GROUP 6 CHAPTER 3 (4) :UNDERSTAND THE AUDITING AT TRADE RECEIVABLES AND PAYABLES PREPARED BY : MOO ZIOW CHENG 06DAT10F1004 RATNA DEWI A/P PALANIAPPAN 06DAT10F1024 YONG YUE LING 06DAT10F1022 YEO SHU CHIN 06DAT10F1006
PURPOSE OF AUDITING TRADERECEIVABLE Trade receivables are due from customers for merchandise sold or services performed in the ordinary course of business. Trade receivables may either be accounts receivable or notes receivable. Nontrade receivables come into being from other types of transactions and may he written promises to pay monies or deliver services. Examples are advances to employees, claims against other entities (i.e., tax refunds, insurance receipts), deposits, and financial receivables (i.e., interest receivable, dividend receivable).
The auditor should obtain an understanding of the accounting policies relevant to trade accounts receivable, the significant types of sales transactions and the monetary volume of transactions flowing through the account. The auditor should evaluate the divisions revenue recognition policy and, if buyers of some or all of the divisions products have the right to return them, consider whether the revenue recognition policy is appropriate. When preparing this program the auditor should consider and design audit procedures that address relevant presentation and disclosure requirements.
Trade creditors in many countries routinely provide their debtors with a monthly statement showing the invoices outstanding. Some businesses routinely reconcile their own records to statements provided by their suppliers. This means that direct confirmation of creditor balances is not always necessary, as documentary, third party evidence, confirming the balance already exists.
Auditors are likely to assess receivables as being subject to the risk of overstatement, and payables as subject to the risk of understatement and this affects the populations from which samples are drawn. Recorded receivables (i.e. the sales ledger), are scrutinised to establish whether there is any need for writing down through the bad debt provision, auditors are less likely to be concerned with unrecorded receivables. Recorded payables on the other hand, may be incomplete and the auditor will tend to look outside the entity for evidence of unrecorded liabilities.
purpose of auditing trade payables Accounts payable is money owed by a business to its suppliers and shown on its Balance Sheet as a liability. An accounts payable is recorded in the Account Payable sub-ledger at the time an invoice is vouchered for payment. Vouchered, or vouched, means that an invoice is approved for payment and has been recorded in the General Ledger or AP sub ledger as an outstanding, or open, liability because it has not been paid.
Accounts payable include liabilities for which invoices have been received and liabilities for goods and services received that have not been matched with the related invoices. Completeness and cutoff are generally high-risk objectives, and existence is generally a low-risk objective for accounts payable. The valuation objective does not apply to trade accounts payable; however, when appropriate, the auditor should estimate potential losses from open purchase commitments.
The auditor should obtain an understanding of the significant types of purchase transactions and the monetary volume of transactions flowing through the account. Particular consideration should be given to the consistent and appropriate accounting treatment of special transactions such as volume rebates from suppliers, interest on overdue liabilities, balances not due within 12 months and purchase transactions subject to reservation of title. When appropriate, substantive tests should be developed for these types of transactions to provide the necessary assurance about each relevant audit objective. When preparing this program the auditor should consider and design audit procedures that address relevant presentation and disclosure requirements.
Define the evidence to audit tradereceivables and trade payables Audit evidence is all the information used by auditors in arriving at the conclusions on which the audit opinion is based. The basic sources of evidence are knowledge of the business and industry, analytical procedures, tests of controls, and direct tests of account balances and transactions. Direct confirmation provides evidence as to existence and accuracy, but not as to collectibility, or unrecorded balances. Indirectly, it confirms the accuracy of cut-off and may draw attention to irregularities such as teeming and lading and window dressing. It gives comfort on the proper operation of controls in the area.
A combination of positive and negative confirmations can be used where there is a small number of large balances which can be confirmed positively, and a large number of small balances which can be confirmed negatively. Direct confirmation constitutes good quality, third party, documentary evidence, however, debtors may agree with a balance without checking it, and they may also agree with a balance that is understated. Positive confirmations, where the debtor is requested to reply whether he agrees or not, are more reliable than negative confirmations, which only request a reply in the case of disagreement
Direct confirmation is a time consuming process and the response rate is often very low. Any audit procedure involving the use of sampling is subject to sampling risk, and where confirmations are carried out at a date other than the period-end, the intervening period must be audited. Direct confirmations require the co-operation of management but must be controlled by the auditor. There is scope for fraudulent responses to requests for direct confirmation, in the absence of proper control.
