2.

What is the significance of segregating receivables into Trade Receivables and non- trade
receivables from an audit perspective?

What are Non Trade Receivables?

Non trade receivables are amounts due for payment to an entity other than its normal customer
invoices for merchandise shipped or services performed. Examples of non trade receivables are amounts
owed to a company by its employees for loans or wage advances, tax refunds owed to it by taxing
authorities, or insurance claims owed to it by an insurance company.

Accounting for Non Trade Receivables

In all of the examples, the non trade items are typically not billed using the company's invoicing
software; instead, they are recorded as journal entries. This is a key distinction, since there should be
few (if any) journal entries impacting the accounts receivable account, while usually journal entries are
the only form of transaction to be used in the non trade receivables account. Indeed, the use of a
journal entry to record a transaction can be considered a key indicator that a receivable should be
treated as a non trade receivable.

You should periodically evaluate the individual items recorded in the non trade receivables account to
see if the company is still likely to receive full payment. If not, reduce the amount in the account to the
level you expect to receive, and charge the difference to expense in the period in which you make this
determination. This evaluation should be conducted as part of the period-end closing process.

Classification of Non Trade Receivables

Non trade receivables are usually classified as current assets on the balance sheet, since there is
typically an expectation that they will be paid within one year. If you anticipate that payment will be
over a longer period of time, then classify it as a non-current asset.

If there is a large amount of interest receivable from a third party, consider recording it in a separate
interest receivable account.

3.Why are returns and allowances sensitive issues in receivables audit?

 Sources and Nature of Accounts Receivables

Receivables-included not only claim against customers arising from the sale of goods or services, but
also a variety of miscellaneous claims such as loans to officers or employee, loans to subsidiaries, claims
against various other firms, claims for tax refunds,  and advances  given to suppliers

In the financial statements of most of the companies, accounts receivables and notes receivables are
relatively large in amounts and auditors need to have more concern about the audit of these items
during the course of audit. Auditors need to have a special attention to the presentation and disclosure
of the loans to the officers, directors and subsidiary companies, as these related party transactions may
benefit only the borrower rather than the lending company.

Auditors’ Objectives in auditing account receivables and sales

The auditor’s objectives in the audit of accounts receivables and sales are:

1. Consider the internal control over accounts receivables and sales transactions

2. Substantiate the existence of the accounts receivables and occurrence  of sales transactions

3. Establish the completeness of the accounts receivables and sales

4. Determine that the client has the rights to the  recorded receivables

5. Establish the clerical accuracy of the records and supporting schedules of accounts receivables
and sales

6. Determine the valuation of receivables and sales is at appropriate net realizable value

7. Determine that the presentation and disclosure of receivables and revenues are adequate
including the separation of receivables into appropriate categories, adequate reporting of any
receivables pledged, and collateral, and disclosure of   related-party sales and receivable

4 . When a client conducts by itself a periodic physical count of all or part of its inventory , list and
discus the normal audit procedures that should be performed by the independent auditor to verify
physical count of inventory

What are Inventory Audit Procedures?

If your company records its inventory as an asset and it undergoes an annual audit, then the auditors
will be conducting an audit of your inventory. Given the massive size of some inventories, they may
engage in quite a large number of inventory audit procedures before they are comfortable that the
valuation you have stated for the inventory asset is reasonable. Here are some of the inventory audit
procedures that they may follow:

 Cutoff analysis. The auditors will examine your procedures for halting any further receiving into
the warehouse or shipments from it at the time of the physical inventory count, so that
extraneous inventory items are excluded. They typically test the last few receiving and shipping
transactions prior to the physical count, as well as transactions immediately following it, to see if
you are properly accounting for them.

 Observe the physical inventory count. The auditors want to be comfortable with the procedures
you use to count the inventory. This means that they will discuss the counting procedure with
you, observe counts as they are being done, test count some of the inventory themselves and
trace their counts to the amounts recorded by the company's counters, and verify that all
inventory count tags were accounted for. If you have multiple inventory storage locations, they
may test the inventory in those locations where there are significant amounts of inventory. They
 may also ask for confirmations of inventory from the custodian of any public warehouse where
the company is storing inventory.

 Reconcile the inventory count to the general ledger. They will trace the valuation compiled from
the physical inventory count to the company's general ledger, to verify that the counted balance
was carried forward into the company's accounting records.

