CHAPTER
8
SUBSTANTIVE TESTS OF RECEIVABLES AND SALES
8-1. Tests of details of financial balances are designed to determine the reasonableness of the balances in sales, accounts receivable, and other account balances which are affected by the sales and collection cycle. Such tests include confirmation of accounts receivable, and examining documents supporting the balance in these accounts. Tests of transactions for the sales and collection cycle are intended to determine the effectiveness of internal control structure and to test the substance of the transactions which are produced by this cycle. Such tests would consist of examining sales invoices in support of entries in the sales journal, reconciling cash receipts, or reviewing the approval of credit. The results of the tests of transactions will be used to affect the procedures, sample size, timing and particular items selected for the tests of details of financial balances (i.e., an effective internal control structure will result in reduced testing when compared to the tests of details required in the case of an inadequate internal control structure). 8-2. There are two common types of confirmations used for confirming accounts receivable: “positive” confirmations and “negative” confirmations. A positive confirmation is a communication addressed to the debtor requesting him to confirm directly whether the balance as stated on the confirmation request is correct or incorrect. A negative confirmation is also a communication addressed to the debtor, but it requests a response only when the debtor disagrees with the stated amount. A positive confirmation is more reliable evidence because the auditor can perform follow-up procedures if a response is not received from the debtor. With a negative confirmation, failure to reply must be regarded as a correct response even though the debtor may have ignored the confirmation request. Offsetting the reliability disadvantage, negative confirmations are less expensive to send than positive confirmations, and thus more of them can be distributed for the same total cost. The determination of which type of confirmation to be sent is an auditor’s decision, and it should be based on the facts in the audit. The following
8-2
Solutions Manual to Accompany Applied Auditing, 2006 Edition are the most important circumstances where positive confirmations should be used: 1. 2. 3.
There are a small number of large accounts which account for a significant portion of total accounts receivable. There are suspected conditions of dispute, inaccuracy, or irregularity. This would be the case when internal controls are considered inadequate or if prior year’s audit test results are unsatisfactory. The rules of certain regulatory agencies require them. This is the case for brokers and dealers in securities.
When the above conditions do not exist, it is acceptable to use negative confirmations, but negative confirmations should not be used if the auditor believes the customer is likely to ignore the confirmation. Typically, when negative confirmations are used, the auditor is using a reduced control risk assessment in the audit of accounts receivable. It is also common to use negative confirmations for audits of hospitals, retail stores, and other industries where the receivables are due from the general public. In these cases, far more assurance is obtained from tests of internal control than from confirmations. It is also common to use a combination of negative and positive confirmations by sending the positives to accounts with large balances and negatives to those with small balances. 8-3. It is acceptable to confirm accounts receivable prior to the balance sheet date if the internal control structure is adequate and can provide reasonable assurance that sales, cash receipts and other credits are properly recorded between the date of the confirmation and the end of the accounting period. Other factors the auditor is likely to consider in making the decision are the materiality of accounts receivable and the auditor’s experience in prior years. If the decision is made to confirm accounts receivable prior to year end, it is necessary to test the transactions occurring between the confirmation date and the balance sheet date by examining internal documents and performing analytical procedures at year end. 8-4. South Technologies, Inc. (a) When confirmation requests are mailed to debtors whose accounts were written off as uncollectible, the auditors’ purpose is to determine that the receivables were genuine when they were first recorded in the accounts. In some fraud cases, fictitious accounts receivable have been created to cover up a shortage. Eventually these fictitious receivables must be disposed of; one method is to write off the fictitious accounts as uncollectible. (b) The South executive appears to believe the auditors are solely concerned with the collectibility of accounts and notes receivable. In fact, the confirmation process is primarily intended to establish that the receivables are genuine and
Substantive Tests of Receivables and Sales
8-3
that the customers (or makers of notes) exist. Other audit procedures are followed to determine collectibility. 8-5. The confirmation requests should go to the makers of the notes regardless of whether the notes have been discounted. The act of discounting a note receivable does not reduce the importance of the note being genuine and collectible. A company which discounts its notes receivable remains in a position of sustaining a loss if the makers of the notes fail to make payment at the maturity dates. 8-6.
(a) When customers fail to respond to positive confirmation requests the CPAs may not assume with confidence that these customers reviewed the requests and found no disagreement and therefore did not reply. Some busy customers will not take the time to review confirmation requests and will not respond; hence, obvious exceptions may exist without being reported to the CPAs. (b) If there is no response to a second request, the CPAs may mail a third request and possibly make telephone calls in an effort to get a reply directly from the customer. When it becomes apparent that the confirmation program will not produce further evidence, the CPAs should consider each remaining customer as to the size, nature, and age of the balance and the apparent reason for the lack of a reply before they decide what additional work is necessary in the circumstances. The CPAs should carry out the alternative audit procedures of examining customers’ purchase orders or contracts, shipping documents and sales invoices of the client, and remittances by nonconfirming customers received by the client subsequent to the balance sheet date. The auditors may also verify the existence, location, and credit standings of the nonconfirming customers by reference to credit agencies or other sources independent of the client.
