lOMoARcPSD|7696077

Audit of Receivables and Sales

Accontancy (Tarlac State University)

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TABLE OF CONTENTS

1. Primary Substantive Procedures

1.1 Reconciliation of Subsidiary Ledger with General Ledger
1.2 Confirmation of Receivables and Review of Subsequent Cash Receipt
1.3 Evaluating the Adequacy of the Allowance for Doubtful Accounts
1.4 Expected Credit Loss
1.5 Accounts Receivable and Sales Cutoff
1.6 Investigate Any Transactions with or Related Party Receivables.
1.7 Analyzing Credit Balances and Unusual Items.
1.8 Ascertaining Whether Any Receivables Have been Pledged or Assigned
1.9 Performing Analytical Procedures.
2. Other Substantive Procedures
2.1 Bill and Hold Transaction
2.2 Multiple Element Arrangement
2.3 Percentage of Completion Method
2.4 Sales Returns
2.5 Receivables Denominated in Foreign Currency
2.6 Analysis of Notes Receivable and Related Interest
3. Situational Problems
3.1 Palisades, Inc. - Unreplied Confirmation Letter
3.2 Lakeside Company - Forbidden Communication with Customers
3.3 Thorne Company - Three GAAS in Fieldwork
3.4 Solar Technologies Inc. - Confirmation Request
3.5 Halston Toy Manufacturing Co. - Sales Returns
4. Problem Solving
4.1 Audit of Trade Receivables
4.2 Estimation of Bad Debt Expense
4.3 Receivable Financing ( Assignment And Factoring)
4.4 Discounting Of Note Receivable
4.5 Audit of Note Receivable
4.6 Audit of Loans Receivable
4.7 Reversal Impairment of Loans receivable
4.8 Audit of Sales

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Primary Risks for Accounts Receivable and Revenues

The main risks are:
 The company intentionally overstates accounts receivable and revenue
 Company employees steal collections
 Without proper cutoff, an overstatement of accounts receivables and revenue occurs
 Allowances are understated
PRIMARY SUBSTANTIVE TEST
1. Reconciliation of Subsidiary Ledger with General Ledger
An aged trial balance of trade accounts receivable at the audit date is commonly prepared for the auditors by
employees of the client, often in the form of computer printout. The client-prepared schedule is a multi-purpose
form designed for the aging of the customers’ accounts, the estimating of probable credit losses, and the
controlling of confirmation requests. The inclusion of so many phases of the examination of receivables in a single
working paper is practicable only for small concerns with a limited number of customers.
When trial balances are furnished to auditors by the client’s employees, some independent verification is
essential. Determination of the proper extent of testing should be made in relation to the adequacy of the internal
controls over receivables. The auditor should test the footings, crossfootings and agings.

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2. Confirmation of Receivables and Review of Subsequent Cash Receipt

The primary audit procedure to verify the existence and gross valuation of receivable is through confirmation.
In accordance with PSA 505 Revised and Redrafted, when using confirmation, the auditor can use either the
positive and negative confirmation, or a combination of the two methods to produce more effective procedures.
a. Positive Confirmation
It is sent to customer of the client by the auditor requesting a response directly as to whether the stated amount
owed is correct or incorrect, or to request the customer to provide specific information, such as their account
balance with the entity, which is referred to as “blank form”.
Positive confirmation is considered to provide more reliable audit evidence; however, it is more costly compared to
negative confirmation.
b. Negative Confirmation
It is sent to customer of the client by auditor requesting a response only if the customer disagrees with the amount
stated on the confirmation.
When to use Negative Method:
 The receivables comprise a large number of small balances.
 Internal control surrounding receivables is considered to be effective.
 The auditor reasonably believes that recipients of negative confirmation requests will give the
requests adequate consideration.
Negative confirmation provides audit evidence that is less reliable and less costly as compared to
positiveconfirmation. Non-response of the customer may either indicate that the customer agrees with the information
in the confirmation request or the customers just ignore the confirmation letter.
Other Audit Considerations When Using Confirmation:
 The confirmation request should be described that it is not a request for payment, but merely to confirm the
account.
 The confirmation request should be prepared and sent to the customer under the control of the auditor.
 The auditor may include in the confirmation request the details of the transactions, such as
customer’s purchase order numbers to improve the response rate.
 The confirmation request should be mailed in envelopes bearing the CPA firm’s return address.
 Receipt of reply to confirmation request should be under the control of the auditor.

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3. Evaluating the Adequacy of the Allowance for Doubtful Accounts\