 Test high-value items. If there are items in the inventory that are of unusually high value, the
auditors will likely spend extra time counting them in inventory, ensuring that they are valued
correctly, and tracing them into the valuation report that carries forward into the inventory
balance in the general ledger.

 Test error-prone items. If the auditors have noticed an error trend in prior years for specific
inventory items, they will be more likely to test these items again.

 Test inventory in transit. There is a risk that you have inventory in transit from one storage
location to another at the time of the physical count. Auditors test for this by reviewing your
transfer documentation.

 Test item costs. The auditors need to know where purchased costs in your accounting records
come from, so they will compare the amounts in recent supplier invoices to the costs listed in
your inventory valuation.

 Review freight costs. You can either include freight costs in inventory or charge it to expense in
the period incurred, but you need to be consistent in your treatment - so the auditors will trace
a selection of freight invoices through your accounting system to see how they are handled.

 Test for lower of cost or market. The auditors must follow the lower of cost or market rule, and
will do so by comparing a selection of market prices to their recorded costs.

 Finished goods cost analysis. If a significant proportion of the inventory valuation is comprised of
finished goods, then the auditors will want to review the bill of materials for a selection of
finished goods items, and test them to see if they show an accurate compilation of the
components in the finished goods items, as well as correct costs.

 Direct labor analysis. If direct labor is included in the cost of inventory, then the auditors will
want to trace the labor charged during production on time cards or labor routings to the cost of
the inventory. They will also investigate whether the labor costs listed in the valuation are
supported by payroll records.

 Overhead analysis. If you apply overhead costs to the inventory valuation, then the auditors will
verify that you are consistently using the same general ledger accounts as the source for your
overhead costs, whether overhead includes any abnormal costs (which should be charged to
expense as incurred), and test the validity and consistency of the method used to apply
overhead costs to inventory.

 Work-in-process testing. If you have a significant amount of work-in-process (WIP) inventory,

the auditors will test how you determine the percentage of completion for WIP items.
  Inventory allowances. The auditors will determine whether the amounts you have recorded as
allowances for obsolete inventory or scrap are adequate, based on your procedures for doing
so, historical patterns, "where used" reports, and reports of inventory usage (as well as by
physical observation during the physical count). If you do not have such allowances, they may
require you to create them.

 Inventory ownership. The auditors will review purchase records to ensure that the inventory in
your warehouse is actually owned by the company (as opposed to customer-owned inventory or
inventory on consignment from suppliers).

 Inventory layers. If you are using a FIFO or LIFO inventory valuation system, the auditors will test
the inventory layers that you have recorded to verify that they are valid.

If the company uses cycle counts instead of a physical count, the auditors can still use the procedures
related to a physical count. They simply do so during one or more cycle counts, and can do so at any
time; there is no need to only observe a cycle count that occurs at the end of the reporting period. Their
tests may also evaluate the frequency of cycle counts, as well as the quality of the investigations
conducted by counters into any variances found.

The extent of the procedures employed will decline if inventory constitutes a relatively small proportion
of the assets listed on a company's balance sheet.

5. State the essential points that should be considered in planning for audit of purchases and Accounts
Payable

 No clear separation of accounting duties. These are just a few of the risks that may be lurking along the
audit trail in your accounts payable (AP) department.

Auditing accounts payable, whether as part of a larger internal audit or as a standalone process, is an
essential weapon in the war on fraud and inaccuracy. For companies doing business in or with the
United States, accounts payable audit procedures are ideally guided by auditing standards set forth by
the American Institute of Certified Public Accountants (AICPA). This ensures the audit achieves four
critical benchmarks for clarity, accuracy, and comprehensiveness—namely:

 Proper disclosure of end-of-year financial statements is critical to accurate financial reporting,

strategic forecasting, and procurement. Unusual transactions are documented, contextualized,
and clarified as needed. Management completes all necessary documentation verifying that the
company’s financial statements are complete, and fully record all AP and purchasing amounts.