8-7. North, Inc. No, the matter remains unresolved. First, oral evidence from the client is never in itself sufficient; the auditors must follow up to determine the reliability of the oral evidence. Second, payment of an account receivable is not confirmation; the account might be fictitious, and the “payment” could have been made by a dishonest employee who had created the fictitious account to conceal a cash shortage. The auditors must examine the customer purchase order or contract, and copies of the sales invoice and shipping document, in support of the unconfirmed receivable. They should also determine the genuineness of the customer by reference to the telephone directory or to credit agency reports. 8-8. Monty’s Meat, Inc. a.
The workpaper does not include a description of the auditing procedures performed in confirming the accounts. The workpaper is also incomplete in the following respects:
8-4
Solutions Manual to Accompany Applied Auditing, 2006 Edition 1) The workpaper does not state whether the auditor traced the ABC Grocery remittance of P3,000 to November cash receipts. 2) The workpaper does not state whether the auditor examined the November 2 credit memo issued to Sari-Sari Store. 3) The workpaper does not state whether the auditor traced the Lucena’s Meat Market remittance to November cash receipts. 4) The workpaper does not state whether and how the auditor obtained satisfaction regarding confirmation requests not returned. 5) The workpaper does not state whether the auditor examined documentation for the Diana’s Supper Club order returned and received on October 31. 6) Rather than summarizing the confirmations returned without exception, as was done at the bottom of Working Paper 1, these confirmations should have been listed separately. b.
1) Sales Accounts receivable Inventory Cost of goods sold
P11,100 P11,100 8,600 8,600
To reverse 2007 sale recorded in 2006. 2) Allowance for uncollectible accounts Accounts receivable
1,277 1,277
To write off uncollectible account. 3) Sales returns and allowances Accounts receivable
3,634 3,634
To record return of spoiled meat and recognize loss in period in which incurred. Meat not restored to inventory, inasmuch as it was spoiled. 4) Sales Accounts receivable
13,000 13,000
To correct error in recording customer remittance as a sale. 5) Sales Returns Accounts receivable Inventory Cost of goods sold
334 334 250 250
Substantive Tests of Receivables and Sales
8-5
To record return and restore meat to inventory because meat returned in good condition. (See completed Exhibits 1.1 and 1.2 reproduced below and on the following page.)
c. Exhibit 1.1
Monty’s Meat, Inc. Accounts Receivable - Trade Aging Analysis October 31, 2006 Conf. No.
Customer
1060
Culley’s Meats
1061
Jolly Roger Restaurant ABC Grocery (Other)
1064 1602 1603 1607 1608 1612 10/31
Rudy’s Deli General Foods Grocers Kim’s Fresh Meats Dill’s Discount Grocery Diana’s Supper Club Balance per ledger Audit Adjustments
10/31
Audited balance
Balance
Current
P 1,330 466
P 1,330
4,256 329,433
3,000 280,763
378 13,468
13,000
2,334 12,469
1,074 12,469
1,256 33,467 P12,324
P 2,879
378 468 1,260
P335,65 5 #
P P 36,449 P13,234 P 283,902 2,070 P(210,113 )
Outstanding
Estimated uncollectible
466
334 532 P P 36,449 P13,234 P 311,970 3,347 P P(1,27 (28,068) 7)
P P (13,353 )
0P
0&
P P 23,096 P13,234 P 73,789 2,070
Estimated percent uncollectible 10/31
P
866 P365,00 0 P (29,345 )
Cash receipts 11/1 – 11/27 11/27
Past Due (Days) 1-30 31-60 Over 60
10% P 24,487
P P 7,379
25%
70% 100%
5,774 P 9,264
P 2,070
8-6
Solutions Manual to Accompany Applied Auditing, 2006 Edition
& #
Traced subsequent collections to November remittance advices. Obtained balances from subsidiary ledger after agreeing to general ledger control account.
Prepared by: Initial Date
Reviewed by: Initial Date
Exhibit 1.2 Monty’s Meat, Inc. Accounts Receivable - Trade Allowance for Doubtful Accounts October 31, 2006 11/1/05 11/1 - 10/31 11/1 - 10/31 10/31/06
Balance per general ledger Monthly provision Write-offs Balance ledger
per
general
AJE 2
10/31/06
P28,000
24,000 & (37,000) @ P15,000
AJE 6
(1,277) P13,723 P10,777
Audited balance
P24,500
AJE 6 Bad debts expense P10,777 Allowance for doubtful accounts P10,777 To adjust allowance for doubtful accounts to amount considered reasonable in the circumstances.
#
^
Substantive Tests of Receivables and Sales
8-7
# Traced to last year’s WTB - audited balance & Traced to standard journal entries @ Examined documentation and discussed with credit manager and legal counsel ^ In light of aging analysis, the above balance, as adjusted, appears to be adequate.
Prepared by: Initial Date
Reviewed by: Initial Date
8-9. Makati Company For all of the exceptions, the auditor is concerned about four principal things. (a) Whether there is a client error. Many times the confirmation response differences are due to timing differences for deposits in the mail and inventory in transit to the customer. Sometimes customers misunderstand the confirmation or the information requested. The auditor must distinguish between those and client errors. (b) The amount of the client error if any. (c) The cause of the error. It would be intentional, a misunderstanding of the proper way to record a transaction, or a breakdown of internal control. (d) Potential errors in the sample not tested. The auditor must estimate the error in the untested population, based on the results of the tests of the sample. Suggested steps to clear each of the comments satisfactorily are: 1.
