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You have been asked by the manager in charge of the audit of Timab agencies to consider and describe various aspects of carrying out a...

      

You have been asked by the manager in charge of the audit of Timab agencies to consider
and describe various aspects of carrying out a debtor’s circularization at its year ending 31st
December 2006. The company sells its products on credit and the draft accounts show annual
turnover of twenty five million shillings. The accounts also show debtors of five million shillings.
Your compliance test on the sales system has shown that there is only satisfactory division of
duties in the sales system and only minor errors were found in compliance tests.

Required
a. Consider the reliability of a debtor’s circularization in providing audit evidence and in
verifying value of year end debtors.
b. Describe the work you will carry out in auditing the replies to debtors circularization
where debtor does not reply to circularization

  

Answers


Wilfred
a)
The most common type of circularization is where auditor writes a letter to the debtor or clients
audited paper asking them to reply directly to the auditor whether he agrees, disagrees or
can not confirm the balance on client’s sales ledger. The client is asked to reply under all
circumstances i.e. Positive circularization.
With negative circularization, a similar procedure is carried out but the debtor is asked to
reply only if he disagrees with the balance.
Frequently with circularization of debtors, the percentage of debtors who reply is low. With
negative circularization, the percentage is even lower. However, negative circularization
leads to an invalid conclusion as many debtors never reply to any circularization and some
of them will disagree with the balances. Negative circularization provides weak evidence of
the reliability of debtors figure in the sales ledger as many debtors who do not agree with the
balance will not reply.
Where client and debtor are independent of each other, replies to circularization are quite
good evidence. However, there are some limitations in reliability
•• Some debtors reply agreeing balance for any circularization even when there is a
difference. In some cases they sign the reply that they agree with the balance without
checking the purchases ledger. If the reply is from junior members of debtor staff, it is
less reliable from senior’s e.g. chief accountant.
•• Sometimes the debtor will disagree with the balance on clients sales ledger is correct.
Usually this arises through cash and goods in transit. In most businesses, the ledger
is more reliable than the purchases ledger, as sales invoice is posted to sales ledger
at the same time as the goods are dispatched to customer and cash is posted to sales
ledger when it is received usually within a day. However with purchases ledger, there
will be a considerable delay between receiving the goods and posting the invoice to
the purchase ledger because there may be delay in receiving purchase invoice and
delays in checking invoice to goods received note and purchase order. This creates
inaccuracies in customers purchase ledger.
•• Some debtors reply saying that they cannot confirm the balance because of accounting
records they keep. In this case, only the existence of debtor is confirmed.
•• Agreement of balance by debtor does not confirm that it is recoverable e.g. the debtor
may confirm the balance but because of cash flow problems, he is unable to pay it
and becomes a bad debt. Also, debtors who are experiencing cash flow problems may
not reply to the circularization. Nevertheless, this is a serious weakness of debtor’s
circularization. Checking cash received at the year end is best way of verifying the
recoverability of a debt.
•• Although the great advantage over debtor’s circularization is to confirm existence of
debtor, it is time consuming to carry out and because of limitations above. It is a less
efficient way of verifying debtors than other techniques such as looking at aged debtors
at the year end and checking cash received after year end.
•• It is carried out only on a small sample of debtors which could be a very small percentage
of the total valuation of debtors. Therefore there is a problem of sampling risk.

b)
Where a debtor does not reply to circularization, a number of techniques are used to confirm
the existence of such a debtor.
•• Check sales invoices, dispatch notes and order confirmations generated by the company.
This evidence is weak in reliability because it is generated by the company.
•• The best evidence of the existence of the debtor which is available within the company
is correspondence from the debtor such as orders from the debtor which can be found
in sales department and in the credit control.
•• Cheques received are further evidence of existence of debtors. Only the most recent
cheques will be available for auditor to inspect but there should be remittance advices
from customers showing invoices each cheque pays.
•• Other evidence can be obtained from trade directories and telephone directories. This
confirms existence of the business on client’s sales ledger but does not confirm that the
business is a debtor of the client i.e. the debtor balance on the sales ledger could either
be made of fictitious sales invoices or invoices posted to wrong accounts.
•• A further letter could be sent to the debtor to confirm that he received goods from the
client but in the same way the debtor did not reply to the circularization, he could also
not reply to the letter.
•• The debtor could be telephoned and asked if he purchased goods from the client. In
using the telephone, one must be careful that the call is not intercepted by the client.
To check the recoverability of a debt at the year end, the auditor should check its aging. The
auditor should also check cash received between year end and the time of audit visit after
year end. Any year end invoices cleared by cash received since year end can be considered
good as it is unusual for a debtor to request repayment. If some paid since year end is
large, one should check that the cheque has cleared particularly for debtors who have been
outstanding for a long period. The auditor will discuss all old outstanding amounts because
there is likely to be a dispute between the debtor and the client over the amount.
Wilfykil answered the question on April 13, 2019 at 07:22


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