23

GUIDANCE NOTE ON
AUDIT OF DEBTORS, LOANS AND ADVANCES*

Contents
Paragraph(s)

Introduction ..........................................................................................3-4
Internal Control Evaluation .................................................................... 5
Verification..........................................................................................6-33
Examination of Records ..................................................................7-19
Special Considerations in Case of loans and Advances .........15-19
Direct Confirmation Procedure......................................................20-32
Analytical Review Procedures ........................................................... 33
Disclosure.............................................................................................. 34
Management Representations............................................................. 35
Documentation ...................................................................................... 36
Appendices

* Published in June, 1994 issue of ‘The Chartered Accountant’.

 Audit of Debtors, Loans and Advances

The following is the text of the Guidance Note on Audit of Debtors, Loans
and Advances issued by the Auditing Practices Committee (APC)** of the
Council of the Institute of Chartered Accountants of India. This Guidance
Note should be read in conjunction with the Statements on Standard Auditing
Practices++ issued by the Institute.
1. Paragraph 2.1 of the “Preface to the Statements on Standard Auditing
Practices” issued by the Institute of Chartered Accountants of India states
that the “main function of the APC is to review the existing auditing practices
in India and to develop Statements on Standard Auditing Practices (SAPs) so
that these may be issued by the Council of the Institute.” Paragraph 2.4 of
the Preface states that the “APC will issue Guidance Notes on the issues
arising from the SAPs wherever necessary.”
2. The Auditing Practices Committee has also taken up the task of reviewing the
Statements on auditing matters issued prior to the formation of the Committee. It
is intended to issue, in due course of time, AASs or Guidance Notes, as
appropriate, on the matters covered by such Statements which would then stand
withdrawn. Accordingly, with the issuance of this Guidance Note on Audit of
Debtors, Loans and Advances, Chapter-7 of the Statement on Auditing
Practices, titled ‘Debtors, Loans and Advances’, shall stand withdrawn. In due
course of time, the entire Statement of Auditing Practices shall be withdrawn.

Introduction
3. Debtors, loans and advances may constitute a significant proportion of the
total assets of an entity. Debtors represent the amounts due to an entity for
goods sold or services rendered or in respect of other similar contractual
obligations, but do not include the amounts which are in the nature of loans or
advances. Loans represent the claims of an entity in respect of such contractual
obligations as moneys lent. Advances represent payments made on account of,
but before completion of, a contract or before acquisition of goods or receipt of
services. For purposes of this Guidance Note, debtors, loans and advances
include instruments such as bills of exchange, promissory notes and similar other
instruments, evidencing debtors, loans and advances.
4. An important feature of debtors, loans and advances which has a
significant effect on the related audit procedures is that these assets are

**
Now known as the Auditing and Assurance Standards Board (AASB).
++
Now known as the Auditing and Assurance Standards (AASs).

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represented only by documentary evidence; they have no physical existence.

Moreover, the documentary evidence is generally in the form of invoices,
loan documents, etc., prepared by the entity itself. The auditor should take
these factors into account in designing his audit procedures.

Internal Control Evaluation

5. The auditor should study and evaluate the system of internal control
relating to debtors, loans and advances, to determine the nature, timing and
extent of his other audit procedures. He should particularly review the
following aspects of internal control relating to debtors, loans and advances.1
(a) In respect of debtors
(i) The basis on which credit limits for customers are to be
determined should be clearly laid down. The credit limits fixed in
respect of individual customers should be approved by an official
independent of the sales department. These limits should be
checked before orders are accepted from the customers. There
should also be a system of periodic review of the credit limits.
(ii) The procedure should ensure prompt recording of debts and
realisations and of linking receipts with outstandings.
(iii) There should be a procedure for preparation of aging schedule of
debtors at regular intervals. The schedules should be reviewed by
a responsible official and necessary action initiated in respect of
overdue accounts.
(iv) Statements of account should be sent to all debtors at periodic
intervals. They should be prepared and despatched by a person
independent of the ledger-keeper. The debtors should be
requested to confirm the balances as per the statements with
reference to their own records. The confirmations received should
be reviewed by a person independent of the ledger-keeper and the
person responsible for preparing the statements of account, and
necessary action taken in case of discrepancies.

