MODAUD1 UNIT 3 - Audit of Receivables

UNIT 3 AUDIT OF RECEIVABLES, RELATED REVENUES AND CREDIT LOSSES Estimated Time: 6.0 HOURS *Use Louwers 4th edition

Discussion questions 3-1

1. What account balances are included in the revenue and collection cycle? 2. How should accounts receivable be measured initially? Subsequently? 3. What are the audit working papers related to receivables? Provide an example for each. 4. When should a client recognize impairment of receivables? How should the client reflect such impairment in the financial statements?

Discussion questions 3-2 Substantive procedures in the revenue and collection cycle Refer to Louwers 7-15, 7-16 and 7-19.

Problem 3-1 Analysis and classification of receivables

Your audit disclosed that on December 31, 2012, the accounts receivable control account of CCC Company had a balance of P1,432,000. An analysis of the accounts receivable account showed the following: Accounts known to be worthless Advance payments to creditors on purchase orders Advances to affiliated companies Customers’ accounts reporting credit balances arising from sales return Interest receivable on bonds Other trade accounts receivable – unassigned Subscriptions receivable due in 30 days Trade accounts receivable – assigned (CCC Company’s equity in assigned accounts is P75,000) Trade installment receivable due 1-18 months, including unearned finance charges of P15,000 Trade receivables from officers due currently Trade accounts on which post-dated checks are held (no entries were made on receipts of checks) Total

P18,200 75,000 187,500 (112,500) 75,000 375,000 412,500 187,500 165,000 11,500 37,300 P1,432,000

1) What is the adjusted trade accounts receivable as of December 31, 2012? 2) What is the adjusted net current trade and other receivables as of December 31, 2012?

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Problem 3-2 Analysis and classification of receivables

When examining the accounts of CLOVER COMPANY, you ascertain that balances relating to both receivables and payables are included in a single controlling account (called receivables), which has a P23,050 debit balance. An analysis of the details of this account revealed the following:

Items Accounts receivable – customers Accounts receivable - officers (current collection expected) Debit balances – creditors Expense advances to salespersons Share capital subscriptions receivable Accounts payable for merchandise Unpaid salaries Credit balance in customer accounts Cash received in advance from customers for goods not yet shipped Expected bad debts, cumulative

Debit

Credit

P40,000 2,500 450 1,000 4,600 P19,250 3,300 2,000 450 500

1. Give journal entry to eliminate the above account and to set up the appropriate

accounts to replace it.

2. How should the items be reported on Clover Company’s balance sheet?

Problem 3-3 Confirmation of receivables

Lawrence Company maintains its accounts on the basis of a fiscal year ending October 31. Assume that you were retained by the company in August to perform an audit for the fiscal year ending October 31, 2012. You decide to perform certain auditing procedures in advance of the balance sheet date. Among these interim procedures is the confirmation of accounts receivable, which you perform at September 30. The accounts receivable at September 30 consisted of approximately 200 accounts with balances totaling P956,750. Seventy-five of these accounts with balances totaling P650,725 were selected for confirmation. All but 20 of the confirmation requests have been returned; 30 were signed without comments, 14 had minor differences that have been cleared satisfactorily, and 11 confirmations had the following comments: 1. We are sorry, but we cannot answer your request for confirmation of our account because Moss Company uses a computerized accounts payable voucher system. 2. The balance of P1,050 was paid on September 23, 2012. 3. The above balance of P7,750 was paid on October 5, 2012. 4. The above balance has been paid. 5. We do not owe you anything at September 30, 2012, since the goods represented by your invoice dated September 30, 2012, Number 25,050, in the amount of P11,550, were received on October 5, 2012, on FOB destination terms. 6. An advance payment of P2,500 made by us in August 2012 should cover the two invoices totaling P1,350 shown on the statement attached. 7. We never received these goods. Auditing Practice I Workbook

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8. We are contesting the propriety of the P12,525 charge. We think the charge is excessive. 9. Amount okay. As the goods have been shipped to us on consignment, we will remit payment upon selling the goods. 10. The P10,000, representing a deposit under lease, will be applied against the rent due to us during 2012, the last year of the lease. 11. Your credit in the amount of P440, dated September 5, 2012, cancels the above balance.

