MABALACAT CITY COLLEGE AUD 02| Auditing And Assurance Concepts

And Application 1
Teacher’s Guide Week No. 3-5

After the lesson, the students can be able to:

1. Refresh on the Generally Accepted Accounting Learning Materials

Principles and the Philippine Financial Reporting
Standards relating to receivables. Laptop, pen, calculator, & book
2. Identify and explain the audit objectives on
receivables.
3. Perform audit procedures and solve auditing
problems on receivables.
4. Prepare audit working papers on receivables.

Lesson Preview/Review

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)

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Teacher’s Guide Week No. 3-5

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:

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:
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Teacher’s Guide Week No. 3-5

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
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And Application 1
Teacher’s Guide Week No. 3-5

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. Customer’s 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 buyer’s receipt of merchandise.

b. FOB Shipping point - means that ownership to the merchandise is transferred

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

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Teacher’s Guide Week No. 3-5

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.

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And Application 1
Teacher’s Guide Week No. 3-5

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.

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
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And Application 1
Teacher’s Guide Week No. 3-5

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.

Theory
c 1. After the auditor has prepared a flowchart of internal control for sales and cash receipts

transactions and evaluated the design of the system, the auditor would perform tests of controls

on all control procedures

a. Documented in the flowchart.

b. Considered to be deficiencies that might allow errors to enter the accounting system.
c. Considered to be strengths that the auditor plans to rely on in assessing control risk.
d. That would aid in preventing irregularities. (AICPA ADAPTED)
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Teacher’s Guide Week No. 3-5

b 2. To determine whether internal control effectively minimized errors of failure to bill a customer

for a shipment, the auditor would select a sample of transactions from the population represented

by the

a. Customer order file.

b. Shipping records file.
c. Subsidiary customer accounts ledger.
d. Sales invoice. (AICPA ADAPTED)

a 3. Which of the following would the auditor consider to be an incompatible operation if the cashier

receives remittances from the mailroom?

a. The cashier posts the receipts to the accounts receivable subsidiary ledger.
b. The cashier makes the daily deposit at a local bank.
c. The cashier prepares the daily deposit.
d. The cashier endorses the checks. (AICPA ADAPTED)

c 4. The least crucial element of control over cash is

a. Separation of cash record keeping from custody of cash.

b. Preparation of the monthly bank reconciliation.
c. Batch processing of checks.
d. Separation of cash receipts from cash disbursements. (AICPA ADAPTED)

b 5. Which of the following is not a universal rule for achieving control over cash?

a. Separate the cash-handling and record-keeping functions.

b. Decentralize the receiving of cash as much as possible.
c. Deposit each day's cash receipts by the end of the day.
d. Have bank reconciliations performed by employees who do not handle cash.
(AICPA ADAPTED)

d 6. At which point in an ordinary sales transaction of a wholesaling business is a lack of specific

authorization of least concern to the auditor in the conduct of an audit?

a. Granting of credit.
b. Shipment of goods.
c. Determination of discounts.
d. Selling of goods for cash. (AICPA ADAPTED)
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Teacher’s Guide Week No. 3-5

d 7. To verify that all sales transactions have been recorded, a test of transactions should be completed on a
representative sample drawn from

a. Entries in the sales journal.

b. The billing clerk's file of sales orders.
c. A file of duplicate copies of sales invoices for which all prenumbered forms in the series have been
accounted.
d. The shipping clerk's file of duplicate copies of shipping documents. (AICPA ADAPTED)

d 8. The negative form of accounts receivable confirmation request is particularly useful except when

a. Control procedures surrounding accounts receivable are considered to be effective.

b. A large number of small balances are involved.
c. The auditor has reason to believe the persons receiving the requests are likely to give them consideration.
d. Individual account balances are relatively large. (AICPA ADAPTED)

d 9. Which of the following is not a primary objective of the auditor in tests of accounts receivable?

a. Determine the approximate realizable value.

b. Determine the adequacy of internal controls.
c. Establish the validity of the receivables.
d. Determine the approximate time of collectibility of the receivables. (AICPA ADAPTED)

b 10. Tracing copies of sales invoices to shipping documents will provide evidence that all

a. Shipments to customers were recorded as receivables.