As part of risk in conducting a business, some customers may default from their payment. Since receivables
need to be valued at net realizable value, the company needs to make a reliable estimate of bad debts or doubtful
accounts in its financial statements. In some circumstances, receivables are proven to be worthless are written
off.An important part of obtaining evidence about the proper valuation of accounts receivable is the auditor's
evaluation of the adequacy of the allowance for uncollectible accounts. Since this account is a management
estimate, it is typically audited by one or a combination of the following procedures:
1. Evaluating management process of developing the estimate.
The auditor's evaluation ordinarily includes:
Obtaining a general understanding of the process used in developing the estimate
a) Considering the reasonableness of the entity's policies regarding additions to the allowance and write-
offs of doubtful accounts
b) Discussing with management the key assumptions regarding collectability and evaluating the
reasonableness of the assumptions
c) Considering the effectiveness of the controls over the data used in the process
d) Evaluating the entity's method of calculating the allowance
2. Reviewing subsequent transactions.
Since the best evidence of collectability of receivable is payment by the debtors subsequent to the reporting date,
the auditor may review subsequent payment and ascertain the appropriateness of the provisions for bad debts
recorded.
3. Developing auditor's independent estimate.
Based on the knowledge gained by the auditor regarding the credit and collection process and
management process in developing the estimate, the auditor may come up with its independent estimate and
compare it with the management estimate. Any significant difference should be investigated and resolved with the
management (e.g., credit manager).
4. Expected Credit Losses
General Model:
Three Stages
Stage 1: Insignificant Deterioration
Estimate the probability of default in the first 12 months.
Ex. On Jan. 1, 2019, Zoom Bank provided a loan of 4M to D Company. Under the loan agreement, the effective
interest rate is 10% and that D Company is to pay the annual interest every Dec. 31. The principal amount of the
loan is due on Dec. 31, 2023.
Jan. 01, 2019
Loan Receivable 4,000,000
Cash 4,000,000
On Dec. 31, 2019, Zoom Bank needs to measure the 12-month expected credit loss for the loan. Zoom Bank
determined that the probability of default over the next 12 months is 1%.
Dec. 31, 2019
Cash 400,000
Interest Income 400,000
Carrying Amount, 12/31/2019 P4,000,000
PV of Expected CF (4M x 0.683) (2,185,600)
Expected Credit Loss 1,814,400
Probability Of Default x 1%
12-month ECL P18,140
Impairment Loss 18,140
Allowance for Credit Loss 18,140
Stage 2: Significant Deterioration
Review macro-economic factors, industry information, and reassessing risk in general.
Estimate the probability of default for the remaining life of loan.
Continuation of example
On Dec. 31, 2020, Zoom Bank has determined that there is a significant increase in credit risk of the loan
receivable. The probability of the loan being default over the life of the loan is 10%.
Dec. 31, 2020
Cash 400,000
Interest Income 400,000

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Carrying Amount, 12/31/2020 P4,000,000

PV of Expected CF (4M x 0.7513) (2,253,900)
ECL 1,746,100
Probability f Default x 10%
12-month ECL 174,610
ECL allowance, 12/31/2019 (18,140)
Impairment Loss P156,470
Impairment Loss 156,470
Allowance for Credit Loss 156,470
Stage 3: Credit Impaired
Estimate the probability of default over the loan’s remaining life and records a loss provision.
Continuation of example
During 2021, D Company began to face financial difficulties. At year-end, Zoom Bank considered the loan
impaired. Interest for that year was collected. However, only 40% of the principal amount is expected to be
received on due date.
Dec. 31, 2021
Cash 400,000
Interest Income 400,000
Carrying Amount, 12/31/2021 P4,000,000
PV of Expected CF (4M x 40% x .8264) (1,322,240)
ECL 2,677,760
Allowance for CL12/31/2020 (174,610)
Impairment loss P2,503,150
Impairment Loss 2,503,150
Allowance for Credit Loss 103,150
Loan receivable 2,400,000
5. Accounts Receivable and Sales Cutoff
The auditor usually tests the sales cutoff by examining invoices and shipping documents for several days both
before and after the year-end and by tracing such documents to the sales and accounts receivable records for the
appropriate period. This test of sales cutoff may occasionally be made at an interim date to check the adequacy of
the company’s procedures. All substantial sales returns after the statement of financial position date should be
reviewed carefully as they may represent fictitious sales recorded at year-end.
6.Investigate any transactions with or related party receivables.
The auditor must determine the existence of related parties and identify significant related party transactions
including those not recognized in the accounting records. These related party relationships can provide
opportunities for individuals to act in a way that creates confusion to shareholders.
There are many related party transaction risks that materially affects the amount of receivables and sales that
appears in the financial statements of an entity. These include all of the contracts entered with related parties that
have substantially different terms than those similar transactions entered with unrelated parties. However, the
auditors should be concerned more with the possibility that an undisclosed relationship with a party to a material
transaction has been used to fabricate transactions.
After a related party receivable is identified and considered as material, the auditor should apply substantive
tests to that transaction by performing the following steps:
1. Recalculate the total balance of receivables in the subsidiary ledger and determine that it agrees with the
balance in the general ledger.
2. Review the list for potential problem accounts or large amounts and obtain an understanding of these
transactions and their potential collectibility.
3. If the balances are significant, consider confirmation of several selected individual balances with the related
parties involved and reconcile replies. The auditor may also examine the invoices, executed copies of contracts
and other documents to support the balances.
4. Determine whether the transaction has been approved by the appropriate officials.
5. Determine the nature of any related party receivable that were written off during the audit period but
subsequently reinstated to the general ledger.
6. Determine the adequacy of disclosure in the notes of the transaction, balance of receivable and any amount
written off.
7. Analyzing credit balances and unusual items.
Customer's credit balances are credit balances in accounts receivable resulting from overpayments, returns
and allowances, advance payments from customers, or any unusual items caused by errors or irregularities in the