What steps would you take to clear satisfactorily each of the above 11 comments? Problem 3-4 Analysis of accounts receivable and related losses

In your audit of ASTER Corporation for the year ended January 31, 2012, you obtained the following information directly from the client: Sales (cash and credit) Cash received from credit customers, all of whom took advantage of the discount feature of the corporation’s credit terms 4/10, n/30 Cash received from cash customers Accounts receivable written off as worthless Credit memoranda issued to credit customers for sales returns and allowances Cash refunds given to cash customers for sales returns and allowances Recoveries on accounts receivable written off as uncollectible in prior periods (not included in cash amount stated above)

P 591,050 303,800 210,270 5,250 63,800 13,318 8,290

The following balances were taken from the January 31, 2011 ledger: Accounts receivable – trade Allowance for doubtful accounts (credit balance)

P 95,842 9,740

The corporation provides for its net uncollectible account losses by crediting Allowance for doubtful accounts for 2.5% of net credit sales for the fiscal period. 1) Prepare the journal entries to record the transactions for the year ended January 31,

2012.

2) Prepare the adjusting journal entry for estimated uncollectible accounts on January

31, 2012.

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Problem 3-5 Analysis of accounts receivable and related losses

Your audit client, GRYFFINDOR Corporation, provided for uncollectible accounts receivable under the allowance method since the start of its operations to December 31, 2012. Provisions were made monthly at 2 percent of credit sales; bad debts written off were charged to the allowance account; recoveries of bad debts previously written off were credited to the allowance account; and no year-end adjustments to the allowance account were made. Gryffindor’s usual credit terms are net 30 days. The credit balance in the allowance for doubtful accounts was P260,000 at January 1, 2012. During 2012, credit sales totaled P18,000,000, interim provisions for doubtful accounts were made at 2 percent of credit sales, P180,000 of bad debts were written off, and recoveries of accounts previously written off amounted to P30,000. Gryffindor installed a computer system in November 2012 and an aging of accounts receivable was prepared for the first time as of December 31, 2012. A summary of the aging is as follows: Classifications by Month of Sale November – December 2012 July – October 2012 January – June 2012 Prior to January 1, 2012

Balance in Each Category P 2,460,000 1,450,000 750,000 260,000

Estimated % Uncollectible 2% 15% 25% 75%

Based on the review of collectibility of the account balances in the “prior to January 1, 2012” aging category, additional receivables totaling P120,000 were written off as of December 31, 2012. Effective with the year ended December 31, 2012, Gryffindor adopted a new accounting method for estimating the allowance for doubtful accounts at the amount indicated by the year-end aging analysis of accounts receivable. 1. How much is the adjusted balance of the allowance for doubtful accounts as of

December 31, 2012? 2. How much is the doubtful accounts for the year 2012? 3. How much is the increase in allowance for doubtful accounts?

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Problem 3-6 Analysis of accounts receivable and related losses

In your audit of KNIGHT Company, a wholesaler, for the year ended December 31, 2012, you obtained the following schedule of aged accounts receivable. Age of Accounts 0-30 days 31-60 days 61-90 days 91-120 days Over 120 days

Amount P561,600 196,100 88,400 18,500 9,600 P874,200

The following schedule shows the year-end receivables balances and uncollectible accounts experience for the previous four years. Year-end 31-60 61-90 91-120 Over 120 Year 0-30 days receivables days days days days 2011 P780,700 0.7% 1.0% 10.2% 49.1% 78.2% 2010 750,400 0.6 1.1 10.0 51.2 77.3 2009 681,400 0.8 1.2 11.0 51.7 79.0 2008 698,200 0.7 0.9 10.1 52.3 78.5 Additional information: 1. The company uses the aging method to estimate doubtful account losses. 2. The unadjusted allowance for doubtful accounts balance on December 31, 2012 is P31,364. 1) Compute the correct balance for the allowance for doubtful accounts based on the

average loss experience for the last four years.

2) Based on the first requirement, prepare the appropriate end-of-year adjusting entry.