(a) Examine supporting documents, including the sales invoices and applicable sales and shipping orders, for propriety and valuation of the sales. (b) Review the cash receipts books for the period after December 31, 2005, and note any collections from the PDQ Company. The degree of internal control over cash receipts should be an important consideration in determining the reliance that can be placed on the cash receipts entries. In addition, as there is no assurance that collections after December 31
8-8
Solutions Manual to Accompany Applied Auditing, 2006 Edition represent the payment of invoices supporting the December 31 trial balance, consideration should be given to requesting a confirmation from the PDQ Company of the invoices paid by their checks. 2.
(a) The cause should be investigated thoroughly. If the credit was posted to the wrong account, it may indicate merely a clerical error. On the other hand, posting to the wrong account may indicate lapping. (b) Such a comment may also indicate a delay in posting and depositing of receipts. If upon investigation such is the case, the company should be informed immediately so that it can take corrective steps.
3.
This is a confirmation of the balance with an additional comment. Since the customer has given us the data, it is preferable to check to see that the information agrees with the company’s records. Such a procedure may disclose misposting or delay in recording receipts.
4.
This incomplete comment should raise an immediate question: does the customer mean paid before or paid after December 31? Because the customer’s intent is unknown, this account should be reconfirmed and the customer asked to state the exact date. Upon receipt of the second confirmation, the information thereon should be traced to the cash receipts book. The auditor should first evaluate how long it takes to ship goods to the customer in question. If it ordinarily takes more than five days, there is no indication of error.
5.
A comment of this type may indicate that the company may be recording sales before an actual sale has taken place. The auditor should examine the invoice and review with the appropriate officials the company’s policies. Sales, cost of sales, inventories and accounts receivable may have to be adjusted if title has not passed to the buyer as of December 31, 2005. 6.
(a) Determine if such advance payment has been received and that it has been properly recorded. A review should be made of other advance payments to ascertain that charges against such advances have been properly handled. (b) If the advance payment was to cover these invoices, the auditor should propose a reclassification of the P1,350, debiting the advance payment account and crediting accounts receivable--trade.
7.
(a) Examine the shipping order for indications that the goods were shipped and, if available, carrier’s invoice and/or bill of lading for receipt of the goods. (b) If it appears that goods were shipped, send all available information to the customer and ask the customer to reconfirm. If the customer still insists that goods were never received, all data should be presented to an appropriate company official for a complete explanation. This may indicate that accounting for shipments is inadequate and consideration
Substantive Tests of Receivables and Sales
8-9
should be given to reviewing the procedures to determine if improvements can be made. (c) If the goods were not shipped, the auditor should recommend an adjustment reducing sales, cost of sales, and accounts receivable, and increasing inventories. 8.
This should be discussed with the appropriate officials and correspondence with the customer should be reviewed to allow determination whether an adjustment should be made in the amount receivable or if an allowance for doubtful accounts should be set up.
9.
As title on any goods shipped on consignment does not pass until those goods are sold, the sales entry should be reversed, inventory charged, and cost of sales credited if it is actually a consignment sale. Other so-called sales should be reviewed and company officials queried to determine if other sales actual represent consignment shipments; if so, the adjustment set forth in the preceding sentence should be made for all consignment shipments.
10. This is a noncurrent asset and should be reclassified to either deposit or prepaid rent. A review of other accounts, especially those with round numbers, may disclose other accounts that should be so reclassified.
8-10.
11. This may indicate a misposting of the credit or a delay in posting the credit. Comments under 2 above would also apply to credits. Ken Company Requirement (a) Ken Company Accounts Receivable Aging Schedule May 31, 2006
Age Category Not yet due Less than 30 days past due 30 to 60 days past due 61 to 120 days past due 121 to 180 days past due Over 180 days past due
Proportion of Total
Amount in Category
Probability of Non-Collection
.680 .150 .080 .050 .025 .015 1.000
P 816,000 180,000 96,000 60,000 30,000 18,000 P1,200,000
.010 .035 .050 .090 .400 .900
Estimated Uncollectible Amount P 8,160 6,300 4,800 5,400 12,000 16,200 P52,860
Requirement (b) Ken Company Analysis of Allowance for Doubtful Accounts May 31, 2006 June 1, 2005 balance Bad debt expense accrual (3,000,000 x .04)
P 30,250 120,000
8-10
Solutions Manual to Accompany Applied Auditing, 2006 Edition Balance before write-offs of bad accounts Write-offs of bad accounts Balance before year-end adjustment Estimated uncollectible amount Additional allowance needed
P150,250 108,750 P 41,500 52,860 P 11,360 Debit
Bad Debts Expense Allowance for Doubtful Accounts
Credit
11,360 11,360
Requirement (c) 1.
Steps to Improve the Accounts Receivable Situation Establish more selective credit-granting policies, such as more restrictive credit requirements or more thorough credit rating investigation.
2.
Establish a more rigorous collection policy either through external collection agencies or by Ken’s own personal.
This policy may offend current and thus risk future sales. collection costs could result policy. This policy may offend current and thus risk future sales.
Charge interest on overdue accounts. Insist on cash on delivery (COD) or cash on order (COO) for new customers or poorer credit risks.
8-11.
