Accounts receivables of any business entity are related to revenues. When a business entity makes credit sales, the invoices are issued to the customers, who are bound to pay the selling price at a future date. Therefore, we can say that accounts receivables are a very significant account for any business entity and play a role in determining a company’s financial position and profitability.
In today’s article, we will understand the audit procedures, objectives, assertions, and risks associated with the accounts receivable audit. We have tried to simplify the audit process of the account receivables so that not only auditors but the business owners can understand what is actually going on during an audit.
So let’s get into it.
Objectives Of Accounts Receivable Audit
The auditor performs the accounts receivable audit with the following objectives:
- An accounts receivable audit’s primary objective is to ensure that the company has followed completeness and accuracy assertion in recording the AR balances.
- Yet another objective of AR audit is to ensure that the balances recorded in the financial statements present a true and fair view of the company’s financial position.
- The overall objective of the AR audit also includes ensuring that the AR internal controls are efficient and effective.
Risks Associated With Accounts Receivable
The risks associated with any account can be related to internal control procedures, control deficiencies, inherent risks, and other human errors that might go undetected during the audit procedures. Here are the risks associated with the accounts receivables audit that auditors must understand before designing the audit program.
Risk Of Material Misstatement
The risk of material misstatement in accounts receivables is measured as a combined impact of inherent risk and the control risk associated with a specific account. When we study the inherent risks of accounts payable, the complexity and nature of a financial transaction is the key determinant of it.
The control risk related to the accounts receivables relates to the deficiencies in the internal control. The higher inherent risk and control risk means a higher risk of material misstatement. It implies that there might be an intentional overstatement of the sales and accounts receivable of the business entity.
Control Deficiencies
The main control deficiencies related to the accounts receivables can be the result of weaker internal control, no proper segregation of duties, no surprise inspections & audit, unauthorized access to confidential information, no account reconciliations, etc.
Unrecorded Transactions
Yet another risk associated with the audit of accounts receivable is the unrecorded transactions that occurred during an accounting period.
Allowance For Doubtful Debts
There is also a risk of misstatement and understatement of the debt allowances related to accounts receivables.
Audit Assertions Of Accounts Receivable
The audit assertions are the managerial claims about the trueness and fairness of the figures disclosed in the financial statements of the business entity. The audit procedures are designed to check the assertions made by the management.
Here are the primary assertions to be tested when performing an accounts receivable audit:
Existence
The existence assertion related to accounts receivable means that the auditor will test the accounts’ existing balances. Therefore, the auditor will break up the accounts receivables based on the customers’ listings and request confirmation from the debtors.
Completeness
The completeness assertion of audit related to accounts receivable implies that the auditor will verify theirs is no missing record of the accounts receivables by the ending date of the accounting period. It also involves the identification of any additional transaction related to sales returns.
Accuracy
The accuracy assertion of the accounts receivable relates to the arithmetical accuracy of transactions and checking that there is no material misstatement regarding the AR transactions. The misstatements can be either due to human error or fraudulent practices.
Valuation
The valuation assertion of the AR audit implies that the auditor will check that the accounts receivable are properly valued and recorded.
CutOff
Cutoff assertion implies that no transaction that relates to the current financial period should be delayed or made earlier. It means transactions related to January should be recorded on 1st Feb or 31st Dec of the previous year. Therefore, an auditor will also test the cutoff assertion when performing an AR audit.
Rights and Obligations
Rights and obligations assertion of AR audit includes checking the accounts receivable balances and verifying that the company’s rights are protected related to the credit sales.
Audit Procedures For Accounts Receivable
After understanding and assessing the risks associated with a specific account or business entity, the auditor plans and designs the audit program. When performing an audit for accounts receivables, an auditor will typically adopt the following procedures:
Walkthrough Test
Walkthrough Test is often categorized as the test of control and serves as the beginning point for testing the control procedures of a specific department or overall accounting system of the business entity. The walkthrough test for accounts receivable is similar to the one designed for other accounts and overall accounting systems.
However, some of the specific questions addressed in the accounts receivable walkthrough test are as follows:
- The segregation of duties by asking questions like:
Who prepares the account receivable master file? Who reconciles the AR summary with the general ledger? Who is responsible for ensuring that the accounts receivable transactions are recorded and recognized on time?
- Does the company use software for managing sales orders?
- Does the relevant personnel perform three-way matches by comparing sales orders, shipping documents, and invoices?
- Who is the person responsible for reviewing the aged receivables?
- What controls are implemented to make sure that the revenues are recorded according to the right classification
- What reports about receivables are provided to owners or governing bodies?
- Who has the authority to record and approve the allowances for debtors?
- Does the company uses consistent and reasonable methods for the computation of allowances
- What is the frequency of bank reconciliation, and who is responsible for it?
The auditor will also inspect the documentary evidence and a sample of transactions when performing the AP walkthrough test.
Tests Of Control
The tests of control the auditor needs to perform for accounts receivable should be focused on testing the efficiency of the control procedures. There are different types of tests of controls, including reperformance of transactions, an inspection of documentary evidence, a review of the financial statements, etc.
If we talk about the accounts receivables, here are different tests of controls an auditor might run:
- The evaluation of monthly reconciliation of the balances of accounts receivables with the financial statements of the debtors
- Reperform the tests of transactions which include inspecting the accuracy of the year-end transactions related to account receivables
- Compare the invoices with the shipping logs and approved sales orders to make sure that all the sales made during an accounting period are recorded and recognized properly.
- The auditor will check the signatures of authoritative personnel on each document related to credit sales and invoices.
- Reperform the pricing checks by taking a sample of sales invoices with the master price list of debtors
Based on the results of the tests of control, the auditor will design the audit program. The auditor will adopt rigorous audit procedures if a weak internal control has several deficiencies.
Substantive Procedures
As highlighted in the above sections, the accounts receivable audit auditor will adopt substantive procedures to check different audit assertions. So here are the audit procedures an auditor will perform for the accounts receivable of a business entity:
Occurrence and Validity
The auditor might adopt the following tests to check the occurrence and validity assertions for account receivables:
- Get the aged schedule of accounts receivable and notes receivables and reconcile it to the general and subsidiary ledgers
- Confirm the account receivables from the debtors and proceed further based on positive or negative confirmation
- Inspection of notes on hand
Rights & Obligations
The auditor might need to test the audit’s rights and obligation assertion to ensure that obligations recorded in the financial statements rightfully belong to the entity. Here are the substantive tests he might run for accounts receivables:
- Receive confirmation from the debtors to make sure that the AR shown in the financial statements belong to the business entity
- Perform analytical procedures to decide about the reasonableness of balances compared with the recorded sales
Completeness
An auditor will run the most common test to check the AR’s completeness by performing cutoff tests on sales and sales returns. The auditor will check the audit assertions related to the completeness of account receivables to make sure that the staff has properly recorded the financial transactions related to accounts receivable. It will ensure no missing entry or extra entry is recorded in the financial statements.
Presentation
The presentation assertions for accounts receivable are tested to make sure that the staff properly makes the classification of accounts receivable. The tests run for this purpose are as follows:
- Evaluation of the business entity’s financial statements to ensure proper disclosures are made.
- Get written representation from the client regarding the accounts receivable presentation and assignment
Valuation
The auditor checks the audit’s valuation assertions to ensure that the business entity has followed the proper reporting standards for proper presentation and recording of transactions. Here are the most common substantive tests the auditor will conduct:
- Recalculation of the interest income on the notes receivables
- Examine the collection cycle and allowance methods for doubtful debts