Apply suitable audit objectives and assertions on trade receivables and trade payables Main audit objectives for (i) trada payables and (ii) trade receivables Assertions(I) trade payables and (ii) trade receivables objectives Existence • :Recorded sales transactions represent goods shipped during the period • Recorded cash receipts transactions represent cash received during the period • Recorded sales adjustment transactions represent authorized discounts, returns and allowances, and bad debts applicable to the period Accounts receivable represent amounts owed by customers at the balance sheet date
Ownership :• The entity has rights to the accounts receivables and cash resulting from recorded sale transactions Accounts receivables at the balance sheet date represent legal claims of the entity on customers for payment.Completeness: • All sales, cash receipts and sales adjustment transactions occurred during the period have been recorded • Accounts receivables includes all claims on customers at the balance sheet date.
Valuation • All sales, cash receipts and sale adjustment transactions are correctly journalized, summarized and posted • Accounts receivable represent gross claims on customers at the balance sheet date and agree with the sum of the accounts receivable subsidiary ledger The provision for bad debts represents a reasonable estimate of the difference between gross accounts receivable and their net realizable value Disclosure • The details of sales, cash receipts and adjustment transactions support their presentation in the financial report, including their classification and related disclosures • Accounts receivable are properly identified and classified in the balance sheet Appropriate disclosures have been made concerning accounts receivable that have been factored or otherwise assigned.
Management is responsible for the fair presentation of financial statements that reflect the nature and operations of the entity. Assertions used by the auditor fall into the following categories: a. Assertions about classes of transactions and events for the period under audit: i. Occurrence. Transactions and events that have been recorded have occurred and pertain to the entity. ii. Completeness. All transactions and events that should have been recorded have been recorded. iii. Accuracy. Amounts and other data relating to recorded transactions and events have been recorded appropriately. iv. Cutoff. Transactions and events have been recorded in the correct accounting period.
v. Classification. Transactions and events have been recorded in the proper accounts. b. Assertions about account balances at the period end: i. Existence. Assets, liabilities, and equity interests exist. ii. Rights and obligations. The entity holds or controls the rights to assets, and liabilities are the obligations of the entity. iii. Completeness. All assets, liabilities, and equity interests that should have been recorded have been recorded.
c. Assertions about presentation and disclosure: i. Occurrence and rights and obligations. Disclosed events and transactions have occurred and pertain to the entity. ii. Completeness. All disclosures that should have been included in the financial statements have been included. iii. Classification and understandability. Financial information is appropriatel presented and described and disclosures are clearl expressed. iv. Accuracy and valuation. Financial and other information are disclosed fairly and at appropriate amounts.
The auditor should use relevant assertions for classes of transactions, account balances, and presentation and disclosures in sufficient detail to form a basis for the assessment of risks of material misstatement and the design and performance of further audit procedures. The auditor should use relevant assertions in assessing risks by considering the different types of potential misstatements that may occur, and then designing further audit procedures that are responsive to the assessed risks.
Relevant assertions are assertions that have a g meaningful bearing on whether the account is fairly stated. For example, valuation may not be relevant to the cash account unless currency translation is involved; however, existence and completeness are always relevant. Similarly, valuation may not be relevant to the gross amount of the accounts receivable balance but is relevant to the related allowance accounts. Additionally, the auditor might, in some circumstances, focus on the presentation and disclosure assertion separately in connection with the period-end financial reporting process.
The auditor may use the relevant assertions as they are described above or may express them differently provided aspects described above have been covered. For example, the auditor may choose to combine the assertions about transactions and events with the assertions about account balances. As another example, there may not be a separate assertion related to cut-off of transactions and events when the occurrence and completeness assertions include appropriate consideration of recording transactions in the correct accounting period.
suitable audit test to be used whenauditing the trade receivables andtrade payables Substantive tests provide evidence about managements assertions and the corresponding audit objectives. In the substantive testing phase, the auditor obtains, evaluates, and documents evidence to corroborate managements assertions embodied in the accounts and other information in the financial statements and related notes. The auditors purpose in performing substantive tests is to determine whether the audit objectives have been achieved. Substantive procedures include tests of details of account balances and transactions, and analytical comparisons and other procedures..
