Question

You are a trainee auditor and work for an audit firm in Hong Kong called Admiralty Partners. It is the middle of January and you are auditing at your client, Angel Ltd. a company which sells products to customers on credit. Your manager has asked you to perform the substantive audit testing of trade receivables at Angel Ltd.

While you are at Angel Ltd. the managing director asks to see you. She would like to know some detail of what your auditing colleagues were doing when they visited Angel Ltd. during the previous October. Her understanding is that this was a planning visit by the auditors but would like to have more detail of what activities were carried out in particular in relation to the work performed on controls testing. She does not understand why you are at the business in January doing even more testing and asks why this could not have been performed in the previous October visit. She also would like to understand the role of analytical review in the auditor’s work.

REQUIRED:

1. Write a schedule of the testing activities you will perform for the substantive testing of trade receivables.(for correctly and clearly stated substantive tests relevant to trade receivables (per valid and fully detailed test to a maximum 12).

2. Write a memo to the Managing Director of Angel Ltd. discussing the purpose of each of walk through testing; controls testing and substantive testing.(for valid and clear discussion of each testing category required.)

3. Explain briefly to the Managing Director the role of analytical review in the audit at the stages of planning, substantive testing and final audit review. (for valid and clear statement of the role of AR in each of the three main stages of the audit. Two marks for each stage to maximum of six.)

Answer 1

Details substantive Audit procedure in case of Account receivable – Account ( trade ) receivable is one of most important factor for any Organization . This is one of the major component under current asset section . Companies solvency , Quick asset position depends on Trade receivable . Auditor needs to review trade receivable on a Monthly/ Quarterly / yearly basis and each time documented the movement of trade receivable , collection , impact on DSO ( Debtors Turnover ratio) , impact on cash flow . Need to understand any collection challenge , any further provision is required or not . After introduction of ECL ( Expected Credit Loss) concept as per IFRS 9 ( Financial Instrument ) , Auditor needs to calculate debtors provision ( provision Matrix - % base provision) amount based on debtors age wise report , any chances of 100% debtors impairment etc.

So Auditor last time completed transaction analysis in the Month of Oct and they again visited same company in the month of January to check movement of debtors , collection , any working capital road block , any collection challenge identified last time, whether same has been collected between oct to Jan period etc.

Details substantive test whole doing Trade Receivable Audit includes :

Confirmation- The most common audit procedures involving the account receivable balances is confirmation. To test the account receivable exist , the auditor will send letters to a sample of the clients customer asking to verify the amount that is owed to the company being audited The customer is then asked t return the letter to verify the balances

Subsequent Receipt – for confirmation requests that are not returned by customers , auditor must perform alternative procedures to verify the account receivable balances.

Allowance testing – Under accrual base of accounting , this requires the client to make an estimate of the current amount of debt that remain uncollected . While determining allowance , Auditor has to follow ECL ( Expected credit loss ) method to determine allowance amount , 100% credit impaired receivable ( if any) .

While doing Account receivable Audit , Auditor should consider following factor:

1. Trace receivable report to general ledger
2. Calculate the receivable report total
3. Investigate reconciliation item,
4. Match Invoice to shipping log
5. Confirm account receivable
6. Review cash receipts

Memo to General Manager - details substantive process explained above . below cover mainly Internal control + Risk assessment in case of trade receivable

Auditor should take control plan while doing audit of account receivable :

Account receivable is a high Risk area for fraud and errors.

Internal Control – Even though company has any risk of misstatement in relates to receivable , strong Internal control system should catch any mistake Strong Internal control mean the auditors need to test fewer transaction to assure reliable financial . One of the major control activity for account receivable is establishing Credit limit for customer and review credit limit , credit worthiness , Auditor has to ensure that account receivable balance should not be overstated

Management Estimate – One of the important responsibility by External Auditor to scrutinize all management estimate in case of account receivable process . The two most significant accounts receivable estimates are revenue estimate and allowances for doubtful account Companies can justify their allowance for doubtful accounts by preparing aging reports and collection rates from previous years

Other control testing are as below :

1. Verify contract terms – verify Invoice raised as per Contract ( Mile stone basis )
2. Proper proof read Invoice – ensure that company should raised correct Invoices backed by Purchase Order as supporting documents
3. Authorised credit Memo-need to ensure that all formal approval of a manager for credit memos , which then verified by Internal Auditor
4. Restrict access to Billing software - System should be password protect to access to the billing software to prevent any fraud / error
5. Segregation of duties –
6. Review account receivable journal entries – random check high value sales relates entries and not accept any manual based entry
7. Match Billing to shipping log

Above Step , covered Substantive Test , Internal control + risk Assessment , below represents Analytical review

Analytical Review in case of Trade receivable -   

One of the simplest methods available is the use of accounts is the use of the accounts receivable TO sales . High this ratio is concern for company because higher ratio have difficulty collecting payments from its customer

Another method consist of examine the manner in which allowance for bad debt has changed over time . This allowance is typically reported in the financial statement . Auditor has to see trend of allowance for bad debt and if it is in higher trend then another issue to collect cash on time from Customer .

Auditor also do analytic review in case of specific customer with outstanding debts , collect the names and investigate the credit worthiness of each debt owing customer individually . Auditor can estimate likelihood of each customer repaying their dues or not. The process of estimating credit worthiness can became highly complex.

Another important factor is “ the Importance of Diversification” . A business whose accounts receivable are owed by a highly diversified customer base may be less vulnerable

Auditor has to scrutinise Age wise debtors report and understand the movement of debtors and any high value debtors lying more than 90 days + , need to do detail investigation . Auditor has to take management view in case of debtors age days are OLD + very OLD and Auditor need to review provision policy base on ageing report .