1. AUDITING
CHAPTER 11
Accounts Receivable & Cash
Balances
By
David N. Ricchiute

2. REVENUE/RECEIPT
CYCLE
Relationship assertions & audit
procedures
Relationship audit risk, client
strategies, substantive tests
Substantive tests for assertions
Revenue recognition, earnings
manipulation, & channel stuffing
Audit sampling & accounts
receivable
2
Computer-assisted audit techniques
GBW 8th ed. Ch. 11

3. ASSERTIONS &
OBJECTIVES
Management assertions: Recorded
receivables & cash balances
 Exist
 Include all transactions
(completeness)
 Represent rights of entity
 Are valued appropriately
 Are presented & disclosed properly
3
GBW 8th ed. Ch. 11

4. OBJECTIVES &
PROCEDURES:
Existence/Occurrence
Objective: determine whether all recorded
sales, receivables, cash balances
Procedures
 Existence
 Physical observation
 Confirmation
 Transactions occurred
 Cutoff testing for proper period
4
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5. OBJECTIVES &
PROCEDURES:
Completeness
Objective: determine whether all
receivables, sales, cash of period are
presented in financial statements
Procedures
 Examine documents
 Apply analytical procedures
 Cutoff bank statements, bank
reconciliations, etc.
5
GBW 8th ed. Ch. 11

6. OBJECTIVES &
PROCEDURES:
Rights/Obligations
Objective: determine whether entity has
property rights to cash, accounts
receivable
Procedures
 Examine documentation
 Confirmations
 Inquiries
6
GBW 8th ed. Ch. 11

7. OBJECTIVES &
PROCEDURES:
Valuation, Allocation
Objective: determine whether entity has
recorded items in correct amounts,
accounts, & time periods
Procedures
 Confirm balances
 Verify mathematical accuracy
 Examine details of recording
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GBW 8th ed. Ch. 11

8. OBJECTIVES &
PROCEDURES: Presentation,
Disclosure
Objective: determine whether
recorded transactions, balances
properly classified, described,
disclosed
Procedures
 Compare presentation to GAAP
 Annual updates of AICPA
guidelines
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GBW 8th ed. Ch. 11

9. AUDIT RISK MODEL
AR = CR x IR x DR
Detection risk (DR): likelihood that error
could occur & not be detected
Based on
 Control risk (CR)
 Likelihood of material error
 Inherent risk (IR)
 Strategies & threats
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GBW 8th ed. Ch. 11

10. DETECTION RISK
DR = ____AR___
IR x CR
Nature, extent, timing substantive tests
 Nature: more/less persuasive tests
 Extent: larger/smaller samples
 Timing: balance sheet date or interim
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GBW 8th ed. Ch. 11

11. ASSERTIONS &
PROCEDURES
Accounts Receivable, Sales-1
Valuation
Verify mathematical accuracy AR
 Obtain aged trial balance
 Foot trial balance
 Compare total AR per trial balance to
general ledger
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GBW 8th ed. Ch. 11

12. ASSERTIONS &
PROCEDURES
Accounts Receivable, Sales-2
Existence, rights, valuation
Confirm year-end accounts & notes
receivable with debtors
 Positive: tell auditor if balance correct
 Large balances, inaccuracies
 Negative: tell auditor only if balance
incorrect
 Control adequate, small balances
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GBW 8th ed. Ch. 11

13. ASSERTIONS &
PROCEDURES
Accounts Receivable, Sales-3
Existence or occurrence, completeness
Test cutoff to determine whether sales,
receivables recorded in proper period
 FOB shipping point
 FOB destination
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14. ASSERTIONS &
PROCEDURES
Accounts Receivable, Sales-4
Valuation, rights
Review collectibility receivables
Determine adequacy allowance for
doubtful accounts
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15. ASSERTIONS &
PROCEDURES
Accounts Receivable, Sales-5
Existence or occurrence, completeness,
valuation
Perform analytical procedures for
reasonableness of sales, receivables
balances
 Collections problems
 Overstated sales
 Understated sales
15
GBW 8th ed. Ch. 11

16. ASSERTIONS &
PROCEDURES
Accounts Receivable, Sales-6
Presentation & disclosure
Review financial statements to
determine
 Accounts, notes receivable properly
classified, described
 Disclosures adequate
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GBW 8th ed. Ch. 11

17. TESTING CUTOFF
Sales, Receivables
At or around end each quarter, the former
President directed his subordinates to hold
IGI’s books open, to backdate invoices,
shipping documents. This caused IGI to
record out-of-period sales & to overstate
revenue, net income end each quarter.
Procedures
 Trace recorded sales to shipping documents
before, after end of period
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18. ASSERTIONS &
PROCEDURES: Cash-1
Existence, rights, valuation
Confirm year end balances with all
banks
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GBW 8th ed. Ch. 11

