Question Tag: Trade receivables

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  • 20 Marks

AA – Mar 2023 – L2 – Q3 – Audit and Assurance Evidence

Explain why property, plant and equipment, trade receivables, and inventory were selected for further investigation.

Maggie Manufacturing is a long-established manufacturing company. The audit manager has been provided with the following extracts from the draft financial statements for 2021, prior to the final audit planning meeting with the financial controller.

Draft Statement of Financial Position (Extracts):

The manager has reviewed these extracts and has identified three financial statement headings that require further investigation: property, plant, and equipment, trade receivables, and inventory. He has also calculated certain accounting ratios.

Required:
a) Explain why the manager has selected these three headings for further investigation.

b) Detail and explain the further information that the manager should request from the financial controller at the final audit planning meeting to clarify the situation with regards to the three financial statement headings.

 

a) The manager has selected these three headings for further investigation due to the following reasons:

  • Property, Plant, and Equipment:
    Property, plant, and equipment account for 87% of net assets, which is material for a manufacturing company. Although the balance has increased by 2%, depreciation and loss on sale have increased by 72%. This inconsistency suggests that there might be an issue with the recognition of depreciation or disposals, and further investigation is needed to ensure the balance is not overstated.
  • Trade Receivables:
    Trade receivables have increased by 67%, while revenue has increased by only 6%, indicating a possible recoverability issue. This is supported by the increase in the collection period from 19 days to 30 days. There might be a need for increased allowances for receivables, and further testing is required to assess the recoverability of debts and the accuracy of the cut-off.
  • Inventory:
    Inventory has increased by 16%, driven by significant increases in raw materials and finished goods, despite a 22% decrease in work-in-progress. The inventory turnover has decreased, suggesting possible slow-moving or obsolete inventory. The 6% increase in revenue, without a corresponding increase in cost of sales, could indicate an issue with inventory valuation or cut-off errors.

b) The audit manager should request the following information from the financial controller:

  • Property, Plant, and Equipment:
    • An explanation for the increase in net book value and the significant increase in depreciation/loss on disposals.
    • Confirmation that the depreciation policy is consistent with the prior year.
    • A detailed analysis of additions, disposals, and depreciation charges during the year.
    • Information on whether any assets are carried at valuation rather than cost.
    • A breakdown of the expense between depreciation and loss on sales.
  • Trade Receivables:
    • An explanation for the increase in the trade receivables collection period.
    • Details of significant new customers and their credit ratings.
    • An analysis of bad debts written off and the provision for doubtful debts.
    • An aged receivables analysis.
    • Details of post-year-end cash receipts to assess the collectibility of receivables.
  • Inventory:
    • Explanations for the movements in raw materials, work-in-progress, and finished goods, particularly the reasons for the build-up in inventory.
    • Details of any adjustments required from the year-end inventory count.
    • Post-year-end sales and next year’s order book to assess inventory turnover and potential obsolescence.
    • An analysis of the provision for obsolete or slow-moving inventory.
    • Confirmation that inventory is valued at the lower of cost and net realizable value.
  • 13 Marks

AA – May 2020 – L2 – Q3a – Audit and Assurance Evidence

Explain the main assertions about account balances and give examples from the audit of trade receivables.

Audit Evidence requires the auditor to obtain sufficient, appropriate evidence to be able to draw reasonable conclusions on which to base the audit opinion. That evidence should be relevant to the financial statement assertions.

Required:
i) Explain the main assertions about account balances and provide an example of each one by reference to the audit of trade receivables. (8 marks)

ii) Identify FIVE (5) of the seven main audit testing procedures (e.g., inspection) and give an example of how each might be used in the audit of plant and machinery. State the assertion being tested in each case. (5 marks)

The main assertions about account balances are:

Completeness: All assets, liabilities, and equity interests that should have been recorded have been recorded. Example: Ensuring that all trade receivables are included in the financial statements by reconciling the trade receivables listing to the general ledger.