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accounts. These credit balances are classified as current liabilities and not deducted from the debit balance of
customer accounts, except when the same is not material in which case only the net accounts receivable may be
presented.
The auditors should identify and review the listings of credit balances for large or unsual items and test its
completeness. If the credit balance appearing on the customer's account is caused by a return of goods
purchased, the documents supporting such return of goods, such as credit memo and sales returns and
allowances journal, must be reviewed. It should be noted that the auditors must obtain an understanding of these
credit transactions and their impact on year-end receivables.
8. Ascertaining whether any receivables have been pledged or assigned.
Pledging of receivable happens when a client uses its receivables as collateral on a loan. Accounts receivable
that have been pledged are usually labeled by inserting an identifying code in the receivable records or stamping
on a copy of sales invoice that such receivable was pledged. But the auditors cannot proceed on the assumption
that all pledged receivables have been labeled in that effect and they must be alert to detect any suggestions of
unrecorded pledging of accounts receivable.
Receivables that were pledged or assigned must be disclosed in the notes to inform the reader of financial
statements that there is a contingent liability attached with such receivables. The auditors must review the
footnotes regarding the disclosures made for any factored, assigned or pledged receivables. Bank confirmation
requests and inquiry may also be used as a medium in gathering evidence of the pledging of receivables.
9. Performing analytical procedures.
During an audit, a variety of analytical procedures might be employed, depending on the circumstances and
the nature of the business. The auditors must first establish a threshold (it can be a percentage or an amount or
both) in performing analytical procedures, to determine the transactions that needs a thorough investigation.
Typical analytical procedures for sales include the following:
1. Compare sales for the last month of the fiscal to sales for the rest of the year and the first month after year
end.
2. Compare monthly sales returns and credit memos for the last few months of the fiscal year to the first few
months following year end.
Other analytical procedures can be perform by the auditors are trend analysis, comparison among sales units,
receivables turnover, days’ sales in receivables, amount of past due receivables, gross margin ratio, and
sales/asset ratios to historical data and industry statistics. Account interrelationships can also be used.
For any significant difference or fluctuations noted, investigate the nature and cause of differences and consider
whether additional procedures are needed.

OTHER SUBSTANTIVE PROCEDURES ON AUDIT OF RECEIVABLES AND SALES

a) Bill and Hold Transaction. When a company engages in bill and hold transactions there is a possibility that the
company is inappropriately recognizing revenue. The auditors must ascertain that any transactions recognized
as sales meet the criteria for revenue recognition as set forth in SEC Accounting and Auditing Enforcement
Release No. 108. In these circumstances, the auditors will review the provisions of sales contracts and
consider confirming the terms with customers.
b) Multiple Element Arrangement. When a company sells using a multiple element arrangement, the revenue
must be allocated to the elements in relation to their fair values. Therefore, there is a possibility that
management may attempted to misstate revenue by inappropriate allocation. In these situations, the auditors
will review the sales contracts and evaluate the reasonableness of management’s allocation of the revenue to
the various elements.
c) Percentage of Completion Method. When a company uses the percentage-of-completion method, there is a
risk that management may misestimate the amount of revenue earned on uncompleted contracts. The auditors
must carefully evaluate the costs allocated to the contracts and the estimates of the percentage-of-completion.
In some cases, the auditors may decide to engage a specialist, such as an engineer.
d) Sales Returns. When a company’s sales agreements allow for returns, there is a risk that management may
misstate the estimate of sales returns and, therefore, misstate revenue and receivables. In these situations, the
auditors should carefully review the contracts to determine that revenue should be recognized at the time of
sale. If revenue recognition is appropriate, they should next evaluate the adequacy of management’s estimate
of sales returns.
e) Receivables Denominated in Foreign Currency. Portion of the receivables of an entity may be denominated
in foreign currency as a result of sales, loan or other transaction in that foreign currency. As required by the PAS
21 The Effects of Changes in Foreign Exchange Rates, these receivables should be translated using the closing
rate at the reporting date. The auditor ordinarily obtains the closing rate and reperforms the translation of the

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foreign currency denominated receivables. The auditor should also ensure that any foreign currency transaction
gain or loss should be reported as part of profit or loss.
f) Analysis of Notes Receivable and Related Interest An analysis of notes receivable supporting the general
leger control account may be prepared for the auditor by the client’s staff. The information in the analysis
ordinarily includes the name of the maker, date, maturity, amount and interest rate. In addition to identifying the
accuracy of the analysis prepared by the client, the auditors should trace items to the accounting records and to
the note themselves.
After ensuring the accuracy of the items included in the analysis of notes receivable, the most effective
verification of the Interest Earned account consists of an 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 the following information:
 Accrued interest receivable at the beginning of the year.
 Interest collected during the year.
 Accrued interest receivable at the end of the year.
 Interest earned during the year.
If the interest earned for the year as computed by the auditor does not agree with the interest earned as shown
in the accounting records, the auditor should investigate any difference as there may be unrecorded interest
receipt or notes that was not included in the analysis prepared by the client.