19. ASSERTIONS &
PROCEDURES: Cash-2
Valuation
Verify mathematical accuracy recorded
cash balances
 Foot cash journals
 Trace totals to general ledger, year-end
bank reconciliations
 Test cash on hand
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GBW 8th ed. Ch. 11

20. ASSERTIONS &
PROCEDURES: Cash-3
Existence, completeness, valuation
Test cutoff
 Obtain cutoff bank statement
 Verify accuracy
 Examine & trace to bank reconciliations & cash journals
 Proof of cash
 Reconcile recorded cash with bank confirmation
 Examine interbank, intercompany transfers
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21. ASSERTIONS &
PROCEDURES: Cash-4
Presentation & disclosure
Review financial statements to
determine
 Cash balances properly classified,
described
 Disclosures adequate
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GBW 8th ed. Ch. 11

22. TESTING CUTOFF FOR
CASH
Reconcile internal documents
 Cash journals
 General ledger
 Bank reconciliations
With external documents
 Year-end bank statement
 Cutoff bank statements
 Bank confirmations
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23. REVENUE RECOGNITION
& EARNINGS
MANIPULATION
Increasingly, I have become concerned that the
motivation to meet Wall Street earnings
expectations may be overriding common
sense business practices.
Arthur Levitt, Jr., “The ‘Numbers Game.” Speech NYU, 1998.
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24. REVENUE
RECOGNITION
SAB 104
Criteria
 Persuasive evidence of arrangement exists
 Delivery has occurred or services rendered
 Seller’s price fixed or determinable
 Collectibility reasonably assured
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GBW 8th ed. Ch. 11

25. COMMON MEANS TO
MANIPULATE EARNINGS -
1
Method Revenue Recognition Error
Bill & hold Shipments to 3rd party warehouses
Cancelled orders Cancelled, duplicate orders
Conditional sales Before contingencies resolved
Consignment sales Goods on consignment, trial
Continuing Seller involved after delivery, e.g.,
involvement installation
Improper cutoff Before title, risk ownership passed
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26. COMMON MEANS TO
MANIPULATE EARNINGS -
2
Method Revenue Recognition Error
Kickback sales Inflated selling price for kickback
Overstated Inflated % completion on construction
completion projects
Partial shipments Not all goods ordered are shipped
Pre-invoicing Goods still in production
Premature Goods ordered but not authorized for
shipment shipment
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27. COMMON MEANS TO
MANIPULATE EARNINGS -
3
Method Revenue Recognition Error
Premature sales Goods ordered but not shipped
Sham sales False shipments
Side agreements To forestall completion earnings
process
Uncertain Seller’s performance uncertain
performance Collection uncertain, unlikely
Uncertain realization
Unauthorized Shipments not authorized
shipment
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28. MANIPULATED EARNINGS
Channel Stuffing
Definition: incentives to induce
incremental demand
Examples
 Bausch & Lomb
 Told distributors to buy large amount of inventory
to maintain distributorship
 B&L recognized extra $22 million
 Sunbeam
 Used price discounting to encourage customers
to hold 80 weeks of inventory
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29. MANIPULATED EARNINGS
Asset Swaps
Definition: companies trading right to
use others asset
Examples
 Global Crossing
 Treated underseas cables as real estate
 Recognized revenue by treating swap as sale
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GBW 8th ed. Ch. 11

30. MANIPULATED EARNINGS
Other
Improper expense capitalization
 Chambers Development
 Capitalized landfill expenses after determining
earnings necessary to meet analysts
expectations
 MicroStrategy
 Recognized revenue before all services
provided for software sales
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31. ACCOUNTS
RECEIVABLE
Update assessment of control risk
Planning confirmations & selecting plan
 Identify population, sampling unit, anticipated error
 Estimate tolerable error & risk incorrect
acceptance
 Calculate sample size
 Choose sample selection method
 Evaluate results
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32. COMPUTER ASSISTED
TESTS: AR Accuracy
Foot, crossfoot recorded amounts
within master file
Total balances
Display/print exceptions
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33. COMPUTER ASSISTED
TESTS: AR Aging
Trace individual balances from master
file to sales journal
Classify balances by invoice dates/age
Display/print aged trial balances
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GBW 8th ed. Ch. 11

34. COMPUTER ASSISTED
TESTS: AR Credit Balances
Scan master receivables file for net
credit balances
Display/print listing credit balance
accounts
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