Risks and Costs Involved This policy could result in lost sales and increased costs of credit evaluation. Ken may be all but forced to adhere to the prevailing credit-granting policies of the office equipment and supplies industry. customers Increased from this customers
This policy could result in lost sales and increased administrative costs.
Demo Inc.
Requirement (a) DEMO INC. Accounts Receivable 12-31-05 Balance Per Per General Ledger Subsidiar y Unadjusted Balances Add (Deduct) Adjustments: AJE (2)to correct
P197,0 00
P198,2 40
AGING DISTRIBUTION Months Outstanding 0-1
1-3
3-6
over 6
P93,2 40
P76,82 0
P22,18 0
P6,000
Substantive Tests of Receivables and Sales understatement of accounts written off on October 31. (3) to write off definitely uncollectible accounts
8-11
(200)
(1,000)
(1,000 )
(4) to reclassify advances from customers
2,000
2,000
(5) to reclassify accounts with credit balances
500
500
1,4 40
_______
______ _
_______
_______
______
P199,7 40
P199,7 40
P95,2 40
P77,32 0
P22,18 0
P5,000
(6) to adjust general ledger balance to agree with subsidiary balance Balances as adjusted
(1,000 )
2,000
500
DEMO INC. Allowance for Doubtful Accounts 12-31-05 Balance per Ledger Add (Deduct) Adjustments: AJE (1)to correct error in recording bad debts recovery (2)to correct understatement of accounts written off (3)to write off definitely uncollectible accounts (4)to adjust allowance to required balance (Schedule 1) Balance as adjusted Schedule 1: Computation of Required Allowance Account Classification 0-1 month outstanding 1-3 months outstanding 3-6 months outstanding over 6 months outstanding Totals
Adjusted Total P 95,240 77,320 22,180 5,000 _______ P199,740
P12,000.00 324.00 ( 200.00) ( 1,000.00) ( 6,359.80) P 4,764.20
Required %
Allowance Amount
1 2 3 P2,000-50% P3,000-20%
P 952.40 1,546.40 665.40 1,000.00 600.00 P4,764.20
8-12
Solutions Manual to Accompany Applied Auditing, 2006 Edition Requirement (b) Adjusting Journal Entries 12-31-05 (1) (2) (3) (4) (5) (6) (7)
8-12.
Bad Debts Allowance for Doubtful Accounts
324.00
Allowance for Doubtful Accounts Accounts Receivable
200.00
Allowance for Doubtful Accounts Accounts Receivable
1,000.00
Accounts Receivable Advances from Customers
2,000.00
Accounts Receivable Customers’ accounts with credit balances
324.00 200.00 1,000.00 2,000.00 500.00 500.00
Accounts Receivable Sales
1,440.00
Allowance for Doubtful Accounts Bad Debts Expense
6,359.80
1,440.00 6,359.80
Tripoli Company
Requirement (1) Accounts receivable, trade.............................................. Advances to suppliers..................................................... Due from officers............................................................ Subscriptions receivable – share capital......................... Expense advances to salespeople.................................... Accounts payable, trade (P19,250 – P450)*............ Advances from customers on sales contracts........... Salaries payable....................................................... Allowance for doubtful accounts............................. Receivables (to close permanently)......................... Customers’ credit balances...................................... Requirement (2) Current assets: Accounts receivable, trade....................................... Less allowance for doubtful accounts...................... Creditors’ debit balances.......................................... Due from officers**................................................. Subscriptions receivable – ordinary shares**.......... Expense advances to salespeople.............................
40,000 450 2,500 4,600 1,000 19,250 450 3,300 500 23,050 2,000
40,000 500
P39,500 450 2,500 4,600 1,000
Substantive Tests of Receivables and Sales Current liabilities: Accounts payable, trade........................................... Customers’ credit balances...................................... Cash advances from customers on sales (not yet shipped)................................................... Salaries payable....................................................... *
19,250 2,000 450 3,300
These amounts are netted against normal balances to reflect control balances; but if material in amount, they should be reported separately on the balance sheet as indicated in Requirement 2.
** Considered as current assets only if currently collectible. assumed to be material in amount. 8-13. 1.
8-13
All items are
Pearl Corporation Estimated bad debt percentage based on year-end accounts receivable: 28.5%# Actual bad debts Credit Sales Outstanding receivables (year-end) Percentage of outstanding receivables a b c d e
f
2.
2003 P 3,300a P90,000
2004 P 5,700c P158,000
2005 P 7,800e P210,000
2006 P 16,800 P459,000
P 9,500b
P 19,900d
P 29,500f
P 58,900
0.347
0.286
0.264
0.285#
P2,500 + P500 + P300 = P3,300 0 + P90,000 - P78,000 - P2,500 = P9,500 P4,600 + P700 + P400 = P5,700 P9,500 + P158,000 - P8,500 - P134,000 - P500 - P4,600 = P19,900 Estimated. The bad debts written off in the third year following the sale have averaged about 7.8% [(P300 + P400) ÷ (P3,300 + P5,700)] of the total actual bad debts in the previous 2 years. Therefore, the bad debts on 2005 sales of P6,200 and P1,000 are about 92.2% of the total bad debts expected on 2005 sales. P19,900 + P210,000 - P200 - P14,200 - P178,800 - P300 - P700 - P6,200 = P29,500
Bad debts estimated as a percentage of year-end accounts receivable P29,500 + P235,000 - P300 - P19,500 - P400 - P1,000 - P200,000 = P43,300 P43,300 x 0.285 = P12,340.50, or approximately P12,300. Criteria for recognition of bad debts or impairment of receivables under PAS 39 should be applied.