1
The extent of review of internal controls would depend upon the facts and circumstances of
each case. Reference may be made in this regard to the "Internal Control Questionnaire",
issued by the Institute of Chattered Accountants of India in 1976, which contains an
illustrative discussion on internal controls in relation to debtors and loans and advances.

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(v) All material adjustments in debtors' accounts, particularly those

relating to rebates, allowances, commissions etc., should require
approval of the competent authority. Similarly, any write-off of bad
debts should require approval of the competent authority.
(vi) There should be a system of periodic reconciliation of various
debtor balances with related control accounts.
(b) In respect of loans and advances
(i) As far as possible, the system should specify the following:
total amount up to which loans may be made;
the purposes for which loans may be made;
maximum amount of loans which may be made for each
such purpose in individual cases;
the terms on which such loans may be made;
the persons who are authorized to make loans;
procedure for ensuring compliance with relevant legal
requirements.
(ii) All variations in the terms of loans and advances should be duly
approved in writing by the competent authority.
(iii) Where security is taken against the loans, the form and adequacy
of security should be reviewed by a responsible official.
(iv) The loan and security documents should be kept in safe custody of
a responsible official. A record of all such documents should be
maintained and the documents should be periodically verified with
reference to such records.
(v) The system should provide for identification of cases where
principal and/or interest have become overdue or where any other
terms are not being complied with.
(vi) Confirmation of balances should be obtained at periodic intervals
in the same manner as in the case of debtors.

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Verification
6. In any auditing situation, the auditor employs appropriate procedures to
obtain reasonable assurance about various assertions (see Statement on
Standard Auditing Practices (SAP) 5, Audit Evidence). In carrying out an
audit of debtors, loans and advances, the auditor is particularly concerned
with obtaining sufficient appropriate audit evidence to corroborate the
management's assertions regarding the following:
Existence - that all amounts recorded in respect of debtors,
loans and advances are outstanding as at the date
of the balance sheet.
Completeness - that there are no unrecorded debtors, loans and
advances.
Valuation - that the stated basis of valuation of debtors, loans
and advances is appropriate and properly applied,
and that the recoverability of debtors, loans and
advances is recognised in their valuation.
Disclosure - that the debtors, loans and advances are
disclosed, classified, and described in accordance
with recognised accounting policies and practices
and relevant statutory requirements, if any.
Verification of debtors may be carried out by employing the following
procedures:
(a) examination of records;
(b) direct confirmation procedure (also known as ‘circularisation
procedure’);
(c) analytical review procedures.
The nature, timing and extent of audit procedures to be performed is,
however, a matter of professional judgement of the auditor.

Examination of Records
7. The auditor should carry out an examination of the relevant records to
satisfy himself about the validity, accuracy and recoverability of the debtor
balances. The extent of such examination would depend on the auditor's

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evaluation of the efficacy of internal controls.

8. The auditor should check the agreement of balances as shown in the
schedules of debtors with those in the ledger accounts. He should also check
the agreement of the total of debtor balances with the related control
accounts. Any differences in this regard should be examined.
9. Verification of subsequent realizations is a widely used procedure, even in
cases where direct confirmation procedure is followed. In the case of
significant debtors, the auditor should also examine the correspondence or
other documentary evidence to satisfy himself about their validity and
accuracy.
10. While examining the schedules of debtors with reference to the debtors’
ledger accounts, the auditor should pay special attention to the following
aspects:
(a) Where the schedules show the age of the debts, the auditor should
examine whether the age of the debts has been properly determined.
(b) Whether the amounts outstanding are made up of items which are not
overdue, having regard to the credit terms of the entity.
(c) Whether transfers from one account to another are properly evidenced.
(d) Whether provisions for allowances, discounts and doubtful debts are
required. In this regard, the auditor should recognise that even though a
debtor may have confirmed the balance due by him, he may still not pay
the same.
11. The following are some of the indications of doubtful and uncollectible
debts, loans and advances:
(a) The terms of credit have been repeatedly ignored.
(b) There is stagnation, or lack of healthy turnover, in the account.
(c) Payments are being received but the balance is continuously
increasing.
(d) Payments, though being received regularly, are quite small in relation to
the total outstanding balance.
(e) An old bill has been partly paid (or not paid), while later bills have been
fully settled.

