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2nd Flr, GF Partners Bldg, 139 H.V. dela Costa, Salcedo Village, Makati City

AUDITING PROBLEMS
Audit of Receivables Prof. L.O. Aristorenas
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GAAP ON RECEIVABLES
DEFINITION:
Receivables refer to claims against others for money, goods or services arising from
sale of merchandise or money lent or the performance of services. For accounting purposes
however, the term is employed to mean claims expected to be settled by the receipts of cash.

RECOGNITION:
Receivables are recognized when title to the goods passes to the buyer or when transfer
of resources take place. The point at which title passes may vary with the terms of the sales.

MEASUREMENT:
1. At face value
2. At discounted amount (present value)

VALUATION:
1. Receivable are valued at their net realizable value or their expected cash value.
Determination of NRV requires estimation of uncollectible receivables, as
such, an allowance account should be set up for doubtful accounts and for any
anticipated adjustments which in the normal course of the business will reduce
the amount receivable.

Net realizable value - is the estimated amount of cash that will be


collected or realized from receivables.
2. Long term note receivables should be valued at an amount
representing the present value of the expected future cash receipts.
3. Receivable denominated in foreign currency should be translated to local
currency at the exchange rate on balance sheet date.

CLASSIFICATION:
1. Current Assets vs. Non Current
Current - receivables which are expected to be realized cash within the
normal operating cycle or one year, whichever is longer.
Non current - receivables which are expected to be realized beyond one year
or those receivables which are not currently collectible.
2. Trade vs. Non-trade
Trade receivable - refers to claims arising from credit sale of merchandise
or services in the ordinary course of the business. The usual
type of trade receivables are:
a. Accounts receivable - short term, unsecured and informal
credit arrangements (open accounts).
b. Notes receivable - evidenced by a formal instrument which
is the promissory note.
Non trade receivables - represent claims arising from sources other than
the sale of merchandise or services in the ordinary course of the
business.

BALANCE SHEET PRESENTATION:


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Receivables whether trade or non trade which are currently collectible should be
presented on the balance sheet as one line item called Trade and Other receivables.

AUDIT OBJECTIVES:
1. Existence - to determine whether receivables actually exist.
Audit Procedure: Obtain a schedule of aged trade accounts receivable and
notes receivable schedules and reconcile them to the general ledger.
2. Rights and Obligations - to determine whether receivables represent bona
fide obligations owed to the company as of balance sheet date.
Audit Procedures:
a. Confirm receivables with debtors
b. Inspect notes on hand
c. Perform analytical review procedures
3. Completeness - to determine that all transactions relative to
receivables have been recorded in the proper accounting period.
Audit Procedure: Test cutoff of sales and sales returns to determine
whether receivables are recorded in the proper accounting period.
4. Valuation - to determine whether receivables are recorded at proper amounts
in accordance with GAAP.
Audit Procedure: Review collectibility of receivables and determine
the adequacy of allowance for doubtful accounts.
5. Presentation and Disclosure - to determine whether receivables are properly
presented and classified in the balance sheet.
Audit Procedure: Evaluate financial statement presentation and
disclosure of receivables.

OTHER ITEMS:
1. Methods of Receivable Confirmation
a. Positive confirmation
- used when individual account balances are relatively large.
- there is a reason to believe that there may be a substantial number
of accounts in dispute or with inaccuracies or irregularities.
- internal substantiating evidences are not adequate
- internal control system is weak
b. Negative confirmation
- internal control procedures regarding receivables are
considered effective.
- a large number of small balances are involved
- the auditor has no reason to believe that persons receiving the
requests are unlikely to give them consideration.

2. Trade discounts vs. Cash discounts


Trade discounts- this also known as volume discount or quantity discount. It
is a means of adjusting the list price for different buyers or varying quantities.
Accounts receivables should be recorded net of trade discounts.
Cash discounts - this is a reduction from the invoice price by reason
or prompt payment.

3. Customers credit balances - credit balances in Accounts receivables resulting


from overpayments, returns and allowances and advance payments from customer. This
account should be classified as current liabilities and must not be offset against the debit
balances in other customers account.