8-14.
Flores Corporation
8-14
Solutions Manual to Accompany Applied Auditing, 2006 Edition
Requirement (1) Flores Corporation Analysis of Changes in the Allowance for Doubtful Accounts For the Year Ended December 31, 2006 Balance at January 1, 2006 Provision for doubtful accounts (P9,000,000 x 2%) Recovery in 2006 of bad debts written off previously Deduct write-offs for (P90,000 + P60,000) Balance at December 31, 2006, before additional impairment loss Increase in estimated uncollectible accounts during 2006 (P235,300 - P175,000) Balance at December 31, 2006, adjusted (Schedule 1)
P130,000 180,000 15,000 P325,000 150,000 P175,000 60,300 P235,300
Schedule 1: Computation of Allowance for Doubtful Accounts at December 31, 2006 Aging category November-December 2006 July-October January-June Prior to 1/1/06 a
Balance P1,140,000 600,000 400,000 70,000 a
Percent 2 10 25 75
Doubtful accounts P 22,800 60,000 100,000 52,500 P235,300
P130,000 - P60,000
Requirement (2) Flores Corporation Journal Entry December 31, 2006 Bad Debt Expense Allowance for Doubtful Accounts To increase the allowance for doubtful accounts at December 31, 2006, resulting from evaluation of collectibility of remaining receivables. 8-15.
60,300 60,300
Visayas Company Requirement (a) Visayas Company Accounts Receivable 12.31.06 Balance, 12.31.05
P 546,400
Substantive Tests of Receivables and Sales Add: Sales on account for the year Total Less: Collections during the year - with discount (1) - without discount (2) Accounts written off Credit memo for sales returns & allowances
2,622,832 P3,169,232 P2,050,859 848,118 18,700 37,000
Balance, 12.31.06 Total collections Less: Accts paid w/ discount Accts paid by customers w/o discount
8-15
2,954,677 P 214,555
P2,857,960 2,009,842
(÷ 98% = P2,050,859) (1)
P 848,118
(2)
Requirement (b) AJE (1) Doubtful accounts expense Allowance for doubtful accounts
6,599 6,599
Supporting Analysis: % allowance to AR 12.31.05 Required % allowance to AR 12.31.06 Required allowance 12.31.06 2% x P214,555
P 16,392 P546,400
=
3%
2/3 x 3%
=
2%
P4,291
Allowance for doubtful accounts balance, 12.31.05 Less: Accounts written off
P 16,392 18,700 P( 2,308)
Required balance, 12.31.06
4,291
Estimated bad debts expense for 12.31.06 8-16.
P 6,599
Charry Company
Requirement (a) Adjusting Journal Entries (1)
(2)
Accounts Receivable Customers’ accounts with credit balances (P500 + P5,000)
5,500
Sales
5,000
5,500
8-16
Solutions Manual to Accompany Applied Auditing, 2006 Edition Accounts Receivable (3) (4) (5) (6) (7) (8)
5,000
Subscriptions Receivable Accounts Receivable
15,000
Deposit on Contract Accounts Receivable
15,000
Claims Receivable Accounts Receivable
500
Advances to Employees Accounts Receivable
500
Advances to Affiliated Company Accounts Receivable Advances to Supplier Accounts Receivable
15,000 15,000 500 500 10,000 10,000 5,000 5,000
Requirement (b) Balance Sheet Presentation 12-31-06 Current Assets Accounts Receivable - Trade Claims Receivable Advances to Employees Advances to Supplier
P59,500 500 500 5,000
Investments Advances to Affiliated Company
10,000
Other Assets Deposit on Contract
15,000
Shareholders’ Equity Subscribed Share Capital (net of subscriptions receivable of P15,000)
xxx
Supporting Analysis: Charry Company Accounts Receivable -Trade 12-31-06 Balance per ledger Add (Deduct) Adjustments: AJE (1) To reclassify accounts with credit balances
P105,000 5,500
Substantive Tests of Receivables and Sales (2) (3) (4) (5) (6) (7) (8)
To reverse entry for consignment deliveries To reclassify subscriptions receivable To reclassify deposit on contract To reclassify balance of claims from carrier for shipping damages To reclassify employee’s IOU’s To reclassify advances to affiliate To reclassify advances to supplier Net adjustments
8-17
( 5,000) ( 15,000) ( 15,000) ( 500) ( 500) ( 10,000) ( 5,000) ( 45,500)
Balance as adjusted
P 59,500
If correct entries were made for the transactions given, the Accounts Receivable account would show the following postings: Accounts Receivable Jan. 1 Balance Charge Sales Recoveries of accounts written off
P 56,000 625,000 1,000 ________ P682,000 ________ P682,000
8-17.
