Auditors sometimes rely on a “balance sheet approach” when examining financial statements. When adopting this approach, they will focus the majority of their substantive tests on verifying the ending balance sheet accounts and rely to a significant extent on indirect verification of income statement amounts.

In our discussion of this approach, we illustrated somewhat simplified versions of the relationships among income statement accounts, cash transactions, and beginning/ending balance sheet accounts. For instance, Revenue = Cash receipts – Beginning Accounts Receivable + Ending Accounts Receivable. To effectively examine the revenue/receivables/collections cycle, the auditor is likely to apply at least some tests to each part of this equation.

Answer the following questions regarding the application of the “balance sheet approach” to auditing receivables and revenue:

Part A. Identify four critical substantive auditing procedures the auditor is likely to adopt to verify the ending balance of accounts receivable. (6)

1. Obtain an aged trial balance of trade accounts receivable and analyses of other accounts receivable and reconcile to ledgers.
2. Obtain analyses of notes receivable and related interest.
3. Inspect notes on hand and confirm those with holders.
4. Confirm receivables with debtors.
5. Review the year-end cutoff of sales transactions.
6. Perform analytical procedures for accounts receivable, notes receivable, and revenue.
7. Review significant year-end sales contracts for unusual terms.
8. Test the valuation of notes receivable, computation of interest income, interest receivable, and amortization of discount or premium.
9. Evaluate the propriety of the client’s accounting methods for receivables and revenue.
10. Evaluate accounting estimates related to revenue recognition.
11. Determine the adequacy of the client’s allowance for uncollectible accounts.
12. Ascertain whether any receivables have been pledged.
13. Investigate any transactions with or receivables from related parties.
14. Evaluate the business purpose of significant and unusual sales transactions.
15. Evaluate financial statement presentation and disclosure of receivables and revenue.

Part B. Explain how the auditor will verify the beginning balance of accounts receivable under each of the following three scenarios: 

(1) The auditor is the continuing auditor on the engagement, i.e., the auditor audited the prior year's financial statements.

(2) The prior year's statements were audited by a predecessor auditor.

(3) The company has never been audited before.

Part C. Explain two commonly applied tests that will contribute to the verification of cash collections during the current year. 

Part D. How will the auditor obtain satisfaction regarding the revenue account? 

Answer rating: 100% (QA)

answers to part A 1 Identify four critical substantive auditing procedures the auditor is likely to adopt to verify the ending balance of accounts receivable a Confirmation The auditor sends a confirm... View the full answer