3. Terms related to freight charges


a. FOB Destination - means that ownership to the merchandise is transferred
to the buyer only upon reaching the point of destination
or upon the buyers receipt of merchandise.
b. FOB Shipping point - means that ownership to the merchandise is transferred
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to the buyer upon shipment thereof.


c. Freight collect - means that the freight charges on the merchandise
shipped is to be paid by the buyer.
d. Freight prepaid - means that the freight charges on the merchandise
shipped was already paid by the seller.

4. Accounting for bad debts expense


a. Allowance method - this requires the recognition of bad debt loss if the
accounts are doubtful of collection.
b. Direct write off method - this requires the recognition of bad debt
loss only when the account proved to be worthless or
uncollectible.

5. Methods of estimating bad debts expense


a). Percentage of sales (Income statement approach) - bad debts expense
is calculated by applying a percentage to credit sales for the period. This process results in an
adjusting entry that debits bad debts expense and credits allowance for doubtful accounts
without regard to the existing balance in the allowance account. A proper matching of cost and
revenue is achieved because bad debt loss is directly related to sales and reported in the year
of sales
b). Percentage of Receivables (Balance sheet approach) - results in a
more accurate valuation of receivables on the balance sheet since this method attempts to
value accounts receivables at their future collectible amounts.
a. Composite percentage - a single rate is applied to Accounts
receivable at the end of the period to obtain the desired ending balance of the allowance. The
amount of bad debts expenses recognized is the difference between the existing balance in the
allowance account and the desired ending balance.
b. Aging - accounts receivable are classified by age and a different
percentage is applied to each age group. The allowance is then determined by multiplying the
total of each classification by the rate or percent of loss depending on the experience of the
company for each category.

6. NOTES RECEIVABLES
a. Definition -these are claims supported by formal promises to pay, which are in the
form of notes.
b. Recognition
1. Short term notes are generally recorded at face value because the interest
implicit in the maturity value is immaterial.
2. Long term notes should be recorded at present value.
a. Interest bearing notes - the PV of the note is the same as the face
amount of the note.
b. Non interest bearing notes
Present Value
note exchanged solely for cash equal to the amount of cash proceeds
note exchanged for property, goods Present value is according to the
ff. order of priority:
1. FMV of the property, goods or
services
2. FMV of the note received
3. Discounted amount of note using
appropriate rate of interest.

The difference between the face amount of the note and its PV is recorded as
discount or premium and amortized to Interest income account over the life of
the note using the effective interest method.

c. Valuation and reporting


1. Short term notes are reported at their net realizable value.
2. Long term notes are reported at present value.
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7. ACCOUNTS AND NOTES RECEIVABLE FINANCING:


a. Pledging - receivables are used as collateral or security for a loan and not
reflected in the accounts although a disclosure should be made in the financial statements
either in a note or parenthetically.

b. Assignment - a more formal borrowing arrangement in which the receivables are


used as security . The assignor or borrower transfers its rights in some of its accounts
receivables to a lender or assignee in consideration for a loan
1. The loan is at a specified percentage of the face value of the collateral and
interest and service fees are charged to the assignor (borrower).
2. The debtors are occasionally notified to make payments to the assignee (lender)
but most assignments are not on a notification basis.
3. Assigned accounts are segregated from other accounts. The Notes payable
should be deducted from the balance of A/R assigned to determine the equity in assigned
accounts receivable.

c. Factoring - it is similar to a sale of receivables because it is generally on a without


recourse-notification basis. The factor or buyer assumes the risk of collectivity and generally
handles the billing and collection function. A gain or loss is recognized for the difference
between the proceeds received and the net carrying amount of the receivables factored.

d. Discounting - this is a sale of the note to a third party, usually a bank. The sales is
usually on a with recourse basis which means that upon the default of the debtor, the seller of
the note becomes liable for its maturity value. Proceeds from discounting is computed as
follows:
1. Interest to maturity (P x R x T)
2. Maturity value (P + I)
3. Discount (MV x DR x DP)
4. Net Proceeds (MV - Discount)

If the face value of the note is > proceeds, the difference is interest expense.
If the face value of the note is < proceeds, the difference is interest income.

END