In my previous article, I discussed auditing standards and the impact of the assessed level of risk of material misstatement (RMM) on the design of confirmation procedures. This article will focus on relevant financial statement assertions for accounts receivable and the impact of RMM on specific auditing procedures.
Relevant Assertions for Accounts Receivable
Financial statement assertions—management's representations in financial statement classifications—are presented in AU-C 315 of the Clarified Auditing Standards. Relevant assertions are those that are most important when an auditor evaluates the appropriateness and reasonableness of a financial statement classification. Auditing procedures should be designed to test the applicable relevant assertions based on the facts and circumstances of a particular audit engagement. Risk and materiality will always be the guide!
Following are the relevant financial statement assertions for accounts receivable (condensed from AU-C 315) arranged in the acronym COVED. For accounts, notes and loans receivable, all assertions are normally relevant, except for Rights and Obligations, which have been omitted.
To determine that all receivables transactions and account balances that should be recorded have been included in the financial statements.
Occurrence and cutoff
To determine that all receivables transactions occurring during the period have been recorded in the financial statements in the proper period.
Valuation, accuracy and classification
To determine that all accounts, loans and notes receivable, and related valuation allowances have been included in the financial statements at accurate amounts, classified properly.
To determine that all recorded receivables accounts exist at a given date.
Disclosure and presentation
To determine that all components of the financial statements and other transactions and events are accurately classified, clearly described and disclosed.
Substantive Tests of Balances Procedures for Accounts Receivable
The nature, extent, and timing of detailed tests of balances procedures should be determined based on the assessed level of misstatements for each financial statement classification (assertion level) after considering the results of risk assessment and analytical procedures. The assessed level of risk should be determined based on the documentation of the auditor's risk assessment procedures.
To illustrate the modification process, following are suggested basic procedures for accounts receivable at three levels of risk of material misstatement, 1) high, 2) slightly less than high, and 3) low to moderate. The bold fonts represent guidance on how to perform the auditing procedures that are applicable to all levels of risk.
- Send positive confirmations, and/or perform alternative procedures, for individually significant accounts comprising a substantial portion of the receivables balances at the engagement date. Consider sending positive confirmations on a few representative accounts in the sampling population.
- Select accounts for confirmation from a trial balance reconciled to the general ledger.
- Perform extensive sales cutoff tests by reference to sales and shipping documents for a large period before and after the engagement date.
- Select recorded sales from the sales journal before and after the yearend and obtain supporting documents.
- Select shipping documents and/or customer orders from the population of all issued during the period of the cutoff test before and after the yearend and trace to recorded sales.
- Review subsequent collections and consider inspecting supporting documents for an appropriate period after the engagement date.
- Inspect duplicate deposit slips and supporting documentation, trace to postings in the customer's account as necessary.
Slightly less than high RMM (same performance procedures as above):
- Select fewer items as individually significant for positive confirmations. Consider a combination of positive and negative confirmations for representative balances in the remaining population. Consider sending confirmations a month before the engagement date and performing appropriate roll-forward procedures.
- Shorten the period for sales cutoff tests.
- Shorten the period for reviewing subsequent collections.
Moderate to low RMM (same performance procedures as above):
- Send positive confirmations on fewer individually significant items before the engagement date and perform roll-forward procedures. Consider sending negative confirmations or performing alternative procedures for selected representative balances in the remaining population.
- Shorten the period for sales cutoff tests significantly.
- Shorten the period for reviewing subsequent collections significantly.
On-demand webcasts with more guidance on performing tests of balances can be obtained by clicking on the applicable box on the left side of my home page, www.cpafirmsupport.com. An electronic copy of my book, Small Audits Made Easy and Profitable, can also be ordered by clicking on the appropriate tab. Registration on my website will entitle you to receive a 20 percent discount on all live and on-demand webcasts ordered through my website starting September 1, 2014.