Account Receivable: Test of Details Balance | Auditing and Attestation | CPA Exam

In this session I discuss test of details balance for account receivable.

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The Summation of Accounts Receivable Agrees with the Master File and the General Ledger

Most tests of accounts receivable and the allowance for uncollectible accounts are based on the aged trial balance. An aged trial balance lists the balances in the accounts receivable master file at the balance sheet date.
Recorded Accounts Receivable Exist

Confirmation of customers’ balances is the most important test of details of balances for determining the existence of recorded accounts receivable. When customers do not respond to confirmations, auditors also examine supporting documents to verify the shipment of goods and evidence of subsequent cash receipts to determine whether the accounts were collected. Normally, auditors do not examine shipping documents or evidence of subsequent cash receipts for any account in the sample that is confirmed, but they may use these documents extensively as alternative evidence for nonresponses.

Existing Accounts Receivable Are Included

It is difficult for auditors to test for account balances omitted from the aged trial balance except by relying on the self-balancing nature of the accounts receivable master file. For example, if the client accidentally excluded an account receivable from the trial balance, the only likely way it will be discovered is for the auditor to foot the accounts receivable trial balance and reconcile the balance with the control account in the general ledger.

Accounts Receivable Are Accurate

Confirmation of accounts selected from the trial balance is the most common test of details of balances for the accuracy of accounts receivable. When customers do not respond to confirmation requests, auditors examine supporting documents in the same way as described for the existence objective. Auditors perform tests of the debits and credits to individual customers’ balances by examining supporting documentation for shipments and cash receipts.

Accounts Receivable Are Properly Classified

Normally, auditors can evaluate the classification of accounts receivable relatively easily, by reviewing the aged trial balance for material receivables from affiliates, officers, directors, or other related parties. Auditors should verify that notes receivable or accounts that should be classified as noncurrent assets are separated from regular accounts, and significant credit balances in accounts receivable are reclassified as accounts payable.

Cutoff for Accounts Receivable Is Correct

Cutoff misstatements exist when current period transactions are recorded in the subsequent period or vice versa. The objective of cutoff tests, regardless of the type of transaction, is to verify whether transactions near the end of the accounting period are recorded in the proper period. The cutoff objective is one of the most important in the cycle because misstatements in cutoff can significantly affect current period income. For example, the intentional or unintentional inclusion of several large, subsequent period sales in the current period — or the exclusion of several current period sales returns and allowances — can materially overstate net earnings.

Cutoff misstatements can occur for sales, sales returns and allowances, and cash receipts. For each one, auditors require a threefold approach to determine the reasonableness of cutoff:

Decide on the appropriate criteria for cutoff.
Evaluate whether the client has established adequate procedures to ensure a reasonable cutoff.
Test whether the cutoff was correct.
Sales Cutoff
Most merchandising and manufacturing clients record a sale based on shipment of goods criterion. However, some companies record invoices at the time title passes, which can occur before shipment (as in the case of custom-manufactured goods), at the time of shipment, or subsequent to shipment. For the correct measurement of current period income, the method must be in accordance with accounting standards and consistently applied.

Sales Returns and Allowances Cutoff
Accounting standards require that sales returns and allowances be matched with related sales if the amounts are material. For example, if current period shipments are returned in the subsequent period, the sales return should appear in the current period. (The returned goods should be treated as current period inventory.)