Discussion of audit of account receivables in financial statement audit

THE NATIONAL ECONOMICS UNIVERSITY CENTER FOR ADVANCED EDUCATIONAL PROGRAMS AUDITING PROJECT Topic DISCUSSION OF AUDIT OF ACCOUNT RECEIVABLES IN FINANCIAL STATEMENT AUDIT Name NGUYỄN MỸ HẠNH Student’s[.]

THE NATIONAL ECONOMICS UNIVERSITY

CENTER FOR ADVANCED EDUCATIONAL PROGRAMS

AUDITING PROJECT

Topic:

DISCUSSION OF AUDIT OF ACCOUNT RECEIVABLES IN

FINANCIAL STATEMENT AUDIT

Student’s Code : 11141338

HANOI, 2017

TABLE OF CONTENTS TABLE OF CONTENTS

List of abbreviations

List of tables

INTRODUCTION 1

CHAPTER 1 THEORETICAL FRAMEWORK OF AUDIT OF ACCOUNT RECEIVABLES IN FINANCIAL STATEMENT AUDIT 2 1.1 Account Receivables and Its Accounting 2

1.1.1 The Role of Account Receivables 2

1.1.2 The Impact of Overstating Account Receivable 2

1.1.3 Common Material Misstatement of Account Receivables 3

1.1.4 Accounting for Account Receivables 4

1.2 Audit of Account Receivables 4

1.2.1 Audit Objectives 4

1.2.2 Audit Process 6

CHAPTER 2 CURRENT SITUATIONS OF AUDIT OF ACCOUNT RECEIVABLES IN FINANCIAL STATEMENT AUDIT 13

2.1 Auditing Receivable Accounts at ABC Company implemented by Auditing and Consulting company DCPA 13

2.2 Audit Completion of Audit Receivables 29

CHAPTER 3 ASSESSMENT AND RECOMMENDATIONS FOR IMPROVING AUDIT OF ACCOUNT RECEIVABLES IN FINANCIAL AUDIT 30

3.1 Evaluations of Audit of Account Receivables in Financial Statement Audit 30

3.1.1 Strengths 30

3.1.2 Weaknesses 31

3.2 Recommendations for Improving Audit of Account Receivable

in Financial Statement Audit 31

3.2.1 The Audit Process in Audit of Accounts Receivables 31

3.2.2 Skills of auditors 31

CONCLUSION 32

REFERENCES 33

LIST OF ABBREVIATIONS

LIST OF TABLES

Table 2.1: Summary of receivables accounts 23

Table 2.2: A summary of detailed account receivables per customer 24

Table 2.3: A summary of contra account 24

Table 2.4: Account receivable confirm letter 25

Table 2.5: Detail of account receivables 27

As an integral part of the economic management system, auditing is becomingincreasingly important and necessary not only for government managementagencies but also for business managers, investors The information whichprovided by the audit is a reliable sources for the government to recognize,evaluate and properly handle the emerging economic problems and to serve as thebasis for investors, managers when making business decisions

In particular, auditing financial statements is one of the most characteristic types

of auditing Through the information which obtained by the audit process, we canknow the situation of assets, capital as well as the debt situation, payment of debt

of the company With the function of verifying and expressing opinions onfinancial statements, financial statement audits not only function to verify thetruthfulness of the information on the financial statements but also help investors,managers make the right decisions

In particular, receivables are a large item on the financial statements Therefore,audit this account is very important in the audit process It tells us about thecompany's financial position, its ability to pay, as well as its capital position Fromthat we can make decision whether the company is doing business effectively ornot Acknowledging the importance of account receivable, I chose the topic:

"Discussion of audit of accounts receivable in financial statement audit.”

Apart from the introduction and the conclusion section, the audit project consists

CHAPTER 1

THEORETICAL FRAMEWORK OF AUDIT OF ACCOUNT

RECEIVABLES IN FINANCIAL STATEMENT AUDIT

1.1 Account Receivables and Its Accounting

1.1.1 The Role of Account Receivables

The developing of society leads to the complication of economic activity andother social relation The most economical information is finance information,which contains more risks, more variances and reliability decreases Therefore,auditing activities was created

Auditing was developed in parallel with economic activities Audit plays a bigrole in building trust between investors, banks, stockholders, government withcompany Moreover, audit helps consolidate accounting activity, strengthens thenational financial system and promotes economic growth

