Module 2

Audit of receivables
Learning Outcome Based on the Syllabus:
LO1. Identify and apply the audit objectives, procedures, evidences and documentation of
individual accounts in various accounting transaction cycles.

Learning Objectives
At the end of this module, the following learning objectives will be attained by the students:
1. Describe the nature of receivables.
2. Describe the auditor’s objectives in the audit of receivables and revenue.
3. Describe the documents, records and accounts that compose the revenue (sales)
transaction cycles and the fundamental controls over receivables and revenue.
4. Use the understanding of the client and its environment to consider inherent risks
(including fraud risks) related to receivables and revenue.
5. Obtain an understanding of internal control over receivables and revenue.
6. Assess the risk of material misstatement of receivables and revenue and design further
audit procedures, including tests of controls and substantive procedures, to address the
risks.

Direct Instructions

Overview
Because of the close relationship between revenue and accounts receivables, the two
can best be considered jointly. The determination of the amount of revenue to be recognized
for a particular period is integrally related to a number of financial statement accounts,
including sales and accounts receivables, adjustments to sales and accounts receivable,
service revenue, deferred revenues, and cash.

In addition, it is a major determination of the amount of net income that the company
reports for a particular period. Therefore, the audit of revenue and receivables is an area of
significant risk to auditors.

The auditor’s objectives in the audit of receivables and revenue are to:
1. Use the understanding of the client and its environment to consider inherent risks,
including fraud risks, related to receivables and revenue.
2. Obtain an understanding of internal control over receivables and revenue.
3. Assess the risks of material misstatement and design tests of controls and substantive
procedures that:
a. Substantiate the existence of receivables and the occurrence of revenue
transactions.
b. Establish the completeness of receivables and revenue transactions.
c. Verify the cut-off of revenue transactions.
d. Determine that the client has rights to recorded receivables.
e. Establish the proper valuation of receivables and the accuracy of revenue
transactions.
f. Determine that the proper presentation and disclosure of information about
receivables into appropriate categories, adequate reporting of any receivables
pledged as collateral, and disclosure of related party sales and receivables.
Because of the risk of intentional misstatement of revenues, the control environment is very
important to effective internal control over revenue and receivables. Management should
establish a tone at the top of the organization that encourages integrity and ethical financial
reporting. Also, incentives for dishonest reporting, such as undue emphasis on meeting
unrealistic sales or earnings targets, should be eliminated.

Management should make appropriate background checks of prospective employees

and obtain fidelity bonds on employees in positions of trust. Internal control is also improved
when individuals who maintain accounting records or cash are required to take vacations
and when their assigned duties are rotated periodically.

Management should develop a formal process of monitoring external factors, such as

changes in economic conditions, competition, customer demand, and regulations that may
affect the risk of achieving the company’s sales objectives. In addition, management should
evaluate the effects of internal factors, such as changes in accounting principles, the
introduction of new products and services, and the use of new types of sales transactions.
These factors may create new risks for the company, indicating a need to implement new
types of controls to prevent misstatement of revenue.

REVENUE CYCLE – ACCOUNTING SYSTEM & CONTROL ACTIVITIES

For many companies, the primary source of revenue is from the sale of goods or
services to customers on credit. Ineffective controls over credit sales and receivables can be
costly to a business. When control activities over sales on account are inadequate, large
credit losses are almost inevitable. For example, merchandise may be shipped to customers
whose credit standing has not been approved. Shipments may be made to customers without
notice being given to the billing department; consequently, no sales invoice is prepared.
Sales invoices may contain errors in prices and quantities; and if sales invoices are not
controlled by serial numbers, some may be lost and never recorded as accounts receivable.
To avoid such difficulties, strong controls over credit sales are necessary. Usually, internal
control over credit sales is strengthened by a division of duties so that departments or
individuals are responsible for:
1. Preparation of sales order
2. Credit approval
3. Issuance of merchandise from stock
4. Shipment
5. Billing
6. Invoice verification
7. Maintenance of control accounts
8. Maintenance of customer’s ledgers
9. Approval of sales returns and allowances
10.Authorization of write-offs of uncollectible accounts.

Controlling Customer’s Orders

The controlling and processing orders received from customers require carefully
designed operating procedures and numerous controls if costly errors are to be avoided.
Important initial steps include registering the customer’s purchase order, reviewing items
and quantities to determine whether the order can be filled within a reasonable time, and
preparing a sales order.

The sales order is a translation of the terms of the customer’s order into a set of
specific instruction for the guidance of various divisions, including the credit, finished goods
stores, shipping, billing and accounts receivable units. The action to be taken by the factory
upon receipt of sales order will depend upon whether the goods are standard products
carried on stock or are to be produced to specification set by the customer.

Credit Approval
Before sales orders are processed, the credit department must determine whether
goods may be shipped to the customer on open account. This department is supervised by a
credit manager who reports to the treasurer of the vice president of finance. The credit
department implements management’s credit policies and uses them to evaluate prospective
and continuing customers by studying the customer’s financial statements and by referring
to reports if credit agencies. Once a new customer has been granted a line of credit,
approval of particular sales transaction involves a simple determination of whether the
customer has sufficient unused credit. This process is often performed by the IT system.
If the sales transaction will cause the customer’s credit limit to be exceeded, the
computer will print out the details for the credit department, which will initiate the process
determining whether to increase the customer is notified and an effort is made to negotiate
some other terms, such as cash on delivery.

Issuing Merchandise
Companies that carry standard products in stock maintain a finished goods storeroom
supervised by a storekeeper. The storekeeper issues the goods covered by a sales order to
the shipping department only after the sales order has been approved by the credit
department. Perpetual inventory records or finished goods should be maintained by the
accounting department, not by the storekeeper.