Collections Write offs Merchandise returns Allowance for shipping damages Balance Dec. 31
P615,000 3,500 2,500 1,500 P622,500 59,500 P682,000
The Preston Companies (amounts in P millions)
Requirement (1) (a) Preston’s earnings would have increased (1 – 0.40) P105 million or P63 million in 2006. Net accounts receivable and total assets would have been P105 million higher than actually reported in 2006. Ignoring differences between tax and financial reporting, income tax payable would have increased by P0.40 (P105 million) or P42 million, and retained earnings would be greater by P63 million. This example illustrates the material effect estimated bad debts can have on reported earnings and total assets. (b) Under the allowance method, failure to write off an account has no effect on earnings (assuming a sufficient balance exists in the allowance account), or any net balances in the balance sheet. Only the components of net accounts receivable would be affected. Both gross accounts receivable and the allowance for doubtful accounts would be overstated P0.6 million.
8-18
Solutions Manual to Accompany Applied Auditing, 2006 Edition
Requirement (2) Beginning allowance balance Bad debt expense Ending allowance balance Write-offs of accounts
1998 P183 105 (212) P 76
Requirement (3) (a) The ratio of bad debt expense to operating revenue for the two years is: 2006, P105/P3,729 = 2.8%; 2005, P81/P3,534 = 2.3%. This ratio appears relatively stable although is increasing. (b) The composite rate of uncollectible accounts as a percentage of gross accounts receivable = ending allowance balance/ending accounts receivable. The ratio for 2006 is P212 / (P951 + P212) = 18.2%, and for 2005 is P183 / (P972 + P183) = 15.8%. This ratio is less stable and also is increasing. (c) Bad debt expense is considerably higher than the write-offs in 2006. The firm has experienced an increase in expected write-offs. Apparently the firm expects an increase in bad debts, which is partially an estimate of future write-offs. 8-18.
Rain Company
Requirement (1) Present value of the note: P150,000 x (PV1, 12%, 3) (0.71178) = P106,767
Requirement (2) Correction and Collection Schedule: Date
Explanation and Interest Revenue
1-1-2005
Recorded originally at face amount
12-31-
Correction to restate to present
–
Note Receivable Chang Balance e P150,00 0 P 106,767
Substantive Tests of Receivables and Sales 2005 12-312005 12-312006 12-312007 12-312007
value To accrue 12% = To accrue 12% = To accrue 12% = Collection Cash
interest, P12,812 interest, P14,349 interest, P16,072* on face
8-19
P106,767
x +
43,233 12,812
119,579
P119,579
x +
14,349
133,928
P133,928
x +
16,072
150,000
150,00 0
0
amount, debit –
* Rounded.
8-19. 1.
d.
The Josefina note is a short-term note and is reported at face value although the note can be recorded at present value. The Nicole note is reported at present value: [(P20,000 + 5(0.3) (P20,000)] (PV1, 8%, 5) = P23,000 (0.68058) = P15,653
2.
c.
The annual payment is computed as: P10,000 (PVA, 8%, 5) = P10,000 / 3.99271 = P2,505. Discounting this stream of payments at 9% yields cash proceeds of: P2,505 (PVA, 9%, 5) = P2,505 (3.88965) = P9,744. Total interest equals total payments less proceeds = 5 (P2,505) – P9,744 = P2,781.
8-20.
3.
b.
Interest receivable is recorded for one month.
4.
c.
Maturity value..................................................................... P100,000 Discount P100,000 (0.10) (6/12)......................................... (5,000) Proceeds............................................................................... P 95,000
Luce Company (1)
AJE :
Sales returns and allowances
30,000
Inventory 12.31.06 Accounts receivable Cost of sales
24,000 30,000 24,000
Income will decrease by P6,000 if the above AJE is made. (2)
Ans.
(c)
AJE :
Sales Accounts receivable Income was overstated by P10,000
Ans.
(a)
10,000 10,000
8-20
Solutions Manual to Accompany Applied Auditing, 2006 Edition (3)
Actual number of units sold to Mr. Lazo was 320. Ans.
(4)
8-21.
P48,000 P150
(b)
Correct receivable from Mr. Lazo : 320 x P100 Per client Overstatement Ans. (d)
P 32,000 48,000 P 16,000
(5)
Accounts receivable from Mr. Sia is correctly stated because the goods are considered sold in 2006. Ans. (a)
(6)
Ans.
(d)
ETC Co.
Adjusting Journal Entries AJE 1. 2. 3. 4.
5. 6.
Cash Other Current Liabilities (UCPB Overdraft)
225,000 225,000
Accounts Receivable Cash
37,500
Cash Accounts Payable
28,709
Notes Payable Interest Expense Cash
67,500 16,200
Cash – BPI Other Current Liabilities (UCPB Overdraft)
25,000
Cash – SBTC Accounts Receivable
73,690
37,500 28,709
83,700
73,690
Cash 5.31.06 Per books AJE 1. 2. 3. 4. 5. 6.
25,000
P 15,825,000 225,000 (37,500) 28,709 (83,700) 25,000 73,690
Substantive Tests of Receivables and Sales Adjusted balance P16,056,199 Accounts Receivable 5.31.06
AJE 2. 6.
Subsidiary Ledger P8,047,054 37,500 (375,215) 122,500 P7,831,839
8-21
(1) (c)
General Ledger P7,868,029 37,500 (73,690)
P7,831,839
(2) (b)
Allowance for Doubtful Accounts Aging Distribution Current Past due: 1 – 30 31 – 60 61 – 90 Over 90
8-22.