The audit of financial statement is the most characteristic audit activity Financialaudit is an activity to verify and express an opinion on the level of fair andreasonable present in the material aspects of the items in the financial statement

on the basis of audited evidences Audit of account receivables has the samepurpose Moreover, audit of account receivables contributes checking the level ofaccuracy of revenues and sales on credit in accounting period because it has directrelationship to each other Audit of account receivables also helps collectevidences in relation to expense accounts such as allowance for doubtful account.From that, checking the accuracy of profit in accounting period

Besides, account receivables is a part of assets of a company Audit this accounthelps auditor check partially the honesty of some assets accounts of the companyand the current ratios also

Accounts receivable is an account that easy to have misappropriation of assets,especially the company which has big amount of accounts receivable and thoseaccounts receivable have lasted for many years, could lead to the situation thatemployee did not record the amount account receivable which was received Theaudit of accounts receivable and detect misstatements are necessary to decreaserisks for client and improve the effective of internal control

1.1.2 The Impact of Overstating Account Receivable

Accounts Receivable Reporting

Accounts receivable represent the amount of cash that a business expects from itsclients, the term typically pertains to credit transactions When a companyoverstated its accounts receivable, it mean that the company recorded morereceivables than customers owed The terms “understatement” and

“overstatement” generally fall under the concept of misstatement, which mightinvite the scrutiny of regulators as diverse as the Internal Revenue Service, theTreasury Department and the Securities and Exchange Commission

Overstated accounts receivable affect not only the balance sheet but also effect onreported income and equity However, overstating accounts receivable has noeffect on a company’s cash flow.

Balance Sheet

When an organization overstates its accounts receivables, the “short-term assets”section of balance sheet increases This results in a statement of financial positionthat’s incorrect and not in line with accounting standards Besides accountsreceivables, elements such as cash, merchandise and prepaid expenses constituteshort-term resources

Income Statement

Overstating accounts receivables leads to overstating sales revenue, which isintegral to income statement It means the reporting business made more moneyduring accounting period, leading to higher revenues and net income

Cash Flow Statement

When manager prepare statement of cash flows, they translate an overstatement ofthe accounts receivables into a decrease in the cash account, subtracting theincrease in receivables from net income A company’s receivables go down when

it receives money from customers Therefore, accounts receivables increases makemore income but less cash in cash flows from operating activities

Statement of Shareholders’ Equity

Overstating receivables account positively affects retained earnings An increase

in retained earnings means an increase in the company equity statement becauseretained earnings are integral to the report

1.1.3 Common Material Misstatement of Account Receivables

When performing audits, the auditors as well as the auditing companies areconcerned about the audit risk It is the risk that the audit report does not express

an honest opinion of the truthfulness and reasonableness according to materialaspects of the financial statements or items on the statement This will greatlyaffect the image and reputation of the auditing company in general and thereputation of the auditors in particular Therefore, when conducting the audit, it isnecessary to understand the nature of the item and control the risk of the audit.The following is common material misstatement when auditing accountsreceivable in financial audits:

 Reported receivables and sales could be false False sales are especiallylikely if:

 Reported income is down for the period

 Employee compensation or bonuses are based on profits

 Company intends to issue stock or borrow money in the near future

 Incoming cash is stolen It is done by unethical accountant by writing offreceivable account as a bad debt account

 Lapping is carried out Cash from one receivable account is stolen andcovered by cash received from another customer during the following day

or two

 The year end cut – off of transactions is recorded incorrectly Transactionsoccurred near before the year end could be recorded in the followingperiod

 Transactions after the end of year could be recorded early in the initialyear

 Incorrect amount in invoices (because of mathematic errors, wrong items,wrong quantity, wrong price ) or customer is not billed at all of goods thatwere actually shipped

1.1.4 Accounting for Account Receivables

 Account receivables are accounted for in detail for each customerreceivable to be collected and recorded on each payment Objects ofreceivables are those having economic relations with the company onrelation to products, goods and services

 Does not record on this account sales transactions that payment is collectedimmediately (cash, checks, pay through the bank)

 Customer who pay their payable by selling their goods or services to thecompany , need to reach an agreement with the company about the debtclearing document

 In accounting for this account, the accountant must classify the debts, thepayments can be paid on time In case of bad debts or uncollectibleaccounts at the end of the accounting period, it is necessary to set upallowance for uncollectible account or take actions to handle them