 A thorough payable audit is one that ensures accounts payable is fully compliant with generally
accepted accounting principles (GAAP). Using the year-end (or end-of-period) financial
statements (including income and cash flow statements as well as the balance sheet), auditors
choose and trace general ledger entries back to their creation to form an audit trail. This trail
reveals any potential control weaknesses in the accounting system and areas where compliance
can be improved.
  Verified transactions are accurate and legitimate transactions. Auditors contact the company’s
entire roster of regular suppliers (whether the company currently has an outstanding balance or
not) to verify data on transactions conducted with that vendor in the period being audited. This
verification helps ensure the accounts payable function of your company is free from material
misstatement, or incorrect financial data that affects reporting, planning, and other decisions
made by those using it.

 To be effective, a payable audit must examine all available information and reconcile all
transactions. Auditors use cutoff tests—i.e., procedures that determine whether a transaction
was recorded in the proper recording period—to confirm AP ledger transactions are accurate
and complete. They use audit trails to follow transactions and confirm payments match the
values recorded by payables, with a special focus on open files containing unmatched
documents.

6.Define Audit sampling. Why do auditors sample instead of examining every

transaction?
What is Audit Sampling?

Audit sampling is an investigative tool in which less than 100% of the total items within the
population of items are selected to be audited. It is an auditing technique that provides supporting
evidence that allows auditors to issue audit opinions without having to audit every single item
and transaction.

Auditing Explained

Auditing is the process by which a company’s financial records are verified and examined. It is to ensure
that the transactions on the financial records are accurately and fairly represented.

Since financial statements are prepared internally by companies and organizations, there is a high risk of
manipulation and fraudulent behavior surrounding the preparation of the statements.

Types of Auditing

Auditing is important in ensuring that companies are representing their financial statements fairly and
accurately. There are three types of auditing:

 Internal audits are performed by the internal employees of an organization, but they are usually not
distributed outside of the company.
 External audits are performed by external parties that are seen as having more unbiased opinions
since internal audits may be influenced by conflicts of interest.
 Government audits are performed by government entities to ensure that financial statements have
been prepared accurately. In the U.S., the Internal Revenue Service (IRS) performs audits that verify
the accuracy of a taxpayer’s tax returns. The IRS’s counterpart in Canada is the Canada Revenue
Agency (CRA).
No matter what kind of audit is being performed – internal, external, or government – audit sampling
needs to be used so that auditors can complete their audits without wasting resources in checking every
single item. The objectives of audit sampling are as follows:

Gather enough evidence to conclude an audit opinion

Reduce the number of resources used

Provide the basis for auditors to issue a conclusive audit opinion

Detect any errors or fraud that can occur

Prove that auditors have completed their audit fully in accordance with auditing standards

Used as a tool for investigating

Audit Sampling Importance

When auditing financial statements, it is not feasible to audit and check every single item within the
financial statements. It will be very costly and will take a lot of resources and time to do so.

Audit sampling enables auditors to make conclusions and express fair opinions based on predetermined
objectives without having to check all of the items within financial statements. The auditors will only
verify selected items, and through sampling, can infer their opinion on the entire population of items.

7. Discus Test of Controls and Substantive Tests.

Tests of Controls are audit procedures performed to test the operating effectiveness of controls in
preventing or detecting material misstatements at the relevant assertion level. A test of controls is an
audit procedure to test the effectiveness of a control used by a client entity to prevent or detect
material misstatements.

Substantive testing is the stage of an audit when the auditor gathers evidence as to the extent of
misstatements in client’s accounting records or other information. These tests are required as
confirmation to maintain the declaration that the financial records of an entity are complete, applicable,
and correct.

Differentiate between the terms ‘Test of Control’ and ‘Substantive Tests’

Test of Control

 Component: Test of controls is the testing tool for assessing control risk.

 Step: It is the second step in audit testing.

 Types: Test of controls can be classified into two types: Concurrent test and planned tests of
control.

 GAAS: It has no specific formulation of GAAS.

 Determination: It determines effectiveness and efficiency of internal control.

 Basis: Test of control is the police end procedures.

  Timing: Tests of control are done in interim date.

Substantive Test

 Component: the Substantive test is the control mechanism of controlling detection risk.

 Step: It is the third step in audit testing.

 Types: Substantive test can be classified into three types.

 GAAS: It is done in accordance with die GAAS.

 Determination: It determines fairness of financial statements.

 Basis: It is done on the basis of monetary error.

 Timing: the Substantive test is done on the balance sheet date.