Problem 3-7 Analysis of accounts receivable and related losses

You are auditing the accounts receivable and the related allowance for doubtful accounts of Singer Company. The control account of the aforementioned accounts had the following balances: Accounts receivable Less: Allowance for doubtful accounts Net realizable value

P1,270,000 78,000 P1,192,000

Upon your investigation, you found out the following information: a. The company’s normal sales term is n/30. b. The allowance for doubtful accounts had the following details in the general ledger: Jan 1 – Balance P30,000 CR July 31 – Write-off 24,000 DR December 31 – Provision 72,000 CR

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c. The subsidiary ledger balances of the company’s accounts receivable as of December 31, 2012 contained the following information: Debit balances Under one month One to six months Over six months

Credit balances P540,000 Pop Co. 552,000 Jazz Corp. 228,000 RnB Inc. P1,320,000

P12,000 21,000 27,000 P60,000

Additional information: ¾ The credit balance with Pop Co. was for an overpayment from the customer. The company delivered additional merchandise to Pop Co. on January 3, 2013 to cover such overstatement. ¾ The credit balance of Jazz Corp. was due to a posting error, the amount should have been credited to Jezz Corp. for a 60-day outstanding receivable. ¾ The credit balance from RnB Inc. was a cash advance for a delivery to be made on January 15, 2013. Moreover, it was estimated that 1 percent of accounts under one month is doubtful of collection while 2% percent of accounts one to six months are expected to require an allowance for doubtful of collection. The accounts over six months are analyzed as follows: definitely uncollectible, P72,000; doubtful (estimated to be 50% collectible), P36,000; and apparently good, but slow (estimated to be 90% collectible), P120,000.

1. What is the entry to adjust any unlocated difference between the control account and the subsidiary ledger? 2. Determine the adjusted accounts receivable balance on December 31, 2012. 3. Determine the required balance of the allowance for doubtful accounts on December 31, 2012. 4. What is the adjusting entry to correct the allowance for doubtful accounts? Problem 3-8 Analysis of accounts receivable and related losses with subsequent recovery

RAIN Company started operations in 2008. The company has no allowance for doubtful accounts. Uncollectible receivables were expensed as written off and recoveries were credited to income as collected. Data from company’s records for five years is as follows: Year 2008 2009 2010 2011 2012

Credit Sales P3,000,000 4,500,000 5,900,000 6,600,000 8,000,000

Amount Written Off P30,000 76,000 104,000 130,000 166,000

Recovery P0 5,400 5,000 9,600 10,000

Balances of accounts are P3,000,000 as of December 31, 2011 and P3,500,00 as of December 31, 2012. On March 1, 2012, right after the 2011 financial statements were released, management realized that the company’s policy regarding treatment of uncollectible accounts was not Auditing Practice I Workbook

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correct, and decided that an allowance method must be followed. A policy was established to set-up an allowance for doubtful accounts based on the company’s historical uncollectible accounts loss percentage to be applied to year-end AR. The historical loss shall be recomputed each year based on the average of all available past years up to a maximum of five years.

1. Compute for the amount of allowance for doubtful accounts that should be set-up as of January 1, 2012. 2. Compute for the average percentage of net doubtful accounts to credit sales that should be used in setting up the 2012 allowance. 3. Compute for the correct balance of allowance for doubtful accounts as of December 31, 2012. 4. Compute for the correct doubtful accounts expense for 2012. Problem 3-9 Analysis of receivables used as source of cash

CHRIS Trading required additional cash for its operation and used accounts receivable to raise such needed cash, as follows: 1) On December 1, 2012, Chris assigned on a nonnotification basis accounts receivable of P5,000,000 to bank in consideration for a loan of 90% of the receivables less a 5% service fee on the accounts assigned . Chris signed a note for the bank loan. On December 31, 2012, Chris collected assigned accounts of P3,000,000 less discount of P200,000. Chris remitted the collections to the bank in partial payment for the loan. The bank applied first the collection to the interest and the balance to the principal. The agreed interest is 1% per month on the loan balance. 2) Chris sold P1,550,000 of accounts receivable for P1,340,000. The receivables had a carrying value of P1,470,000 and were sold outright on a nonrecourse basis. 3) Chris received an advance of P300,000 from Metrobank by pledging P360,000 of accounts receivable. 4) On June 30, 2012, Chris discounted at a bank a customer’s P600,000, 6-month, 10% note receivable dated April 30, 2012. The bank discounted the note at 12% on the same date.

