Accounts Receivable Auditing

If your company is subject to an annual audit, the auditors will review its accounts
receivable in some detail. Accounts receivable is frequently the largest asset that a
company has, so auditors tend to spend a considerable amount of time gaining assurance
that the amount of the stated asset is reasonable.

Here are some of the accounts receivable audit procedures that they may follow:

 Trace receivable report to general ledger. The auditors will ask for a period-end accounts
receivable aging report, from which they trace the grand total to the amount in the accounts
receivable account in the general ledger. (If these totals do not match, you may have a
journal entry somewhere in the general ledger account that should not be the re)
 Calculate the receivable report total. The auditors will add up the invoices on the accounts
receivable aging report to verify that the total they traced to the general ledger is correct.
 Investigate reconciling items. If you have journal entries in the accounts receivable account
in the general ledger, the auditors will likely want to review the justification for the larger
amounts. This means that these journal entries should be fully documented.
 Test invoices listed in receivable report. The auditors will select some invoices from the
accounts receivable aging report and compare them to supporting documentation to see if
they were billed in the correct amounts, to the correct customers, and on the correct dates.
 Match invoices to shipping log. The auditors will match invoice dates to the shipment dates
for those items in the shipping log, to see if sales are being recorded in the correct
accounting period. This can include an examination of invoices issued after the period
being audited, to see if they should have been included in a prior period.
 Confirm accounts receivable. A major auditor activity is to contact your customers directly
and ask them to confirm the amounts of unpaid accounts receivable as of the end of the
reporting period they are auditing. This is primarily for larger account balances, but may
include a few random customers having smaller outstanding invoices.
 Review cash receipts. If the auditors are unable to confirm accounts receivable, their
backup auditing technique is to verify that customers have paid the invoices, for which they
will want to review checks copies and trace them through your bank account.
 Assess the allowance for doubtful accounts. The auditors will review the process that you
follow to derive an allowance for doubtful accounts. This will include a consistency
 comparison with the method you used in the last year, and a determination of whether the
method is appropriate for your business environment.
 Assess bad debt write-offs. The auditors will compare the proportion of bad debt expense
to sales for this year in comparison to prior years, to see if the current expense appears
reasonable.
 Review credit memos. The auditors will review a selection of the credit memos issued
during the audit period to see if they were properly authorized, whether they were issued in
the correct period, and whether the circumstances of their issuance may indicate other
problems. They may also review credit memos issued after the period being audited, to see
if they relate to transactions from within the audit period.
 Assess bill and hold sales. If you have situations where you are billing customers for sales
despite still retaining the goods on-site (known as "bill and hold"), the auditors will examine
your supporting documentation to determine whether a sale has actually taken place.
 Review receiving log. The auditors will review the receiving log to see if it records an
inordinately large amount of customer returns after the audit period, which would suggest
that the company may have shipped more goods near the end of the audit period than
customers had authorized.
 Related party receivables. If there are any related party receivables, the auditors may
review them for collectability, as well as whether they should instead be recorded as wage s
or dividends, and whether they were properly authorized.
 Trend analysis. The auditors may review a trend line of sales and accounts receivable, or a
comparison of the two over time, to see if there are any unusual trends. Another possible
comparison is of receivables to current assets. They may also measure the average
collection period. If so, expect them to make inquiries about the reasons for changes in the
trends.

The preceding list of audit procedures is designed to detect a variety of audit risks, w hich
include the following:

 That receivables do not exist

 That recorded receivable balances are inaccurate
 That it may not be possible to collect accounts receivable
 That the derivation of the allowance for doubtful accounts may not properly reflect bad debt
experience
 That sales transactions were not processed in the correct periods
 That revenue was incorrectly recognized

I. Audit Objectives for Accounts Receivable

Receivables relate to amounts due from others from sales of merchandise, services, or other
assets, or as a result of a loan. Receivables are generally placed into one of three categories:
trade, nontrade, and related party. Trade receivables include open accounts, notes, and
installment contracts representing claims for goods and services sold in the ordinary course of
business. Nontrade receivables may include tax refund claims, sale of plant or equipment, or
dividends receivable. Related-party receivables could be due from employees, stockholders,
officers, management, or affiliates.

