3.

Inspect notes on hand

The auditor should generally inspect all of the actual notes and any collateral for the notes, preferably
simultaneous with the counting of cash and examination of securities. However, if there are a great
number of notes receivables, the auditor might consider examining only a sample of notes. Also, if some
of the notes are held by some other party, the auditor should send a confirmation to the holder of the
note.

4.Perform analytical procedure to determine whether the receivables, sales, and interest revenue
balances appear reasonable.
The auditor should compare significant statistics related to accounts and notes receivable with those of
the prior year. This procedure can highlight potential weakness in the client’s collection efforts that may
affect the overall collectability of accounts receivable. This procedure may be used also to evaluate the
overall reasonableness of accounts receivable. This statistics include

(1)Ratio of accounts receivable to sales;

(2)Ratio of overdue accounts to total accounts receivable;
(3)Number of average day’s sales in accounts receivable;
(4)Average annual accounts receivable turnover;
(5)Percentage of bad-debts expense to the total sales;
(6)Ratio of the valuation allowance to accounts receivable; and
(7)Ratio of interest revenue to notes receivable.

5.Test sales and sales returns cutoff to determine whether receivables are recorded in the accounting
period
The auditor usually tests the sales cutoff by examining invoices and shipping documents for several days
both before and after the year end by tracing such documents to the sales and account receivable for
the appropriate period.

6.Review collectibility of receivables and determine the adequacy of allowance for doubtful accounts.
(1)Verify the past-due accounts receivable listed in the aging schedule that have not been paid
subsequent to the statement of financial position date.
(2)Determine credit ratings for delinquent and unusually large accounts.
(3)Evaluate confirmation exceptions for indication of amounts in dispute or other clues as to possible
uncollectible account.
(4)Summarize in a working paper those accounts considered to be doubtful of collection based on the
preceding procedures. List customer names, doubtful amounts and reasons, considered doubtful.
(5)Confer with the credit manager the current status of each doubtful account ascertaining the
collection action taken and the opinion of the credit manager as to ultimate collectibility. Provide for the
estimated losses on accounts considered by the auditors to be uncollectible. Confer with client’s legal
counsel .

7.Recalculate the interest income from notes receivable.

The most effective verification of the interest earned account consists of and independent computation
by the auditors of the interest earned during the year on notes receivable. The interest section of
working paper consists of four columns showing for each note receivable owned during the year of the
following information:
a) Accrued interest receivable at the beginning of the year.
b) Interest collected during the year.
c) Accrued interest receivable at the end of the year
d) Interest earned during year.

8&9 Evaluate financial statement presentation and disclosure of receivables, Obtain written client
representations regarding pledge, discount or assignment of receivable, and about receivables from
officers, directors, affiliates or other related parties.
In addition to the foregoing audit procedures mentioned, the auditor should also review of the minutes
of directors meeting and confirm with banks of any selling or assigning of accounts receivable.

Illustrative Audit Case 10.1

During the annual audit of Cookie Corporation, you encountered the following account, entitled
receivables and payables:
Items Debit Credit
Due from customers 156,000
Payables to creditors for merchandise 62,000
Note receivable, long-term 80,000
Expected cumulative losses on bad debts 4,000
Due from employees, current 2,200
Cash dividend payable 24,000
Special receivable, dishonored note 22,000
Accrued wages 2,400
Deferred rent revenue 1,600
Insurance premiums paid in advance 1,200
Mortgage payable, long –term 40,000

*Collection probable in two years

REQUIRED :
1.Give the journal entry to eliminate the above account and to set up the appropriate accounts to
replace it.
2.Show how the various items should be reported on a current statement of financial position.

Requirement (1)
Accounts receivable 156,000
Note receivable, long-term 80,000
Special receivable-loans to employees 2,200
Special receivable-dishonored note 22,000
Prepaid insurance 1,200
Accounts payable- trade 62,000
 Allowance for doubtful accounts 4,000
Cash dividends payable 24,000
Wages payable 2,400
Rent revenue collected advance 1,600
Mortgage payable- long-term 40,000
Receivables and payables 127,000

Requirement (2)
Current assets:
Accounts receivable- trade 156,000
Less Allowance for doubtful accounts 4,000 152,000
Receivables from employees 2,200
Prepaid insurance 1,200
Investment and funds:
Notes receivable - long- term 80,000
Other assets:
Special receivable – dishonored 22,000
Current liabilities:
Accounts payable- trade 62,000
Cash dividends payable 24,000
Wages payable 2,400
Rent revenue collected in advance 1,600
Long-term liabilities:
Mortgage payable 40,000

Illustrative Audit Case 10.2: Sales Cut-off Examinations

You have been asked to audit records of XYZ Manufacturing Company, a small manufacturer of precision
tools and machines, for the year –ended December 31, 2017. Your examination of sales transactions
revealed among others the following:
1. Some machines have been shipped on consignment to XYZ’s regular dealers. These transactions have
been recorded as ordinary sales and billed as such. As of December 31, 2017 the machines billed and in
the hands of consignees amounted to P130,000. Sales price was determined by adding 30% to cost.
2.On December 30, 2017. Two machines were shipped to a costumer on FOB shipping point basis. The
sale was entered in the records on January 5, 2018 when cash was received in the amount of P13,000
3. The inventory as of December 31, 2017 included goods sold during November, 2015 for P6,500 but
returned on December 15, 2017, No entry has been made to adjust the costumer’s account for the
goods returned. The goods were included at selling price which was 103% of cost.

As auditor of XYZ Manufacturing Company, what adjusting journal entries would you recommend
relative to the above findings?
Solution: Illustrate Audit Case 10.2
The following are the recommended adjusting entries to correct the accounts of XYZ manufacturing
company as of December 31, 2017.

For Audit Finding No.1

AJE (1) Sales 130,000

Accounts Receivable 130,000
To reverse the entry made to record
Deliveries to consignees which are
still unsold as 12/31/17.

(2) Inventories, 12/31/17 100,000

Cost of sales- Inventories, 12/31/17 100,000
To include goods in the hands of
consignees.

For Audit Finding No .2

AJE(3) Accounts Receivable 13,000
Sales 13,000
To record the sale of machines
shipped on 12/31/17, FOB shipping
point.

For Audit Finding No.3

AJE(4) Sales returns and allowance 6,500
Accounts Receivable 6,500
To record goods return by customer.

(5) Cost of Sales- Inventories, 12/31/17 1,500

Inventories, 12/31/2017 1,500
To correct overstatement of inventories.