The existence and accuracy of an account receivable may be tested by

The auditor will compare the amount in the accounts receivable account in your general ledger with the grand total of your receivables in your period-end accounts receivable aging report, to check if the totals match. A mismatch indicates the presence of a wrong journal entry in the ledger account.

Matching invoices to shipping log

The auditor will match the date on each of your invoices with the shipment dates of the corresponding items in your shipping log. They will also examine invoices that were issued on dates after the auditing period. This is done because your sales must be recorded in the right accounting period, so it’s important to catch any invoices that should have been included in an earlier period.

Confirming receivables

In this part of the audit, the auditor directly contacts your customers to confirm any unpaid accounts receivable as of the reporting period’s end. This is done to verify the accounts receivable that you have recorded. Auditors usually select customers that have large unpaid balances first, then customers with overdue invoices, and finally customers with smaller receivable balances.

Reviewing cash receipts

The auditor will look for proof of the payments made by customers. This is a backup plan that’s used if the auditor fails to confirm the accounts receivable with your customers directly. If customers pay you via checks, the auditor looks for check copies, and attempts to confirm them with the bank or by checking your bank transactions.

Reviewing credit notes

Credit notes are important transactions because they can affect future transactions. Customers can deduct the credit note amount the next time they pay you for goods or services. This makes their payment different from the original invoice amount, which affects your receivables. The auditor will review credit notes you have issued to your customers to make sure they were properly authorized and issued during the correct period. The auditor will also check if the circumstances under which you issued them were legitimate and match the records of issued credit notes.

Trend analysis

Auditors use trend lines to compare accounts receivable with the company’s sales or current assets. Trend lines, usually used in technical analysis of budgeting and forecasting, are graphed sets of data points that show how a particular financial figure is trending. They help auditors analyze patterns and conduct inquiries if they spot anomalies like an increase in accounts receivable or revenue without a proportionate increase in sales or assets.

Preparing for the audit

So how do you get your business ready for an AR audit?

• Get an accounting system that helps create invoices and other sales transactions
• Collect payments and update the corresponding invoices to paid status
• Keep track of credit notes and refunds
• Reconcile your bank accounts

Get audit-ready in no time

When an audit is around the corner, it is best to have clear and easy-to-track records of your accounts receivable. It is not impossible to get your records sorted for the audit by hand. However, a modern accounting system that uses automation to keep your accounts receivable audit-ready can cut down hours of manual work and eliminate undesirable errors. AR automation helps you schedule invoices and payment reminders, while also updating invoices with their corresponding payment status through workflows. The result is well-organized accounts receivable records and a smooth audit procedure.

If your company is subject to an annual audit, the auditors will review its accounts receivable in some detail. Accounts receivable is frequently the largest asset that a company has, so auditors tend to spend a considerable amount of time gaining assurance that the amount of the stated asset is reasonable. Here are some of the accounts receivable audit procedures that they may follow:

• Trace receivable report to general ledger. The auditors will ask for a period-end accounts receivable aging report, from which they trace the grand total to the amount in the accounts receivable account in the general ledger. (If these totals do not match, you may have a journal entry somewhere in the general ledger account that should not be there)

• Calculate the receivable report total. The auditors will add up the invoices on the accounts receivable aging report to verify that the total they traced to the general ledger is correct.

• Investigate reconciling items. If you have journal entries in the accounts receivable account in the general ledger, the auditors will likely want to review the justification for the larger amounts. This means that these journal entries should be fully documented.

• Test invoices listed in receivable report. The auditors will select some invoices from the accounts receivable aging report and compare them to supporting documentation to see if they were billed in the correct amounts, to the correct customers, and on the correct dates.

• Match invoices to shipping log. The auditors will match invoice dates to the shipment dates for those items in the shipping log, to see if sales are being recorded in the correct accounting period. This can include an examination of invoices issued after the period being audited, to see if they should have been included in a prior period.

• Confirm accounts receivable. A major auditor activity is to contact your customers directly and ask them to confirm the amounts of unpaid accounts receivable as of the end of the reporting period they are auditing. This is primarily for larger account balances, but may include a few random customers having smaller outstanding invoices.

• Review cash receipts. If the auditors are unable to confirm accounts receivable, their backup auditing technique is to verify that customers have paid the invoices, for which they will want to review check copies and trace them through your bank account.

• Assess the allowance for doubtful accounts. The auditors will review the process that you follow to derive an allowance for doubtful accounts. This will include a consistency comparison with the method used in the last year, and a determination of whether the method is appropriate for your business environment.

• Assess bad debt write-offs. The auditors will compare the proportion of bad debt expense to sales for this year in comparison to prior years, to see if the current expense appears reasonable.

• Review credit memos. The auditors will review a selection of the credit memos issued during the audit period to see if they were properly authorized, whether they were issued in the correct period, and whether the circumstances of their issuance may indicate other problems. They may also review credit memos issued after the period being audited, to see if they relate to transactions from within the audit period.

• Assess bill and hold sales. If you have situations where you are billing customers for sales despite still retaining the goods on-site (known as "bill and hold"), the auditors will examine your supporting documentation to determine whether a sale has actually taken place.

• Review receiving log. The auditors will review the receiving log to see if it records an inordinately large amount of customer returns after the audit period, which would suggest that the company may have shipped more goods near the end of the audit period than customers had authorized.

• Related party receivables. If there are any related party receivables, the auditors may review them for collectibility, as well as whether they should instead be recorded as wages or dividends, and whether they were properly authorized.

• Trend analysis. The auditors may review a trend line of sales and accounts receivable, or a comparison of the two over time, to see if there are any unusual trends. Another possible comparison is of receivables to current assets. They may also measure the average collection period. If so, expect them to make inquiries about the reasons for changes in the trends.

Accounts Receivable Audit Risks

The preceding list of audit procedures is designed to detect a variety of audit risks, which include the following:

• That receivables do not exist

• That recorded receivable balances are inaccurate

• That it may not be possible to collect accounts receivable

• That the derivation of the allowance for doubtful accounts may not properly reflect bad debt experience

  What is the main procedure you would perform to test the existence of receivables?

  The primary test that can be performed is to obtain the aged trial balance of receivables and trace the total balance to the general ledger. This provides the auditor comfort that all outstanding receivables are included in the financial statements.

  What method is used to measure accounts receivable?

  One simple method of measuring the quality of accounts receivables is with the accounts receivable-to-sales ratio. The ratio is calculated as accounts receivable at a given point in time divided by its sales over a period of time. It indicates the percentage of a company's sales that are still unpaid.

  Which key assertion is tested by the confirmation of accounts receivable?

  Rights and Accuracy Accounts receivable confirmations can also prove the assertion of rights. When customers confirm that an invoice is owed to the company, this proves the assertion that the business undergoing auditing has a right to the assets it claims in accounts receivable.

  What is the examination of accounts to find out their accuracy?

  "auditing is an examination of accounting records undertaken with a view to establish whether they correctly and completely reflect the transactions to which they relate.