SITUATIONAL PROBLEMS
SITUATIONAL PROBLEM 1
Your regular annual audit of Palisades, Inc., included in the confirmation of accounts receivable. You decided to use
the positive form of confirmation request. Satisfactory replies were received from all but one of the large amounts.
You sent a second and third request to this customer, but received no reply. At this point an employee of the client
company informed you that a check had been received for the full amount of the receivable. Would you regard this as
a satisfactory disposition of matter?
Answer:No. The matter remains unresolved. First, oral evidence from the client is seldom 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 may also determine the genuineness of the customer by
reference to the telephone directory or to credit agency reports.
SITUATIONAL PROBLEM 2
Lakeside Company has retained you to conduct an audit so that it will be able to support its application for a bank
loan with audited financial statements. The president of Lakeside states that you will have unlimited access to all
records of the company and may carry out any audit procedures you consider necessary, except that you are not to
communicate with customers. The president feels that contacts with customers might lead them to believe that
Lakeside was in financial difficulty. Under these circumstances, will it be possible for you to issue the auditors’
standard unqualified audit report?
Answer: Confirmation of accounts receivable by direct communication with debtors is usually essential to the
issuance of an unqualified audit report. Confirmation of receivables is a presumed procedure, and failure to
perform such a procedure when issuing an unqualified report requires justification in the working papers. The
auditors must generally disclaim an opinion on the client’s financial statements when they have been forbidden
by the client to confirm receivables.
SITUATIONAL PROBLEM 3
Elizabeth Cole, the senior-auditor-in-charge of auditing statements of Thorne Company, a small manufacturer, was
busy writing the audit report for another engagement. Accordingly, she sent Martin Joseph, a recently hired staff
assistant of the C PA firm, to begin the audit of Thorne Company, with the suggestion that Joseph start with the
accounts receivable. Using the preceding year’s audit working papers for Thorne Company as a guide, Joseph
prepared a trial balance of Thorne’s accounts receivable, aged them, prepared and mailed positive confirmation
requests, examine underlying documents plus other support for charges and credits to the Accounts Receivable
ledger account, and performed such other work as he deemed necessary to assure the validity and collectibility of the
accounts receivable. At the conclusion of Joseph’s work, Cole travelled to Thorne Company to review Joseph’s
working papers, Cole found that Joseph had carefully followed the prior year’s audit working papers. Does the three
generally accepted auditing standards of field fulfilled or not fulfilled in the audit of Thorne Company?
Answer:All three generally accepted auditing standards of field work were violated in the audit of the accounts
receivable of Thorne Company. The first standard of field work, which requires adequate planning of the audit
and proper supervision of assistants, was obviously violated. Planning was inadequate because no audit plan,
audit programs, or time budgets were prepared. Supervision was inadequate because Martin Joseph, an
inexperienced staff assistant, was left on his own to audit the accounts receivable, with no guidance from the
senior auditor.

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The second standard of field work, which requires the auditors to obtain an understanding of the entity and its
environment, including existing internal control, was violated. Martin Joseph did not obtain an understanding of
the internal control for the business processes related to accounts receivable, nor did he perform tests of
controls over receivables and sales transactions. Obviously, the substantive procedures that Joseph applied to
Thorne Company’s accounts receivable were merely a repetition of the preceding year’s audit procedures.
The third standard of field work, which requires the obtaining of sufficient competent evidence matter, was
violated because no assessments of the risks of material misstatement were performed. What constitutes
sufficient, competent evidence in an audit is determined principally by the assessed levels of risks of material
misstatement (inherent and control risks).
SITUATIONAL PROBLEM 4
During the audit of Solar Technologies, Inc. The auditors sent confirmation request to customers whose accounts has
been written off as uncollectible during the year under audit. An executive of Solar protested saying: “You people
should be verifying that the receivables on the books are collectible. We know the ones we wrote are no good.”
a. What purpose, if any, is served by this audit procedure?
b. Does the Solar executive’s statement suggest some misunderstanding of audit of objectives? Explain.
Answer:
A. When confirmation requests are mailed to debtors whose accounts were written off as uncollectible, the
auditors’ purposes are to determine that the receivables were genuine when they were first recorded in the
accounts and to determine that the accounts were not collected and the proceeds stolen. 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. In other
cases, valid accounts receivable have been collected, but written off as uncollectible by the employee who
has procured the funds.
B. The Solar executive appears to believe the auditors are solely concerned with the valuation or collectibility of
accounts and notes receivable. In fact, the confirmation process is primarily intended to establish that the
receivables are valid and that the customers (or makers of notes) exist. Other audit procedures are followed
to determine proper valuation.
SITUATIONAL PROBLEM 5
Halston Toy Manufacturing Co. introduced a number of new products in the last quarter of the year. The company has
a liberal return policy allowing retail customers to return products within 120 days of purchase.
Required:
a. Describe the audit problem indicated by this scenario.
b. List audit procedures that could be used to audit the allowance for sales returns.
Answer:
(a) Due to the fact that Halston has a number of new products and a liberal return policy, it may be very difficult to
estimate the allowance for sales returns. With new products it may be difficult to use prior return history to
estimate the amount of returns.
(b) The auditors might consider performing the following procedures:
A. Review any trade journals and industry data that might have information relevant to sales of the new
products.
B. Review trends in sales returns in prior periods, especially when new products were introduced.
C. Make inquiries of sales personnel about customer feedback on sales of the new toys.
D. Review sales returns given in the subsequent period and compare the amounts to prior periods

PRACTICAL PROBLEMS

PRACTICAL PROBLEM 1: AUDIT OF TRADE-RECEIVABLES

You were assigned to audit the existence assertion of Primo Inc.'s receivables as of December 31, 2018. You have
decided to send confirmation letters to pre-selected customers. The following is a summary of the confirmation replies
of client customers where you noted audit exceptions. Gross profit on sales is at 30% and inventory records are kept
under the perpetual inventory method.
Custome Balance per
Customer's Comments Audit findings
r Books
UNO Inc. P30,000 Your Credit Memo No. 0978 representing The Credit Memo was taken up by
price adjustment dated December 29, 2018 PRIMO Inc. in January 2019.
cancels this.
DOS P300,000 P140,000 was for Sales Invoice No. 1190 Returned goods were received on.
Corp. were for goods returned on Deceinber 30, December 31, 2018. Credit Memo No.
2018 . Correct balance is P160,000. 1256 were issued and recorded on
January 5, 2019
Tres Co. P288,000 This is for outstanding sales invoice No. 1280 The customer complaint is valid.

