Accounts Receivable Company by qmq41563

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									AP-3: Audit Program for Accounts
Company            Balance Sheet Date

      The company has the following general ledger accounts that are classified in the accounts, notes,
or other receivables captions of the balance sheet:
      Ledger            Description or Brief Purpose             Current or
      Number            of the Account                           Noncurrent Asset?

Audit                                                                              N/A       Workpaper
Objectives                                                                         Performed Index
             Audit Procedures for Consideration                                    by

             E/O   Existence or occurrence.   V/A   Valuation or allocation.
             C     Completeness.              P/D   Presentation and disclosure.
             R/O   Rights and obligations.


                 A. Accounts receivable are authentic obligations owed to the
             company at the balance sheet date (assertions E/O, R/O, and V/A).
                 B. Accounts receivable include all amounts owed to the
             company at the balance sheet date (assertion C).
                 C. The allowance for doubtful accounts is adequate but not
             excessive. If the direct write-off method is used, all significant
             doubtful accounts have been written off, and the bad debt exposure
             in the remaining accounts is insignificant (assertions V/A and
       D. Pledged, discounted, or assigned accounts receivable are
    properly disclosed. Related party receivables are properly
    disclosed (assertions R/O and P/D).
       E. Accounts receivable are appropriately classified in the
    balance sheet, and required disclosures are made (assertion P/D).

    The letters preceding each of the above audit objectives, i.e., A, B,
    etc., serve as identification codes. These codes are presented in the
    left column labeled “Audit Objectives” when a procedure
    accomplishes an objective. If the alpha code appears in a bracket,
    e.g., [A], [B], etc., the audit procedure only secondarily
    accomplishes the objective. If an asterisk precedes a procedure, it
    is a preliminary step or a follow up step that does not accomplish
    an objective.
*       1. Obtain or prepare an aged trial balance of accounts
        a. If the trial balance is prepared by the client, test the clerical
    accuracy. Do not test the accuracy of the aging of individual
    accounts until you start Step 7.
        b. Briefly inquire of management as to steps taken to ensure
    the trial balance is complete, i.e., that all receivables due the
    company are included on the trial balance. (See also Step 10.)
        c. Reconcile the balance to the general ledger account
    Practical Considerations:

    ¯ Meet with the client before the balance sheet date and arrange
    for a duplicate copy of the trial balance for yo ur workpapers.
    ¯ If the aged trial balance is computer generated, consider using
    computer audit software (such as IDEAt or ACLt ) to test the
    mechanical accuracy.
    ¯ If the client uses packaged accounting software and the auditor
    has determined that the client is unable to make changes to
    program coding, testing the mechanical accuracy of the accounts
    receivable trial balance may not be necessary. If procedures are
    performed to test mechanical accuracy in this situation, they may
    be limited.
    ¯ If the listing is manually prepared, instruct the client to
    identify each customer and account number on the aging and to
    leave adequate space to record subsequent collections. Stress the
           importance of clarity and neatness in preparing the schedule as it
           will be the primary worksheet.
           ¯ Utilize client employees whenever possible to reduce the time
           required to test clerical accuracy. For example, for long reports,
           remove several pages and have the client foot the remaining pages,
           then add your page totals. Also, avoid footing all the columns on
           the trial balance. Instead, foot two columns and crossfoot the total
*              2. Review the aged trial balance to determine if there are
           natural groups within the total population of accounts. See
           paragraphs 401.5 and 401.10 for guidance.
           Practical Considerations:

           ¯ Identifying groups within the accounts receivable population
           can lead to more efficient testing of accounts. The following
           groups normally exist in the population: (Use CX-7a to assist
           ¯¯ Customers with individually significant account balances or
           one customer with numerous small account balances that, when
           totaled, are significant. See paragraph 401.4 for guidance on
           determining an individually significant amount.
           ¯¯ Accounts with unusual characteristics other than the dollar
           amount of the balance. Such characteristics might include
           significant past due balances, an unusual customer name, accounts
           prone to misstatement, etc.
           ¯¯ Accounts with credit balances.
           ¯¯   Related party accounts.
           ¯¯   All other accounts.
           ¯ The groups do not need to be documented or listed in a
           separate schedule. Tickmarks can be used to identify accounts
           within a group, or you can simply have a mental awareness of each
           individual group. Groups may also be identified by simply
           scanning the trial balance.
A, E,          3. Select those groups that will be confirmed 100% by the use
[B], [C]   of positive confirmation letters. (Do not confirm accounts until the
           subsidiary ledger has been reconciled to the general ledger. See
           Step 1.)
               a. Identify the accounts selected on the aged trial balance.
               b. Review those accounts selected for confirmation with the
           owner/manager. If the client objects to a confirmation with a
           particular customer, determine if this restriction will affect your
           ability to accomplish the audit objectives for receivables.
               c. Have the client prepare the positive confirmation letters
reflecting, if possible, on the face of the letter or in an attached
statement, the individual invoice number, invoice date, and invoice
amounts that make up the customer’s balance.
    d. Include the audit firm’s return address on all envelopes to
ensure that all confirmation requests that are undeliverable by the
post office are returned directly to the audit firm.
    e. Be sure that the confirmations are to be returned directly to
the auditor and contain a return envelope for this purpose.
    f. Control the mailing of the letters.
    g. Send second requests approximately 10 days after the first
mailing. Determine the cause for confirmation requests returned as
undeliverable. If possible, obtain new addresses and remail.
    h. Retain copies of all confirmations in the workpapers.
Practical Considerations:

