Special purpose frameworks normally include the cash or modified cash basis, income tax basis, statutory or contractual basis and the AICPA's Financial Reporting Framework for Small- and Medium-Sized Entities (FRF for SMEs). The focus in this series of articles is on auditing financial statements prepared on the FRF for SMEs basis, whose framework is underpinned by the accrual basis of accounting. For this reason, there are no significant differences from accounts receivable auditing procedures that would be applied to financial statements using a U.S. GAAP framework, which also is based on the accrual basis of accounting.
The focus of this article is, first, on understanding the maximum required procedures for auditing accounts receivable. The second step is learning how to perform only the procedures required for each engagement based on the assessed levels of risk of material misstatement (RMM) for accounts receivable.
The amount of audit work necessary for all account classifications depends on risk of material misstatement evaluations at both the financial statement and classification (assertion) levels. In other words, an auditor can't default to performing all possible procedures in the hope that this approach will compensate for all RMM or complete the job efficiently! For example, when RMM is low at the financial statement and assertions level for accounts receivable, substantive procedures may be significantly reduced. Substantive procedures may, in these circumstances, primarily consist of risk assessment procedures, analytical procedures and limited confirmation and sales cutoff procedures.
Know the Relevant Auditing Standards
The principal auditing standard specifically applicable to accounts, loans and notes receivable is External Confirmations (AU-C 505). Some of the key issues in this clarified auditing standard include:
- The requirement to confirm accounts receivable to obtain relevant and reliable audit evidence.
- The relationship of audit risk to confirmation procedures, i.e., more evidence is required when risk is higher.
- Control over the confirmation process is necessary for confirmations to be reliable; electronic confirmations are discussed.
- Guidance on how to perform alternative procedures.
- Guidance on how to evaluate confirmation results.
Confirmations and Risk
Confirmations are obtained from third parties to obtain evidence about financial statement assertions. As RMM (the combination of inherent and control risk) increases, more and better evidence is needed to evaluate financial statement assertions. Possible effects of high and low risk on accounts receivable confirmation procedures are outlined in the following table.
Level of Risk of Material Misstatement
Illustrative Procedures Based on Risk
Send positive confirmations covering all individually significant items (ISIs) above the calculated lower limit, based on risk and a number of units selected, by using a non-statistical sampling model or an extensive non-sampling plan at the engagement date.
Send positive confirmations covering all ISIs above a higher calculated lower limit, based on risk and a small number of units in the remaining population, using the model approach or a non-sampling plan at the engagement date or one month before. Perform roll-forward procedures for the period from the confirmation date to the engagement date.
Send positive confirmations for all ISIs above a calculated lower limit based on risk (whose level should be higher than moderate risk). A small number of units should also be judgmentally selected from the sampling population—representative of the transactions—for negative confirmation or tracing to supporting sales and collection documents. Confirmation procedures may be performed 30 to 60 days before the engagement date. Perform roll-forward procedures.
In the next article, confirmation procedures and other substantive tests of balances procedures for accounts receivable will be discussed. Live and on-demand webcasts on this and other auditing subjects are available by clicking on the applicable box on the left side of my home page, www.cpafirmsupport.com.