The Shipping Function

When the goods are transmitted by the finished goods storeroom to the shipping
department, this group must arrange for space in railroad cards, aircraft, or motor freight
carriers. Shipping documents, such as bill of lading, are created at the time of loading the
goods into cars or trucks. The shipping documents are numerically controlled and are
entered in a shipping register before being forwarded to the billing department.
When shipments are made by truck, some type of gate control is also needed to ensure
that all goods leaving the plant have been recorded as shipments. This may require the
surrender to the gatekeeper of copies of shipping documents.

The Billing Function

The term billing means notifying the customer of the amount due for goods or services
delivered. This notification is accomplished by preparing and mailing a sales invoice. A
department not under the control of sales executive should perform billing. The function is
generally assigned to a separate section within the accounting, data processing, or finance
department.
The billing section has the responsibility of (1) accounting for the serially numbered
shipping documents, (2) comparing shipping documents with sales orders and customers’
purchase orders and change notices, (3) entering pertinent data from these documents on
the sales invoice, (4) applying prices and discounts from price lists to the invoice, (5) making
the necessary extensions and footings, and (6) accumulating the total amounts billed.

Collection of Receivables
Most receivables held by companies are collected by receipt of customer’s checks and
remittance advice through mails. The cashier will control and deposit checks. The remittance
advices or listing of the receipts will then be forwarded to the accounts receivable section of
the data processing department, which will record them in the appropriate accounts in the
customers ledger. The total reduction in accounts receivable will be posted periodically to
the general ledger control account from the total of the accounts receivable column in the
cash receipts journals. An aged trial balance of customer’s accounts should be prepared at
regular intervals for use by the credit department in carrying out its collection program.

Adjustments to Sales and Receivables

All adjustments to sales for allowances, returns, and write-offs of accounts receivable
should be supported by serially numbered credit memoranda signed by an officer or
responsible employee having no duties relating to cash handling or to the maintenance of
customers’ ledgers. Good internal control over credits for returned merchandise usually
includes a requirement that the goods be received and examined before credit is given. The
credit memoranda should then bear the serial number of the receiving report on the
returned shipment.
 The credit manager should initiate the process of uncollectible receivable write-off,
with subsequent authorization by the treasurer. Receivables that are written off should then
be either turned over to a collection agency or retained and transferred to a separate ledger
and control account. The records may be of a memorandum nature rather than part of the
regular accounting system. Also, when possible – generally when the debtor is still in
existence – statements requesting payment should continue to be mailed. Otherwise, any
subsequent collections may be embezzled by employees without necessarily of falsifying
records to conceal the theft.

AUDIT DOCUMENTATION for RECEIVABLES & REVENUES

Besides preparing lead schedules for receivables and net revenue, the auditors obtain
or prepare the following working papers:
1. Aged trial balance of trade accounts receivables
2. Analyses of other accounts receivable
3. Analysis of notes receivable and related interest
4. Analysis of allowance for uncollectible accounts
5. Comparative analyses of revenue by month, by product, by territory, or by relating
forecasted revenue to actual revenue
6. Documentation of internal controls
7. Risk analyses and audit programs

EXAMPLES OF FURTHER TEST OF CONTROLS FOR RECEIVABLES AND REVENUES

A. Examine Significant Aspects of a Sample of Sales Transactions
To determine that the controls portrayed in the flowchart are effectively
functioning in everyday operations, the auditors will examine significant aspects of a
sample of sales transactions. The size of the sample and the transactions included
therein may be determined by either statistical or non-statistical sampling techniques.
The audit procedure for verification of a sales transaction that has been selected for
testing may begin with comparison of the customer’s purchase order, the client’s sales
order, and the duplicate copy of the sales invoice. The descriptions and quantities of
items are compared on these three documents and traced to the duplicate copy of the
related shipping documents. The credit manager’s signature denoting approval of the
customer’s credit should appear on the sales order.
The extensions and footings on each invoice in the sample should be approved
to be arithmetically correct. In addition, the date of each invoice should be compared
with two other date: (1) the date on the related shipping documents and (2) the date of
entry in the accounts receivable subsidiary ledger.
Consistent pricing and sales discount policies are a necessary element of good
internal control over sales transactions. After discussing the policies with
management, the auditors can verify the prices and discounts on the invoices selected
for testing by comparison with authorized price lists, catalogs, or contracts with
customers.
After proving the accuracy of selected individuals’ invoices, the auditors next
trace the invoices to the sales journal and to postings in the accounts receivable
subsidiary ledger. When performing tests of sales transactions, the auditors should be
alert for indications of consigned shipments treated as sales. Some companies that
dispose of only a small portion of their total output by consignment fail to make any
distinction between consignment shipments and regular sales.
If the subsidiary records for receivables include some accounts with large debit
entries and more numerous small credit entries, this should suggest to the auditors
that goods have been shipped on consignment and that payments are being received
only as the consignee makes sales. Numerous large returns of merchandise are also
suggestive of consignment shipments.
The auditors should also investigate the controls for sales to related parties.
Effective control over intercompany or interbranch transfers of merchandise often
requires the same kind of formal procedures for billing, shipping, and collection
functions as for sales to outsiders; hence, these movements of merchandise are often
invoiced and recorded as sales.
 B. Compare a Sample of Shipping Documents to Related Sales Invoices
To assure that all shipments are billed, the auditors may obtain a sample of
shipping documents issued during the year and compare these to sales invoices. In
making this test, particular emphasis should be placed upon accounting for all
shipping documents serial number. Any voided shipping documents should have been
mutilated and retained in the files. The purposeful or accidental destruction of
shipping documents before the creation of a sales invoice might go undetected if this
type of test is not made.

