Accounts receivable are defined as claims against customers related to goods or services sold to them on credit. However, the list of accounts receivable is extended to accommodate other miscellaneous claims such as loans to officers and employees, loan to subsidiaries, and claims against various other firms. The advances to suppliers and tax refunds are also included in the accounts receivable for accounting purposes. Trade receivables are usually recorded in separate sections with other accounts receivable because they are large amounts especially for large organizations (Whittington and Kurt 12). Audit for accounts receivable entail checking on the presentation and disclosures of loans to officers directors, and affiliated companies. These are the components that the company would want to conceal or manipulate to evade taxes and also look good to potential investors. Most of these transactions are not meant to benefit the leading company but for the convenience of the borrower. The same way, the loans are collected at the convenience of the borrower. The basic tenet of financial statements is that such transactions should be disclosed. The notes receivable are defined in accounting as written promises to settle a certain amount relating to a transaction at a future date. They are used when transactions involve transferring a huge amount of money. They are also called negotiable documents. They are most important assets especially in financial institutions like banks. In case of sale of industrial machinery and farm equipment that are capital intensive, the installation notes are uses. Installation notes are contacts that allow he seller to retain the lieu of the goods until the buyer settles all the installments. Notes receivable also arise during disposal of items of plant and equipment. When a company is selling part of its stake, or there is the issuance of capital, notes receivable may also be used.
The Objectives of the Auditor in auditing for accounts receivable
Audit entails an examination of the financial statements of a company to ascertain whether they reflect a true and fair view of the financial position of the company. Each item in the financial statements is of ultimate concern to the auditors. In auditing for accounts receivable, the auditor’s goal is to realize the following:
- To identify any inherent risks including fraud risk relating to the accounts receivable. The auditor seeks to understand the client and the environment that they operate in to assess whether it bears any risk.
- To understand if the company has put in place measures to control accounts receivable to ensure they are realized. The auditor assesses if the company’s internal control systems are capable of preventing frauds and defaults relating to receivables.
- To identify material misstatements and the risk they bear. The major goal, in this case, is to design tests and procedures to unveil any material misstatements and prevent their occurrence in future. The tests and procedures ensure that accounts receivable are recorded in a manner that guarantees the completeness, recognition in the books, proper valuation, and appropriate presentation and disclosure (Whittington and Kurt 12). They must be separated into the appropriate categories on the balance sheet. The accounts receivable that are pledged as collateral must be reported adequately to make the financial statements reflect a true and fair view of the company’s financial position. All material disclosures must be made in the appropriate accounts and notes.
The accounts receivable are closely related to the revenue and for accounting purposes they are considered jointly. Accounts receivable are added to other accounts in determining the amount of revenue to be recognized in the books of account. Accounts receivable also play a key role in the determination of the net income that a company generates in a given period. To auditors, the audit for accounts receivable and revenue is a field of significant risk.
Internal control of accounts receivable
The major components that auditors need to consider when auditing of accounts receivable and revenue include control environment, risk assessment, monitoring, communication and accounting systems, and other related control activities.
There is a possibility of misstatement of accounts receivable and revenues. The auditors assess if a company can able to install effective internal control to ensure that these components are recorded as accurately as possible. There should be an independent audit committee constituted by the board of directors. The committee has the responsibility for monitoring management’s judgments about accounts receivable recognition. They also determine the principles to be used to set up an effective internal audit function. Ethics and integrity in financial reporting must be observed. The audit committee must ensure that all policies are followed in reporting. To ensure the financial statements are prepared properly, there should be ethical standards observed throughout the organization. The standards help in eliminating dishonest reporting relating to unrealistic targets for sales and earnings.
There are complex accounting principles and computations that are involved in the recognition of revenue and accounts receivable. The company’s management ought to remain committed to competence to ensure these computations and estimates are done correctly. The financial and accounting personnel should be the competent team with high level of qualifications and experience. The management should identify the skills and training needed to implement effective procedures. The personnel should be trained so that they can perform the key functions in the computation of revenue and accounts receivable.
The philosophy and operating style of the management determine the effectiveness of the control of revenue and accounts receivable. The philosophy and the operating style are indicated by the attitudes of the management towards financial reporting. The management should be aggressive rather than conservative in selecting the method of revenue recognition. The uncollected accounts should be created in a conscientious manner.
There should be appropriate human resource policies and practices. These ensure that internal control is in place even when the employees are rotated in their duties periodically. Whoever is on duty at whatever time will follow the policies to ensure consistency in reporting for accounts receivable. Without the policies, there is the possibility of confusion within the organization regarding how revenue and accounts receivable can be recognized.
The objectives of financial reporting may not be realized if some events identified as risks are not dealt with. These risks must be identified, analyzed, and appropriate measures taken to ensure they do not tamper with financial reporting. In auditing for revenue cycle, the auditors check whether there is a formal process of monitoring external factors that escalate the risks of realizing the company’s sales targets. Such factors include changes in economic conditions, competition, customer demand, and regulations that may pose a threat to the realization of the objectives of financial reporting. The management should also monitor the internal factors that can be a threat in realizing the objectives of the company’s financial reporting. These factors may include a change in the accounting principles, the addition of new products or services in the product line, and a change of types of the sales transaction. The management and the audit committee should put in place new types of control to prevent these factors from causing misstatement of revenue and accounts receivable.
Accounting systems and control activities
Sales of goods and services to customers on credit are mostly the major sources of revenue for a company. They represent the accounts receivable relating to primary trading activities of the firm. They need to be controlled effectively to avoid misstatement of revenue. Huge losses are inevitable when there are inadequate control activities over credit sales. To prevent these cases from happening, the auditors ensure key responsibilities in the control process are given do different departments or individuals in the organization. This will ensure there is accountability and avoid confusion in reporting. The activities to be shared include:
- Preparation of sales order
- Credit approval.
- Merchandise issuance.
- Invoice verification
- Maintenance of control accounts
- Maintenance of customer’s ledgers.
- Approval of sales returns and allowances.
The division of responsibilities ensures that any accidental errors in reporting is detected and corrected. The cases of fraud will be eliminated when different activities and handled by different people. The orders received from the customers should be processed and controlled using careful operating procedures to avoid errors. The auditor will check if the purchase orders were registered correctly, assessing the order processing time, and preparation of sales order are done correctly. If they are erroneously recorded, the revenues and net income will be misstated. The auditor must also ensure credit approval procedures are followed to the letter. The credit department will scrutinize the client’s order and assess if their orders will be processed on open account. The manager’s credit policies developed by the management must be followed when processing the client’s orders.
The auditors should also verify that the merchandise issuance is done after the credit department approves. The store keeper should only issue goods that are covered by the sales order to the shipping department. This must be checked keenly by the auditor to ensure that the right protocol is followed. The accounts department should have the responsibility of maintaining the finished goods record. This should not be left to the storekeeper.
The auditors should verify that billing function plays its role effectively. Billing entails informing the customers of the amount they need to settle related to the goods sold or services offered. The auditor should find out if the billing procedures are adequate to avoid errors on the invoices.
Accounts receivable are important components of the revenue made by the company. They represent unsettled accounts that customers owe the business. They should be recorded carefully to avoid misstatement in the financial statements. The internal control systems should be well set up to ensure accounts receivables are determined correctly and recorded accurately in the financial statements.
Whittington, Ray, and P. Kurt. Principles of Auditing and Other Assurance Services, London: McGraw-Hill/Irwin, 2013. Print.