The nature of substantive tests, when they are performed, and the extents to which they are performed depend on the auditors materiality judgments and risk assessments. Furthermore, the assurance required from substantive tests may be obtained from tests of details, analytical procedures, or some combination of both, with the assurance obtained from one reducing the assurance needed from the other. Substantive tests may also provide evidence about the control structure such as when a misstatement discovered through a substantive test is, upon further investigation, found to have resulted from deficiency in the control structure. In that situation, the auditor may have to reassess his or her prior conclusions about the control structure
Suitable audit procedures on tradereceivables and trade payablesAccounts Payable Audit Procedures Accounts payable is a critical portion of your financial records and can be subject to fraud without careful reconciliation and oversight. Strong accounts payable audit procedures can ensure the accuracy and timeliness of your bill payments. The best accounts payable audit procedures allow a mixture of daily checks, routine internal controls and external audit procedures.
Routine Procedures Accounts payable should be balanced daily to reconcile payments to recorded entries. Any discrepancy between the total amount paid and the total recorded should be examined and reconciled immediately. Management oversight of every individual involved in accounts payable should be stringent and should include routine monitoring of activities. Managers should be trained to watch for any signs of misconduct by accounts payable staff. Sign-off procedures that help establish an audit trail should be enacted. These sign-offs should include management review of daily reconciliations, monthly discrepancy reports and individual sign-offs for large transactions to ensure that all information is correct.
Internal Controls Internal controls for accounts payable should include signature requirements according to payment amounts. Consider implementing several tiers of signature requirements. For example, you could require an accounting managers signature for items of more than $5,000, an executive sign-off for items of more than $10,000 and dual signature requirement for payments of more than $25,000. Match your signature requirements to your revenue totals and the susceptibility of your business to fraud for maximum benefit. Establish routine control procedures for accounts payable. Include spot checks on individual payments to ensure accuracy. For example, review five payables every day and check the payment amount and payee information and ensure that accounting records have been completed correctly. During book closing procedures at the end of a month or financial period, include sign-off procedures for all account payable work including summary totals and account reconciliations. Additionally, keep a running report that monitors payment levels from accounts payable processing. If payment levels suddenly increase or decrease, an automatic investigation into the causes can head off potential problems.
External Audits Most external audits include accounts payable as a testing area. External audits should take a detailed accounts payable listing and trace totals from the details through all accounting records to the summary total and should include the bank withdrawals. Select items should be chosen for in- depth testing. Select payees should be contacted to verify receipt of payments. Additionally, routine reconciliations should be reviewed for accuracy and logical processing. Any reconciliations with large discrepancies should be investigated completely. External audits should test for unrecorded liabilities. Consider selecting all invoices over a specified threshold and a random selection of routine invoices for in-depth review. Look at disbursement records, credits for returns, goods received but not invoiced, and any invoice-specific accounts. Ensure that every invoice is recorded properly in the correct time period. Review the account for to see if it was recorded as a liability or if it was properly excluded from the time period.
Substantive Audit Proceduresfor Accounts Receivable Audits are internal and external reviews of a company’s financial information. Companies use audits to ensure its financial information is accurate and represents the true nature of the company’s financial transactions. Accounts receivable represents the money owed to the company by client and consumers. Auditors use substantive audit procedures to test the balances of accounts receivable accounts. Substantive audit procedures are direct tests using specific information from the company’s accounting system and financial statements
Reviewing Accounts Receivable Process The first step in auditing a company’s accounts receivable process is scouring out the originating information. Auditors usually pull a sample of clients or customers from the company’s account receivables ledger and review the originating information that resulted in the current balance. This is an important step because companies can easily create fraudulent accounting balances by simply adding fake clients and receivables balance to bolster its financial statement. Reviewing the original sales information will prove to the auditors that a sales on account actually occurred, resulting in the accounts receivable balance.
Interview Accounting Employees Auditors will usually interview the employees who handle customer accounts to determine how well the company operates. Accounting employees may be required to math check the receivables information and ensure that sufficient backup is included with the customer’s paperwork. Interviewing these employees can also help auditors determine how much training is involved in the accounts receivable process. A lack of employee training may indicate the potential for errors to occur in the accounts receivable process.
Verifying Balances with Clients Another important audit procedure is contacting the company’s major clients and requesting the client to verify their accounts payable amounts owed to the company. Auditors will take this external information and match it to the company’s internal information. Variations in the dollar amounts will result in further tests or more information needing to be provided by the company to determine why the variation occurred. Auditors will usually review information for several months of the accounts receivable account to determine how well the company operates over an extended period of time.
Tracking the Payoff Process Testing the payoff process for accounts receivable is another important part of the auditing process. Auditors will review when the company was paid for goods and services and how long it took the company to apply the money received to the open accounts receivable balance. Variation between the amount paid and the amount owed will also need to be justified by the company. Auditors may need to review the company’s bank statements to completely source the depositing of the check from the client.