C. Review the Use and Authorization of Credit Memoranda

Auditors should review the credit memoranda if serially numbered and signed
by an officer or responsible employee having no duties relating to handling cash or to
the maintenance of customers ledger. The memoranda should then bear the date and
serial number of the receiving report on the return shipment.
In addition, the auditors should make tests of these documents similar to those
suggested for sales invoices. Prices, extensions, and footings should be verified, and
postings traced from sales return journal or other accounting record to the customer’s
accounts in the subsidiary receivable ledgers.

D. Reconcile Selected Cash Register Tapes and Sales Tickets and Sales Journals
In the audit of clients that make substantial amount of sales for cash, the
auditors may compare selected daily totals in the sale journals with the cash register
reading or tapes. The serial numbers of all tickets used during the selected periods
should be accounted for and the individual tickets examined for accuracy of
calculations and traced to the sales summary journal.

E. Examine Evidence of Review and Approval of Revenue Estimates

When a client uses accounting principles that require estimates of significant
amounts of revenue, the auditors may examine evidence of review and approval of the
estimates.

SUBSTANTIVE PROCEDURES FOR RECEIVABLES & REVENUE

1) Obtain an Aged Trial Balance of Trade Accounts Receivable and Analyses of

Other Accounts Receivable and Reconcile to Ledgers
An aged trial balance of trade accounts receivable at the audit date is commonly
prepared by employees of the client for the auditors. The client-prepared schedule has
a multipurpose format designed to display the aging of customers’ accounts, the
estimate of probable credit losses, and the confirmation control information. When
trial balance or analyses of accounts receivable are furnished to the auditors by the
client’s employees, some independent verification of the listing is essential.
Determination of the proper extent of testing should be made in relation to the
adequacy of the controls over receivables.
The auditors should test footings, cross-footings, and agings. In testing agings,
it is important to test some accounts classified as current, as well as those shown as
past due. These selected accounts should be traced to the subsidiary ledgers. The
totals of schedules prepared by client personnel should also be compared with related
controlling accounts. In addition, the balances of the subsidiary ledger records should
be verified by footing the debit and credit columns on a test basis.
 GDC PAGING SERVICES
Aged Trial Balance - Accounts Receivable
12/31/2021
Customer Total <30 days 30-60 days 60-90 days >90 days
Name
Abbott Construction P 100,000 AA P 50,000 P 50,000
Action Labs 150,000 150,000
APMI Corporation 50,000 25,000 25,000
Wright Industries 80,000 50,000 30,000
Zorcon 120,000 60,000 60,000
Velvet 200,000 100,000 100,000
Johnson Construction 500,000 AA 250,000 250,000
XYZ Company 300,000 300,000
Total P 1,500,000 P 410,000 P 665,000 P 125,000 P 300,000
F T/B F F F F
F = Footed
T/B = Agreed to Trial balance
AA = Customer account traced to subsidiary ledger; agreed to total and proper ageing tested.

2) Confirm Receivables with Debtors

Confirmation is a type of documentary evidence secured from outside the client
organization and transmitted directly to the auditors. Direct communication with debtors
is the most essential and conclusive step in the verification of accounts receivable. By
confirming accounts receivable, the auditors prove that the receivables and the customer
exist. Written acknowledgement of the debt by the debtor serves the purposes of (a)
establishing the existence and gross valuation of the asset, and (b) providing some
assurance that no lapping or other manipulation affecting receivables is being carried on
at the balance sheet date.
However, the confirmation of a receivable provides only limited evidence about the
completeness and valuation assertions because only recorded amounts are confirmed,
and debtors may acknowledge debts even though they are not able to pay them.
An important part of confirming receivable is considering the validity of the debtor’s
addresses. The auditors should investigate thoroughly any suspicious circumstances, such
as an excessive number of individual debtors with addresses that are post office boxes;
the boxes may have been rented under fictitious debtors’ names by employees of the
client company who are engaged in accounts receivable fraud.
A summary should be prepared outlining the extent and nature of the confirmations
send and overall results obtained. Such a summary is a highly important part of the audit
working papers.

Positive and Negative Confirmations

a. The use of positive confirmations consists of a request addressed to the debtors
asking for a reply. Most positive forms ask the debtor to confirm directly to the
auditors the accuracy of the peso amount shown on the confirmation request.
b. The use of negative confirmations consists of a communication addressed to the
debtor company asking it to advise the auditors only if the balance is incorrect.

Discrepancies in Customers’ Replies

 The auditors should resolve differences reported by customers. The majority of
such reported discrepancies arise because of normal lags in the recording of cash
receipts or sales transactions, or because of misunderstanding in the part of the
customer company as to the date of the balance it is asked to confirm.
 Some replies may state that the balance listed is incorrect because it does not
reflect recent cash payments; in such instances, the auditors normally trace the
reported payments to cash records.

Alternative Procedures for Nonrespondents

 When using positive confirmation requests, the auditors should generally follow up
with a second and sometimes a third request to produce replies. When replies are
 still not received, the best alternative auditing procedure ordinarily is the
examination of subsequent cash receipts in payment of the receivables.
 However, in order to make certain that the payment is for a receivable that existed
at year-end, the auditors also may need to examine shipping documents, customer
purchase orders, or sales invoices for the sales transactions making up the
receivables. Examination of these sales documents is also the alternative procedure
used for receivables that are not paid during the subsequent procedure
Example of Positive Confirmation Request
GDC PAGING SERVICES

January 5, 2022

Wright Industries
Zamora St.
Tacloban City
Philippines

Dear Customers:

Please examine the accompanying statement carefully and either confirm its correctness
or report any differences to our auditors

SGV & Co.