 In the relationship of products, goods and services, under the agreement ofthe company with the customer, if the goods have been delivered or theservices have been provided are not in accordance with the agreement inthe economic contract, the customer has the right to ask for a discount orget back money

1.2 Audit of Account Receivables

1.2.1 Audit Objectives

Receivables is refer to amounts that come from sales of merchandise, services, other assets, or ass a result of a loan

Generally, receivables fall into one of three following categories:

 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 come from employees, stockholders, officers, management, or affiliates

Because account receivables is related to management manipulation in several ways, it often seen to have significant risk If a company is doing fraud by

overstating revenues with fictitious sales, the amounts would be included in accounts receivable at period-end Therefore, if management is to overstate

earnings, existence of accounts receivable will likely be a significant risk What’s more, by adjusting the valuation of recorded receivables, management can

manipulate financial results The valuation of accounts receivable is an important area, where hypothesis can be challenged based on additional information

obtained after the balance sheet date Which is why, 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 Dependingon:

 The assumptionsof the company’s overall internal control environment

 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 For example: accounts receivable are

authentic obligations owed to the company at the date of the balance sheet

• Completeness For example: accounts receivable include all amounts owed to the company at the date of the balance sheet

• Rights and obligations For example: pledged, discounted, or assignedaccounts receivable are properly disclosed

• Cutoff For example: accounts receivable are recorded in the proper period

• Valuation or allocation For example: allowance for doubtful accounts

is adequate but not excessive

• Accuracy or classification For example: 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 accountswhich is related to revenues In some cases, tests of controls supporting the

completeness assertion may be necessary, 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 toinquiry, observation, and substantive analytical procedures

According to Auditing and Assurance Services by Alvin A Arens, In designing tests of details of balances for accounts receivable, auditors must satisfy each of the eight balance-related audit objectives These eight general objectives are the same for all accounts Specifically applied to accounts receivable, they are called accounts receivable balance-related audit objectives and are as follows:

1 Accounts receivable in the aged trial balance agree with related master file amounts, and the total is correctly added and agrees with the general ledger (Detail tie-in)

2 Recorded accounts receivable exist (Existence)

3 Existing accounts receivable are included (Completeness)

4 Accounts receivable are accurate (Accuracy)

5 Accounts receivable are correctly classified (Classification)

6 Cutoff for accounts receivable is correct (Cutoff)

7 Accounts receivable is stated at realizable value (Realizable value)

8 The client has rights to accounts receivable (Rights)

1.2.2 Audit Process

1.2.2.1 Audit Planning

The company always considers audit planning to be a top priority task whenstarting an audit There are three main reasons why the auditor must plan the auditproperly:

(1) to enable the auditor to obtain sufficient and effective evidence in all

circumstances

(2) keep auditing costs reasonable

(3) avoid disagreements with customers

In the audit planning phase, there are six main parts outlined in the followingdiagram:

Diagram 1.1: 6 parts of audit planning

Planning an audit is to prepare material and technical conditions, people, timeneeded to conduct audits During the planning process, the auditor takes intoaccount the relationship between the items, such as customer receivables inrelation to revenue, cash, financial expenses

If the goods and cash received are assets that exist under specific material forms,

it is possible to combine inventory with other auditing methods so that customerreceivables are not so easily verified The receivables audit uses a particular

method of sample selection and confirmation The auditor must consider thisfeature to plan a confirmation letter (cost, delivery time )

Based on the characteristics of each client, the level of significance and risk of theinitial audit, the auditor applies the audit program accordingly, and supports therelevant audit sections in the process of auditing financial statement

Prepare the plan

The auditor obtains an understanding of the controls by

 Walk-through of the processing of transactions

 Inquiry

 Observation

 Review of client documentation

It is critical this understanding be documented in the work papers

Internal control procedures should be sufficient to ensure the management

assertions are achieved:

 Existence/Occurrence: all sales transactions are recorded only whenshipment has occurred and the primary revenue producing activity hasbeen performed

 Completeness: all valid sales transactions are recorded

 Rights/obligations

 Valuation

 Presentation and disclosure

 Substantive Tests of Accounts Receivable Existence & Occurrence

Valuation

 Are sales and receivables initially recorded at their correct amount?

 Will client collect full amount of recorded receivables?