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(f) The cheques received from the debtor have been repeatedly
dishonoured.
(g) The debt is under litigation, arbitration, or dispute.
(h) The auditor becomes aware of unwillingness or inability of the debtor to
pay the dues e.g., a debtor has either become insolvent, or has closed
down his business, or is not traceable.
(i) Amounts due from employees, which have not been repaid on
termination of employment.
(j) Collection is barred by statute of limitation.
12. Bad debts written off or excessive discounts or unusual allowances
should be verified with the relevant correspondence. Proper authorisation
should be inspected.
13. In the case of claims made against insurance companies, shipping
companies, railways, etc., the auditor should examine the correspondence or
other available evidence to ascertain whether the claims have been
acknowledged as debts and there is a reasonable possibility of their being
realized. If it appears that they are not collectible, they should be shown as
doubtful. Similar considerations apply in respect of claims for export
incentives, claims for price escalation in case of construction contracts,
claims for interest on delayed payments, etc.
14. The auditor should examine whether the contingent liability, if any, in
respect of bills accepted by customers and discounted with the banks is
properly disclosed. He should also examine whether adequate provision on
this account has been made, where required.2

Special Considerations in Case of Loans and Advances

15. In general, the procedure outlined above in regard to debtors is also
applicable in the case of loans and advances. However, in the case of loans
and advances, the auditor may find greater documentary evidence (in the
form of loan and security documents and related correspondence) on which
he can place reliance.

2
Reference may be made in this regard to Accounting Standard (AS) 4, Contingencies and
Events Occurring after the Balance Sheet Date, issued by the Institute of Chartered
Accountants of India.

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 Audit of Debtors, Loans and Advances

16. In the case of loans and advances, an important aspect to be examined

by the auditor is whether the entity is empowered to make loans. In many
cases, the statute governing the entity may contain restrictions or conditions
about the amount of loans, purposes for which loans may be granted, parties
to which loans may be granted etc. Similarly, the internal regulations of the
entity may also prescribe the procedure to be followed for making the loans.
For instance, in the case of companies, sections 292, 295 and 370 place
restrictions on the making of loans by companies.3 The competence of the
borrower to receive the loan may also affect the legality and, hence, the
recoverability of the loan. The auditor should examine the loan documents
and other evidence with reference to the above while determining the legality
and recoverability of the loans made by the entity.
17. The auditor should ascertain whether the parties to whom loans and
advances have been made have complied with the terms and conditions
relating to payment of interest, repayment of loans or adjustment of
advances, etc. In the case of defaults, e.g., where the repayment of loans or
advances or the payment of interest are overdue, the auditor should consider
whether such defaults are indicative of unwillingness or inability of the parties
concerned to make the payment.
18. The auditor should pay particular attention to loans and advances given to
parties in whom directors or persons who are substantial owners of the entity are
interested. He should ascertain the purpose of such loans and advances, the
terms and conditions on which they have been made as also their recoverability.
19. The auditor should also examine any other aspects required to be
examined or reported upon by the relevant statute. For example, the auditor
of a company covered by the Manufacturing and Other Companies (Auditor's
Report) Order, 1988, is required to state in his report whether the terms and
conditions on which loans and advances have been made are prima facie
prejudicial to the interests of the company. Similarly, clause (a) of sub-
section (1A) of section 227 of the Companies Act, 1956, requires the auditor
to inquire "whether loans and advances made by the company on the basis

3
For a detailed study of this aspect, reference may be made to the Institute's publication
titled A Guide to Company Audit. Similarly, in the case of entities like banks, insurance
companies, etc., reference may be made to the relevant publication(s) of the Institute, e.g.,
Guidance Note on Audit of Banks, Guidance Note on Audit of Companies Carrying on
General Insurance Business, Guidance Note on Companies Carrying on Life Insurance
Business, Guide to Audit of Cooperative Societies, etc.

