Accounts receivable are usually material items on the balance sheet; hence to audit accounts receivable, it is very important to perform proper audit procedures in order to obtain sufficient audit evidence for making appropriate conclusion on receivables.
In the audit of accounts receivable, the inherent risk of accounts receivable involves more on the existence of their balances. This is due to the client’s accounts receivable usually expose to the risk that is related to the intentional manipulation of sales in order to reach the target sales or an actual fraud to steal the products.
An example of accounts receivable manipulation would be the client’s personnel may persuade or collude with the customers to buy the products on credit and promise to have them return products to the company after year-end to increase sales at year-end in order to achieve the target sales. In this case, the accounts receivable balance here should not exist in the first place as the customers will return the goods after the year-end.
As auditors, we usually perform audit procedures on accounts receivable by testing the audit assertions such as existence, valuation, completeness, and right and obligation. Also, accounts receivable are usually tested together with the sale revenue transactions in the client’s account.
In the audit of accounts receivable, we usually test the audit assertions included in the table below:
Existence assertion tests whether the accounts receivable on the balance sheet actually exist. Similar to other asset items, the existence is usually the major auditing issue for us when we perform the audit of accounts receivable.
This is due to receivable is likely to be a material area and its inherent risk is usually related to fraud and sales revenue manipulation. In order to test existence on accounts receivable, the confirmation is usually made by sending the letter to the client’s customers asking them to confirm whether they really owe such amount to the client.
As the process of confirmation procedures, from preparation confirmation letter until receiving back the confirmation letter, usually takes some time especially after the letter was sent out, we usually perform the accounts receivable confirmation at the early of the audit fieldwork.
In the audit of accounts receivable, we can achieve two objectives in performing the receivable confirmation. First, we can verify the existence of the customer’s balances; second, we can ensure the correctness of those balances.
There are two types of confirmation, positive confirmation and negative confirmation, as included in the table below:
In the case that the amount is incorrect, in which the customer’s account is not agreed to the client’s account, the customer still needs to indicate the correct amount on the letter and send it back to us. We will make further investigation on the issue.
We usually only perform this type of receivable confirmation when the assessed level of risk of material misstatement on accounts receivable and related accounts are low and there is a large number of small customers in the accounts receivable balance.
Valuation assertion tests whether the accounts receivable recorded in the client’s accounts reflect their actual economic value. Though the receivable confirmation in the audit of accounts receivable mentioned above can ensure the existence and the accuracy of customers’ balances, it cannot provide evidence on the correctness of accounts receivable valuation.
For example, the client’s customers may confirm on the letter that they really owe such amount to the client. However, they may not have sufficient resources to pay the debt that they owe at all.
We usually test valuation by performing both substantive analytical procedures and tests of details. In substantive analytical procedures, we usually compare figures and ratios with the previous year and industry average.
Completeness assertion tests whether all accounts receivable have been recorded. Lack of completeness usually results in the understatement of the accounts and balance; in this case, as we audit accounts receivable, the lack of completeness means the understatement of accounts receivable balances.
Right and obligation assertion tests whether the client has the right of control on all accounts receivable show on its financial statement. The concern in the audit of accounts receivable is usually on the factoring of the receivables in which the client should no longer have the right of control to receivables.
This is because the control should have been transferred when the company sold or factored its receivable. Hence, the factored receivables should be removed from the balance sheet.
We usually test the right and obligation assertion on accounts receivable by making inquiries of management on factoring matter, reviewing the loan agreement and reviewing board minutes for any evidence that receivables have been sold or factored.
All in all, accounts receivable’ existence and valuation are the primary concerns for us as auditors. The existence of accounts receivable itself is the high-risk area as the misstatement in this area could be due to fraud or manipulation of sales.
On the other hand, misstatement occurred in the area of valuation usually tends to be an overstatement of net receivables as the client might forget to make sufficient allowance for receivables or they are perhaps not willing to make sufficient allowance as the bigger allowance means the bigger expense, hence the lower profit.