Rights and Obligations

 Contingent liabilities associated with factor or sales arrangements

 Discounted receivables

Presentation and Disclosure

 Pledged, discounted, assigned, or related party receivables

 Substantive audit procedures for accounts receivable

 Obtain and evaluate aging of accounts receivable

 Confirm receivables with customers

 Perform cutoff tests

 Review subsequent collections of receivables

Aging Accounts Receivable

Because receivables are reported at net realizable value, auditors must

evaluate management estimates of uncollectible accounts

 Auditor will obtain or prepare schedule of aged accounts receivable

o If schedule is prepared by client, it is tested for mathematical andaging accuracy

 Aging schedule can be used to

o Agree detail to control account balance

o Select customer balances for confirmation

o Identify amounts due from related parties for disclosure

o Identify past-due balances

 Auditor evaluates percentages of uncollectibility

 Auditor then recalculates balance in the Allowance account

Confirming Receivables with Customers

Confirmations provide reliable external evidence about

 Existence of recorded accounts receivable and

 Completeness of cash collections, sales discounts, and sales returns andallowances

Confirmations are required by GAAS unless one of the following is present:

 Receivables are not material

 Use of confirmations would be ineffective

 Environment risk is assessed as low and sufficient evidence is availablefrom using other substantive tests

The Confirmation Process

The auditor should exercise an appropriate level of professional skepticismthroughout the confirmation process Professional skepticism is important indesigning the confirmation request, performing the confirmation procedures, andevaluating the results of the confirmation procedures

Designing the Confirmation Request

Confirmation requests should be tailored to the specific audit objectives Thus,when designing the confirmation requests, the auditor should consider theassertion(s) being addressed and the factors that are likely to affect the reliability

of the confirmations Factors such as the form of the confirmation request, priorexperience on the audit or similar engagements, the nature of the informationbeing confirmed, and the intended respondent should affect the design of therequests because these factors have a direct effect on the reliability of the evidenceobtained through confirmation procedures

Types of Confirmations

Positive confirmations

 Customers are asked to agree the amount on the confirmation with theiraccounting records and to respond directly to the auditor whether theyagree with the amount or not

 Positive confirmation requires a response

 If customer does not respond, auditor must use alternative proceduresNegative confirmations

 Customers are asked to respond only if they disagree with the balance(non-response is assumed to mean agreement)

 Less expensive since there are no additional procedures if customer doesnot respond

 May be used when all of the following are present

o Confirming a large number of small customer balances

o Environment risk for receivables is assessed as low

o Auditor believes customers will give proper attention toconfirmations

What is the follow-up procedures for non-responses?

If customer does not respond to positive confirmation, auditor may send a second,

or in some case, third request

If customer still does not respond, auditor will use alternative procedures

 Examine the cash receipts journal for cash collected after year-end

 Care is taken to ensure receipt is year-end receivable, not subsequent sale

 Examine documents supporting receivable (purchase order, sales invoice, shipping documents) to determine if sale occurred prior to year-end

 Evidence gathered from internal documents is not considered as reliable

What is the follow-up procedures for exceptions noted?

Customers are asked to agree the amount on the confirmation to their accounting records The differences are called exceptions

There are some reasons for exceptions:

Amounts due from related parties should be separately disclosed

Audit procedures to identify related-party transactions include:

 Review SEC filings

 Review the accounts receivable subsidiary ledger and trial balance

Receivables sold with recourse, discounted, or pledged as collateral should be disclosed.

Audit procedures to identify these items include:

 Management inquiry

 Scan cash receipts journal for large cash inflows from unusual sources

 Bank confirmations, which include information on obligations and terms

 Review board of director minutes, which contain approval for these items

Fraud Indicators and Audit Procedures

 Potential fraud indicators:

o Excessive credit memo or other adjustments to accounts receivable just after year-end

o Customer complaints and discrepancies in receivable confirmations

o Unusual entries to the receivable subsidiary ledger or sales journal

o Missing or altered source documents

o Lack of operating cash flow when operating income has been

reported

o Unusual reconciling differences between receivable subsidiary ledgerand control account

o Sales in the last month with unusual terms

o Pre- or post-dated transactions

o Unusual adjustments to sales accounts just before or after year-end

 Substantive procedures that may highlight potential fraud indicators:

o Review of source documents including invoices, shipping

documents, customer purchase orders, etc

o Review and analyze credit memos and other adjustments to

receivables

o Confirm sales terms with customers

o Analyze large or unusual sales made near year-end

o Scan the general ledger, receivables subsidiary ledger, and sales journal for unusual activity

