Efficient Tests of Balances Series—No. 12: Maximizing Substantive Evidence from Analytical Procedures for Receivables

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Determining the nature, extent and timing of analytical and tests of balances procedures is based on the results of the auditor’s risk assessment procedures.  More substantive evidence obtained from the auditor’s risk assessment procedures and analytical procedures can result in less evidence required from the detailed tests of balances.  Today’s focus is on maximizing evidence that can be gathered from analytical procedures.

For all levels of risk of material misstatement, analytical procedures normally performed for accounts receivable would include:

  • Compare account balances in accounts, loans and notes receivable with the preceding year or years.  Investigate significant changes in amounts or deviations from trends.
  • Investigate large and/or unusual balance classified as other accounts receivable.
  • Consider computing the following ratios and comparing to the prior year or years to evaluate the valuation assertion (collectability):
  • Number of days net revenues in accounts receivable
  • Yearend receivables as a percent of gross revenues
  • Bad debts as percentage of gross revenues
  • Allowance for doubtful accounts as a percentage of accounts receivable
  • Aged categories as a percentage of total accounts
  • Interest income as a percentage of the average balance of notes receivable outstanding.

Significant variations in expectations compared to recorded amounts from these analytical procedures require additional procedures to determine their effects are not causing the financial statements to be materially misstated. Significant variations are generally those that comprise dollar amounts over the lower limit for individually significant items or, in the case of ratio analysis, percentage variations that are significant in relation to the auditor’s expectations.

Acceptable results from analytical procedures and/or additional procedures result in substantive evidence that may result in decreases of tests of balances sample sizes.  Once the auditor has investigated variations and determined either they aren’t the result of error or fraud, or proposed a journal entry to correct significant misstatements, the results of analytical procedures can be considered to have produced acceptable results. In other words, the analytical procedures with acceptable results provide substantive evidence that decreases the risk of material misstatement in the accounts receivable financial statement classification. In such cases, less substantive evidence will be required from the detailed tests of balances.  As a part of an audit strategy, effective analytical procedures provide a significant opportunity to do less work and to increase engagement profits!

Live and on-demand webcasts in my Basic Staff Training Series (“how to audit” major financial statement classifications) contains extensive guidance on efficiently performing analytical and tests of balances procedures.  You can download a syllabus or register by clicking on the applicable website on the left side of my home page, www.cpafirmsupport.com.


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