Meaning of Accounts receivables
Accounts receivables generally mean Trade receivables in the financial statement of large listed public companies. Accounts receivables are disclosed under the headings “Current Assets”. These are trade or non-Trade receivables that have been specified by the company or regulations and meet the criteria of being classified separately. Accounts receivables are characterized as common and significant.
The company is running an account of Accounts receivables. The company has made sales to the tune of $ 1000 to Kuman Inc. This transaction sales made on account will be recorded under Accounts receivables. Similarly, the fixed asset if sold on account, would also come under accounts receivable. However, the sales transactions on account are general and fixed assets disposal are rarely made.
Risk of material misstatement for accounts receivable
The risk for accounts receivable would be internal control risk and inherent risk. The risk of being susceptible to misstatement due to the nature of the debt is the inherent risk of the accounts receivable. Control risk occurs when the internal control system of the client fails to prevent or detect material misstatement in the accounts receivable. Some of the risks associated are unauthorized transactions, wrong recording, and non-compliance with accounting standards on assets and accounts receivables.
An unauthorized transaction is a case where someone other than a person authorized and responsible for accounts receivable deals with the related matters either within the entity or with outsiders. Such risks generally create the risk of fraud which is itself material misstatement. The audit client shall correctly record debtors as per applicable accounting standards.
The proper classification of debtors shall be done. Further, the breach of Sales terms and conditions may lead to material misstatements. Hence, the auditor needs to clearly understand the sales arrangements and check if they are complied with within time and in full.
Inherent Risk for Accounts Receivable
The inherent risk in the case of accounts receivable is high. Auditors need to perform a test of control as well for accounts receivable to get a clearer picture of the inherent risk of accounts receivables. The inherent risk for accounts receivable would relate to nature, size, and the complexity of the business of the auditee.
If the business is more inclined towards financial or special situations like hire purchase business, the inherent risks would be higher in such a scenario. The susceptibility of accounts receivable to misstatement is basically an inherent risk. Some of the scenarios that are inherent risks and procedures to be followed for accounts receivables are as follows:
- The non-existence of accounts receivables. For instance, fictitious invoices are generated to increase sales, and receivables are recorded on the current year when they are actually made after the year-end
- Accounts receivables do not reflect true economic value. This generally happens during the creation of allowance for doubtful accounts based on probabilities and aging analysis.
- The auditee has no control over receivables. This scenario happens when the accounts receivables notes are pledged as collateral for loans from banks are given to financial institutions on factoring arrangements.
- Accounts receivables are based on contingent events. This happens if the company does not follow the guidelines issued by their accounting bodies such as IFRS and GAAP or regulatory authorities.
- Aging analysis is not correct and does not signify the true picture of the certainty of receivables.
Control Risks for accounts receivables
The risk that internal control cannot prevent or detect material misstatement in financial statements is called control risk. Control risk for accounts receivable is related to control procedures of accounts receivable which is not able to prevent or detect a misstatement that can occur in accounts receivable. In case the inherent risk is high, the auditors carefully assess the internal control procedures in such a case. In such cases, control risks are minimized due to initial work is done.
Auditors would however need to perform tests of controls to obtain assurance of sufficient appropriate audit evidence to support their assessment if they assess that control risk is low. Further, if auditors think otherwise that control risk is high, tests of controls need not be performed.
Auditors would directly perform substantive audit procedures taking on bigger samples. Some of the scenarios that are control risks and procedures to be followed for accounts receivables are as follows:
- Accounts receivable should be recorded alongside sufficient supporting documents. Supporting documents include customer purchase order, letter of lading, and sale invoice to ensure the existence of accounts receivables
- Reconciliation of accounts receivables by tracing supporting documents and invoices with beginning and closing balances.
- Ensuring that documents purchase order, bill of lading, and sales invoice are serially or prenumbered. This is useful to avoid omission.
- Computation of allowance for doubtful accounts is made properly.