b. Billed sales were shipped.
c. Debits to the subsidiary accounts receivable ledger are for sales shipped.
d. Shipments to customers were billed. (AICPA ADAPTED)

a 11. To gather audit evidence about the proper credit approval of sales, the auditor would select a sample of
documents from the population represented by the

a. Customer order file.

b. Bill of lading file.
c. Subsidiary customers' accounts ledger.
d. Sales invoice file. (AICPA ADAPTED)

b 12. Which of the following functions is common to the revenue/receipt cycle?

a. Resources are acquired from vendors and employees in exchange for obligations to pay.
b. Resources are sold to customers in exchange for promises for future payments.
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c. Resources are acquired from employees in exchange for obligations to pay.

d. Capital funds are received from investors and creditors.

c 13. Which of the following is not a common activity of the revenue/receipt cycle?

a. Order entry.
b. Inventory control.
c. Receiving.
d. Cash collection.

a 14. To achieve control when there is no Billing Department, the billing function should be performed by the

a. Accounting Department.
b. Sales Department.
c. Shipping Department.
d. Credit and Collection Department. (AICPA ADAPTED)

b 15. The person who opens the mail commonly prepares a remittance advice when a customer fails to return one
with a payment. Consequently, mail should be opened by the:

a. Credit manager.
b. Receptionist.
c. Sales manager.
d. Accounts receivable clerk. (AICPA ADAPTED)

a 16. Which of the following control procedures will likely prevent the concealment of a cash shortage that was
perpetrated by improperly writing off a trade account receivable?

a. Write-offs must be approved by a responsible officer after reviewing Credit Department recommendations
and supporting evidence.
b. Write-offs must be supported by an aging schedule showing that only receivables months overdue have
been written off.
c. Write-offs must be approved by the cashier.
d. Write-offs must be authorized by field sales representatives. (AICPA ADAPTED)

c 17. Which of the following would best protect a company that wishes to prevent lapping?

a. Segregate duties so that accounting has no access to incoming mail.

b. Segregate duties so that no employee has access both to checks from customers and to currency from daily
cash receipts.
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c. Have customers send payments directly to the company's bank.

d. Request that customers checks be made payable to the company and be addressed to the treasurer.
(AICPA ADAPTED)

c 18. During the review of a small owner-managed company's internal controls, the auditor discovers that the
accounts receivable clerk approves credit memos and has access to cash. Which of the following controls
would offset this deficiency?

a. The owner reviews errors in billings to customers and postings to subsidiary records.
b. The controller receives the monthly bank statement directly and reconciles the checking accounts.
c. The owner reviews credit memos after they are recorded.
d. The controller reconciles the detailed receivables records to the general ledger.
(AICPA ADAPTED)

d 19. Defective merchandise returned by customers should be presented to

a. Inventory control personnel.

b. Sales personnel.
c. Purchasing personnel.
d. Receiving personnel. (AICPA ADAPTED)

c 20. A sales cutoff test complements tests of

a. Sales returns.
b. Cash.
c. Accounts receivable.
d. Sales allowances. (AICPA ADAPTED)

b 21. In considering internal control within the revenue/receipt cycle, what is the purpose of a transaction walk-
through?

a. To assure that employees are performing assigned functions accurately.

b. To confirm the auditor's understanding of the internal control structure.
c. To select documents for detailed tests of controls.
d. To verify the results of the auditor's sampling plan.

c 22. Following are four steps an auditor undertakes in assessing control risk:

A. Determine what control procedures are used by the entity.

B. Identify the system's control objectives.
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C. Design tests of controls.

D. Consider the potential errors or irregularities that could result.

In what order would an auditor perform these steps?

a. DBAC.
b. BCDA.
c. BDAC.
d. DCAB.

b 23. The purpose of tests of controls over shipping is to

a. Determine whether billed goods have been shipped.

b. Determine whether shipments are billed.
c. Determine whether shipping department personnel are competent.
d. Determine whether credit is approved before goods are shipped.

a 24. The purpose of tests of controls over billing is to

a. Determine whether billed goods have been shipped.

b. Determine whether shipments are billed.
c. Determine whether billing department personnel are competent.
d. Determine whether credit is approved before goods are billed.

Problems

The December 31, 2018 adjusted trial balance of Aguinaldo Company shows the following:

Debit Credit
Accounts receivable P50,000
Allowance for bad debts P 2,000

Additional information:

• Cash sales of the company represents 10% of gross sales.

