Debtors in the audit of assets

Debtors
form a significant item amongst the assets of most companies and its
verification is a key part of the audits work.

Debtors
generally comprises of two main components:
·        
Trade debtors, i.e. sales ledger balances;

·        
Prepayment.
The
audit will be gathering sufficient appropriate evidence to verify the
assertions that:
·        
The debtors represent bona fide customers (existence)
·        
The amount are due to the business (right and obligations)
·        
The amount due are correctly stated at the appropriate value (valuation
and allocation)
·        
All amount due have been recorded (completeness).
One
point to remember is that auditors are only interested in validating the figure
for debtors as a total, they are not interested in individual; debtors account
except:
·        
If there is a suspicious of fraud
·        
As part of compliance test of the sales system
Trade Debtors-Compliance Testing of Internal
Control Procedures
As
part of their audit of balance sheet items auditors will have regard to the
internal control incorporated into the system in which the debtors are
recorded. For example, the figure for trade debtors is largely derived from the
sales ledger which is part of the sales system, so control within the sales
system are relevant to the auditor’s evidence gathering procedures for trade
debtors’ verification.
The
auditor will consider control designed to ensure that the control objectives
for the sales and debtors system are achieved, i.e.
·        
All goods and services despatched are invoiced.
·        
Invoices are raised for the correct prices.
·        
All discounts are authorised.
·        
Goods on credit are only despatched to approve credit-worth customer.
·        
All invoices for sales are properly recorded and that the persons
responsible for dealing with these are separate for those responsible for
processing sales transactions.
·        
Outstanding balances are reviewed and possible bad debts pursued.
·        
All balance written off is authorised.
Compliance Tests
Determine
the system of internal control over sales and debtors. The system for debtors
should ensure that:
·        
Only bona fide sales bring debtors into being.
·        
All such sales are to approved customers
·        
All such sales are recorded
·        
Debts are collected promptly
·        
Balance are regularly reviewed and aged, a proper system for follow-up
exists, and if necessary, adequate provision for bad and doubtful debts is
made.
Substantive Testing
·        
Obtain an aged schedule of debtors and agree the total to the control
account. Note that with computerised accounting system the balance will
undoubtedly agree.
·        
Test a sample of balances on ledge accounts to the schedule and vice
versa where this has not been produced directly from the sales ledge system.
·        
Ensure the make up of balances. They should be composed of specific
items.
·        
Ensure each account is settled from time to time.
·        
Enquire into the reason for any credit balance-this may lead to omitted
sales.
·        
Consider the valuation of debtors. This is dealt with in the next
paragraph.
Provision for Bad and Doubtful Debts
The
valuation of debtors is really a consideration of the adequacy of the provision
for bad and doubtful debts. The auditors should consider the following:
·        
The adequacy of the system of internal control relating to the approval
of credit and following up of poor payers.
·        
The period of credit allowed and taken.
·        
Whether balance have been settled after the year end.
·        
Whether an account is within the maximum credit approved.
·        
Reports on major debtors from collectors, trade associations etc.
·        
Present value and reliability of any security lodged as collateral.
Analytical Review
Auditors
should carry out analytical review proceeding as part of substantive testing.
These should include:
·        
Debtor days ratio i.e.;
                                   

·        
Comparisons with budgets or prior years;
·        
Comparison of aged debtors bands with prior years to identify increased
debtors ageing.
Note
that:
·        
Debts which are considered irrecoverable should be written off to the
profit and loss account.
·        
Specific provisions for doubtful debts should be set up against debts
which are considered doubtful.
Debtors Circularisation
Good
independent audit evidence can be obtained from circularising the debtors (or
some of them) for direct confirmation.
The
advantages of this technique are:
·        
Direct external evidence is the effectiveness for the system of internal
control. If the sales ledger is recording the debtors correctly it follows that
the system that leads up to it, i.e.
·        
It assists in the auditor’s evaluation of cut-off procedures as it can
identify invoices in transit over the year end.
·        
It provides evidence of items in dispute.
There
are two methods:
1.     
Negative Circularisation:
The
customer is asked to communicate only if they do not agree the balance. This
method has within it a fatal flaw insofar as it is impossible to tell whether
the debtor agrees with the balance or has simply thrown the letter away.
2.     
Positive Circularisation:
The customer is asked to reply whether they agree the balance or not or
is asked to supply the balance themselves. This is the favoured method.
The
approach is as follows:
·        
Obtain the co-operation of the client-only they can ask third parties to
divulge information.
·        
Select a sample. All customers can be circularised but this is unusual.
·        
Do not omit-
·        
Nil balances;
·        
Credit balances;
·        
Accounts written off in the period.
·        
Give weight to overdue or disputed balances.
·        
The letter should be:
·        
From the client;
·        
It should request a reply direct to the auditor;
·        
It may contain a stamped, addressed, envelope or a pre-paid reply
envelope addressed to the auditor;
·        
It must be despatched by the auditor-do not let the client post the
letter as this will devalue the inadequate of the test.
·        
Receive and evaluate replies.
Example of Debtors Circularisation Letter (Positive
Method)
FROM:                                                                                   TO:
HEDONITE
MANUFACTURING LTD                     ECSTATIC
MINING LTD
CLOGHAMPTON                                                    WIMPTON
Dear Sir,
As
part of their normal audit procedures, we have been requested by our auditors
Tackett and run to ask you to confirm direct to them your indebtedness to us as
shown on the enclosed statement as at 31 December 20-7.
If
the statement is in agreement with your records, please sign in the space
provided below and return this letter directly to our auditors using the
per-paid envelope provided.
If
the statement is not in agreement with your records please notify our auditors
directly of the amount shown by your records and if possible send them full
particulars of the difference.
It
will be of assistance to us if you will give this request your early attention.
This
is not a request for payment and no remittance should be sent to our auditors.
Yours
faithfully,
J. Brown,
Chief
Accountant
____________________________________________________________
Name
of Debtor                 ECSTATIC Mining
Ltd
The balance shown on the statement at 31.12-7 of
£1,432.00 due from us is/is (delete as appropriate) in agreement with our
record at 31.12-7.
If it does not agree the reason for the difference
is
______________Signature                                                  _____________Date
______________Position
______________Company
Stamp
____________________________________________________________
Pre-payments
These
are amount paid for in one period which relate to the next period. In many
cases these are not material and testing will be minimal.
Most
prepayments are verified by:
·        
Reviewing the client’s system for ensuring all prepayment are identified
and properly calculated.
·        
Re-performing the calculations.
·        
Reviewing transactions after the year end.

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