¯ SAS No. 96, Audit Documentation, requires documentation of
substantive tests of details involving inspection of documents or
confirmation to include identification of the items tested. The
authors believe items tested can be identified by listing the items;
by including a detail schedule in the workpapers, such as an aged
trial balance, on which the items are identified; or by documenting
in the workpapers the source and selection criteria. For example:
¯¯ For tests of significant items, documentation may describe
the auditor’s scope and the source of the items (for example, all
account balances greater than $5,000 from the 12/31/X2 accounts
receivable detail).
¯¯ For haphazard or random samples, documentation should
include the identifying characteristics of the items (for example,
the specific invoice numbers, customer account numbers, etc.).
¯¯ For systematic samples, documentation may indicate the
source, starting point, and sampling interval (for example, a
selection of accounts from the 12/31/X2 accounts receivable
detail, starting with account number 2150 and selecting every 10th
account thereafter).
       SAS No. 96 is effective for audits of financial statements for
periods beginning on or after May 15, 2002, with early application
¯ There is a presumption auditors will confirm accounts
receivable. If accounts receivable are not confirmed, SAS No. 67
requires auditors to document how they overcame that
¯ Many auditors assign a numerical or alpha code to each
customer selected for confirmation and record this code by the
account on the aged trial balance and on the confirmation letter, for
example, confirmation 1, 2, 3, etc. This makes check- in of replies
¯ The auditor should obtain photocopies of positive
confirmation letters and any attached statements for sending
second requests and documenting performance of alternative
procedures for nonreplies. The “Confirmation and Correspondence
Control” at CX-24 can be used to monitor the status of
¯ It may be helpful to record a client code on the return envelope
to facilitate routing of the reply to the appropriate client mail file in
the auditor’s office. This may be especially helpful during peak
periods when the firm has several audits in progress.
¯ Some customers may have different billing vs. shipping
addresses. Inquire if the proper address is used.
¯ The wording of the request should be clear and simple. A
deadline date can also enhance the response time. See the sample
accounts receivable confirmation letters at CL-7 through CL-11.
Also, see paragraph 703.4 for other suggestions for improving
confirmation responses.
¯ If possible, client personnel should prepare the letters. If there
are numerous letters, a word processing mail merge can be used to
insert the mailing address, salutation, and account balance into the
form letter.
¯ The auditor should mail the letters or accompany the letters to
the post office or mail drop. First class mail should be used to
facilitate response time.
¯ Special handling procedures should be considered for
international mail, for example, both a telex request and a
confirmation letter may be appropriate. Also, including one or two
international reply coupons (purchased at the post office) with
confirmations may increase the response rate. Customers can use
the coupons to purchase stamps in their own currency.
¯ If the auditor, based on his or her consideration of fraud risk
factors, decides to modify procedures related to accounts
receivable balances, the auditor should consider contacting
customers by telephone in addition to sending written
confirmations. In addition, the auditor may consider confirming
additional information with the customer. For example, relevant
contract terms such as acceptance criteria, delivery and payment
terms, the absence of future or continuing client obligations, the
right to return product, guaranteed resale amounts, and cancellation
and refund provisions may also be confirmed. The auditor should
also consider confirming that the client and customer do not have
           any side agreements in addition to stated contract terms.
           ¯ Accounts receivable often represents one of the best
           opportunities to use data extraction software in an audit. Both the
           auditor and the client may save significant time by automating the
           accounts receivable confirmation process. Data extraction software
           also can be used to divide the population of accounts into natural
           groups (see Step 2), review subsequent cash collections and test the
           accounts receivable aging (see Step 7), and test sales cutoff (see
           Step 11).
A, E,         4. For the remaining balance that is not confirmed 100% in
[B], [C]   Step 3, determine if a sample of the accounts making up the
           balance should be selected for confirmation.
              a. If sampling is appropriate, document the sampling
           selection process.
              b. Repeat program Steps 3a through 3h on accounts being
           Practical Considerations:

           ¯ Review Chapters 4 and 7 before performing a sampling
           application and determining a sample size. In many situations,
           sampling the remaining balance may not be necessary. See CX-7a
           for a worksheet to determine the extent of procedures to apply to
           the remaining balance.
           ¯ If sampling is used, consider confirming invoices instead of
           account balances.
           ¯ The “Sampling Planning and Evaluation Form—Substantive
           Tests,” (CX-7b) can be used to document the sampling process.
A, E,         5. For significant employee receivables, notes receivable, or
[B], [C]   other receivables not on the aged trial balance, consider mailing
           positive confirmations. Retain copies of all confirmations in the
           Practical Consideration:

           ¯ Normally these receivables are not material, and audit
           procedures are not warranted. If the owner/manager has a large
           payable to the company, the auditor should evaluate whether the
           receivable actually represents salary or a dividend. Confirmation of
           a loan to an owner/manager can also be obtained in the
           management representation letter if the owner/manager is the party
           signing the representation letter.
A, E,          6. Process the confirmation replies:
[B], [C]
              a. Reconcile differences reported by customers on
           confirmation replies.
Practical Considerations:

¯ In most instances, it is efficient to have the client’s personnel
perform the initial reconciliation of the confirmation replies. In that
case, a copy of the confirmation reply should be provided to the
client with instructions on the format they should use to reconcile
the customer’s balance to the client’s balance. (See CX-21 for a
suggested workpaper format that may be used.) If practical, client
personnel should be requested to attach supporting documentation,
such as validated deposit slips, invoices, and shipping
documentation, to each reconciliation to facilitate examination by
the auditor.
¯ Respondents sometimes use nontraditional means such as fax
machines or e- mail to answer confirmation requests. In those cases,
the auditor should consider the following additional steps:
¯¯ Verifying the source and content of the response over the
telephone and documenting in the workpapers that this was done.
¯¯ Requesting that the respondent mail the original confirmation
directly to the auditor.
    b. Perform alternative procedures for those customers that do
not respond.
Practical Considerations:

¯ Generally, the following approach can be used to perform
alternative procedures for each nonreply:
¯¯ First, examine cash receipts subsequent to the confirmation
¯¯ If a portion of the balance has not been collected, examine
sales invoices and corresponding shipping documents.
       The auditor may also examine shipping documents on the
subsequently collected portion if additional evidence about sales
cutoff is needed.
¯ If practical, alternative procedures should be performed on all
nonreplies. However, if a nonreply will be extremely time-
consuming to test, consider classifying the entire nonreply
customer balance as a misstatement. In that case, if the nonreply
was part of a sampling application, the misstatement should be
projected to the population (see Step 6d). Then, if the resulting
projected misstatement in the total account is acceptable, additional
testing is not necessary.
    c. For groups confirmed 100%, summarize the results of
confirmation procedures and indicate the total accounts and
balances confirmed without exception, confirmations reconciled,
    nonreplies with alternative procedures performed, and
    confirmations and nonreplies with misstatements.
       d. For accounts receivable groups that were sampled,
    summarize and evaluate the sample results and project the
    misstatements in the strata.
       e. Based on results of confirmation procedures, determine if
    additional confirmation or alternative procedures are warranted on
    untested customer balances.
    Practical Considerations:

    ¯ The “Confirmation Summary Form” (CX-8) can be used to
    summarize the confirmation results for sampling or nonsampling
    ¯ The “Sampling Planning and Evaluation Form—Substantive
    Tests” (CX-7b) can be used to summarize, as well as evaluate, the
    results for sampling applications.
C       7. Test the adequacy of the allowance for doubtful accounts:
        a. Have the client post subsequent cash collections to your
    copy of the aged trial balance obtained in Step 1.
        b. Test the client’s subsequent collections on major account
    balances by examining deposit slips and remittance advices.
    Document the account balances selected for testing.
        c. If uncollected accounts are significant, test the aging of the
    remaining accounts. (It is advisable to use original sales documents
    to test the propriety of aging.)
        d. If practical, for each material past due account, inspect
    credit files, review customer correspondence, or discuss the status
    of collection with the client. Identify potentially doubtful accounts.
        e. Inquire if there are collection problems likely to occur with
    accounts that are presently classified as current.
        f. If you become aware that individual accounts have been
    converted to notes, determine if they should be classified as
    noncurrent assets.
        g. Relate your findings in Steps 7a to 7f to the allowance for
    doubtful accounts and evaluate its adequacy. If meaningful,
    consider computing prior year bad debt statistics and prior year
    collection statistics.
        h. If the company uses the direct write-off method, evaluate
    the exposure that significant uncollectible accounts remain in
    accounts receivable.
    Practical Consideration:

    ¯   The direct write-off method is not GAAP. However,
         depending on the materiality of the allowance and write-offs
         during the period, it may approximate GAAP.
             i. Consider the collectibility of significant employee
         receivables, notes receivable, or other receivables not on the aged
         trial balance.
         Practical Considerations:

         ¯ Comments made by client personnel should not be taken at
         face value without other evidence to support the accuracy of client
         ¯ Other considerations or approaches that you may wish to use
         ¯¯ Use alternative approaches to develop an independent
         ¯¯ Compare the allowance with actual results after the balance
         sheet date.
         ¯¯ Consider the client’s process for estimating the allowance,
         including the qualifications and experience of the person who
         determines the amount of the allowance account.
         ¯¯ Determine whether the estimate of the allowance balance was
         subjected to management review.
         ¯¯ Determine what steps the company takes to identify any
         unusual variations and the reasons therefor.
         ¯ Statistics regarding bad debt history may be meaningful and
         can be maintained on a form similar to the “Accounts Receivable
         Statistics Form,” CX-9.
         ¯ In evaluating the allowance for doubtful accounts, it may be
         helpful to determine a range of amounts within which the
         company’s bad debt allowance would be acceptable. If the
         company’s balance does not fall in this acceptable range, the
         potential error would be the difference between the client’s amount
         and the closest amount in the acceptable range.
         ¯ For significant delinquent balances, it may be necessary to
         evaluate the creditworthiness of the debtor and the value of any
         collateral pledged to secure payment of the receivable.
D, [A]      8. Based on a review of confirmation replies from financial
         institutions, loan agreements, minutes, inquiry with the
         owner/manager, and work performed in other audit areas,
         determine if there are pledged, discounted, or assigned receivables.
         Practical Considerations:

         ¯ If the above procedures do not indicate the existence of such
         receivables, consider documenting this by stating “none noted”
         under the index column of this program.
         ¯ If existence of such receivables was noted, briefly summarize
         the financial statement disclosure in a memo or cross-reference to
         other audit workpapers where such information is summarized.
D, E        9. Based on work performed in previous steps and knowledge
         obtained in other audit areas, determine that the fo llowing accounts
         are identified for separate classification in the balance sheet.
            a. Large credit balances that should be classified as accounts
            b. Related party receivables.
            c. Material employee receivables.
            d. Material notes receivable.
            e. Noncurrent receivables that should be reclassified.
B           10. Evaluate whether evidence obtained in the preceding
         steps and from procedures in the audit of revenue is adeq uate to
         support the completeness assertion, i.e., whether all transactions
         are included in revenue and related accounts receivable balances.
         Practical Considerations:

         ¯ The procedures do not have to be complex or time-consuming.
         Evidence about completeness can be obtained by inquiry,
         observation, analytical procedures, tests of transactions, and
         management’s representations. See Chapters 3 and 7 for additional
         discussion of these procedures.
         ¯ The documentation of this step can be a brief memo or note in
         the workpapers. It should correlate the work performed in other
         areas such as analytical predictive tests in the revenue area.
A, [B]       11. Perform the following analytical procedures. For any
         significant differences noted, investigate the nature and cause of
         the differences and consider whether additional procedures are
         needed to test sales cutoff:
             a. Compare sales for the last month of the fiscal year to sales
         for the rest of the year and the first month after year end.
             b. Compare monthly sales returns and credit memos for the
         last few months of the fiscal year to the first few months following
         year end.
         Practical Considerations:

         ¯ Basic accounts receivable confirmation procedures and the
         preceding analytical procedures are usually adequate to test the
         sales cutoff. However, the following circumstances warrant
         consideration of performing additional cutoff tests:
         ¯¯ When accounts receivable are confirmed as of an interim
    ¯¯ When large quantities of merchandise awaiting shipment are
    noted during the year-end inventory observation.
    ¯¯ When there has been a large increase in sales during the last
    month of the year under audit or in the first month of the new year.
    ¯¯ When there has been a large increase in sales returns or credit
    memos in the first few months after year end.
    ¯¯ When the auditor’s knowledge of the client and/or
    understanding of internal control indicates a high risk of material
    misstatement of sales cutoff.
    ¯ When an analytical procedure is used as the principal
    substantive test of a significant financial statement assertion, SAS
    No. 56, Analytical Procedures, as amended by SAS No. 96, Audit
    Documentation, requires the auditor to document (1) the
    expectation and the factors considered in its development (unless
    readily determinable from the work performed), (2) the results of
    the comparison between the expectation and recorded amounts,
    and (3) any additional procedures performed in response to
    significant unexpected differences and the results of those
    procedures. SAS No. 96 is effective for audits of financial
    statements for periods beginning on or after May 15, 2002, with
    early application permitted.
*       12. Consider the need to apply one or more additional
    procedures. The decision to apply additional procedures should be
    based on a consideration of whether information obtained or
    misstatements detected by performing substantive tests or from
    other sources during the audit alter your judgment about the need
    to obtain a further understanding of control activities, the assessed
    level of risk of material misstatements (whether caused by error or
    fraud), and on an evaluation of whether the basic procedures have
    been sufficient to achieve the audit objectives. Attach audit
    program sheets to document additional procedures.
    Practical Considerations:

    ¯ Certain common additional procedures relating to the
    following topics are illustrated following this program:

    ¯¯   Year-end cutoff.

    ¯¯   Write-offs.

    ¯¯   Imputed interest.
    ¯¯    Interest on notes receivable.

    ¯¯    Related party receivables.

    ¯¯    Employee travel advances.

    ¯¯    Analytical procedures.

    ¯¯    Fair value disclosures.

    ¯¯    Noncurrent notes and accounts receivable.

    ¯¯    Collateralized accounts receivable.

    ¯¯    Accounts receivable confirmed at interim date.

    ¯¯    Transfers of receivables.

    ¯¯ Cash receipts.
    ¯ Practitioners may refer to PPC’s Guide to Fraud Investigations
    for more extensive fraud detection procedures if it is suspected that
    the financial statements are materially misstated due to fraud.
*       13. Consider whether procedures performed are adequate to
    respond to identified fraud risk factors. If fraud risk factors or other
    conditions are identified that require an additional audit response,
    consider those risk factors or conditions and the auditor’s response
    in connection with the performance of Step 11 in AP-1b.
    Practical Consideration:

    ¯ Specific responses to identified fraud risk factors are addressed
    in individual audit programs. In connection with evaluation and
    other completion procedures in AP-1b, the auditor considers the
    need to perform additional procedures based on the results of
    procedures performed in the individual audit programs and the
    cumulative knowledge gained from performing those procedures.
*       14. Consider whether the results of audit procedures indicate
    reportable conditions in internal control and, if so, add to the memo
    of points for the communication of reportable conditions. (See
    section 1504 for examples of reportable conditions, and see CX-18
    for a worksheet that can be used to document the points as they are
    encountered during the audit.)

    We have performed procedures sufficient to achieve the audit
           objectives for accounts receivable, and the results of these
           procedures are adequately documented in the accompanying
           workpapers. (If you are unable to conclude on any objective,
           prepare a memo documenting your reason.)

Additional Audit Procedures for Accounts Receivable
Instructions: Additional procedures will occasionally be necessary on some small
business engagements. The following listing, although not all- inclusive, represents
common additional procedures and their related objectives.

           Year-end Cutoff
A, [B]     Test the year-end cutoff procedures for sales to determine if
           receivables are recorded in the appropriate period.
              a. Scan the sales journals for one month before and after year
           end. Investigate any unusual entries.

              b. Review the journal for sales returns and credit memos for
           two months before and after year end. Investigate any unusual

              c. Trace the shipping documents for the last five shipments of
           the year and the first five shipments after year end to the sales
           journal to determine whether they were recorded in the proper
           Practical Considerations:

           ¯ Normally, the shipping documents will have already been
           identified at the year-end inventory observation. (See basic
           procedure 6a at AP-5.)
           ¯ Basic accounts receivable confirmation procedures and the
           preceding analytical procedures are usually adequate to test the
           sales cutoff. However, the following circumstances warrant
       consideration of performing additional cutoff tests:
       ¯¯ When accounts receivable are confirmed as of an interim
       ¯¯ When large quantities of merchandise awaiting shipment are
       noted during the year-end inventory observation.
       ¯¯ When there has been a large increase in sales during the last
       month of the year under audit or in the first month of the new year.
       ¯¯ When there has been a large increase in sales returns or credit
       memos in the first few months after year end.
       ¯¯ When the auditor’s knowledge of the client and/or
       understanding of internal control indicates a high risk of material
       misstatement of sales cutoff.