Campetic
Palo, Leyte
Philippines

who are auditing our financial statements.

Your prompt attention to this request will be appreciated. An envelope is enclosed for your reply.
Please do not send your payments to the auditors.

Sincerely,
Jan Rodriguez
Controller, GDC Packaging Services

Confirmation:

The balance receivable from us for P80,000 as of December 31, 2021 is correct except as noted
below:

Wright Industries
Date: By:
3) Review the Year-End Cutoff Sales Transactions
One of the more common methods of falsifying accounting records is to inflate the
sales for the year by holding open the sales journal beyond the balance sheet date. The
purpose is to present a more favorable of financial picture that actually exists. Since sales
are frequently used as the base for computation of bonuses and commissions, an
additional incentive for padding the Sales account is often present. A related abuse
affecting accounts receivable is the practice of holding the cash journals open beyond the
balance sheet date.

To guard against misstatements due to inaccurate cutoff of sales records, the auditors
should compare the sales recorded for several days before and after the balance sheet
date with the duplicate sales invoice and shipping documents. The effectiveness of this
step is largely dependent upon the degree of segregation of duties between the shipping,
receiving, and billing functions.

Fictitious sales are occasionally recorded at year-end as a means of overstating

financial results. Therefore, auditors should be aware of, and investigate:
i. Unusually large increases in year-end sales to a single customer or a few. This
might be indicative of bill and hold transactions, in which sales are billed but goods
are not shipped.
ii. Large increases in revenue and receivables along with increases in gross profit
margins that are inconsistent with the client’s experience or industry averages.
iii. Inappropriate changes in accounting principles that result in an increase in
recorded revenue.
iv. Substantial sales returns following the balance sheet date that might indicate
merchandise shipped to customers without a customer order for those goods or
channel stuffing, in which sales are boosted by inducing customers to buy
substantially more inventory that they can promptly sell.

4) Perform Analytical Procedures for Accounts Receivable and Revenue

Several ratios and relationships can be computed to indicate overall reasonableness of
the amounts shown for accounts receivable and revenue. Examples include (a) gross
profit rate (by product line, storage, or region), (b) the ratio of sales in the last month or
week to total sales for the quarter or year, (c) revenue in relation to productive capacity,
(d) units shipped in relation to revenues and production records, (e) accounts receivable
turnover, (f) ratio of accounts receivable to the year’s net credit sales, (g) the ratio of
accounts written off during the year to the ending balance of accounts receivable, (h) the
ratio of returns and allowances to sales, and (i) the ratio of uncollectible account expense
to credit sales. These ratios and relationships are compared with corresponding data for
the preceding years, and with budgets, performance statistics, or comparable industry
averages.

5) Review Significant Year-End Sales Contracts for Unusual Terms

To boost the level of sales for a period, management may be inclined to modify the
terms of sales contracts near year-end. These modifications may affect the collectability
of the related accounts receivable, the customers’ return rights, and even whether the
sales meet the criteria to be recognized in the current period. Therefore, the auditors
should carefully review any significant year-end sales contracts for unusual pricing,
billing, delivery return, exchange, or acceptance clauses.

6) Evaluate the Propriety of the Client’s Accounting Methods for Receivables and
Revenue
The auditors must carefully evaluate the propriety of the client’s treatment of certain
transactions to determine that they meet these criteria, not only in form but also in
substance. Problems that the auditors might discover include:
i. An allowance for sales returns may not be set up for goods shipped to
customers with the right to return the goods under certain circumstances.
 ii. Management or client personnel may have established, formally or informally,
side agreements that significantly alter the terms of sale.
iii. Cash receipts from franchise fees may be inappropriately recognized when
services have not been rendered to the franchisees.
iv. Bill and hold transactions may be recorded when they do not meet requirements
for revenue recognition.
7) Evaluate Accounting Estimates Related to Revenue Recognition
The auditors are responsible for evaluating the reasonableness of accounting
estimates related to receivables and the recognition of revenue. The auditors audit
accounting estimates by reviewing and testing management’s method of developing the
estimates, by developing their own estimates, or by reviewing subsequent transactions
and other events that provide evidence about the accuracy of the estimates.
Because fraudulent financial reporting often is accomplished through the intentional
misstatement of accounting estimates, the auditors are required to perform a
retrospective review of the prior year’s significant accounting estimates to determine
whether they indicate bias on the part of the management.

