Testing Valuation of Accounts Receivable in Audits

Valuation assertion is a critical step in auditing accounts receivable to ensure that the reported assets accurately reflect their true financial position. This process involves several steps and requires a thorough understanding of both the existence and valuation of these receivables. The audit process begins with verifying the existence of receivables, followed by assessing the adequacy of the allowance for uncollectible accounts.

Verification of Existence

In all asset categories, the valuation assertion is closely tied to the existence assertion. Therefore, the first task in testing valuation is to confirm that all accounts listed as receivable are indeed genuine. This involves cross-referencing the receivables with underlying documentation such as sales orders, invoices, and customer agreements. The next step is to determine the upper bound of the valuation, understanding that no customer is likely to pay more than the amount they owe.

Assessing the Allowance for Uncollectible Accounts

The primary valuation task during the audit is to determine the adequacy of the allowance for uncollectible accounts. This allowance is often referred to as the allowance for doubtful accounts or the allowance for bad debts. It is essential to evaluate this allowance to ensure that the company has adequately provisioned for expected losses.

Using Past History for Prediction

Affordable accounting software and financial data analytics tools often provide valuable insights into the historical write-offs of receivables. By examining this data, auditors can gain a clearer picture of the likelihood of future write-offs. For instance, the auditor should consider:

How many of the client's receivables were written off in the past? How many receivables were three to six months past due as of the previous balance sheet date? How many receivables were six months or more past due?

With this historical data, auditors can apply the results to the client's aged list of existing accounts receivable as of the current balance sheet date. This provides a more informed prediction of the collectibility of the receivables.

Post-Balance Sheet Analysis

Towards the end of the audit process, auditors should examine the cash receipts that occurred after the balance sheet date. This analysis helps to verify which customers actually paid their respective debts. Combining this post-balance sheet activity with the past history data allows auditors to compute their best estimate of the collectibility of the client’s receivables.

Evaluating the Allowance for Uncollectible Accounts

Once the collectibility estimate is determined, auditors can compare it against the client's allowance for uncollectible accounts. If the auditor believes that the allowance is inadequate, suggestions or adjustments may be made to ensure that it reflects the true financial position of the company. This process helps in maintaining accurate and reliable financial statements.

Conclusion

Testing the valuation of accounts receivable is a crucial component of the audit process. It involves verifying the existence of receivables, estimating the allowance for uncollectible accounts, and making post-balance sheet adjustments. By following these steps, auditors can provide assurance to stakeholders that the financial statements accurately represent the company's financial health.