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which should have been priced at P122 per

unit. You erroneously billed us P144 per unit.
Kwatro P265,000 Our records show a correct balance of PRIMO Inc. recorded the transaction as
Inc. P220,000 The difference is for Sales Invoice a purchase by crediting accounts
No. 1109 which were for goods delivered to payable for 45,000. The related
us but were subsequently returned to you inventories were appropriately. Taken in-
because the goods were with wrong the perpetual records.
specifications.
Cinco P122,000 This is for Sales Invoice No. 1341. We The goods were delivered on December
Corp. received the corresponding goods only on 30, 2018 under term FOB Shipping
January 5. Point
Requirements:
1. What is the effect to the net income, if there are any, as a result of the customer's UNO Inc. reply?
2. What is the effect to the net income, if there are any as a result of the customer's DOS Corp.'s reply?
3. The accounts receivable from Tres Co. is Overstated(Understated) by
4. What is the effect to the net income, if there are any, as a result of the customer's Kwatro Inc. reply?
5. The accounts receivable from Cinco Corp. is:

PROBLEM 1: SUGGESTED SOLUTION

1. Decrease by P30,000 4. No effect. Adjusting entry:

Adjusting entry: Sales return 45,000
Sales P30,000 Accounts receivable 45,000
Accounts receivable P30,000 Accounts payable 45,000
Purchases 45,000
2. Decrease by P42,000.
Adjusting entry: *Note that the inventories
Sales returns 140,000 were appropriately taken
Accounts receivable 140,000 in the perpetual records.
Inventory 98,000 The Debit to Sales return
Cost of Sales 98,000 is offset by the Credit to
Purchases, thus no effect
3. Overstated by P44,000 to net income
Adjusting entry:
Sales 44,000
5. P122,000
Accounts receivable 44,000
The transaction is a valid sale as it
is in transit FOB Shipping point.

PRACTICAL PROBLEM 2: ESTIMATION OF ALLOWANCE FOR DOUBTFUL ACCOUNTS

As part of your engagement to audit the financial statements of San Antonio Corporation, you have been
assigned to examine the accounts receivable. You gathered the following data from the trial balance as of December
31, 2018:
Accounts receivable P2,000,000
Allowance for doubtful accounts 100,000
You determined the following from the schedule of accounts receivable as of December 31, 2018:
Accounts with debit balances
60 days old and below P1,000,000
61 to 90 days 500,000
Over 90 days 400,000 P1,900,000
Advances to officers 150,000
Accounts with credit balances (50,000)
Accounts receivable per GL P2,000,000
Additional information:
o Accounts receivable for more than a year totaling to P20,000 should be written off.

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o On November 1, 2018, goods amounting to P50,000 were shipped to ABC Co, FOB shipping point but the
same has not been recorded by the company. No collection has yet been made by the company on this
account.
o The bank returned on December 29, 2018, a customer's check for P30,000 marked "No Sufficient Funds",
but no entry was made. The customer's invoice was dated and recorded on December 1, 2018.
o Confirmation replies received directly from customers disclosed the following exceptions:

COMMENTS FROM
CUST. BALANCE AUDIT FINDINGS
CUSTOMERS
Balance was paid December 29, San Antonio received mailed check on January 3,
Tim P 10,000
2018. 2019, Tim was billed on December 5, 2018
San Antonio credited accounts payable for P14,800 to
Balance was offset by our
Tony 14,800 record purchase of tires. Tony was billed on October
December 10 shipment of tires.
28, 2018.
The above balance has been The payment was credited to customer Parker. Boris
Boris 32,000
paid. was billed on September 4, 2018.
Our recordss show a bigger A new confirmation was mailed Parker was billed on
Parker 20,000
balance, please check. November 25, 2018.
We do not owe San Antonio on
The shipment costing P20,500 was made on
December 31 as goods were
Leonard 47,400 December 29, 2018 but the goods were included in
received in January 3, 2019, FOB
recording the December 31, 2018 inventory
destination
San Antonio had previously credited the deposit to
Our deposit of P90,000 should
Danny 30,000 sales. The P30,000 worth of merchandise was shipped
cover this balance.
and billed on December 1, 2018.
Sure we ordered P20,000 of
merchandise on October 10,
2018 but San Antonio was out of- The goods were shipped FOB Shipping point on
Kawhi 20,000 stock until recently. They back December 15, 2018 and billed on the same date.
ordered the goods and we finally
received them on January 6,
2019.

Based on your discussion with San Antonio's Credit Manager, you both agreed that an allowance for doubtful
accounts should be maintained using the following rates:
60 days old and below 4%
61 to 90 days 5%
Over 90 days 10%
Questions:
What is the adjusted allowance for doubtful accounts as of December 31,2018?
What is the adjusted balance of the doubtful accounts expense for the year ended December 31, 2018?
PROBLEM 2: SUGGESTED SOLUTION

TOTAL 60 days and 61-90 days Over

below 90 days
Unadjusted balance 1,900,000 1,000,000 500,000 400,000
Write off (20,000) (20,000)
Unrecorded sales 50,000 50,000
NSF check 30,000 30,000
Sales-Tony (14,800) (14,800)
Payment of Boris
credited to Parker 32,000 (32,000)
Overstatement of
sales-
Leonard (47,400) (47,400)
Sales-Danny (30,000) (30,000)
Adjusted balance 1,867,800 1,034,600 485,200 348,000