8) Determine the Accuracy of the Client’s Allowance for Uncollectible Accounts

The allowance for uncollectible account represents a particularly significant
accounting estimate for most organizations. Since the best evidence of the collectability
of accounts receivable is payment by the debtors subsequent to the balance sheet date,
the approach of analyzing subsequent transactions is also an appropriate overall audit
approach. In the audit working papers, the auditors should document the subsequent
payments inspected.
The auditors also may decide to independently develop their own estimate of the
amount of uncollectible receivables to compare to management’s estimate. The following
procedures may be used by the auditors both in developing an estimate and in evaluating
the reasonableness of management’s estimate:
i. Compare details of the aging of accounts receivable to prior year’s aging. Examine
the past due accounts receivable listed in the aging schedule that have not been
paid subsequent to the balance sheet date, noting such factors as the size and
recentness of payments, the settlement of old balances, and whether recent sales
are on a cash or credit basis. The client’s customer correspondence file may
contain much of this information.
ii. Investigate the credit ratings for delinquent and unusually large accounts. This is
particularly efficient when receivables from one or few customers represent a
major portion of the total. Financial statements and credit data should be available
in the client’s credit files.
iii. Review confirmation exceptions for an indication of amounts in dispute or other
clues as to possible uncollectible accounts.
iv. Summarize in a working paper those accounts whose collectability is doubtful
based on the preceding procedures. List customer names, doubtful accounts, and
reasons for considering these accounts doubtful.
v. Review with the credit manager the current status of significant doubtful accounts,
ascertaining the collection action taken and the opinion of the credit manager as to
the ultimate collectability. Indicate in the working papers the credit manager’s
opinion as the collectible portion of each account listed, and use this information to
assist in evaluating the collectability of the specific accounts.
vi. Compute relationships, such as the number-of-days’-sales in accounts receivable
and the relationship of the valuation allowance to (1) accounts receivable and (2)
net credit sales. Compare the ratios to comparable ratios for prior years and
industry averages, and investigate any unexpected results.

9) Ascertain whether any Receivables have been Pledged

The auditors should inquire directly as to whether any notes or accounts receivable
have been pledged or assigned. Evidence of the pledging of receivables may also be
disclosed through the medium of financial institutions confirmation requests, which
specifically call for a description of the collateral securing bank loans.
10) Investigate any Transactions with or Receivables from Related Parties
To identify related party transactions, the auditors should review (1) proxy and other
filings with the SEC or other regulatory agencies, (2) conflict-of-interest statements
obtained by the company from its management, (3) transactions with customers or
suppliers that have unusual terms, and (4) accounting records for unusual balances or
transactions, particularly those occurring near year-end.
If related party transactions are discovered, the auditors should obtain an
understanding of the transactions, determine whether the transactions have been
approved by the board of directors or other appropriate officials, confirm the terms of the
transactions with the related parties, evaluate the collectability of any receivables
outstanding, and evaluate the adequacy of disclosure of the details of the transactions in
the notes to the financial statements.

11) Evaluate the Business Purpose of Significant and Unusual Sales Transactions
Auditors are required to evaluate the business purpose of any transaction that comes
to their attention that is significant and unusual. Such transactions may be indicative of
fraudulent financial reporting.

12) Evaluate the Financial Statement Presentation and Disclosure of Receivables

and Revenue
The auditors must ascertain that the financial presentation of accounts receivables and the
related disclosures are in accordance with GAAP. Related party receivables should be shown
separately with disclosure of the nature of the relationships and amounts of transactions.
Also, amounts of allowances for uncollectible receivables should be shown as deductions
from the related receivables. Finally, significant concentrations of credit risk arising from
trade accounts receivable should be disclosed.

ILLUSTRATIVE PROBLEMS:

Problem No. 1
For each of the test of control audit procedures for sales and receivables, indicate the
control assertion by placing the correct letter in the blank.

A. Existence or occurrence D. Valuation or allocation

B. Completeness E. Presentation and disclosure
C. Rights and Obligations

______ Scan sales invoices for missing numbers in sequence.

______ Perform arithmetic recalculation of a sample of recorded sales invoice.

______ For a sample of recorded sales invoices from the sales journal,

determine whether credit was approved.

______ Trace a sample of credit memos to postings in customers’ accounts.

______ Select a sample of customer accounts and vouch debits to supporting

sales invoices.

Problem No. 2
Following are errors, frauds, or other circumstances that an auditor might encounter as a
result of applying year-end substantive tests to accounts receivable as of December 31,
2021.
A. Sales totalling P12,500 were shipped on January 2, 2022 and recorded on December
31, 2021.
B. Balances in selected individual customer accounts do not reconcile with supporting
documentation (e.g. sales invoices, cash receipts)
C. Not all sales transactions are recorded.
D. The aged trial balance prepared by the client includes a customer account within 30 –
60 day category that is actually 120 days old.
E. Positive confirmations were not returned by 27 of 100 mailed receivable confirmation.
F. Actual write-offs during 2021 of receivables arising 2020 sales were greater than the
December 31, 2021 allowance for doubtful accounts.
For each of the preceding items indicate a specific audit procedure(s) that might
address the error, fraud, or circumstance and identify the assertion(s) addressed
by each procedure.
Audit Procedure(s) Assertion(s)

Problem No. 3
Cheryl Ralston is planning analytical procedures for the December 31, 2021 financial
statement audit of Singulair, Inc., a publicly traded manufacturer of small electrical
appliances, including mixers, toasters, can openers and electric blankets. The appliances are
marketed to low-end retailers throughout Philippines.
Singulair, Inc.
An industry Statement of Financial Position trade
publication estimates
December 31, 2021 and 2020
Singulair’s 2021 market
share at 12 percent.
Singulair’s Assets 2021 2020 December
31, 2021 and Cash P 42,000,000 P 52,500,000 2020
statements of Accounts Receivable, net 325,500,000 175,000,000 financial
position and Inventory 252,000,000 234,500,000 statements of
profit or loss Other current assets 17,500,000 21,000,000 follows:
Noncurrent assets, net of depreciation 210,000,000 280,000,000
Total Assets P 847,000,000 P 763,000,000

Liabilities and Equities

Trade accounts payable P 133,000,000 P 143,500,000
Taxes payable 105,000,000 50,400,000
Noncurrent liabilities 70,000,000 140,000,000
Ordinary share capital 245,000,000 245,000,000
Retained earnings 294,000,000 184,100,000
Total Liabilities and Equities P 847,000,000 P 763,000,000
 Singulair, Inc.
Statement of Profit or Loss
Years Ended December 31, 2021 and 2020

2021 2020
Net credit sales P 5,894,000,000 P 4,375,000,000
Less: Cost of goods sold 3,244,500,000 2,485,000,000
Gross Profit 2,649,500,000 1,890,000,000
Less: Selling and Administrative Expenses 2,387,000,000 1,764,000,000
Income before taxes 262,500,000 126,000,000
Less: Income Tax Expense 105,000,000 50,400,000
Net Income P 157,500,000 P 75,600,000

Total industry-wide sales approximated P37.5 billion in 2017. The allowance for doubtful
accounts was P24,500,000 in 2021 and P35,000,000 in 2020, and the accounts receivable,
net was P200,000,000 in 2019.