Accuracy, Valuation, and Allocation: Assets, liabilities, and equity interests are included in the financial statements at appropriate amounts. Example: Verifying that trade receivables are stated at their net realizable value by reviewing subsequent cash receipts or evaluating the adequacy of the allowance for doubtful accounts.

Rights and Obligations: The entity holds or controls the rights to assets, and liabilities are the obligations of the entity. Example: Confirming that the receivables are the entity’s legal rights by sending direct confirmations to customers.

Existence: Assets, liabilities, and equity interests exist at the reporting date. Example: Verifying the existence of trade receivables by sending confirmations to customers to confirm balances at the year-end date.

Classification: Assets, liabilities, and equity interests have been recorded in the proper accounts. Example: Ensuring that trade receivables are classified as current assets in the financial statements.

Presentation: Assets, liabilities, and equity interests are appropriately aggregated or disaggregated and clearly described in the financial statements. Example: Using a disclosure checklist to verify that trade receivables are properly disclosed in accordance with IFRS/IAS requirements.

(8 marks)
ii)
The five main audit testing procedures and examples related to plant and machinery are:

Inspection: Physically inspecting plant and machinery to confirm their existence (testing the existence assertion).
Observation: Observing the maintenance of plant and machinery to confirm their condition and allocation (testing the accuracy, valuation, and allocation assertion).
Inquiry: Inquiring of management regarding useful lives and profitability of the plant (testing the valuation and allocation assertion).
Confirmation: Writing to third parties that hold the company’s plant to confirm its existence (testing the existence assertion).
Recalculation: Recalculating depreciation of plant and machinery to verify that the depreciation charge is correct (testing the accuracy, valuation, and allocation assertion).
(5 marks)

  • 10 Marks

AAA – May 2021 – L3 – Q5b – Audit-related services | Assurance services

Discuss how audit software can be used to audit revenue and trade receivables and evaluate the extent of reliance on internal auditor's use of embedded software.

Mike Developers’ Audit Manager is of the view that audit software can be used effectively in the audit of revenue and trade receivables. He has discussed this with the firm’s computer audit department and with Mike Developers’ Finance Director, and this approach has been agreed as a feasible one. Furthermore, the Finance Director has asked the internal audit team to investigate the possibility of installing embedded software to help the external auditors in their work.

Required:

i) Describe, giving examples, how audit software, in general, could assist the audit firm in their audit of revenue and trade receivables. (6 marks)

ii) Discuss the extent to which the external auditor could rely on the results of the internal auditor’s use of embedded software. (4 marks)

i) Use of Audit Software in the Audit of Revenue and Trade Receivables:

  1. Sequence Checks on Pre-Numbered Documents:
    • Audit software can perform sequence checks on pre-numbered documents such as invoices and credit notes to ensure that all documents are accounted for and that there are no missing or duplicated documents.
  2. Data Extraction and Analysis:
    • Audit software can extract large volumes of data from the client’s accounting system and analyze it for unusual patterns or anomalies. For example, it can identify outliers in sales data or detect irregularities in customer accounts.
  3. Recalculation of Key Figures:
    • The software can be used to recalculate key figures such as the aging of receivables, the sales ledger, and revenue totals. This helps to verify the accuracy of the financial records by ensuring that calculations are correct.
  4. Generating Reports for Substantive Testing:
    • Audit software can generate detailed reports that support substantive testing. For instance, it can create an aged analysis of receivables, which can then be used by the auditor to identify overdue accounts and assess the need for provisions.
  5. Audit Trail Verification:
    • The software can help verify the audit trail by tracing transactions from the financial statements back to source documents. This ensures that transactions have been recorded correctly and that there is a clear link between the records and the underlying documentation.
  6. Selection of Sample Transactions:
    • Audit software can be used to select a stratified sample of transactions for further testing. This ensures that the sample is representative of the population and that the auditor’s testing covers all relevant areas of the audit.