o Perform analytical review of credit memo and write-off activity

o Analyze recoveries of written-off accounts

Explain Auditing of Allowance for Doubtful Accounts

 Accounts receivable should be reported at their net realizable value

 The balance of the allowance for doubtful accounts is estimated and

depends on a number of factors

 Understating the allowance overstates net accounts receivable and net income

 Where accounts receivable are material, the auditor should obtain an understanding of how management developed the estimate by using one or more of these approaches:

o Review and test the process used by management to develop the estimate

- Test aging schedule

- Evaluate estimated percentages of uncollectibility used

o Develop an independent model to estimate the accounts

Review subsequent events such as subsequent collections on account

1.2.2.3 Audit Completion

After conducting the audit and giving the findings The auditor will hold adiscussion with the board of directors of the client company to discuss correctiveentries and to find consistency between the two parties The audit report willdepend heavily on whether the customer is adjusting to the opinion of the auditor.The auditor will then make a minutes of the meeting The minutes of the meetingwill be evidence of the completion of the audit work and shall be kept in the auditfirm’s audit file

Finally, the auditors shall prepare the audit report An audit report is an auditconducted in accordance with Vietnamese Standards on Auditing as to thefairness of financial information as well as the compliance with currentaccounting standards and practices of the information presented in the financialstatements Depending on the results of the audit, the auditors have included inthe audit report one of the following four types of opinions:

 Unqualified opinion: when the auditor considers that the financialstatements accurately and fairly reflect the material aspects of the financialposition of the entity being audited

 Qualified opinion: If the auditor considers that the financial statementsonly give a true and fair view of the financial position of the entity, if it isnot affected by it Dependent factors that the auditor has stated in the auditreport

 Adverse opinion: given in the case of limitation of scope of audit isimportant or lack of information related to a large volume of items

 Disclaimer opinion: given in the case of disagreement with the board ofdirectors critical issues

The report is made at the auditor’s office After completing the audit team, theauditor will review the final report and send it to the customer In some auditingcompanies, auditing reports are issued in both Vietnamese and English, thenumber of reports issued depends on the requirements of customers, including atone auditing company English and Vietnamese

After the release of the audit report, the auditors of the company always keep intouch with the board of directors of the client company Thereby grasp thesituation of the company

CHAPTER 2 CURRENT SITUATIONS OF AUDIT OF ACCOUNT RECEIVABLES IN

FINANCIAL STATEMENT AUDIT 2.1 Auditing Receivable Accounts at ABC Company implemented by

Auditing and Consulting company DCPA

2.1.1 Design Audit Program of Accounts Receivables of DCPA Auditing

Specifically, the general audit plan at DCPA is structured in the following order:

 Understand business activities, business objectives, form of ownership,

to increase the understanding of client company

 Arranging personnel, expected time, place of audit, for the audit

 Expected documents needed by the client company

 Observe, interview, inquiry the company’s internal control

 Determine the materiality level for the whole financial statement and thenallocate it to the accounts

 Risk Assessment: In all audits, auditor always has to pay attention to riskassessment The level of risk depends on each company and is determinedat: high, medium and low Auditor determines the audit risk assessmentbased on desired audit risk for each item

 Plan to perform some other tasks

2.1.1.2 Develop Audit Program of Account Receivables at DCPA Auditing

 Estimate the material level of account receivables

 Risk assessment in the audit of account receivables

 Do some other work

 Design audit program of receivables receivable at DCPA Auditing andConsulting Co., Ltd

As described above, after learning the business characteristics, internal controlsystems, of the client The Company’s auditors rely on the sample auditprogram that builds up the audit program for the accounts Specifically, for thereceivables, the audit program is as follows:

Table 2.1: Auditing program receivables customers

Content Performed day Performed person Reference

1 Audit procedures

- Plan to meet client to

investigate information about

client

- Collecting a summary

detailed of accounts

receivable, including:

Opening balance, arising in

the period, ending balance -

Performing the reconciliation

of data on the summary

detailed of debts with general

ledger, detailed accounting

books and financial reports

- Comparing the balance at

the beginning of the period

with the balance at the end of

the previous period

- Check the accuracy of

presentation of customer

receivables on the balance

sheet

- Analysis of the fluctuation

between the ending balance of

the period with the ending

balance of the previous period

and customer receivables in

the current period with the

previous period, if there is any

abnormal fluctuation, it

should be explained the

reasons for the changes

- Comparing the client debt

ratio to the total revenue of

this year compared to the

previous year, if there are big

fluctuations, discuss with the