Required: {Use Analytical Procedures for Accounts Receivable and Sales as a

Guide):
a. Perform analytical procedures you think appropriate for Singulair’s December
31, 2021 audit. For example, the statements of financial position and
statements of profit or loss include information that can be used to calculate
the numbers of days sales in receivables and receivables turn-over and to
make several informative comparisons.
b. Explain the results for each ratio or comparison.
c. Discuss substantive tests appropriate for the results explained in requirement
b.

Problem No. 4
Daffodil Auto Parts sells new parts to auto dealers. Company policy requires that a
prenumbered shipping documents be issued for each sale. At the time of pick up or
shipment, the shipping clerk writes the date on the shipping document.
The last shipment made in the year ended December 31, 2021, was recorded on document
3167. Shipments are billed in the order that the billing clerk receives the shipping
documents.
For late December 2021 and early January 2022, shipping documents are billed on sales
invoices as follows:

Shipping Document No. Sales Invoice No.

3163 5332
3164 5326
3165 5327
3166 5330
3167 5331
3168 5328
3169 5329
3170 5333
3171 5335
3172 5334

The December 2021 and January 2022 sales journals have the following information
included:
Sales Journal - December 2021
Day of Month Sales Invoice No. Amount of Sales
30 5326 P 72,611
30 5329 191,430
31 5327 41,983
31 5328 62,022
31 5330 4,774

Sales Journal - January 2022

Day of Month Sales Invoice No. Amount of Sales
1 5332 P 264,131
1 5331 10,639
1 5333 82,206
2 5335 125,050
2 5334 64,658

a) What is the net overstatement (understatement) of Daffodil’s sales for the year ended
December 31, 2021?
b) What adjusting entry is necessary to correct Daffodil’s financial statements for the
year ended December 31, 2021?

December 2021 Sales

Overstatement or
Shipping Misstatement in
Invoice No. Understatement in
Document No. Sales Cutoff
December 31 Sales
January 2022 Sales

Problem No. 5
You have been asked to audit the records of XYZ Manufacturing Company to a small
manufacturer of precision tools and machines, for the year-ended December 31, 2021. Your
examination of sales transactions revealed among others the following:
 Some machines have been shipped on consignment to XYZ’s regular dealers. These
transactions have been recorded as ordinary sales and billed as such. As of December
31, 2021, the machines billed and in the hands of consignees amounted to P130,000.
Sales price was determined by adding thirty percent to cost.
 On December 30, 2016, two machines were shipped to a customer on FOB shipping
point basis. The sale was entered in the records on January 5, 2022 when cash was
received in the amount of P13,000.
 The inventory as of December 31, 2021 included goods sold during November, 2021
for P6,500 but returned on December 15, 2021. No entry has been made to adjust the
customer’s account for the goods returned. The goods were included at selling price
which was one hundred thirty percent of cost.

As auditor of XYZ Manufacturing Company, what adjusting journal entries would

you recommend relative to the above findings?

Adjusting Entries Debit Credit

Problem No. 6
The Accounts Receivable control account balance of Blooms Company was P214,100 as of
December 31, 2021.
The subsidiary ledger accounts of the Company are summarized below. Credit terms are 60
days net.

Customer Date Debit Credit Balance

Mark May 31 P 5,000 P 5,000
July 1 3,000 2,000
July 7 5,000 7,000
September 1 3,000 4,000
September 25 8,000 12,000
November 1 3,000 9,000
December 10 3,000 12,000
Kent August 8 8,400 8,400
October 4 8,400 -
November 25 22,000 22,000
Fretcyl
2-month, 12% note January 1 120,000 120,000
March 1 122,400 2,400 cr.
2-month, 6% note December 1 100,000 97,600
Rey February 3 10,000 10,000
August 3 10,000 20,000
Julius February 10 30,000 30,000
April 9 30,000 -
May 4 40,000 40,000
July 2 40,000 -
September 6 52,780 52,780
November 25 2,220 55,000
Jeremy July 17 5,000 5,000
August 16 4,440 9,440
September 30 7,500 16,940
October 15 9,440 7,500
October 18 6,000 13,500
December 20 6,000 7,500

The allowance for uncollectible accounts, before audit, has a credit balance of P5,000.
The Allowance for Uncollectible Accounts is to be adjusted to balance determined as follows:
Accounts not due 1 percent
Accounts 1 – 60 days past due 2 percent
 Accounts 61 – 120 days past due 5 percent
Accounts over 120 days past due 50 percent

The provision is to be based only on trade accounts. Except where payments are earmarked,
the oldest items are paid first.
a) Prepare audit work papers for aging the accounts receivable.
b) Show the necessary audit adjustments as at December 31, 2021.