Based on the information you gathered and the result of your audit, answer the following: 1) What should be the entry to record the sale of accounts receivable? 2) How much is Chris’ equity in accounts receivable assigned? 3) How much note payable should Chris report as a current liability? 4) How much is proceeds from the note receivable discounted on June 30, 2012?

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Problem 3-10 Analysis of notes receivable and related accounts

You are engaged in your fifth annual examination of the financial statements of LEE Corporation. Your examination is for the year ended December 31, 2012. The client prepared the following schedules of Trade Notes Receivable and Interest Receivable for you at December 31, 2012. You have agreed the opening balances to your prior year’s audit work papers. LEE CORPORATION TRADE NOTES RECEIVABLE AND RELATED INTEREST RECEIVABLE Trade Notes Receivable Date

Maker

Terms

Int Balance Rate 12/31/11 12% P60,000

1 year 90 days 12% 60 days Demand 12% 12% 60 days

ABC DEF GHI EDL NOP

040/1/11 05/01/12 07/01/12 08/03/12 10/02/12

QRS TUV

11/01/12 90 days 11/01/12 90 days Total

Due From

Balance 12/31/11

ABC

P5,400

8% 12% P60,000

2012 Debits

2012 Credits P60,000 29,375

P30,000 P 625 6,000 6,000 15,000 15,000 50,000 50,000 -----50,000 50,000 42,000 35,000 7,000 32,000 32,000 P225,000 P174,375 P110,625

Interest Receivable 2012 Debits Credits P 1,800

Balance 12/31/12

Balance 12/31/12

P7,200

GHI EDL

120 400

NOP

1,000

660

340

560 640

______

560 640

P4,520

P7,860

P2,060

QRS TUV

_______

Totals

P5,400

P120 400

Your examination reveals this information: 1. Interest is computed on a 360-day basis. In computing interest, it is the corporation’s practice to exclude the first day of the note’s term and to include the due date. 2. The DEF Company’s 90-day non-interest bearing note was discounted on May 16 at 10%, and the proceeds were credited to the Trade Notes Receivable account. The note was paid at maturity. 3. GHI Industries became bankrupt on August 31, and the corporation will recover 75 cents on the peso. All of Lee’s notes receivable provide for interest at a rate of 12% on the maturity value of a dishonored note. Auditing Practice I Workbook

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4. EDL, president of Lee Corporation, confirmed that he owed Lee Corporation P15,000 and that he is expected to pay the note within six months. You are satisfied that the note is collectible. 5. NOP Company’s 60-day note was discounted on November 1 at 8%, and the proceeds were credited to the Trade Notes Receivable and Interest Receivable accounts. On December 2, Lee Corporation received notice from the bank that NOP Co.’s note was not paid at maturity and that it had been charged against Lee’s checking account by the bank. Upon receiving the notice from the bank, the bookkeeper recorded the note and the accrued interest in the Trade Notes Receivable and Interest Receivable account. NOP Company paid Lee Corporation the full amount due in January 2012. 6. QRS, Inc. 90-day note was pledged as collateral for P35,000, 60-day 10% loan from the Philippine National Bank on December 1. 7. On November 1, the Corporation received four, P8,000, 90-day notes from TUV Co. On December 1, the corporation received payment from TUV Co. for one of the P8,000 notes with accrued interest. Prepayment of the notes is allowed without penalty. The bookkeeper credited the TUV Co.’s Accounts Receivable account for the cash received.

Prepare the adjusting journal entries that you would suggest at December 31, 2012. Reclassify all past due notes and related carrying costs to Accounts Receivable. Problem 3-11 Analysis of noncurrent receivables and related accounts

