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a) The easiest way to know whether a debtor exists is to ask him this is called circularisation.
Reasons for carrying out circularisation of debtors.
• To obtain confirmatory direct external evidence of the existence and beneficial ownership of the asset debtors.
• To give evidence that the figure in the accounts for debtors is a true and fair one.
• To provide confirmatory evidence that the system of recording and documenting sales and debtors and the controls there on can be relied upon to produce an accurate figure for debtors. Normally, tests which are designed to obtain evidence of the reliability of the systems are called compliance test. Circularisation therefore is useful both for substantive and compliance tests.
• To provide evidence as to the correctness of cut-off. Cut-off is the technical term used to ensure that in computing profits sales are accurately compared with the costs of the goods sold. Cut-off tests can be substantive i.e. examining last numbers of documents or compliance that is, if control exists their application can be tested.
• To provide evidence on the existence of disputed items. It is a direct confirmation.
b) Positive:
The customer is asked to reply whether he agrees to the balance or not; or is asked to supply the balance himself. This method is used where there is weak internal controls, suspicion of irregularities or items in dispute and numerous book-keeping errors.
Negative:
The customer is asked to communicate only if he does not agree with the balance. Effectively the customer is told that if no reply is received from them then the auditor will conclude that the debtor is in agreement with all the terms in the circular.
The major drawback in this method is that if the debtor does not receive the circular, he will not respond.
This method therefore is unreliable and should only be used when there is strong internal control.
c) (i) Determine the system of internal control over sales and debtors. The system should ensure that:
• Only bona fide sales bring debtors into being.
• All such sales are approved.
• Check if all sales are recorded
• Check that once they were recorded the debts are only eliminated by receipt of cash or on the authority of a responsible official.
• Check balances are regularly reviewed and aged and a proper follow up exists and if necessary there is provision for bad and doubtful debts.
(ii) A circularisation is very effective in confirming the existence of the debtor and the title to the asset debtor, but is not designed for establishing the value of debtors. It is therefore up to the auditor to confirm the balance and not the debtor.
(iii) If there is no reply send a reminder. Still no response, then the following alternative auditing
procedures should be adopted:
• Detailed vouching of all entries in the debtors accounts
• Examining the debtors remittance advice.
• Awareness of the possibility of unusual items or misstatements
• Reviewing correspondence if any with the debtor.
• Examining the post balance sheet events e.g. settlements
Musyoxx answered the question on March 14, 2018 at 16:07
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