Audit Objectives

Audit objectives for revenue and receivables are concerned with

obtaining sufficient audit evidence for the transactions and
balances. The key issues in auditing sales and receivables are to
ensure that:
a) the sales are neither understated nor
overstated, and the sales are genuine;
b) The receivables are in existence and the
amounts are collectible

c)Provisions for doubtful debts are adequately

provided for receivables that have became a
bad debt or are doubtful in terms of their
collectability
Nature of Revenue and Receivables
Auditors should understand the process of revenue
recognition when they audit the revenue and receivables.
The revenue recognition process included in the revenue
cycle. The information flows in the cycle through
numerous accounts such as:
a) Sales:
(b) Cash receipts;
(c) Accounts receivable; and
(d) Sales returns and allowances.
Revenue cycle process includes receiving orders from customers, which
involves documentation to support the transactions such as customer
orders, sales orders and shipping documents.
The process of delivering and billing to customers involves documents
such as shipping documents for a delivery and invoice for billing of
sales.
Journals, accounts and statements are involved in the recording process
and receipts are documents used in sales and account receivable
collections.
For each process in the revenue cycle, some controls should be put in
place by the companies to mitigate any frauds or misstatements in the
financial statements.
Auditors should assess whether such controls are working effectively to
mitigate misstatements in a financial statement assertion.
The control assessments are performed in the test of controls after considering results from
risk assessments.
The auditor should design an appropriate audit approach based on the assessment of the
identified risks at both the financial statement level and the assertion level.
The assessed risks are different between the material lasses of transactions, account balances
and disclosures.
Therefore, the most appropriate and effective audit approach varies.
For example, tests f controls are more appropriate to test for the completeness of sales and
ubstantive tests are applicable for the other assertions.
Furthermore, tests f controls focus on the operation of controls over sales transactions and
cording process in the revenue cycle rather than on the accuracy of sales d receivables
amount.
 The Accounting System
and Control Activities
Implementing adequate control activities is crucial for sales and receivable
account because they affect the business as a whole. However, before control
activities are further discussed, it is important to understand the three main
components of the revenue cycle, which are sales, cash receipts and sales
adjustments. The sales process starts with a customer placing orders for with the
sales department. The sales department will check the order and customer credit
rating before approving the amount of sales and credits
The approved sales order will be sent to warehouse for processing and delivering
the goods to the customer.
A delivery note with the description of goods and quantity will be issued together
with goods sent to the customer.
The date of delivery will be taken as a point where sales can be recognized, on the
shipping term such as freight on board (FOB) destination and shipping point.
Then, a sales invoice is issued based on the information depending stated in the
delivery note and the price list.
If the company gives any discount to the customer, it will be clearly stated in the
invoice together with the credit terms (if any).
The sales invoice is then sent to the customer and a copy will be sent to the
accounts department for recording purposes.
The collection department is responsible for collecting payments from the customer.
While the keying in of data is delegated to each department, the accounts
department is responsible for ensuring that all transactions such as sales, return
and allowances and cash collections are properly recorded.
 Understanding the Entity
to Identify Inherent Risks
An understanding of the entity and planning. It helps to determine the potential
misstatements on the financial report. Regarding the sales and receivables, the auditor
should understand the nature of the entity's businesses in terms of margins can be
determined by:
(a) The types of products or services-gross
(b) The target markets and customers-the level of receivables can
be understanding the products; estimated by understanding the
customer classes and the industry
(c) Pricing, sales returns, discounts, credit sales and payment
policies average collection periods, andpotential fictitious
adjustments or transactions can be determined.
Furthermore, understanding the entity's business environment helps to
assess inherent risks relating to assertions for receivables and sales. A
number of potential inherent risks are derived from business risks, such as:

a) A decrease in sales due to economic

declines;

(b) Doubtful debts due to the inability to collect receivables;

(c) Overstatements or understatements of sales due to improper sales

recognition.
The auditor should consider factors that may affect the assertions about
classes of transactions and account balances, such as:

(a) Pressure to report high profit-the entity tends to engage in

fraudulent reporting by creating fictitious sales or incorrectly recognize
sales; and
(b) Pressure to report a higher level of working capital-the entity may
understate allowance for doubtful accounts or overstate account
receivables.
In the event that a fraud risk is identified, the auditor should make sure
that controls over sales and receivables are established and implemented
adequately and effectively.
The design of an audit plan should reflect its response to a fraud risk such
as performing further audit procedures
 ASSESSING RISKS OF
MATERIAL MISSTATEMENTS
Based on the information obtained from understanding an
entity, inherent risks and internal controls, the auditor
assesses risks of material misstatement (inherent and control
risks). For example, the auditor may determine whether the
sales are susceptible to risk of overstatement due to pressure
to report high profits. In addition, the auditor should assess if
controls over sales cut off are effective to ensure sales are
recorded in the proper period. Once risks of material
misstatement are determined, the auditor should design
further audit procedures.
PERFORMING FURTHER AUDIT
PROCEDURES
This section discusses tests of controls and substantive procedures for sales and
receivables. The tests of controls should be performed prior to the substantive
tests. However, in the event that the controls over sales and receivables are not
well implemented or ineffective, the substantive procedures should be done after
the auditor obtains an understanding of internal controls. Certain tests of controls
are performed during an understanding of internal controls.
 TESTS OF CONTROLS
Tests of controls are designed to obtain sufficient evidence to determine
whether controls over sales and receivables are functioning effectively.
For example, vouching and tracing procedures are performed to evaluate
the controls over sales and receivables effectively ensure the occurrence
and completeness of sales and receivables transactions. The tests of
control involve testing of design effectiveness and operating
effectiveness.
TESTS OF DESIGN EFFECTIVENESS
Auditors use the understanding of the information system and internal control system
specific to the client to determine the presence of essential controls over sales and
receivables .Auditors need to understand the function within the revenue cycle to
determine the necessary controls and potential misstatements. Once the auditor
identifies the presence and absence of the necessary controls, the auditor makes a
preliminary assessment of control risk
TEST OF OPERATING EFFECTIVENESS
Next, the auditor should perform a test of operating effectiveness of controls, which
invovles a variety of procedures. For example ,the auditor may perform observation,
reperformance , and document inspection (vouching and tracing).The auditor may
obtain substantive evidence simultaneously when they perform porcedures to test
the operating effectiveness of controls, which are known as dual purpose tests.
However, the auditor should draw conclusions cautiously because the test of controls
onlydetermines the number of misstatements and not the size of misstatements.The
size of misstatements is determined by the substantive test, of which the
misstatements are consdered to be signficant when they are material.For example in
the event that misstatements are detected in sales transactions, the auditor may
conclude that the cotrols over sales are not operating effectively
SUBSTANTIVE PROCEDURES
The audit program or substantive procedures prepared based on a preliminary
assessment of control risks. The timing or extent of the procedures is based on the
results from the test of controls and the level of detection risk. However, the auditor
may use the professional judgement to determine how detailed substantive
procedures are and normally, the auditor performs more than the minimum level of
testing. When inherent risks for sales and receivable transactions are high and their
control risks are low, it is appropriate for the auditor to set a moderate level of
detection risks to achieve the required audit risk. The level of detection risks
influences the amount of procedures undertaken by the auditor to ensure the
existence and occurrence of sales transactions.
DESIGNING SUBSTANTIVE PROCEDURES

The substantive procedures should be carefully planned in terms of their nature

to ensure that the type of procedures is effective to obtain appropriate audit
evidence to determine the existence of sales and receivables transactions. When
the planned level of detection risk is low, the most effective substantive
procedures should be performed. Effective substantive procedures help to reduce
the detection risk when the possibility of material misstatements remaining
undetected in individual assertions is low. This section discusses the substantive
procedures for receivables and the related allowances. The types of substantive
procedures are:
The substantive procedures should be carefully planned in terms of their nature to
ensure that the type of procedures is effective to obtain appropriate audit evidence
to determine the existence of sales and receivables transactions. When the planned
level of detection risk is low, the most effective substantive procedures should be
performed. Effective substantive procedures help to reduce the detection risk when
the possibility of material misstatements remaining undetected in individual
assertions is low. This section discusses the substantive procedures for receivables
and the related allowances. The types of substantive procedures are:

(a) Analytical procedures;

(b) Test of details of transactions, and

(c) Test of details of balances.
Prior to performing the above procedures, auditors should perform initial
procedures such as tracing the opening balance for the current period to the
audited balance of previous year's working papers. A listing of all customer
balances is obtained from the client and the amount is reconciled to the
ledger. In addition, auditors should obtain the aged trial balance of an
accounts receivable. Then, auditors should perform the following procedures
on the listing of customer balances:

a) Recalculation-auditors should add up the listing and compare the total with
the amount in the ledger

b) Compare a sample of customer details and balances between the listing

and the subsidiary ledger.
ANALYTICAL PROCEDURES
Analytical procedures are used to confirm expectations and performed
in three stages:
a) To review the understanding of an entity as to whether any changes to
sales and receivables balances are to be expected;