C      Select individual accounts that were written off during the audit
       period. Determine that the entries were properly approved by the
       owner/manager. Document the items tested.
       Practical Consideration:

       ¯ This is a fraud test and should not be performed unless the
       auditor suspects that improprieties have occurred.

       Imputed Interest
A, E   Review accounts and notes receivable to determine if any interest
       should be imputed for significant balances that are due in excess of
       one year from the balance sheet date. Also consider proper balance
       sheet classification of such receivables.
       Practical Consideration:

       ¯ Extended term accounts receivable are rare but can arise when
       a company establishes payment terms for its trade accounts
       receivable based on a poor economy or difficulty with some key
       customers. Normally, this type of interest should not be accrued,
       but instead be recognized on a cash basis.

       Interest on Notes Receivable
A, E   For significant notes receivable, test the reasonableness of interest
       earned and any prepaid or accrued interest receivable.
         Related Party Receivables
D, [A]   If related party receivables are material, prepare or obtain an
         analysis of advances to directors, officers, employees, stock holders,
         and other affiliated parties and perform the following steps:
             a. Recompute the total balance and determine that it agrees
         with the balance in the general ledger or the detailed trial balance.

           b. Review the list for potential problem accounts or large

            c. Identify the purpose for advances and their potential
         collectibility. Determine if such advances should be reflected as
         dividends or salary.

             d. If the balances are significant, consider confirmatio n of
         several selected individual balances with the employees or
         affiliated parties and reconcile replies. Retain copies of all
         confirmations in the workpapers.
             e. Determine that such advances have been properly approved
         by individuals appropriate under the bylaws of the company.

            f. Determine the nature of any accounts receivable from such
         parties that were written off during the audit period but
         subsequently reinstated to the general ledger.
         Practical Consideration:

         ¯ These steps should be coordinated with the related party
         procedures in the general program.

         Employee Travel Advances
A, [D]   Obtain or prepare a schedule of the detailed balances included in
         employee travel advances and perform the following steps:
            a. Recalculate the schedule to determine the clerical accuracy
         and determine that the total balance agrees with the general ledger.

             b. Compare individual information with the source records on
         a test basis. Document the items tested.
             c. Confirm account balances with individual employees if the
         total amount is significant (this is very rarely the case) and
         reconcile replies. Retain copies of all confirmations in the

              d. Determine whether there is a proper cutoff of expense
           advances with the last payroll for year end.
           Practical Consideration:

           ¯ In most cases, small businesses do not generate a significant
           amount of employee advances. These advances should normally be
           cleared on a regular basis and, thus, should not grow to significant

           Analytical Procedures
[A],[B],   Apply analytical procedures to accounts receivable by determining
[C]        the following and comparing to percentages maintained in the
           permanent audit file:
              a. Trade receivables divided by current assets.

              b.   Trade receivables divided by total assets.

              c.   Trade receivables divided by net worth.

              d.   Net sales divided by trade receivables.

              e. Trade receivables divided by (net sales divided by 360).
              f. Determine the cause of any significant fluctuations in these
           Practical Consideration:

           ¯ Normally, these analytical procedures should only be
           performed when the auditor feels additional evidence is necessary
           beyond that obtained by basic procedures identified earlier in the

           Fair Value Disclosures
E          Obtain information about the fair values of financial instruments
           (e.g., trade accounts receivable and notes receivable) for disclosure
           in the financial statements.
           Practical Considerations:

           ¯ SFAS No. 126, Exemption from Certain Required Disclosures
           about Financial Instruments for Certain Nonpublic Entities: An
Amendment of SFAS No. 107, makes SFAS No. 107’s disclosures
about the fair value of financial instruments optional for companies
that meet the following criteria:
¯¯ The company is a nonpublic company.

¯¯ The company’s total assets are less than $100 million on the
date of the financial statements.

¯¯ The company has no instrument that, in whole or in part, is
accounted for as a derivative instrument under SFAS No. 133
during the reporting period.
¯ Unless the client provides extended repayment terms (e.g., in
excess of 90 days), the carrying amount of accounts receivable will
ordinarily approximate their fair value and no disclosure is required
by SFAS No. 107.

