Enhance your sales audit procedures for accounting

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welcome to part two of our video on auditing accounts receivable today i'm going to get into tests of internal controls and substantive tests so let's get into [Music] it what i've done from our last video is i've summarized all of the controls and i've already written them out here on my document and then i'm going to talk about the types of tests of internal controls and substantive tests that we might do now i'm not going to write them down because what i discovered from making my last video where i did this is that the writing tends to take quite a long period and you can take notes or look at the transcripts and closed captions of the video so let's look at the first internal control which is a process to approve customers to buy on credit if i'm testing this as an internal control of course you know i want to be sampling i'm not going to test all of the debtors but the sorts of things that i would do here is i would select a sample of our debtors perhaps new ones approved this year and go back to check the approval documentation is there some sort of cover sheet what did the clients have to provide was it bank statements financial statements what did we approve who approved it and was that approval within our regular schedule so normally there'll be some sort of guideline about who can approve and also how much credit people can be granted so if a company has you know audited financial statements and they have a turnover for x number of thousands of dollars then we'll set the amount of credit that that entity will have appropriately so i need to look at these approvals for credit make sure that approval has been done there was an approval process we've got signatures we've got documentation and those signatures and documentation seem to follow the company policies so we do expect that there is a policy or a procedure or a document somewhere that says how much credit people can apply for and who can approve those now the second internal control is that when a sale is made the system records a journal entry based on whether the sale is a credit sale or a cash sale so when i'm auditing sales and i'm looking at those control processes in the sales system i want to make sure that i investigate what is the mechanism to make sure that the journal entry does go to accounts receivable and not to cash i might need to test some of those select a sample of sales made on credit from the sales orders and then see if i can follow trace through to those journal entries to make sure it's debiting accounts receivable accounts receivable appropriately now if the company has a lot of accounts receivable accounts or sub accounts for customers we need to make sure that it's also going to the correct sub account so what sort of programming goes into the system in our internal controls in our point of sale system to make sure that that happens now the next one was depositing cash or checks and they said that you know there should be some sort of register of the monies or checks received at reception as there should be a different person that takes that to the bank and then those two separate documents should go to accounting so we want to make sure that that reconciliation was done so the accountants are receiving the check or the deposits or the monies receive register and the bank deposits we also want to make sure that those are being filled out by different people so usually there's some sort of signature or initials on each of those two documents make sure that they're different people within the firm you might need a staff list or a hr list for that and then check that they've been reconciled to make sure that for every money that was received a deposit was received so we need to make sure that that reconciliation is done that's usually part of the process of course for recording payments for accounts receivable so usually when we have our accounts receivable we record monies received by cheque by cash but also by direct deposit so through the bank statement we should be able to see any direct deposits that come through and then the accountant has prepared journal entries now normally they can't just prepare journal entries and do whatever there's normally a process to approve the posting of those journal entries so that means somebody schedules all the journal entries then somebody else looks at the journal entries that have been prepared compares them to the supporting documentation which could be the bank statement proof from the bank deposit or some other format to prove that that transaction really did occur we've received the money and then approves those transactions usually there's a two-stage process there in a large firm in a smaller firm then you might want the owner to check or to do this particular part and we'll check that the owner is doing that then the last one is the reporting of overdue debtors by management now in the reporting of overdue debtors we hope that in most larger firms that we would be auditing or that would need an audit that they would have some sort of monthly report about what is overdue we want to make sure that that report exists and also that that report is being reviewed by somebody so it's not enough for the report simply to be just made it needs to be reviewed and checked by somebody so that then we know that there is an oversight process it's not just somebody doing something on their own now one thing that i forgot to include but i'm going to add here is an approval process to write off bad debts now the reason that we need to have that is to stop somebody from saying to a friend hey buy some goods of credit from the company i work for and then don't pay for them and i'll write off your accounts receivable as a bad debt so we need to make sure that there is an approval process for any bad debts that have been written off so you'll go through your bad debt expense journal entries find those trace or vouch backs or i should say the correct term here vouch back to the supporting documentation and make sure the financial controller or the cfo has signed off on that write-off of that bad debt expense because that should definitely be a control okay so now let's get into the substantive testing and when it comes to substantive testing of course we always want to start by making sure that we identify all of the different assertions so we have the existence assertion we need to worry about the accuracy valuation and allocation assertion the completeness assertion and the rights and obligations assertion okay so for existence we need to prove that these accounts receivable actually do exist so how could we prove that these customers are real customers well number one we could look for real sales so we could select a sample of accounts receivable and send a debtors confirmation now a debtor's confirmation is basically a letter that the auditor sends to the debtor and says hey are you a real debtor do you owe us this amount of money so it's a really great test for existence it'll also help you a little bit with testing valuation but it's not a great test and it's not a great test for a very specific reason if you owed fifty thousand i'm going to just scroll down here a bit so let's say that the amount owed was 50 000 by the customer okay but ing to the journal entries and the records it says that you owe forty thousand so if you got a letter that said do you owe xyz company forty thousand you'd go yes all right i don't have to pay this extra ten thousand they've forgotten about it or they've lost a transaction okay so when accounts receivable is understated a data's confirmation doesn't help us but what if the situation was reversed what if the journal entry said you owed sixty thousand you received that letter in the mail or the email you you'd be bringing up or ringing them up on the phone going uh excuse me it says fifty thousand but actually i owe sixty thousand so if you've overstated accounts receivable it's a really great test so when it comes to doing data's confirmations they're a really great test for overstatement only okay they're not a really great test for understatement