(3 points @ 2 marks each = 6 marks)

ii) Reliance on the Internal Auditor’s Use of Embedded Software:

  1. Organizational Status and Independence:
    • The external auditor should assess the organizational status and independence of the internal audit function. If the internal auditors are independent and report directly to those charged with governance, their work, including the use of embedded software, may be more reliable.
  2. Scope and Nature of Work Performed:
    • The external auditor should evaluate the scope and nature of the work performed by the internal auditors using embedded software. The relevance and adequacy of the procedures applied by the internal auditors in relation to the audit objectives will determine the extent of reliance.
  3. Competence and Due Care:
    • The external auditor should assess whether the internal auditors have the necessary competence and have exercised due care in using embedded software. This includes reviewing the internal auditors’ qualifications, training, and experience with such software.
  4. Security and Accuracy of Embedded Software:
    • The external auditor should evaluate the security measures in place to protect the integrity of the data processed by the embedded software. Additionally, the accuracy and reliability of the software outputs should be verified to ensure that the audit conclusions are based on sound evidence.
  • 10 Marks

FA – Mar 2024 – L1 – Q2a – Bad and doubtful debt

Prepare the trade receivables, bad debt expense, and allowance for doubtful debts accounts for Lukay's sales transactions over three years.

Lukay is a wholesaler who is into the distribution of soft drinks. Lukay has been in operation for some time now, and the following transactions in relation to sales occurred in the first 3 years:

Year 1
Lukay made credit sales of GH¢60,000 and received GH¢45,000 from his credit customers. At the end of the year, she decided to write off Abrantie’s debt of GH¢2,400, made a specific allowance for Keke’s debt totaling GH¢1,050, and created a general allowance of 5% of the remaining trade receivables balance.

Year 2
During the second year of trading, Lukay made credit sales of GH¢90,000 and received cash of GH¢84,000, including GH¢1,200 from Abrantie. He decided to write off Keke’s debt and create a specific allowance against 50% of Yakubu’s total debt of GH¢1,800. He decided that his general allowance should now be 8% of the remaining trade receivables balance.

Year 3
Lukay made credit sales of GH¢150,000 and received cash of GH¢120,000. Additionally, he also received a cheque from Yakubu for GH¢1,800. At the year-end, he decided to create a specific allowance against Atia’s debt of GH¢15,000 and maintained his general allowance at 8%.

Required:

For each of the above years, show the trade receivables account, bad debt expense account, and allowance for doubtful debts account, and the statement of financial position extract as at each year-end. (10 marks)

Trade Receivables Account

Tutorial Notes:

  • Recovery of Written-Off Debts: If Abrantie’s receipt was not included in the GH¢280,000 but recorded as a receipt from a non-active customer, it should be credited directly to the bad debt expense account as a recovery.
  • Allowance Adjustment: There’s no need to adjust Keke’s write-off against the allowance account, even if it was previously provided for. The previously made allowance is “released” to the expense account since it’s no longer needed.
  • Provision vs. Write-Off: Since Yakubu’s debt was only provided against and not written off, a “reinstatement” adjustment would be incorrect.

Bad debt expenses a/c

Allowance for doubtful debts a/c

 

  • 9 Marks

FM – MAY 2019 – L2 – Q4a – Management of receivables and payables

Analyze the impact of using a factor on annual profits for Lisa-Joys Company, considering savings on bad debts, administration costs, and interest.

Question:
Lisa-Joys Company has annual credit sales of GH¢1,000,000. Credit customers take 45 days to pay. Bad debts are 2% of sales. The company finances its trade receivables with a bank overdraft, on which interest is payable at an annual rate of 15%.

A factor has offered to take over administration of the receivables ledger and collections for a fee of 2.5% of the credit sales. This will be a non-recourse factoring service. It has also guaranteed to reduce the payment period to 30 days. It will provide finance for 80% of the trade receivables, at an interest cost of 8% per year.

Lisa-Joys Company estimates that by using the factor, it will save administration costs of GH¢8,000 per year.

Required:
What would be the effect on annual profits if Lisa-Joys Company decides to use the factor’s services? (Assume a 365-day year). (9 marks)

 

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