Problem No. 7
You were able to obtain the following information from your audit of Superman
Corporation’s Accounts Receivable and Allowance for Doubtful Accounts:
 From the general ledger you noted that the Accounts Receivable has a balance of
P848,000 as of December 31, 2021. Below is a transcript of the Allowance for Doubtful
Accounts:
Debit Credit Balance
January 1 - Balance P 20,000
July 31 - Write-off P 16,000 4,000
December 31 - Provision P 48,000 P 52,000

 The summary of the subsidiary ledger as of December 31, 2021 was totaled as follows:

Debit Balances:
Under one month P 360,000
One to six months 368,000
Over six months 152,000
P 880,000

Credit Balances:
Alien P 8,000 - OK; additional billing in January, 2021
T. Twister 14,000 - Should have been credited to Apol *
Dee Lah 18,000 - Advances on sales contract
P 40,000

*Account is one to six months classification

The customers’ ledger is not in agreement with the accounts receivable control. The
client requested you to adjust the control account to the subsidiary ledger after
corrections are made.

 It is agreed that one percent is adequate for accounts less than one month. Accounts one
to six months are expected to require a reserve of two percent. Accounts over six months
are analyzed as follows:

Definitely bad P 48,000

Doubtful (estimated to be 50% collectible) 24,000
Apparently good, but slow (estimated to be 90% collectible) 80,000
Total P 152,000
Based on the result of your audit, answer the following:
a) How much is the adjusted balance of Accounts Receivable as of December 31,
2021?
b) How much is the adjusted balance of Allowance for Doubtful Accounts as of
December 31, 2021?
c) How much is the Doubtful Accounts Expense for the year 2021?

Problem No. 8
You have substantially completed the audit of Esau Industries Inc. (EII) for the year ended
April 30, 2021. EII sells household appliances.
In preparation for your conference with the officers of the company, you are now going over
your working papers which contain analysis and schedules as well as findings and
information that may require adjustments to come up with audited balances as of April 30,
2021.
The following are the audit working papers relating to receivables:
Accounts Receivable - Trade
Reconciliation Between General Ledger Balance and The Total of Subsidiary Ledger Balances - April 30, 2021
Accounts for Uncollectible Trade Receivables
Analysis of Movement during the year April 30, 2021
Total of Subsidiary ledge balances P 5,635,700
Undelivered sales, based on sales orders received up to April 30, 2021 per JV No. 4-030 2,732,900 *
Allowance, May 1, 2020 P 1,020,000
Goods consigned to Automatic Center, Trinoma and others 3,260,700 ©
Movements during the period May 1, 2020 - April 30, 2021
Collections received from Cebu and Davao branches on May 1 based on offical receipts
Provisions 3,425,625
dated April 30, 2021 for sales made on April 15, 2021 (1,092,800) +
Write offs (4,164,370)
Balance per general ledger P 10,536,500
Allowance, April 30, 2021 P 281,255

* Goods are physically segregated during inventory count. Sales invoices for these were issued on May 1
and deliveries to customers were made on May 2.
© These goods were physically verified in customers' stores. Under the terms of consignment, goods are
billed to customers, based upon their sales report.
1 Aging of accounts receivable - trade, based on accounts receivable schedule as of April 30, 2021,
+ Subsequently deposited on May 2, 2021.
before considering any adjustments on the accounts:
Customers are billed at 20% above cost. Terms 30 days.
Per client Per audit
Current P 4,469,760 P 4,067,320
31 - 60 days 267,320 402,440
61 - 90 days 455,440 267,320
91 days and over 443,180 898,620
Total 5,635,700 5,635,700

2 A review of collectibility of each account disclosed the following:

(a) A customer with an account balnace of P168,000 classfied as 91 days and over in aging can no
longer be located by company lawyers. He has known assets and his liabilities to other creditors
totaled to P5,000,000. The other creditors have the same experience as the company. The
lawyers suggested that this account be written off, to which the company president agreed.

(b) It is the company policy to provide monthly for accounts doubtful of collection, based on aging
schedule, as follows: 2% for current; 5% for 31 - 60 days; 10% for 61-90 days, and 30% for 91
days and over.

Monthly write-offs are charged against the allowance. At the end of the year, a review of
collectability of each account is understaken by the credit and collection manager, the lawyers,
together with a representative of its external auditor.
Based on the above information, compute the adjusted balances of the following:
a) Trade Accounts Receivable – Gross
b) Allowance for Uncollectible Trade Receivables
c) Uncollectible Accounts Expense
Problem No. 9
The following data were taken from the records of Mervin Corporation:

Mervin Corporation
Aging of Accounts Receivable
December 31, 2021

Customers Balance Due Current 1 - 30 days 31 - 60 days Over 60

Jan P 2,300 P P P 2,300 P
Riazon 10,500 6,200 2,000 1,300 1,000
Walter 8,750 2,300 1,450 1,000 4,000
Apryl 9,350 5,300 2,050 1,000 1,000
Mae 4,000
Transport 4,000
Steve 3,100 1,500 1,600
Vangie 100 100
Lorna Co. 6,400 2,000 1,800 1,600 1,000
Joel Corp. 6,000 6,000
Totals P 50,500 P 23,400 P 8,900 P 7,200 P 11,000

Accounts Receivable (control), P50,500.

