Homework Assignment Due June 15 at 11:55 pm Question 2 You are the audit senior
ID: 2411213 • Letter: H
Question
Homework Assignment Due June 15 at 11:55 pm Question 2 You are the audit senior on the Victoria Waterworks Ltd. audit. You have collected the following information about the accounts receivable: The AR turnover ratio was eight times for the current year and twelve times for the prior year. The AR balance has increased from $52,140 in the prior year to $176,983 in the current year. In an attempt to boost sales, Victoria Waterworks Ltd. loosened its credit-granting policies during the year and also extended payment terms for its customers. . Required: Identify the risks for accounts receivable at Victoria Waterworks Ltd. and the related assertions. Document the audit procedures to address the risks.Explanation / Answer
Risks: The ratio decreases from 12 times to 8 times because of extending credit terms. It means if there are 365 days in a year to be counted, number of days for collection increases from (365/12 =) 30.42 days to (365/8 =) 45.625 days. Increasing such collection period is a risk in the sense that (1) there is time value of money, and (2) there would be increasing bad debts.
(1) Money gets depreciated as the time goes on; a sum of money receiving today has more purchasing power than it is receiving in future. Therefore, what the account shows as increasing AR in the book may not be the actual financial strength of the company in future.
(2) More balance in accounts receivable (AR) means more chance of failure of payment; such amount is considered as bad debt. This is indeed a risk, since it abuses the concept of credit sale.
Procedures:
(1) Suppose a sum of money, $15,000, is received after 3 years. The present value of such money at 10% discount rate would be as below:
PV = $15,000 / (1 + rate) ^year
= 15,000 / (1 + 0.10) ^3
= 15,000 / 1.10 ^3
= 15,000 / 1.331
= $11,269.72
Therefore, if it is shown as $15,000 in the balance today it should be incorrect; the actual amount, $11,269.72, is lower than the balance amount.
(2) If aging schedule of AR is done, it could be seen that those balances of having long-period of outstanding mostly go into bad debts. Therefore, such long-period of outstanding is making a huge financial loss.
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