Amount Estimated to be Subsidiary Ledger % Uncollectible P1,737,690.00 + P122,500 = P1,860,190.00 x 2 = P 37,203.80 P1,617,340.00 P1,437,706.50 P1,474,450.00 P1,779,867.50 + P37,500 ___________ – P375,215 P8,047,054.00
= 1,617,340.00 x 5 = 80,867.00 = 1,437,706.50 x 10 = 143,770.70 = 1,474,450.00 x 15 = 221,167.50 = 1,442,152.50 x 20 = 288,430.50 P7,831,839.00 P771,439.50 (3) (a)
Ling, Inc.
Requirement (1) LING, INC. Long-term Receivables Section of Balance Sheet December 31, 2005 9% note receivable from sale of division, due in annual installments of P500,000 to May 1, 2007, less current installment 8% note receivable from officer, due December 31, 2007, collaterized by 10,000 shares of Ling, Inc., ordinary shares with a fair value of P450,000 Non-interest-bearing note from sale of patent, net of 15% imputed interest, due April 1, 2007 Installment contract receivable, due in annual installments of P50,000 to July 1, 2009, less current installment Total long-term receivables
P 500,000 [1] 400,000 84,105 [2] 112,400 [3] P1,096,505
8-22
Solutions Manual to Accompany Applied Auditing, 2006 Edition
Requirement (2) LING, INC. Selected Balance Sheet Balances December 31, 2005 Current portion of long-term receivables: Note receivable from sale of division Installment contract receivable Total
P500,000 [1] 27,600 [3] P527,600
Accrued interest receivable: Note receivable from sale of division Installment contract receivable Total
P 60,000 [4] 11,200 [5] P 71,200
Requirement (3) LING, INC. Interest Income from Long-Term Receivables and Gains Recognized on Sale of Assets For the Year Ended December 31, 2005 Interest income: Note receivable from sale of division Note receivable from sale of patent Note receivable from officer Installment contract receivable from sale of land Total interest income for year ended 12/31/05
P105,000 8,505 32,000 11,200 P156,705
Gains recognized on sale of assets: Patent Land Total gains recognized for year ended 12/31/05
P 37,600 [8] 50,000 [9] P 87,600
Explanation of amounts: [1] Long-term Portion of 9% Note Receivable at 12/31/05 Face amount, 5/1/00 Less: installment received 5/1/05 Balance, 12/31/05 Less: installment due 5/1/06 Long-term portion, 12/31/05
P1,500,000 (500,000) P1,000,000 (500,000) P 500,000
[6] [2] [7] [5]
Substantive Tests of Receivables and Sales
8-23
[2] Non-interest-bearing Note, Net of Imputed Interest at 12/31/05 Face amount, 4/1/05 P 100,000 Less: imputed interest [P100,000 – (P100,0000 x 0.756)] (24,400) Balance, 4/1/05 P 75,600 Add: interest earned to 12/31/05 (P75,600 x 15% x 9/12) 8,505 Balance, 12/31/05 P 84,105 [3] Long-term Portion of Installment Contract Receivable at 12/31/05 Contract selling price, 7/1/05 P 200,000 Less: down payment, 7/1/05 (60,000) Balance, 12/31/05 P 140,000 Less: installment due 7/1/06 [P50,000 – (P140,000 x 16%)] (27,600) Long-term portion, 12/31/05 P 112,400 [4] Accrued Interest – Note Receivable, Sale of Division, at 12/31/05 Interest accrued from 5/1 to 12/31/05 (P1,000,000 x 9% x 8/12) P 60,000 [5] Accrued Interest – Installment Contract at 12/31/05 Interest accrued from 7/1 to 12/31/05 (P140,000 x 16% x ½)
P
11,200
[6] Interest Income – Note Receivable, Sale of Division, for 2005 Interest earned from 1/1 to 5/1/05 (P1,500,000 x 9% x 4/12) P 45,000 Interest earned from 5/1 to 12/31/05 (P1,000,000 x 9% x 8/12) 60,000 Interest income P 105,000 [7] Interest Income – Note Receivable, Officer, for 2005 Interest earned 1/1 to 12/31/05 (P400,000 x 8%) [8] Gain Recognized on Sale of Patent Stated selling price Less: imputed interest Actual selling price (P100,000 x 0.756) Less: cost of patent (net) Carrying value 1/1/05 Less amortization 1/1 to 4/1/06 (P8,000 x ¼)
P
32,000
P 100,000 (24,400) [2] P 75,600 P40,000 (2,000)
(38,000)
8-24
Solutions Manual to Accompany Applied Auditing, 2006 Edition Gain recognized
P
[9] Gain Recognized on Sale of Land Sale of price Less: cost Gain recognized 8-23.