Audit Comments for Possible Adjustments

Merchandise found defective; returned by customer on November 10 for credit, but the
Jan
credit memo was issued by Mervin only on January 3, 2022.
Riazon Accounts is good but usually pays late.
Merchandise worth P4,000 destroyed in transit on June 4, 2021. The carrier was billed on
Walter
July 1. (See Mae Transport and Joel Corp.)
Apryl Customer billed twice in error for P1,000. Balance is collectible.
Mae Transport Collected in full on January 15, 2022.
Steve Paid in full on 12-29-2021 but not recorded. Collections were deposited 1-3-2022.
Received account confirmation from customer for P 1,100. Investigation revealed an
Vangie
erroneous credit for P1,000. (See Lorna Co.)
Lorna Co. Neglected to post P1,000 credit to customer's account.
Customer wants to know reason for receipt of P4,000 credit memo as their account
Joel Corp.
payable balance was P10,000

Based on the result of your audit, answer the following:

a) What should be the adjusted balance of the Accounts Receivable – trade at December
31, 2021?
b) Prepare adjusting entries to correct the Accounts Receivable account by December 31,
2021.

Adjusting Entries Debit Credit

 Account No. Confirmation No.
101 1 D. Sumulong P 18,000
102 2 A. Abante 12,000
103 3 T. Bernabe 10,000
104 4 ABC Corp. 10,000
105 5 Arnel 10,000
Problem No. 10
106 6 Berbano 16,000
You obtained from 107 7 R. Baltazar 24,000 your client, R.O.
Corp., the following 108 8 Andres 8,000 schedule of
accounts receivable 109 9 M. dela Cruz 14,000 as of October 31,
2021: 110 10 L. Sian 30,000
111 11 E. Floro 2,000
112 12 J. Perez 22,000
113 13 M. Lozano 4,000
114 14 S. Fernandez 8,000
115 15 Abas Corp. 12,000
P 200,000
You traced the items in this schedule to individual account balances in the subsidiary ledger,
checked the footing and ascertained that addresses were complete and adequate.
You also reconciled the schedule balance with the controlling account in the general ledger
and found them to be in agreement.
In November 8, 2021, you mailed out confirmation requests to all customers above with the
exception of E. Floro whom you asked personally since she is working with the company as
secretary.
By November 30, the following replies were received:
1) ABC Corporation, received November 15, confirms balance of P10,000.
2) Tony Bernabe, returned by Post Office “Addressee Unknown”.
3) Ricky Baltazar, received November 20, remarks, “Balance is now paid”.
4) Leny Sian, received November 25, confirms P20,000, remarks, “We returned P10,000
worth of merchandise on November 12.”
5) Abas Corp., returned by post office. “No such person.”
6) Susan Fernandez, received November 26, confirms only P6,000, remarks, “You
overcharged us P2,000, we did not order lipstick.”
You verified that P10,000 of merchandise was actually returned by Leny Sian on November
12. This was covered by the company credit memo 1615.
You also verified an error in billing to Susan Fernandez for P2,000. This error was corrected
by the company on November 10.
In accordance with instructions from your senior, you verified that the following accounts
were paid in November on accounts outstanding on October 31, 2021.

ABC Corp., paid November 15, O.R. 4567, P8,000

R. Baltazar, paid November 18, O.R. 5125, P24,000
T. Bernabe, paid November 26, O.R. 5978, P7,000
B. Berbano, paid November 24, O.R. 5467, P16,000
E. Floro, paid November 16, O.R. 4789, P2,000

On December 2, you mailed the second requests for confirmation to all those who did not
reply to the first requests, and by December 15 you received the following replies:
 1) Almarino Arnel, received December 7, P10,000 OK.
2) C. Andres, received December 8, remarks, “This is not yet due, you allowed me 90
days credit.”
3) J. Perez, December 10, balance of P22,000 confirmed.

a) Prepare the working papers compiling the results of confirmation using the
following suggested column headings:
Accounts Number Confirmation Results Subsequent Collection
Names of Customer (1) Confirming Balance (1) Date
Confirmation Number (2) Reporting Differences (2) OR Number
Address (3) Returned by Post Office (3) Amount
Per Client Oct. 31 Dr. Cr. (4) No Reply Remarks

b) Show in the working paper the percentage of confirmation results and subsequent
collection to the total.

Problem No. 11
In connection with your audit of the Gallery Corporation, you noted that the company’s
Notes Receivable consists of the following:
 A four-month note dated November 30, 2021, from AA Company, P200,000;
Interest rate, 16%, discounted on November 30, 2021 at 16%.
 A draft drawn payable thirty days after for P900,000 by the BB Company on the
Charlie Company in favour of the Delta Company, endorsed to Gallery Corp. on
December 2, 2013 and accepted on December 4, 2013.
 A 90-day note dated November 1, 2021 from E. Dy, P500,000; interest at 16%; the
note is for subscription to 5,000 preference shares of Gallery Corporation at P100
per share.
 A 60-day note dated May 3, 2013, from CC Company, P600,000; interest rate, 16%;
dishonored at maturity; judgement obtained on October 10, 2021. Collection within
the next twelve months is doubtful.
 A 90-day note dated January 4, 2021, from Rey Magaling, President of Gallery
Corporation, P160,000; no interest; note not renewed; president confirmed.
 A 120-day note dated September 14, 2021 from DD Company, P120,000; interest
rate, 16%; note is held by bank as collateral.
When the company discounted a note, interest expense was debited for the discount cost and
interest income was credited for the revenue.
From the information presented, prepare the following:
a) All necessary adjustments, including entries for interest accrued and prepaid.
b) Statement of financial position presentation of the notes receivable as of
December 31, 2021.

Problem No. 12
Nissin Company has the following transaction in 2021 involving notes receivable:
Based on the result of your audit, answer the following:
a) Compute the proceeds from discounted Bubble Company note on August 1,
2021.
b) Compute the amount collected on September 28, 2021 on the defaulted Apple
Company note.
c) Compute the amount collected on December 31, 2021 on defaulted Bubble
Company note.
d) Compute the interest income to be recognized in 2021 related to the above
transactions.