- 15 Marks
AA – L2 – Q48 – Audit Sampling
Question
The revenue of Henley Co. for the year ended 30 June 20X8 was C7.5 million, its draft profit before tax was C200,000 and its net assets C1.8 million. At that date the receivables ledger contained 140 live accounts totalling trade receivables of C1.6 million. The accounts can be broken down as follows:
| Value range | Number of balances |
|---|---|
| C000 | 2 |
| 100-150 | 6 |
| 50-100 | 40 |
| 10-50 | 60 |
| 1-10 | 29 |
| 0-1 | 3 |
| Credit balances (all less than C1,000) | 140 |
The auditor is to use direct confirmation to confirm receivables balances.
Required
(a) List the factors which should be considered when selecting a sample of receivables for confirmation and how those factors should be applied to Henley Co.’s receivables.
(b) Set out the procedures to be performed:
(i) when planning and performing the confirmation
(ii) when following up the results.
Answer
(a) Factors in selecting sample
- The objective of the test
The objective is likely to be to test for overstatement. Therefore, the sample should be weighted towards the higher value items. - High risk items
In selecting the sample, certain types of account should be considered for inclusion. These include:- overdue accounts
- credit balances
- accounts on which round sum payments are received
- nil balances
as they may indicate errors or possible bad debts.
- Individually significant items
The eight largest balances should be confirmed as any balance over $50,000 represents 25% of profit before tax and is therefore individually material. - Items to be confirmed
Balances or specific invoices can be confirmed. Balances would be preferable in the first instance as the percentage of the receivables ledger confirmed will be greater. - Method of sample selection
Random, systematic, or judgement sampling could be used. Systematic sampling would be preferable, as there is no bias. It could also be weighted towards higher value items. - Method of confirmation
This should be a positive request as opposed to a negative request. However, there is a choice to be made between whether the balance is supplied or not. The latter may provide stronger evidence, but the former may lead to more replies.
(b) Procedures
Planning
- Discuss with management any customer balances which they consider should not be confirmed (e.g., credit balances).
- Plan the sample size to take account of such factors as materiality.
- Agree the client’s reconciliation of the total of the individual balances (on the receivables ledger) to the balance per the receivables ledger control account (in the nominal ledger).
- Arrange when the requests are to be sent.
Performing
- Review all request letters to verify that they are on client’s headed notepaper and signed by an appropriate client official.
- If the balance is provided, ask for any difference to be reconciled to an enclosed statement.
- Enclose a reply paid envelope (addressed to the audit firm) in each request letter.
- Mail the letters from the audit firm’s office.
Following up the results
- Record all replies on a control schedule.
- Non-replies may be followed up with a second letter or (with the client’s approval) fax or telephone.
- If direct confirmation is not obtained, examine customer orders, despatch records, invoices, and after-date payments (for evidence of existence and amount due).
- Disputed balances or invoices should be investigated by the client (in the first instance).
- For invoices on a customer’s statement but not included in the customer’s records, agree invoice details to despatch records (to confirm existence at the confirmation date).
- For cash claimed to be in transit by the customer (not on the statement), agree the amount and date on which it was received to cash book receipts and bank records.
- For returns, agree amounts to after-date credit notes and, if material, confirm that the client has included them in a year-end accrual.
- Summarise and evaluate the results. Review the nature and effect of misstatements.
- Uploader: Samuel Duah