A. Risk Assessment for Accounts Receivable

Accounts receivable is an area that tends to be of significant risk, as it is subject to management

manipulation in several ways. If a company is perpetrating fraud by overstating revenues with
fictitious sales, the amounts would be included in accounts receivable at period-end. Therefore,
existence of accounts receivable tends to be a significant risk if management is likely to
overstate earnings. In addition, management can manipulate financial results by altering the
valuation of recorded receivables. The valuation of accounts receivable is a subjective area,
where assumptions can be challenged based on additional information obtained after the
balance sheet date. Therefore, when the adequacy of the allowance for doubtful accounts is a
significant risk, sufficiently experienced audit professionals should be intimately involved in the
testing and audit conclusions. Often, the most significant risk with accounts receivable is proper
valuation in accordance with generally accepted accounting principles.

Depending on: (i) the materiality of accounts receivable balances at year-end; (ii) the volume of
transactions flowing through specific accounts receivable accounts; (iii) the strength of the
company’s overall internal control environment; and (iv) the auditor’s assessment of control risk
relative to billings and cash receipts, the auditor may tailor standard audit procedures to reduce
the risk of failing to detect material misstatement in the financial statements to an appropriately
low level.
The audit of any financial statement area must appropriately address each of the six primary
management assertions:

 Existence or occurrence -- e.g., accounts receivable are authentic obligations owed to

the company at the date of the balance sheet

 Completeness -- e.g., accounts receivable include all amounts owed to the company at
the date of the balance sheet;

 Rights and obligations -- e.g., pledged, discounted, or assigned accounts receivable are
properly disclosed;

 Cutoff – e.g., accounts receivable are recorded in the proper period;

 Valuation or allocation -- e.g., allowance for doubtful accounts is adequate but not
excessive; and

 Accuracy or classifications -- e.g., accounts receivable are appropriately classified in the

balance sheet, and required disclosures are made.

The completeness assertion is often the most difficult assertion to test for revenue-related
accounts. In some cases, tests of controls supporting the completeness assertion may be
necessary, as substantive procedures alone may not be adequate. However, for many small
businesses, the risk of material unrecorded revenue may be minimal -- especially in a
circumstance where operations are relatively predictable and stable. Effective tests of
completeness may be limited to inquiry, observation, and substantive analytical procedures.

AU Section 240, Consideration of Fraud in a Financial Statement Audit, requires the auditor to
perform preliminary analytical procedures relative to identifying the risk of material fraudulent
financial reporting related to revenues, which indirectly includes accounts receivable. Unusual or
unexpected relationships identified during preliminary analytical review procedures should be
considered in designing the nature, timing, and extent of testing of accounts receivable.
An effective and efficient audit approach for sales usually is to limit the testing in this area to
analytical procedures. The table below summarizes specific audit objectives related to financial
statement assertions for accounts receivable and identifies common, but not all inclusive,
substantive audit procedures that accomplish these objectives.

Common Substantive Audit Financial Statement

Specific Audit Objectives
Accounts receivable reflected
in the balance sheet exist, are
for valid transactions, and
include all authentic
obligations of third parties to
the entity.
Billings are for the correct
amount and uncollectible
accounts are promptly
identified and provided for; the
allowance for uncollectible
accounts is adequate.
Receivables are properly
classified in the balance sheet
between current and
noncurrent assets and
disclosures are adequate with
respect to assigned, pledged,
unbilled, discounted, and
related-party receivables, and
transfers of receivables.
Disclosures are clearly
expressed.
Procedures
Test the reconciliation of the
aged subsidiary ledger of
individual accounts to the
general ledger.
Mail confirmation requests to
customers and reconcile
confirmation exceptions.
Mail confirmation requests to
customers and reconcile
confirmation exceptions.
Review analysis of doubtful
accounts and bad debt
expense and related
documents.
Review bank confirmations for
indications of liens on
receivables.
Inquire about receivables that
have been assigned, pledged,
unbilled, or discounted or are
with related parties.
Assertions
Existence Occurrence
Completeness Rights and
Obligations
Existence Occurrence
Accuracy Cutoff
Classification
Valuation and allocation
Presentation and disclosure:
Occurrence and rights and
Obligations
Presentation and disclosure1.
Completeness
Presentation and disclosure:
Understand- ability and
classification
Presentation and disclosure:
Accuracy and valuation

Review aged subsidiary

ledger of individual accounts
for amounts due from
employees, credit balances,
or unusual items.