(b) To determine any fluctuations in the amount of sales and receivables balance
between current year and previous year, and
(c) To determine ratios and trends for gross profit and average collection period. An
unusual change in gross profit margin compared with previous year's figure signifies
possibilities of misstatements in recording sales. An increase in average collection
period shows more allowance is required because the client is facing problems in
collecting receivables.
TEST OF DETAILS OF TRANSACTIONS
Test of transactions are used to corroborate test of details of balances. The tests of
transactions are normally performed during an interim audit and in the form of
dual-purpose tests. For example, the cut-off test performed on sales is one of the
tests of detail of transactions. It serves to verify the account balance of sales at the
end of the reporting period.
a) Document inspections
•vouching
Auditors vouch recorded account receivables to supporting documents. Selected sample
of debits in customers' accounts are vouched to sales invoices to obtain appropriate
audit evidence on the existence, right and obligations and accuracy of sales and
receivables. A selected sample of credits is also vouched to remittance advices and
sales adjustment authorizations to ensure the completeness of accounts receivables and
that the reduction on account receivable is properly made and legitimate
TEST OF DETAILS OF TRANSACTIONS
Sales cut-off test

The sales cut-off test is performed to ensure that current year sales and
receivables are recorded in the current period and the changes in current year
sales and receivables are reflected in the records of inventories and cost of
sales for the current year.
The sales return cut-off test is also performed to ensure that sales returns are
recorded in the appropriate period and to avoid overstatement of sales and
receivables. Auditors should check the date of receiving report for sales return and
determine the last receiving report for the year. The auditors should cautiously
review and investigate an unusually heavy volume of sales return immediately after
the year-end as it could signal that fictitious sales in the curren year-end were made
to inflate recorded sales.
TEST OF DETAILS OF TRANSACTIONS
Cash receipt cut-off test

The test is designed to provide evidence as to whether cash receipt are

recorded in an appropriate period. A proper cut-off is important to ensure the
correct presentation of cash and receivables. Selected cash receipts before
the last number of the final receipts for the current year will be inspected in
terms of date and traced to the receipts journal. A daily cash summary and
validated cash slips before the year-end are also reviewed by the auditors to
ensure that the cash receipts are properly recorded. If the auditors are
present during the cash counts at the year-end, the auditors may observe that
all collections received For the day are included in the cash on hand record
and are credited to account receivables.
TEST OF DETAILS OF TRANSACTIONS
Cash receipt cut-off test

The test is designed to provide evidence as to whether cash receipt are recorded
in an appropriate period. A proper cut-off is important to ensure the correct
presentation of cash and receivables. Selected cash receipts before the last
number of the final receipts for the current year will be inspected in terms of date
and traced to the receipts journal. A daily cash summary and validated cash slips
before the year-end are also reviewed by the auditors to ensure that the cash
receipts are properly recorded. If the auditors are present during the cash counts
at the year-end, the auditors may observe that all collections received For the day
are included in the cash on hand record and are credited to account receivables.
TEST OF DETAILS OF BALANCES
Test of details of balances are concerned with obtaining evidence about account
receivable balances. The test are not concerned about debit or credit transactions
but the balances at the end of the period. They also focus on the adequacy of the
allowance for doubtful debts
The test is designed to provide evidence as to whether cash receipt are recorded in
an appropriate period. A proper cut-off is important to ensure the correct
presentation of cash and receivables. Selected cash receipts before the last number
of the final receipts for the current year will be inspected in terms of date and
traced to the receipts journal. A daily cash summary and validated cash slips before
the year-end are also reviewed by the auditors to ensure that the cash receipts are
properly recorded. If the auditors are present during the cash counts at the year-
end, the auditors may observe that all collections received For the day are included
in the cash on hand record and are credited to account receivables.
a) Confirmation of balances

A written confirmation is sent to individual customers to confirm the amount

outstanding and payable from the customers. Responses to a confirmation request are
considered to be highly reliable because they come from third parties. The confirmation
provides evidence as to existence and rights and valuation of the account receivables.
However, it does not provide evidence of completeness. Customers are unlikely to report
more than the figure stated in the confirmation. The confirmation is only used when the
amounts are material and it is highly likely that the debtors will respond to the
confirmation. The likelihood of the response can be based on the previous experience on
that engagement. However, when there is no reasonable assurance that the customers
will respond and it is not effective to obtain sufficient appropriate audit evidence, the
auditor may use alternative audit procedures. For example, small companies may not
maintain sufficiently accurate record to respond to the confirmation.
b)Alternative procedures
Examine subsequent collections
The receipt of payment from customers is the best evidence for existance and
collectability of the debtors' amount. The remittance advice that accompanies the
cash receipt should be matched with the unpaid invoices and the outstanding
balance.
vouch unpaid invoices and supporting documents constituting debour balances
The unpaid inovoices should be traced to the bill of landing signed by the
customer and also to the customer's order to ascertain the debtor balance.

The auditor's working papers summarize the procedures and results obtained from
the procedures performed to confirm the account receivables. The auditor should
evaluate whether the evidence obtained from the received confirmation,
alternative procedures and analytical procedures are sufficient to determine if the
assertions related to account receivables are substantiated.