During your examination of the accounts receivable of Hope Ranch, a new client, you notice that one account is much larger than the rest, and you therefore decide to examine the evidence supporting this customer’s account. Comment on the relative reliability and adequacy of the following types of evidence:
a. Computer printout from accounts receivable subsidiary ledger.
b. Copies of sales invoices in amount of the receivable.
c. Purchase orders received from customer.
d. Shipping documents describing the articles sold.
e. Letter received by client from customer acknowledging the correctness of the receivable in the amount shown on client’s accounting records.
f. Letter received by auditors directly from customer acknowledging the correctness of the amount shown as receivable on client’s accounting records.
Included in the financial statements are a variety of accounting estimates (e.g., allowance for doubtful accounts, obsolete inventory, warranty liability). Audit procedures must be designed to obtain evidence about the assertions of management related to all accounts, including those based on accounting estimates.
List three approaches to auditing accounting estimates. Provide an example of how an auditor might apply each of the three approaches in auditing the allowance for doubtful accounts, which management has established at 1 percent of credit sales.
Discuss the meaning of the valuation or allocation assertion as it relates to the allowance for doubtful accounts.
Discuss factors that bear on whether the allowance for doubtful accounts is likely to be an account with high inherent risk.