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of security have been properly secured and whether the terms on which they
have been made are not prejudicial to the interests of the company or its
members".

Direct Confirmation Procedure

20. The verification of balances by direct communication with debtors is
theoretically the best method of ascertaining whether the balances are
genuine, accurately stated and undisputed, particularly where the internal
control system is weak. It must be recognised, however, that mere
confirmation of balance by a debtor does not by itself ensure ultimate
recovery. Moreover, the utility of this procedure depends to a large extent on
receiving adequate response to confirmation requests. Therefore, in
situations where the auditor has reasons to believe, based on his past
experience or other factors, that it is unlikely that adequate response would
be received from the debtors, he may limit his reliance on direct confirmation
procedure and place greater reliance on the other auditing procedures.
21. The auditor employs direct confirmation procedure with the consent of
the entity under audit. There may be situations where the management of the
entity requests the auditor not to seek confirmation from certain debtors. In
such cases, the auditor should consider whether there are valid grounds for
such a request. For example, the management may explain the reason as
being the fact that there is a dispute with the particular debtor and the
request for confirmation may aggravate sensitive negotiations between the
entity and the debtor. Before accepting a refusal as justified, the auditor
should examine any available evidence to support the management's
explanations, e.g., correspondence between the entity and the debtor. In
such a case, alternative procedures should be applied to debtors not
subjected to confirmation. In appropriate cases, the auditor may also need to
re-consider the nature, timing and extent of his audit procedures including
the degree of planned reliance on management's representations.
22. The confirmation date, the method of requesting confirmations, and the
particular debtors from whom confirmation of balances is to be obtained are
to be determined by the auditor. While determining the information to be
obtained, the form of confirmation, as well as the extent and timing of
application of the confirmation procedure, the auditor should consider all
relevant factors such as the effectiveness of internal control, the apparent
possibility of disputes, inaccuracies or irregularities in the accounts, the

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probability that requests will receive consideration, and the materiality of the
amounts involved.
23. The debtors may be requested to confirm the balances either (a) as at
the date of the balance sheet, or (b) as at any other selected date which is
reasonably close to the date of the balance sheet. The date should be settled
by the auditor in consultation with the entity. Where the auditor decides to
confirm the debtors at a date other than the balance sheet date, he should
examine the movements in debtor balances which occur between the
confirmation date and the balance sheet date and obtain sufficient evidence
to satisfy himself that debtor balances stated in the balance sheet are not
materially misstated.
24. The form of requesting confirmation from the debtors may be either (a)
the 'positive' form of request, wherein the debtor is requested to respond
whether or not he is in agreement with the balance shown, or·(b) the
'negative' form of request, wherein the debtor is requested to respond only if
he disagrees with the balance shown.
25. The use of the positive form is preferable when individual account
balances are relatively large, or where the internal controls are weak, or
where the auditor has reason to believe that there may be a substantial
number of accounts in dispute or with inaccuracies or irregularities. An
illustrative positive form of request letter is given in Appendix I to this
Guidance Note.
26. The negative form is useful when internal controls are considered to be
effective, or when a large number of small balances are involved, or when
the auditor has no reason to believe that the debtors are unlikely to respond.
If the negative rather than the positive form of confirmation is used, the
number of requests sent and the extent of the other auditing procedures to
be performed should normally be greater so as to enable the auditor to
obtain the same degree of assurance with respect to the debtor balances. An
illustrative negative form of request letter is given in Appendix II to this
Guidance Note.
27. In many situations, it may be appropriate to use the positive form for
debtors with large balances and the negative form for debtors with small
balances.
28. Where the number of debtors is small, all of them may be circularized,
but if the debtors are numerous, this may be done on a sample basis. The