¯ The carrying amount of notes receivable will ordinarily
approximate fair value. However, if the interest rate on the note is
significantly more or less than current market rates, fair value can
be determined by discounting future cash flows at an appropria te
rate, considering the relative risk associated with the note. SFAS
No. 107 indicates that one option is for the company to use the rate
at which the same loan would be made under current conditions.
¯ Fair value may be affected by the risk that the customer or
borrower will default. If the risk of default is remote, it is generally
possible to value the receivable by discounting future cash flows. If
the risk of default is probable, fair value can be determined by
valuing the collateral and any secondary sources of repayment
(such as payments made by the business owner). However, if the
risk of default falls somewhere between remote and probable, fair
value estimates will require significant judgment.
¯ Interpretation No. 1 of SAS No. 57, Auditing Accounting
Estimates (AU 9342), addresses auditing the client’s fair value
estimates for disclosures required by SFAS No. 107. The
Interpretation requires that the auditor obtain sufficient competent
evidence to provide reasonable assurance that:
¯¯ Valuation principles are in accordance with SFAS No. 107,
consistently applied, and supported by underlying documentation.
¯¯ The method of estimation and significant assumptions used
are properly disclosed.
¯ Paragraph 60 of SFAS No. 107 allows companies to use
simplified assumptions to estimate fair value of financial
instruments. Consequently, it is important that the methods and
significant assumptions used in the estimates are disclosed.
¯ If a fair value estimate is based on the work of an outside
    specialist (e.g., an appraiser), the requirements of SAS No. 73,
    Using the Work of a Specialist, should be followed. The additional
    procedures to AP-1 contain audit procedures regarding using the
    work of a specialist.
    ¯ AU 9342 provides additional guidance for situations in which
    the client chooses to provide voluntary fair value information in
    addition to that required by SFAS No. 107.
    ¯ SFAS No. 107 does not require that fair values of financial
    instruments be estimated if it is not practicable, or cost effective, to
    develop the estimates. The decision of whether it is practicable
    should consider such things as the importance of the financial
    instrument to the client’s business activities and the materiality of
    the carrying amount of the financial instrument to the financial
    ¯ When it is not practicable to estimate the fair value of a
    financial instrument, disclosure must be made of:
    ¯¯ Information pertinent to estimating the fair value of the
    financial instrument.

    ¯¯     The reasons why it is not practicable to estimate fair value.

    Noncurrent Notes and Accounts Receivable
E   For notes and accounts receivable with maturities greater than one
    year, perform the following procedures:

       a. Evaluate whether the interest and contractual principal
    payments will be collected in accordance with their contractual

        b. If either interest or principal payments will not be collected
    in accordance with their contractual terms, determine whether an
    allowance for credit loss has been computed using one of the
    following methods:
        (1) The present value of expected future cash flows
    discounted at the receivable’s effective interest rate.

         (2)   The receivable’s observable market price.

       (3) The fair value of the collateral (if the receivable is
    collateral dependent).
          Collateralized Accounts Receivable
C         If collateralized accounts receivable are significant, examine
          collateral for existence, ownership, and its fair value.
          Practical Considerations:

          ¯ Some evidence of ownership includes a bill of sale, a title, a
          deed, or a mortgage.
          ¯ Depending on the type of collateral being evaluated, the
          auditor may evaluate the reasonableness of the client’s estimate of
          the fair value of the collateral by using a security or commodity
          quotation, appraisal, assayer’s or other expert’s report, blue book,
          or other general source.

          Accounts Receivable Confirmed at Interim Date
A, [B],   If accounts receivable were confirmed at an interim date, perform
[C]       the following steps:
              a. Obtain a detailed aged accounts receivable trial balance at
          the balance sheet date and perform the following:
              (1) Obtain or prepare a reconciliation of the trial balance to
          the general ledger control account. Examine support for significant
          reconciling items.
              (2) Compare trial balance totals between the balance sheet
          date and the interim date. Investigate significant variations.
              (3) Identify any significant changes in the aging of accounts
              b. Scan receivables activity in the accounting records during
          the period from the interim date to the balance sheet date.
          Investigate and explain the nature and origin of any unusual entries.

             c. Perform a test of sales cutoff at the balance sheet date.
          Practical Considerations:

          ¯ In most small businesses, it is more efficient to confirm
          accounts receivable as of the balance sheet date to avoid incurring
          the additional time necessary to bring the accounts receivable
          balances forward to year end. Section 207 discusses factors to
          consider when deciding whether to confirm accounts receivable as
          of an interim date.

