Introduction to Audit procedures
Audit procedures are the primary part of the audit engagement for auditors to test the accuracy and legality of balances and transactions. Audit procedures guide the auditor to test those balances and transactions in distinct ways.
Audit procedures are exclusive for every diverse client and are based on the risks associated with the client and the accounting heads in their financial statements.
Audit procedures identify any misstatements that occur due to fraud or error. However, various procedures are applied to accomplish the desired purposes of the audit.
What are accounts receivables?
There are two types of accounts that an organization maintain in their books of accounts. A transaction assertion is a temporary account that is not transferred to next year but is closed in the current financial year such as sales, cost of sales, and expenses, etc. The others are balances accounts that are carried forward to next year by updating the balances.
Account receivables are an asset balance account in which the amounts owed by the customers are refurbished. Once supplies or services are rendered to customers, the company renews its general ledger for the invoiced amount.
Accounts receivables general ledger is updated with every non-cash transaction between the company and the customer. This means that supplies or services are rendered to the customer but are not yet paid or partially paid.
These amounts when accumulated at the year-end, give a large particular amount that is imported into the financial statements of the company.
Accounts receivables is an asset account, the balances of which will be received in the forthcoming periods from the customers. Some amounts in this total are expensed out when the company perceives that they are no longer collectable.
Accounts receivable are recorded in the current assets section of the total assets head of the balance sheet. Account receivables have a debit nature and increase the potential inflows of the organization.
Applying audit procedures on Accounts receivables:
Audit procedures are applied to the accounts receivables balances to test their assertions. Testing these assertions include verifying its existence, rights, and obligations, completeness, accuracy, classification, and presentation.
These assertions may be materially misstated due to fraud or error. It is the responsibility of the auditor to perform unique audit procedures for every assertion and reveal any misstatement if present.
However, the extent of applying audit procedures depends on the control systems implemented in the accounts receivables division and how efficiently are those controls practised to bring about the results.
Inherent risks in the accounts receivables balances:
There are some built-in risks the accounts receivables balances. These risks may result in misstatements due to fraud or error. There may be certain circumstances in which the accounts receivables officers may skip some balances or insert wrong postings.
These risks are more probable when there is no connection between corresponding departments involved in the accounts receivables.
In some instances, the management may intentionally increase the accounts receivables figures to give a positive signal to stakeholders, for example by reporting next or previous year’s sales in the current year.
One important and primary risk involved in the accounts receivables balances is that the organization has not expensed out the amounts of the bad debts in the receivables balances, which they acknowledge cannot be recovered anymore.
Bad debts occur when the customers do not pay according to the terms agreed with them by the supplier. These balances should, therefore, be expensed out.
Bad debts curtail the profits made by the organization in the current year and because they will contemplate to not expense them out.
Assertions tested by audit procedures:
Testing assertions are the fundamental part of the audit that is tested by the auditor. Every assertion has its own risk of material misstatement involved in it. Risks present in these assertions and how they can be distilled by the auditor are explained below:
The audit of existence in accounts receivables means to verify the actual existence of these balances. The auditor will analyze the breakup of accounts receivables by customer’s listings and confirming them by sending direct confirmations to customers.
Rights and obligations:
There is not a big reason to worry about the rights of the accounts receivables of the company. However, in some major companies, the accounts receivables are transferred to a factor to collect them on behalf of the company for a discount.
This, therefore, transfers the rights to the factoring company, which will be inspected by the auditor.
It is possible that the company for the sake of reducing tax liability, intentionally missed out some receivables balances for the sales made. This compromises the completeness assertion.
The auditor can confirm these balances by sending blank confirmations to customers along with testing the cash receipts after the year-end which may relate to the sales made in the current year.
Accuracy is a simple assertion in which the auditor performs the recalculation procedures to test the accuracy of the accounts receivables. Misstatements may occur because of human errors by skipping or summing up extra balances.
Presentation means disclosing the major issues in the accounts receivables such as a large balance in the accounts receivables has gone uncollectable which the company needs to expense out. The auditor needs to check the extent of disclosures made in notes to the financial statements.
Unique audit procedures for testing accounts receivables:
- Matching opening balances of accounts receivables to last year’s closing balances.
- Applying analytical procedures to find any unusual differences and reasons behind them.
- Obtaining receivables ageing report from the client and matching the figures to accounts receivables general ledger.
- Recalculating the figures of accounts receivables general ledger to confirm the accuracy.
- Verification of invoices against the supporting documentation to verify that correct postings are carried out in the general ledger.
- Verifying the sales period by inspecting the shipment documents of those sales.
- Verifying completeness and existence by sending direct confirmations to debtors.
- Reviewing the company’s policy for allowance for doubtful debts and applying it to the receivables balances.
- Comparing general ledger balances to actual receivables listings and checking their accuracy.
- Analyze that the necessary disclosures for bad debts and other significant events are correctly presented in the notes to the financial statements.
- Applying cut off procedures to verify that amounts recorded in the current year do not relate to other periods.