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sample list of debtors to be circularized, in order to be meaningful, should be

based on a complete list of all debtor accounts. While selecting the debtors
to be circularized, special attention should be paid to accounts with large
balances, accounts with old outstanding balances, and customer accounts
with credit balances. In addition, the auditor should select accounts in
respect of which provisions have been made or balances have been written
off during the period under audit or earlier years and request confirmation of
the balance without considering the provision or write-off. The auditor may
also consider including in his sample some of the accounts with nil balances.
The nature of the entity's business (e.g., the type of sales made or services
rendered) and the type of third parties with whom the entity deals, should
also be considered in selecting the sample, so that the auditor can reach
appropriate conclusions about the debtors as a whole.
29. In appropriate cases, the debtor may be sent a copy of his complete
ledger account for a specific period as shown in the entity's books. This
procedure is more likely to reveal errors and fraud and may be particularly
useful in the case of large accounts involving many entries, or where there is
evidence that accounts are in dispute or are not being settled in accordance
with the entity's usual trade terms.
30. The method of selection of the debtors to be circularised should not be
revealed to the entity until the trial balance of the debtors' ledger is handed
over to the auditor. A list of debtors selected for confirmation should be given
to the entity for preparing requests for confirmation which should be properly
addressed and duly stamped. The auditor should maintain strict control to
ensure the correctness and proper dispatch of request letters. In the
alternative, the auditor may request the client to furnish duly authorised
confirmation letters and the auditor may fill in the names, addresses and the
amounts relating to debtors selected by him and mail the letters directly. It
should be ensured that confirmations as well as any undelivered letters are
returned to the auditor and not to the client.
31. Where positive form of request is used, the auditor may, in appropriate
cases, request the entity to follow up with a reminder to those debtors from
whom he receives no replies. In exceptional circumstances, the auditor may
also correspond directly with those significant debtors from whom he
receives no replies despite reminders. In the event of inadequacy of
responses received, the auditor will have to increase the extent of
examination of records and analytical review procedures beyond that

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planned originally.
32. Any discrepancies revealed by the confirmations received or by the
additional tests carried out by the auditor may have a bearing on other
accounts not included in the original sample. The entity should be asked to
investigate and reconcile the discrepancies. In addition, the auditor should
also consider what further tests he can carry out in order to satisfy himself as
to the correctness of the amount of debtors taken as a whole.

Analytical Review Procedures

33. In addition to the audit procedures discussed above, the following
analytical review procedures may often be helpful as a means of obtaining
audit evidence regarding the various assertions relating to debtors, loans and
advances:
(a) comparison of closing balances of debtors, loans and advances with the
corresponding figures for the previous year;
(b) comparison of the relationship between current year debtor balances
and the current year sales with the corresponding figures for the
previous year;
(c) comparison of actual closing balances of debtors, loans and advances
with the corresponding budgeted figures, if available;
(d) comparison of current year's aging schedule with the corresponding
figures for the previous year;
(f) comparison of significant ratios relating to debtors, loans and advances
with the similar ratios for other firms in the same industry, if available;
(g) comparison of significant ratios relating to debtors, loans and advances
with the industry norms, if available.
It may be clarified that the foregoing is only an illustrative list of analytical
review procedures which an auditor may employ in carrying out an audit of
debtors, loans and advances. The exact nature of analytical review
procedures to be applied in a specific situation is a matter of professional
judgement of the auditor.

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Disclosure
34. The auditor should satisfy himself that the debtors, loans and advances
have been disclosed properly in the financial statements. Where the relevant
statute lays down any disclosure requirements in this behalf, the auditor
should examine whether the same have been complied with.

Management Representations
35. The auditor should obtain from the management of the entity, a written
statement regarding recoverability of debtors and loans and advances and
their classification for balance sheet purposes. While such a representation
letter serves as a formal acknowledgment of the management's
responsibilities with regard to debtors, loans and advances, it does not
relieve the auditor of his responsibility for performing audit procedures to
obtain sufficient appropriate audit evidence to form the basis for the
expression of his opinion on the financial information. A sample management
representation letter regarding debtors, loans and advances is given in
Appendix III to this Guidance Note. It may be mentioned that the
representations made in the letter can alternatively be included in the
composite representation letter usually issued by the management to the
auditor.