so you could send out one of these confirmations and you could send it by email or you could send it by physical post but it's something that's falling out of favor because people just don't reply you send these to customers and they just don't reply so another way to check the existence is to gather information from your sales so use testing from sales proof that transactions were real and did occur all right so if most of the company sales are on credit then when you've gathered evidence to prove that the sale is correct the credit side of the transaction then you're also gathering information on the debit side so existence there is pretty reasonable now when it comes to accuracy valuation and allocation we want to make sure that transactions have been recorded at the correct amount individual journal entries which you'll do when you're testing sales so that accuracy part will do a lot of when we're testing sales valuation is making sure that all of them add up okay so there's usually some sort of recalculation tests that you can do there to look at the journal entries add all of those journal entries up make sure it adds to the individual value of the accounts receivable now another way that we can test the valuation of accounts receivable is by looking at a subsequent cash receipt test and that means let's say here at the 30th of june which is a year end the customer owed 30 000 okay and rather than go back and try and prove a whole lot of other things by doing a lot of calculations let's say i look in august or september if i can find a payment in the bank transactions for 30 000 that matches back to this transaction over here i can say yep i've got proof that the accounts receivable existed and this is the correct amount i've tested the valuation assertion so i can use this subsequent cash receipt test this is a really important name to learn to actually check valuation and to check existence as well next we move on to the completeness assertion and remember completeness is about understatement and this is less likely because companies are less likely to understate or not record some of their accounts receivable so in terms of trying to test any um missing accounts receivable you might also as part of that subsequent cash receipt test that we did up here also see if you can identify any cash deposits that aren't are not cash sales or existing accounts receivable and that might be an accounts receivable that was forgotten to be recorded when you're testing completeness of sales if you found sales that were made goods that went out but no transaction then that'll also help you here as well so use sales audit procedures for the completeness assertion all right so that that's another way that you can test completeness completeness is one of the hardest assertions to gather evidence on because you're trying to find things that may not be recorded but they might not be recorded because they didn't actually happen so it's a little it's a bit like trying to find an invisible pin um whether it may or may not be there so completeness is sort of a bit like schrodinger's cat in that way now the last assertion that we have is rights and obligations let me just do this in the orange again so it's a little bit clearer to see with rights and obligations it's less so obligations and more so writes do i have the right to record that accounts receivable as an asset now that right is all going to come down to was the sale valid all right so remember that we have sales and we have the cutoff assertion which is about making sure that goods were delivered to make sure that we can record the sale appropriately ing to our accounting standards so we need to make sure that for any accounts receivable we owe those goods were delivered to the customer all right so when we're testing the sales cutoff assertion then that'll also flow through to helping us test the rights and obligations assertion now i realized just then that one of the most important valuation tests that we should also do is an aging of accounts receivable and an aging of accounts receivable is really just stratifying or breaking down the population of accounts receivable into groups based on 0 to 30 days overdue 31 to 60 61 to 90 and 90 plus all right so you would have here all of your different accounts receivables and you'd hopefully have less in the very overdue amount now what is really smart here is if i'm testing general accounts receivable those tests that i'd done before well what i would do is i would select my samples from within 0 to 30 and 31 to 60 all right because the transactions that are overdue i'm going to need to do something a little bit more appropriate too so those 30 00 to 60 days i might do a subsequent cash receipts test i might do recalculations of transactions mapping it back to my sales what i'm going to do with the other ones 60 to 90 90 plus is this is where i'm looking for bad debts all right so whereas before here i might randomly or haphazardly select samples what i'm going to do when it comes to accounts receivable in that 61 to 90 and 90 plus is that i'm going to be looking at these as potential bad debt expense oh i can't spell debt all right and these ones potentially might need to go into the provision for doubtful debts dd there is doubtful debts so i'm going to need to look very carefully and i wouldn't even sample what i'm going to do here is i'm going to look at all of the debtors in these particular categories right because i it wouldn't be any good if i had 10 potential 90 plus day ones and just look at two of them sampling isn't going to help us here so we need to be more specific be more precise in our sampling and instead of sampling looking at all of them because the risk of material misstatement here is much much higher and we need to make sure that we write off any bad debts and make sure that we have the appropriate provisions because remember that's also going to have an impact on ongoing concern when we analyze going concern and we analyze cash flow if the company has had increasing days in receivables so if days in receivables is going up and up then that's going to also affect the cash flow and the going concern of the entity now i did realize that i forgot to include one last assertion and that's about presentation of the information within the financial statements so we also of course do need to make sure that we're presenting our information in ance with the australian accounting standard or with ifris and that also includes appropriate recognition of provisions for bad debts and also bad debt expense all right so there are appropriate there are specific disclosures you need to make about provisions for doubtful debts and bad debt expense you also need to go back and make sure that if they do have provisions for bad debts that they're calculating that appropriately now in most regular day-to-day reporting businesses will do something like five percent of accounts receivable is a provision for doubtful debts but for our accounting financial reporting we can't actually just say five percent um instead what we have to do is we have to go through individual accounts receivables mark some as maybe not able to be collected they will go into the provision and the ones that we definitely can't collect need to be written off as the bad debt expense so that means that where you do have bad debt expense which would be audited sort of at the same time that you'd be auditing accounts receivable you'd need to do that so that's all i've got for testing internal controls and substantive tests around accounts receivable now of course this isn't a fully exhaustive test if you go into auditnet.org you can find heaps of other audit procedures but these are the ones that i like to use and i like to see my students design in terms of their work and they're used most commonly if you have suggestions for other tests please pop them in the comments i'd love for you to share so of course as always thumbs up if you thought the video was useful i'd really love it if you subscribe and please make sure you stay tuned because we've got plenty more in this series on auditing specific accounts thanks for watching and i'll see you next time