• 90% of the credit sales customers do not take advantage of the 2/10, n/30 terms.
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Teacher’s Guide Week No. 3-5

• It is expected that cash discount of P300 will be taken on accounts receivable outstanding at December
31, 2019.
• Sales returns in 2019 amounted to P20,000. All returns were from charge sales.
• During 2019, accounts totaling to P2,200 were written off as uncollectible; bad debt recoveries during the
year amounted to P150.
• The allowance for bad debts is adjusted so that it represents certain percentage of the outstanding
accounts receivable at year end. The required percentage at December 31, 2019 is 150% of the rate
used on December 31, 2018.

QUESTIONS:

Based on the above and the result of your audit, determine the following:

1. The accounts receivable as of December 31, 2019 is

a. P150,000 b. P16,667 c. P15,000 d. P122,200

2. The allowance for doubtful accounts as of December 31, 2019 is

a. P1,000 b. P9,000 c. P6,000 d. P7,332

3. The net realizable value of accounts receivable as of December 31, 2019 is

a. P15,367 b. P143,700 c. P140,700 d. P114,568

4. The doubtful account expense for the year 2019 is

a. P9,050 b. P1,050 c. P6,050 d. P7,382

5. A company uses the allowance method for recognizing doubtful accounts. The entry to record the
writeoff of a specific uncollectible account
a. Affects neither net income nor working capital
b. Affects neither net income nor accounts receivable
c. Decreases both net income and working capital
d. Decreases both net income and accounts receivable

PROBLEM NO. 5 (RPCPA 10.79)

During your examination of the 2019 financial statements of the Mabini Company you find that the company
does not provide allowance for doubtful accounts ever since it started operations in 2015. The company’s
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Teacher’s Guide Week No. 3-5

practice is to directly write-off as expense doubtful accounts and credit recoveries to income. The company’s
contracts are generally for two years.

Upon your recommendation, the company agreed to change its accounts for 2019 to give effect to doubtful
treatment on the allowance basis. The allowance is to be based on a percentage of sales which is derived
from the experience of prior years. Statistics for 2015 to 2019 are shown as follows:

Year of Sale 2015 2016 2017 2018 2019

Charge Sales P600,000 P1,500,000 P1,800,000 P1,950,000 P1,650,000

Accounts Written off & Year

of Sale
2015 3,300
2016 9,000 6,000
2017 3,000 24,000 7,800
2018 7,200 27,000 9,000
2019 16,200 30,000 8,400
Recoveries & Year of Sale
2015
2016 600
2017 2,400
2018 3,000
2019 3,600

Accounts receivable at December 31, 2018 were as follows:

From 2018 sales P90,000

From 2019 sales 810,000
Total P900,000
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Teacher’s Guide Week No. 3-5

REQUIRED:

Based on the above and the result of your audit, you are to provide the answers to the following:

1. The average percentage of net doubtful accounts to charge sales that should be used in setting up the
2019 allowance is

2. How much is the doubtful accounts expense for 2019?

3. The doubtful accounts expense for 2019 is over(under) stated by

4. The net realizable value of accounts receivable that should be presented on the December 31, 2019
balance sheet is

5. Which account balance is most likely to be misstated if an aging of accounts receivable is not
performed?
a. Allowance for bad debts. c. Accounts receivable.
b. Sales returns and allowances. d. Sales revenue.

References

• Ngina, M. A. B., & Escala, R. F. A. (2018). Applied Auditing (2018th ed., Vol. 1). Real Excellence
Publishing.
• CPA REVIEW SCHOOL OF THE PHILIPPINES Manila (AUDITING PROBLEM-Receivables)

OFFICIAL MCC TEACHER’S GUIDE DISCLAIMER

It is not the intention of the author/s nor the publisher of this teacher’s guide to have monetary gain in
using the textual information, imageries, and other references used in its production. This guide is only for the
exclusive use of a bona fide student of Mabalacat City College.

In addition, this teacher’s guide or no part of it thereof may be reproduced, stored in a retrieval system,
or transmitted, in any form or by any means, electronic, mechanical, photocopying, and/or otherwise, without
the prior permission of Mabalacat City College.
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Compiled/Prepared by: Recommending Approval: Approved by:

Pauline R. Dela Cruz, CPA