Documentation
36. The auditor should maintain adequate working papers regarding audit of
debtors, loans and advances. Among others, he should maintain on his audit
file, the confirmations received as well as any undelivered letters of request
for confirmation. The management representation letter concerning debtors,
loans and advances should also be maintained on the audit file.

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 Audit of Debtors, Loans and Advances

Appendix I
Illustrative Letter of Confirmation to be Sent to Debtors Positive Form

[Ref. Paragraph 25]

[Letterhead of Entity]
[Date]
[Name and address of debtor]
Dear Sir,
For audit purposes, kindly confirm directly to our auditors (name and address
of the auditors) that the balance of Rs.................. due by you as on ............,
as shown by our books, is correct. The details of the balance are as under:4
Invoice No. Date Order Reference or Acceptance or Amount
Tender No. etc. (To be used
Particularly for Government
Customers)

Total
Less : Advance received
_________
Net Amount due by you (Rs.)
_________
_________

A stamped envelope addressed to our auditors is enclosed for your

convenience.
If the amount shown is in agreement with your books, kindly strike-out the
paragraph marked (B) below. If the amount shown is not in agreement with
your books, kindly furnish the details in the proforma given in the paragraph
marked (B) below and strike-out paragraph (A). In either case, kindly sign at
the place provided below and return this entire letter directly to our auditors

4
In case the list of invoices forming the balance is too large, these details may not be given.

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in the enclosed envelope. Your prompt compliance with this request will be
appreciated.
Kindly return this form in its entirety.
Yours Faithfully,

(Signature of responsible official of the entity)

..............................
(Do not perforate the form at this point)
(Name and Address of entity)
(A) We confirm that the above stated amount is correct as at ______
OR
(B) We state that the above-stated amount is not correct as per our records.
The details of the balance as at _________ as per our records are as below:
Invoice No. Date Order Reference Amount
Total _________
Less: Advanced paid _________
Net Amount due from us (Rs.) _________
Net Amount due from us (Rs.) _________

Date (Signature of debtor/responsible official)

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Appendix II
Illustrative Letter of Confirmation to be Sent to Debtors Negative Form

[Ref. Paragraph 26]

[Letterhead of Entity]
[Date]
[Name and address of debtor]
Dear Sir,
For audit purposes, kindly write directly to our auditors (name and address of
the auditors) if the balance of Rs. due by you as on _______ as shown by
our books, is not correct, giving details of the differences. The details of the
balance are as under:5
Invoice No. Date Order Reference or Acceptance or Amount
Tender No. etc. (To be used
particularly for Government
Customers)
Total _________
Less: Advanced paid _________
Net Amount due by you (Rs.) _________

If you do not notify our auditors of any difference within ten days of the date
of this letter, it will be presumed that the balance stated above is correct.
A stamped envelope addressed to our auditors is enclosed for your
convenience.
Yours faithfully,

(Signature of responsible official of the entity)

5
In case the list of invoices forming the balance is too large, these details may not be given.

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Appendix III
Representation Letter for Debtors, Loans and Advances
[Ref. Paragraph 35]
The following is a sample representation letter for debtors, loans and
advances. It might be used to supplement the general letter of representation
or included therein. The letter should be modified where appropriate.
[Letterhead of Entity]
[Date]
[Name and Address of the Auditor]
Dear Sir,
In connection with your audit of the financial statements of X Ltd. as of .....,
19.., and for the year then ended, we certify that the following items
appearing in the books as at .......(date of the Balance Sheet) are considered
good and fully recoverable with the exception of those specifically shown as
“doubtful” in the Balance Sheet.
Sundry Debtors Rs.
Loans and Advances6 Rs.
Yours faithfully,

(Signature of responsible official of the entity)

6
It may be pointed out that a similar certificate regarding deposits made by the entity may
also be obtained by the auditor in appropriate cases.

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