The WEBLINK Company included the following in its notes receivable as of December 31, 2012: Notes receivable from sale of plant P880,000 Notes receivable from web development services 1,200,000 Notes receivable from sale of machine 1,600,000 Total P3,680,000 In connection with your audit, you were able to gather the following transactions during 2012 and other information pertaining to the company’s notes receivable: 1) On January 1, 2012, Weblink Company sold a plant to three engineers as an investment. The plant constructed five years ago is being depreciated using straight-line for 25 years without any residual value. It was carried on Weblink’s books at a value of P500,000. Weblink received a noninterest-bearing note for P880,000 from the engineers. The note is due on December 31, 2013. There is no readily available market value for the plant, but the current market rate of interest for comparable notes is 12%. 2) On January 1, 2012, Weblink Company finished web development services and accepted in exchange a promissory note with a face value of P1,200,000, a due date of December 31, 2014, and a stated rate of 5%, with interest receivable at the end of each year. The fair value of the services is not readily determinable and the note is not readily marketable. Under the circumstances, the note is considered to have an appropriate imputed interest rate of 12%. 3) On January 1, 2012, Weblink Company sold a machine with a carrying value of P1,600,000 to M-Zet Company. As payment, M-Zet gave Weblink a P2,400,000 note. The note bears an interest rate of 4% and is to be repaid in three annual installments of P800,000 (plus interest on the outstanding balance). The first payment was received on December 31, 2012. The market price of the machine Auditing Practice I Workbook

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is not readily determinable. The prevailing interest rate for notes of this type is 13%.

Based on the information you gathered and the result of your audit, answer the following (use four significant figures for PV and round-off final answers to the nearest whole peso): 1) Web development services revenue that should be recognized in 2012. 2) Gain on sale of plant and machine that should be recognized in 2012. 3) Noncurrent notes receivable as of December 31, 2012. 4) Current portion of long-term notes receivable as of December 31, 2012. 5) Interest income to be recognized in 2012. Problem 3-12 Impairment of receivables

On January 1, 2012, POWER Company, a calendar-year firm, gave a loan to ABC Enterprises amounting to P200,000 and received a two-year, 9%, P200,000 note. The note calls for annual interest to be paid each December 31. Power collected the 2012 interest on schedule. At December 31, 2013, however, based on ABC’s recent financial problems, Power expects that the 2013 interest will not be collected and that only P120,000 of the principal due December 31, 2013 will be collected. The P120,000 principal amount is expected to be collected in two installments (first installment is P50,000) on December 31, 2015 and December 31, 2017. Power believes that 12% is the market’s assessment of the time value of money.

Required: 1. What entries should be made in the records of Power Company on December 31, 2013? 2. Assume that Power Company collects the expected payments from ABC. What entries should be made on December 31, 2014; December 31, 2015; December 31, 2016; and December 31, 2017?

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Case 3-1 Ethics case

You are an assistant auditor with Zaird & Associates, CPAs. Universal Air (UA), your fifth audit client in your eight months with Zaird, is a national airline based in your hometown. UA has continued to grow while remaining healthy financially over the eight years of its existence. Indeed, as you start the audit you notice that (unaudited) sales are up 30 percent this year (2012), with earnings up 40 percent. Your firm, Zaird & Associates, has been UA’s only auditor. During the audit you noticed that UA records sales when tickets are sold – debit receivable (or cash), credit sales. In performing substantive procedures relating to receivables you also found that some of the “sales” are for 2013 flights – generally in January and early February. You brought up this matter to your in-charge senior and she indicated that she also wondered about this last year when she worked on the audit. She suggested that she concluded that this isn’t likely to be a problem for at least three reasons (any one of which would be sufficient to allow the current method): 1. The company has been using this approach since its inception eight years ago. Thus, any overstatement of this year’s sales at year-end is likely to be “averaged out” by an understatement at the beginning of the year, since the company followed the same policy last year (and the years before). 2. Valid reasons exist for including the sales when “booked.” The small airline’s earnings process is probably best considered about complete when the sale is made because this is the toughest part of the revenue generation process. The planes are scheduled to fly for the first six months of next year, and will fly, regardless of whether these relatively few passengers who paid before year-end for next year’s flights are on them; there are virtually no variable costs incurred for these passengers, except for a few very small bags of peanuts and a few cans of soda. 3. Imagine what a nightmare it would be to have to record an entry when a passenger buys a ticket, and then another one when the flight occurs. She says she is willing to discuss this with you if you disagree, but at this point she thinks it isn’t a problem.

1. Discuss whether you agree or disagree with each of her reasons. 2. Now assume that you potentially agree with her first justification. You think that maybe a journal entry could be made at year-end to estimate the liability for nextyear flights. Yet, this wouldn’t be necessary if everything does “average out” and any year-end liability is immaterial. Given this situation, would you expect the procedure to “average out” over the year? 3. How might one determine whether it does “average out” over the year?

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