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X age uncollectible 4% 5% 10%

Allowance for DA 100,444 41,384 24,260 34,800

Allowance for Doubtful accounts

Write off 20,000 100,000 Beg. Balance
Balance end (required) 101,444 Recoveries
21,444 Doubtful account expense (squeeze)
Total 121,444 121,444

PRACTICAL PROBLEM 3: FINANCING TRANSACTIONS

Odette Corp. had the following receivable financing transactions during the year:
 On March 1, 2019,Odette Corp. factored P500,000 of its accounts receivables to BPI. As of the date of
factoring, It was ascertained that P20,000 of the accounts receivable is doubtful of collection. BPI advanced
P350, 000 cash to Odette Corp. and withheld P50,000 as factors holdback (to cover future sales discount
and sales returns and allowances). The company incurred P10,000 direct transaction costs (legal fees and
other professional fees) related to the factoring. The factoring was done on a without-recourse basis, thus
transferring all significant risks and reward associated to the receivable to BPI.
 On May 1, 2019, Odette Corp. assigned P800,000 of its outstanding accounts receivable to BDO In
consideration of a P500.000, 24% loan. BDO charged the company 2% of the accounts assigned as service
charge. By the end of May, Odette Corp. collected P200,000 cash from the assigned accounts net of a
P5,000 sales discount. By the end of June, Odette Corp, collected another P150,000 from the assigned
accounts after P4,000 sales discount. The company accepted merchandise originally Invoiced at P30,000 as
sales returns and wrote-off P20,000 of the assigned accounts as worthless. It was agreed between parties
that monthly collections shall be remitted to the bank as partial payment of the loan and interest..
Requirements:
1. How much should be reported as gain/loss in the income statement on the transfer of receivables on the
factoring of receivable on March 1?
2. How much should be reported as gain/loss in the income statement on the transfer of receivables on the
assignment of receivable on May 1?
3. What is the carrying value of the accounts receivable-assigned as of June 30?
4. What is the carrying value of the loans payable related to the accounts receivable assigned as of June30?
PROBLEM 3: SUGGESTED SOLUTION
1.)
Cash Received 350,000
Receivable from
factor 50,000
Factoring Fee (10,000)
Net Selling Price 390,000
Carrying Amount of
AR
(500,000-20,000) 480,000
Loss on Factoring -90,000

2.) 0, There is no gain/loss in assignment of receivables because it is a secured borrowing and not a sale

3.) Sales Discount on June Collection (4,000)

Sales Return (30,000)
AR-Assigned Beg. 800,000 Write Off (20,000)
AR-Assigned End 391,000
Cash Collection-May (200,000)

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Sales Discount on May

Collection (5,000)

Cash Collection-June (150,000)

4.)
Loan Payable to BDO 500,000
200,00
Collection-May 31 0
Interest (10000) (190000)
150,00
Collection-June 31 0
Interest (6200) (143800)
Carrying Amount of Loan 166,200
PRACTICAL PROBLEM 4: DISCOUNTING OF NOTES RECEIVABLE
The following were noted during your audit of the Precious Co. for the calendar year 2019:
Notes Receivable
Date Particulars Debit Credit
Sept. 1 Dianne, 21%, due in 3 months 320,000
Oct. 1 Jane Co., 24%, due in 2 months 1,200,000
1 Discounted Dianne note at 24% P320,000
Nov. 1 Keith, 24%, due in 13 months 2,400,000
30 Vren Co., no interest, due in one year 2,000,000
30 Discounted Vren Co. note at 12% 2,000,000
Dec. 1 Alfonso Co, 18%, due in 5 months 3,600,000
1 Ms. Anna, President, 12%, due in 3 months
(For cash loan given to Ms. Anna) 4,800,000
All notes are trade notes receivable unless otherwise specified. The Dianne note was paid on December 1 as
per notification received from the bank. The Jane Co. note was dishonored on the due date but the legal department
has assured management of its full collectibility.
The Company, with your concurrence, will treat the discounting as conditional sale of Notes Receivable.
QUESTIONS:
Based on the above and the result of your audit, answer the following:
1. At what amount on the current assets section of the balance sheet as of December 31, 2019 will Notes Receivable-
trade be carried?
2. What Amount of Loss on Note Receivable discounting should be reported in 2019 Income Statement of the
Company?
3. How much is the accrued interest income as of December 31, 2019?
PROBLEM 4: SUGGESTED SOLUTION
1) 2.)
Current trade notes receivable: Principal 320,000
Keith 2,400,000 Interest (320,000*21%*(3/12)) 16,800
Alfonso 3,600,000 Maturity Value 336,800
Total 6,000,000
Discount (336800*24%*(2/12) (13,472)
3) Net Proceeds 323,328
Jane (P1,200,000 x 24% x 3/12) 72,000 Principal 320,000
Keith (P2,400,000x 24% x 2/12) 96,000 AIR (320,000*21%*(1/12)) 5,600
Alfonso (P3,600,000 x 18% x 1/12) 54,000 Book Value 325,600
Ms. Anna (P4,800,000x 12% x 1/12) 48,000 Loss on Discounting of Dianne
Total accrued interest receivable 270,000 Note (2,272)
2,000,00
Principal/Maturity Value 0
Discount 240,000
1,760,00
Net Proceeds 0
2,000,00
Book Value 0
Loss on Discounting of Vren Note 240,000
TOTAL 242,272
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PRACTICAL PROBLEM 5: AUDIT OF NOTE RECEIVABLES

