10-1.Tests of details of financial balances are designed to determine the reasonablenessof the balances in sales, accounts receivable, and other account balances which areaffected by the sales and collection cycle. Such tests include confirmation ofaccounts receivable, and examining documents supporting the balance in theseaccounts.Tests of transactions for the sales and collection cycle are intended to determinethe effectiveness of internal control structure and to test the substance of thetransactions which are produced by this cycle. Such tests would consist ofexamining sales invoices in support of entries in the sales journal, reconciling cashreceipts, or reviewing the approval of credit.The results of the tests of transactions will be used to affect the procedures,sample size, timing and particular items selected for the tests of details of financialbalances (i.e., an effective internal control structure will result in reduced testingwhen compared to the tests of details required in the case of an inadequate internalcontrol structure).10-2.There are two common types of confirmations used for confirming accountsreceivable: “positive” confirmations and “negative” confirmations. A positiveconfirmation is a communication addressed to the debtor requesting him toconfirm directly whether the balance as stated on the confirmation request iscorrect or incorrect. A negative confirmation is also a communication addressedto the debtor, but it requests a response only when the debtor disagrees with thestated amount.A positive confirmation is more reliable evidence because the auditor can performfollow-up procedures if a response is not received from the debtor. With anegative confirmation, failure to reply must be regarded as a correct response eventhough the debtor may have ignored the confirmation request.Offsetting the reliability disadvantage, negative confirmations are less expensiveto send than positive confirmations, and thus more of them can be distributed forthe same total cost. The determination of which type of confirmation to be sent isan auditor’s decision, and it should be based on the facts in the audit. Thefollowing are the most important circumstances where positive confirmationsshould be used:CHAPTER10SUBSTANTIVE TESTS OFRECEIVABLES AND SALES
10-2 Solutions Manual to Accompany Applied Auditing, 2014 Edition1.There are a small number of large accounts which account for a significantportion of total accounts receivable.2.There are suspected conditions of dispute, inaccuracy, or irregularity. Thiswould be the case when internal controls are considered inadequate or ifprior year’s audit test results are unsatisfactory.3.The rules of certain regulatory agencies require them. This is the case forbrokers and dealers in securities.
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