical accuracy recorded cash balances  Foot cash journals  Trace totals to general ledger, year-end bank reconciliations  Test cash on hand19 GBW 8th ed. Ch. 11
  20. 20. ASSERTIONS &PROCEDURES: Cash-3Existence, completeness, valuation Test cutoff  Obtain cutoff bank statement  Verify accuracy  Examine & trace to bank reconciliations & cash journals  Proof of cash  Reconcile recorded cash with bank confirmation  Examine interbank, intercompany transfers20 GBW 8th ed. Ch. 11
  21. 21. ASSERTIONS &PROCEDURES: Cash-4Presentation & disclosure Review financial statements to determine  Cash balances properly classified, described  Disclosures adequate21 GBW 8th ed. Ch. 11
  22. 22. TESTING CUTOFF FORCASH Reconcile internal documents  Cash journals  General ledger  Bank reconciliations With external documents  Year-end bank statement  Cutoff bank statements  Bank confirmations22 GBW 8th ed. Ch. 11
  23. 23. REVENUE RECOGNITION& EARNINGSMANIPULATIONIncreasingly, I have become concerned that the motivation to meet Wall Street earnings expectations may be overriding common sense business practices.Arthur Levitt, Jr., “The ‘Numbers Game.” Speech NYU, 1998.23 GBW 8th ed. Ch. 11
  24. 24. REVENUERECOGNITIONSAB 104 Criteria  Persuasive evidence of arrangement exists  Delivery has occurred or services rendered  Seller’s price fixed or determinable  Collectibility reasonably assured24 GBW 8th ed. Ch. 11
  25. 25. COMMON MEANS TOMANIPULATE EARNINGS -1Method Revenue Recognition ErrorBill & hold Shipments to 3rd party warehousesCancelled orders Cancelled, duplicate ordersConditional sales Before contingencies resolvedConsignment sales Goods on consignment, trialContinuing Seller involved after delivery, e.g.,involvement installationImproper cutoff Before title, risk ownership passed25 GBW 8th ed. Ch. 11
  26. 26. COMMON MEANS TOMANIPULATE EARNINGS -2Method Revenue Recognition ErrorKickback sales Inflated selling price for kickbackOverstated Inflated % completion on constructioncompletion projectsPartial shipments Not all goods ordered are shippedPre-invoicing Goods still in productionPremature Goods ordered but not authorized forshipment shipment26 GBW 8th ed. Ch. 11
  27. 27. COMMON MEANS TO MANIPULATE EARNINGS - 3 Method Revenue Recognition ErrorPremature sales Goods ordered but not shippedSham sales False shipmentsSide agreements To forestall completion earnings processUncertain Seller’s performance uncertainperformance Collection uncertain, unlikelyUncertain realizationUnauthorized Shipments not authorizedshipment 27 GBW 8th ed. Ch. 11
  28. 28. MANIPULATED EARNINGSChannel Stuffing Definition: incentives to induce incremental demand Examples  Bausch & Lomb  Told distributors to buy large amount of inventory to maintain distributorship  B&L recognized extra $22 million  Sunbeam  Used price discounting to encourage customers to hold 80 weeks of inventory28 GBW 8th ed. Ch. 11
  29. 29. MANIPULATED EARNINGSAsset Swaps Definition: companies trading right to use others asset Examples  Global Crossing  Treated underseas cables as real estate  Recognized revenue by treating swap as sale29 GBW 8th ed. Ch. 11
  30. 30. MANIPULATED EARNINGSOther Improper expense capitalization  Chambers Development  Capitalized landfill expenses after determining earnings necessary to meet analysts expectations  MicroStrategy  Recognized revenue before all services provided for software sales30 GBW 8th ed. Ch. 11
  31. 31. ACCOUNTSRECEIVABLE Update assessment of control risk Planning confirmations & selecting plan  Identify population, sampling unit, anticipated error  Estimate tolerable error & risk incorrect acceptance  Calculate sample size  Choose sample selection method  Evaluate results31 GBW 8th ed. Ch. 11
  32. 32. COMPUTER ASSISTEDTESTS: AR Accuracy Foot, crossfoot recorded amounts within master file Total balances Display/print exceptions32 GBW 8th ed. Ch. 11
  33. 33. COMPUTER ASSISTEDTESTS: AR Aging Trace individual balances from master file to sales journal Classify balances by invoice dates/age Display/print aged trial balances33 GBW 8th ed. Ch. 11
  34. 34. COMPUTER ASSISTEDTESTS: AR Credit Balances Scan master receivables file for net credit balances Display/print listing credit balance accounts34 GBW 8th ed. Ch. 11