You are engaged in the audit of Flordeliz Co., a new client, at December 31 2018. You review the following notes
receivable and other related interest income accounts in the general ledger:
Notes Receivable
Beg. Bal P1,700,000 P1,350,000 Balance end
Apr. 1, 2018 250,000 500,000 04/01/2018
100,000 2/31/2018
P1,950,000 P1,950,000

Interest Income
Bal. end P 180,000 P 180,000 04/01/2018
180,000 P 180,000

Additional information:
A. The beginning balance of the notes receivable is composed of the following,
o Note received from sale of machinery on January 1, The 2017 Costing P800,000 with accumulated
depreciation of P450,000. The company receives as consideration f 200,000 and a noninterest bearing note
for P300,000 due annually in equal amounts of P100,000 every December 31, starting December 31, 2017.
The prevailing rate of interest for note of this type is 12%. The company made the following entry on January
1, 2017:
Cash 200,000
Notes receivable 300,000
Accumulated depreciation 450,000
Equipment 950,000
The company credited the notes receivable account when it received the P100,000 annual payment on
December 31, 2017. The same entry was made on December 31, 2018 regarding the collection.
o Note receivable from sale of plant dated April 1, 2017 amounts to P1,500,000 which bears interest at 12%
per annum. No gain or loss was realized from sale. The note is payable in 3 annual installments P500,000
plus interest on the unpaid balance every April 1. The initial principal and interest payment was made on
April 1, 2018. The company made the following entry: April 1, 2018.
Cash P680,000
Interest income P180,000
Notes receivable 500,000
You found out that no accrual of interest was made in 2017 and 2018
B. The entry on April 1, 2018 represents the note received when it sells equipment from the XYZ Corp on April 1,
2018. The equipment cost P1,000,000 and has accumulated depreciation of P400,000 on the date of sale. The
company receives as consideration P350,000 and a noninterest bearing note for P250,000 due on April 1, 2022. The
prevailing rate of interest for a note of this type is 10%. The following entries were made by the company on April 1,
2018:
Cash P350,000
Notes receivable 250,000
Accumulated depreciation 400,000
Equipment P1,000,000
No additional entry was made on December 31. 2018.

Based on the above data, compute for the following:

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1.The adjustment to retained earnings as of January 1, 2018.

2 The total interest income in 2018.
3. Current portion of long-term receivables as of December 31, 2018.
4. Noncurrent receivables as of December 31, 2018.
5. Assuming that none of the errors were detected and corrected in 2018, the net income in 2018 would be

PROBLEM 5: SUGGESTED SOLUTION

Question No. 1
Unrecorded gain on sale of machinery - 2017 (see below) 90,183
Unrecorded interest income - receivable from sale of machinery (240,183 x 12%) 28,822
Unrecorded accrued interest receivable from sale of plant (1,500,000x 12% x 9/12) 135,000
Net adjustment to R/E - 01/01/18 254,005
Cash consideration 200,000
Add: Present value of future cash flows (2.4018 x 100,000) 240,183
Total selling price 440,183
Less: Carrying value of machine (800,000 - 450,000) 350,000
Gain on sale of machine 90,183
Amortization table (receivable from sale of machinery):
Interest Carrying
Date Collections Income Amortization amount
01/01/2018 240,183
12/31/2018 100,0000 28,822 71,178 169,005
12/31/2019 100,000 20,281 79,719 89,286
12/31/2020 100,000 10,714 89,286
Question No. 2
Interest income from note receivable:
Sale of machinery (169,005 x 126) 20,281
Sale of plant [(1,500,000 x 12% 3/12) + (1M x 12% x 9/12) 135,000
Sale of equipment (170,750 x 10% x 9/12) 12,806
Total interest income 168,087
Question No. 3
Current portion of note receivable from:
Sale of machinery (see amortization table above) 89,286
Sale of plant 500,000
Total current portion 589,286
Question No. 4
Non-current portion of note receivable from:
Sale of plant 500,000
Sale of equipment (170,750+ 12,806) 183,556
Total non-current portion 683,556
Question No. 5
Interest income from sale of machine 20,281
Interest income from sale of plant (180,000 -135,000) (45,000)
Interest income from sale of equipment 12,806
Net overstatement of income (11,912)

PRACTICAL PROBLEM 6: AUDIT OF LOANS RECEIVABLES

In the course of your audit of the Loans receivable account of Esme Financing Corp, a lending company, for the
year ended December 31, 2018, you discovered the balance per its general ledger of its Loans receivable from
Franco was at P4,000,000.
Audit notes:
a. The loan to FRANCO is a non interest bearing loan which shall matyre on December 31, 2020.
b. The loan was originated on January 1, 2016.

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c. The total amount disbursed on that date was based on the appropriate discount rate prevailing on
that date at 10%.
d. The transaction waś recorded by the client as a debit to loans receivable at face value of the loan
charging interest income for its difference to the amount credited to cash.

What is the retroactive, adjustment to retained earnings beg , if any, as a result of your audit of loans
receivable from FRANCO?