37,600
P 200,000 (150,000) P 50,000
Grande Company Requirement 1 PAS 39, paragraph 63 will be applied in this case. On December 31, 2006, Grande Company should record the 2006 accrued interest and the impairment: Notes / Interest Receivable (0.06) (100,000) Interest Income
6,000 6,000
Bad Debts Expense Allowance for decline in note value
55,537 * 55,537
* Carrying value of note and interest (100,000 + 6,000) Present value / New carrying value of note (discount rate – 6%) Principal: Due on 12.31.08 (P30,000 x 0.89000) P26,700 Due on 12.31.10 (P30,000 x 0.79209) 23,763 Impairment write-down
P106,000
50,463 P 55,537
Requirement 2 The entries with the corresponding computations follow: Effective Interest Method December 31, 2007 Allowance for decline in note value Interest income (0.06) (50,463) December 31, 2008 Allowance for decline in note value Interest income (0.06) (50,463 + 3,028) Cash
3,028 3,028
3,209 3,209 30,000
Substantive Tests of Receivables and Sales Notes receivable
30,000
December 31, 2009 Allowance for decline in note value Interest income (0.06) (50,463 + 3,208 + 3,209 – 30,000)
1,602 1,602
December 31, 2010 Allowance for decline in note value Interest income * 0.06 (26,700 + 1,602) Cash Notes receivable
1,698* 1,698 30,000
*
30,000
Allowance for decline in note value Notes receivable To close remaining balance in notes receivable and allowance
46,000 46,000
* At this point, the amortized cost of the notes receivable is zero. Notes Receivable 100,000 6,000 106,000
8-24.
30,000 30,000 60,000 46,000 bal
Amy Corporation Requirement 1
8-25
Allowance for Decline in Note Value 3,028 55,537 3,209 1,602 1,698 9,537 55,537 46,000
8-26
Solutions Manual to Accompany Applied Auditing, 2006 Edition Accounts Receivable (Trade) Accounts Receivable (Officer) Ordinary Shares Subscriptions Receivable Advances to Employees Notes Receivable (Trade) Deposit to Guarantee Contract Performance Utility Deposit Receivables
15,500 3,600 12,000 1,800 6,000 5,000 500 44,400
Requirement 2
8-25.
Accounts receivable (trade)--current asset, trade receivable Accounts receivable (officer)--normally current nontrade receivable Ordinary shares subscription receivable--current or noncurrent asset, depending on due date; nontrade receivable Advances to employees--current asset, nontrade receivable Notes receivable (trade)--noncurrent asset, trade receivable Deposit to guarantee contract performance--separately classify, could be current or noncurrent asset, depending on the length of the contract; nontrade receivable Utility deposit--separately classify, probably noncurrent nontrade receivable Jane’s Department Store Requirement 1 Age Under 30 days 30- 60 days 61-120 days 121-240 days 241-360 days Over 360 days
Balance P193,000 114,000 73,000 41,000 25,000 19,000 P465,000
Estimated Percentage Uncollectible 0.008 0.020 0.050 0.200 0.350 0.600
Estimated Amount Uncollectible P 1,544 2,280 3,650 8,200 8,750 11,400 P35,824
Requirement 2 a. b. c. 8-26.
Bad Debt Expense Allowance for Doubtful Accounts
35,824
Bad Debt Expense (P35,824 + P3,000) Allowance for Doubtful Accounts
38,824
Bad Debt Expense (P35,824 – P2,800) Allowance for Doubtful Accounts
33,024
Blue Corporation
35,824 38,824 33,024
Substantive Tests of Receivables and Sales
8-27
Requirement 1 2005 Dec.
Dec.
1
1 11 31 31
2006 Jan. 29 29
29
Cash [(P175,000 x 0.80) – P1,400] 138,600 Assignment Service Charge Expense (P175,000 x 0.80 x 0.01) 1,400 Notes Payable (P175,000 x 0.80)
140,000
Accounts Receivable Assigned Accounts Receivable
175,000
175,000
Sales Returns and Allowances Accounts Receivable Assigned
1,000
Cash Accounts Receivable Assigned
86,000
Notes Payable Interest Expense (P140,000 x 0.12 x 1/12) Cash
86,000
Cash Accounts Receivable Assigned
60,000
1,000 86,000
1,400 87,400
60,000
Notes Payable (P140,000 – P86,000) 54,000 Interest Expense (P54,000 x 0.12 x 1/12) 540 Cash
54,540
Accounts Receivable Accounts Receivable Assigned (P175,000 – P1,000 – P86,000 – P60,000)
28,000
28,000
Requirement 2 On the December 31, 2005 balance sheet of the Blue Corporation, the assigned accounts receivable and the remaining liability would be reported as follows: Current Assets: Accounts receivable assigned
P88,000
Current Liabilities: Note payable
P54,000
8-28
Solutions Manual to Accompany Applied Auditing, 2006 Edition
8-27.
Tandy Shoes Sept. 15
21
29
8-28.
Accounts Receivable Credit Card Expense (P2,100 x 0.05) Sales Sales Returns and Allowances Accounts Receivable Credit Card Expense (P200 x 0.05) Cash Accounts Receivable
1,995 105 2,100 200 190 10 1,805 1,805
Gabe Company GABE COMPANY Income Statement Effect For the Year Ended December 31, 2005 Expenses resulting from accounts receivable assigned (Schedule 1) Expenses resulting from accounts receivable sold (P300,000 – P260,000) Total expenses
P15,100 40,000 P55,100
Schedule 1: Computation of Expenses for Accounts Receivable Assigned Assignment expense: Accounts receivable assigned Advance by Belle
Interest expense Total expenses
P200,000 x 85% P170,000 x 3% P 5,100 10,000 P 15,100
Substantive Tests of Receivables and Sales
8-29