          ¯ If the results of the rollforward procedures are unsatisfactory,
          consider the need to confirm accounts receivable as of the balance
          sheet date.
       Transfers of Receivables
D, E   If the company has transferred receivables to a third party,
       determine whether the transaction has been accounted for in
       accordance with SFAS No. 140.
       Practical Considerations:

       ¯ Section 302 of PPC’s Guide to Preparing Financial Statements
       discusses accounting for transfers of receivables in accordance with
       SFAS No. 140, Accounting for Transfers and Servicing of
       Financial Assets and Extinguishments of Liabilities.
       ¯ An auditing interpretation of SAS No. 73 (AU 336), Using the
       Work of a Specialist, titled The Use of Legal Interpretations as
       Evidential Matter to Support Management’s Assertion That a
       Transfer of Financial Assets Has Met the Isolation Criterion in
       Paragraph 9(a) of Financial Accounting Standards Board
       Statement No. 140, provides guidance to auditors about obtaining
       evidential matter to determine the proper accounting treatment
       under SFAS No. 140.

       Cash Receipts
*      If the auditor, based on his or her consideration of fraud risk
       factors, decides to modify procedures related to customer cash
       receipts, consider performing a proof of cash (see additional
       procedures at AP-2). In addition, consider verifying the following:
           a. The dates of cash receipts and deposit tickets are identical.
           b. The total amounts on the daily cash receipts list and daily
       deposit slips agree.
           c. The customer’s name and deposit amounts should be the
       same on the daily cash receipts journal and the subsidiary ledger.
           d. Deposit slip totals are accurate.
           e. Review customer complaints.
           f. Search for write-offs that are unusual, such as write-offs of
       balances due from continuing customers.
           g. Review credit memos.
       Practical Consideration:

       ¯ Practitioners may refer to PPC’s Guide to Fraud Investigations
       for more extensive fraud detection procedures if it is suspected that
       the financial statements are materially misstated due to fraud.
Additional Audit Procedures for Accounts
Receivable Beginning Balance in Initial Audit
Company           Balance Sheet Date

Audit                                                                               N/A       Workpaper
Objectives                                                                          Performed Index
             Audit Procedures for Consideration                                     by
             Instructions: Additional procedures will be necessary in an
             initial audit. These procedures are applied to opening balances and
             differ depending on whether you are relying on your review of a
             predecessor’s work or placing no reliance on a predecessor’s audit.
             (Section 1803 discusses considerations when replacing a
             predecessor auditor, including a discussion of what the term
             reliance means when used in this program.) These procedures may
             be applied in conjunction with the basic procedures applied to the
             ending balance. The asterisks preceding the procedures indicate
             that they are an intermediate step in achieving audit objectives for
             the ending balance.
*                1. If a predecessor’s audit of the prior period’s financial
             statements is to be relied on:
                 a. Review the predecessor’s workpapers containing the aged
             trial balance of receivables, including the posting of subsequent
             cash collections and the summary of confirmation results; consider
             the adequacy of confirmation coverage and results.
                 b. Review the predecessor’s workpapers on the adequacy of
             the allowance for doubtful accounts; consider the adequacy of
             procedures and the reasonableness of the conclusion on the
             balance. Note the method of determining the balance and compare
             to the method used in the current period.
                 c. Identify significant noncash credits to receivables during
             the first three months of the current period and consider whether
             they relate to the prior period. Document any items tested.
*                2. If no reliance on a predecessor’s audit is planned or
                 a. Scan the aged trial balance of opening accounts receivable,
             foot the schedule, and trace the total to the general ledger control
                 b. Scan the general ledger control account for significant
             noncash credits (write-offs or sales returns and allowances) for the
             first three months of the current period; consider whether they
             relate to the prior period. Document any items tested.
                 c. Compare cash collections in the first two months of the
current period with the prior period accounts receivable balance.
   d. Compare sales in the first month of the current period with
sales in the last month of the prior period; consider the
reasonableness of the sales cutoff.
   e. Obtain and scan a summary of the activity in the allowance
for doubtful accounts for the prior period; note the method of
determining the balance and compare to the method used in the
current period.
   f. Compare the following ratios for the current period to the
same ratios in the two prior periods.
   (1) Age categories to receivables.
   (2) Receivables to sales.
   (3) Allowance for doubtful accounts to receivables and sales.
Practical Considerations:
¯ Watch for major customers on the prior period trial balance
not on the current period closing trial balance, unusually large
noncash credits, and indications of improper cutoff.
¯ See the practical considerations for basic procedures 1 and 7.

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