PROBLEM 6: SUGGESTED SOLUTION

Loan Proceeds
(4000000*.6209213) 2,483,685

Correct Journal Entry:

Loan Receivable 2,483,685
Cash 2,483,685
Amortization Table
Interest Income Interest Received Amortization Balance
January 1, 2016 2,483,685
December 31,2016 248,369 - 248,369 2,732,054
December 31,2017 273,205 - 273,205 3,005,259
December 31,2018 300,526 - 300,526 3,305,785

Adjusting Journal entry at the Beginning of 2018

Retained Earnings,beg 994,741
Loan Receivable 994,741
Principal Amount 4,000,000
Less: Proceeds 2,483,685
Interest Income Recognized in 2016 1,516,315
Correct Interest Income in 2016 (248,369)
Correct Interest Income in 2017 (273,205)
Overstatement in interest income 994,741

PRACTICAL PROBLEM 7: REVERSAL OF IMPAIRMENT LOSS

On January 1, 2015, KADITA Co. granted a 5 year of P1,000,000 to VALE Inc. Principal payments of P200,000
and interest at 10% are due annually at the end of each year for 5 years. The first payment starts ön December 31,
2015.
VALE, Inc. made the required payments during 2015 and 2016. However, during 2017, VALE Inc. began to
experience financial difficulties, requiring KADITA Co. to reassess the collectibility of the note. Interest was accrued
2017. On December 31, 2017, KADITA Co. determined that the note has been impaired and projects that only the
remaining principal is collectible. The expected future cash flows are as follows:
Expected date of collection Amount of cash flow
December 31, 2018 P140,000
December 31, 2019 200,000
December 31, 2020 260,000
 The amount of the impairment loss in 2017 based on these cash flows was P212,108.
 On December 31, 2018, VALE's credit rating has improved and the loan was then again restructured. After
receiving the scheduled collection on December 31, 2018 the present value of the remaining cash flows on
the newly restructured loan is P654,552.
 Immediately before the restructuring on December 31, 2018, the loan has a carrying amount of P396,681. If
no impairment loss had been recognized previously, the loan would have a carrying amount of P600,000 as
of December 31, 2018.
Questions:
Based on the above data, answer the following:
1. How much is the gain on reversal of impairment to be recognized in 2018 in accordance with PAS 39?

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2 How much is the gain on reversal of impairment to be recognized in 2018 in accordance with PFRS 9?
3. How much is the interest income for 2019 in accordance with PAS 39?
4 How much is the interest income for 2019 in accordance with PFRS 9?

PROBLEM 7: SUGGESTED SOLUTION

1.) Present value of expected cash flows P654,552
vs. Would have been present value if there was no
impairment 600,000
Lower 600,000
Less: Actual amortized cost 396,681
Gain on reversal of impairment loss 203,319
2.) Present value of expected cash flows P 654,552
Less:Actual amortized cost 396,681
Gain on reversal of impairment loss 257,871
3) Interest income (600,000 x 10%) P 60,000
4.) Interest income (654,552 x 10%) P 65,455
PRACTICAL PROBLEM 8: AUDIT OF SALES
As part of your audit of receivables of Viva Merchandising, which has an unadjusted balance per ledger at
P276,500, you performed a cut-off test of sales.
Furthermore, you observed the physical count of the client’s goods on December 30, 2019 and that you
ascertained that all goods delivered on or before the count date were excluded from the said count. The client
records revealed that inventory balance resulting from the physical count was at P120,000.
Results of the cut-off test revealed the following:
Recorded as Sales in December 2019
SI No. Selling price Cost Terms Shipment Date Received by customers
1121 P18,000 P16,500 FOB shipping point 12/26/2019 12/29/2019
1122 12,500 10,200 FOB destination 12/26/2019 12/29/2019
1123 8,680 7,240 FOB destination 12/28/2019 01/02/2020
1124 14,200 12,500 Shipped to consignee 12/29/2019 01/02/2020
1125 9,000 7,500 FOB shipping point 12/30/2019 01/02/2020
1126 10,000 7,750 FOB destination 12/31/2019 01/03/2020
1127 7,800 6,100 FOB destination 12/31/2019 01/02/2020
1128 14,000 12,000 Shipped to consignee 12/31/2019 01/02/2020

Recorded Sales in January 2020

SI No. Selling price Cost Terms Shipment Date Received by customers
1129 P21,000 18,200 FOB shipping point 12/31/2019 01/03/2020
1130 10,500 8,800 FOB destination 12/31/2019 01/03/2020
1131 4,500 3,200 FOB destination 01/02/2020 01/03/2020
1132 6,500 5,000 FOB shipping point 01/02/2020 01/05/2020

What is the correct balance of the accounts receivable as a result of your sales cut-off?

PROBLEM 8: SUGGESTED SOLUTION

Accounts Receivable Sales

Unadjusted P276,500
SI No. 1121 P18,000 Recorded and sold
SI No. 1122 12,500 Recorded and sold
SI No. 1123 (8,680) Recorded but unsold
SI No. 1124 (14,200) Recorded but unsold
SI No. 1125 9,000 Recorded and sold
SI No. 1126 (10,000) Recorded but unsold
SI No. 1127 7,800 Recorded and sold

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SI No. 1128 (14,000) Recorded but unsold

SI No. 1129 21,000 21,000 Unrecorded but sold
SI No. 1130 Unrecorded and unsold
TOTAL 250,620 68,300

Contributors
Dalu, Kia Vanna C.
Gutierrez, Melanie D.
Javier, Katerine R.
Simeon, Catherine A.

References
Applied Auditing by Asuncion,Ngina and Escala
A guide in understanding the PSA by Salosagcol, Tiu and Hermosilla
RESA Review School May 2019 PREWEEK

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