4.8 Substantive Procedures for Revenue & Trade Receivables
Key Takeaways
- Selecting appropriate substantive procedures for a given business scenario is learning outcome 3(f) of ICAB Syllabus 2023, and revenue and receivables are the most frequently examined balances.
- Vouching backwards from the sales ledger to dispatch documentation tests occurrence; tracing forwards from dispatch documentation to the ledger tests completeness.
- Cut-off is tested by matching dispatch dates on goods dispatch notes either side of the year end to the dates the corresponding invoices were recorded.
- Valuation of trade receivables turns on recoverability, tested through aged analysis, after-date cash received, credit notes issued after the year end and correspondence on disputes.
- Customers may disagree with a confirmed balance for legitimate reasons such as cut-off timing differences, payments in transit, disputed invoices and amounts netted off against credit notes.
Substantive Procedures for Revenue & Trade Receivables
Learning outcome 3(f) requires candidates to "select appropriate methods of obtaining evidence from tests of control and from substantive procedures for a given business scenario." Revenue and receivables is the scenario that appears most often, because revenue carries a presumed fraud risk and receivables is usually the largest current asset.
1. Direction of testing: the single most important idea
Two procedures use the same two documents and test opposite assertions. Getting this right is worth marks in almost every sitting.
OCCURRENCE (is recorded revenue real?)
Start: SALES LEDGER / SALES INVOICE ---> Trace back to ---> GDN, customer PO, signed delivery challan
"Vouching" — detects OVERSTATEMENT (fictitious sales)
COMPLETENESS (is all revenue recorded?)
Start: GOODS DISPATCH NOTE (pre-numbered) ---> Trace forward to ---> SALES INVOICE, sales ledger, general ledger
"Tracing" — detects UNDERSTATEMENT (unbilled dispatches)
The rule generalises: start from the accounting record to test occurrence and existence; start from the source document to test completeness.
2. Procedures by assertion — revenue
| Assertion | Substantive procedures |
|---|---|
| Occurrence | Select a sample of recorded sales invoices from the sales journal; agree each to a customer purchase order, an approved sales order, a signed goods dispatch note or delivery challan, and where applicable the Mushak-6.3 VAT invoice. |
| Completeness | Select a sample of pre-numbered GDNs issued during the year and trace each to a sales invoice and to the sales ledger. Perform a sequence check on GDNs and on sales invoices, investigating gaps. |
| Accuracy | Recalculate invoice extensions, discounts and VAT. Agree unit prices to the authorised price master file or the customer contract. |
| Cut-off | Select GDNs issued in the final days before, and the first days after, the year end and check the invoice is recorded in the matching period. Review credit notes issued after the year end for reversals of pre-year-end sales. |
| Classification / presentation | Confirm revenue is analysed correctly between categories and that any agency or principal presentation is appropriate. |
| Analytical evidence | Compare monthly revenue and gross margin against prior year and budget, disaggregated by product line and branch; investigate a spike in the final month. |
A frequent scenario is a surge in sales in the last week of the year. The correct response is not simply to note it: extend cut-off testing on that period, review after-date credit notes for cancellations, and inspect the terms of the transactions for rights of return.
3. Procedures by assertion — trade receivables
| Assertion | Substantive procedures |
|---|---|
| Existence | External confirmation of a sample of balances directly with customers; for non-replies, perform alternative procedures — agree the balance to after-date cash received, or to invoices and dispatch documentation. |
| Completeness | Agree the total of the receivables sub-ledger to the general ledger control account; test the reconciliation and investigate reconciling items. |
| Accuracy, valuation and allocation | Review the aged receivables analysis; test the ageing by re-ageing a sample against invoice dates; examine cash received after the year end; review correspondence on disputed balances; assess the adequacy of the allowance for expected credit losses against the entity's policy and against actual write-off history. |
| Rights and obligations | Inquire whether receivables have been factored, assigned or pledged as security; inspect loan agreements and board minutes for charges. |
| Cut-off | Test that goods dispatched before the year end are included and those dispatched after are excluded. |
| Presentation | Confirm credit balances within receivables are reclassified to payables rather than netted off; check related party balances are disclosed. |
After-date cash: the strongest single procedure
Cash received from a customer after the year end, agreed to the specific invoices making up the balance, is powerful evidence of both existence and recoverability in one step. It is external, documentary and largely outside the client's control. Two cautions: match the receipt to the specific invoices rather than to the balance in total, because a customer paying recent invoices while an old one festers is a warning sign, not comfort; and consider whether a receipt was a genuine settlement or a round-sum payment on account.
4. Why customers disagree with a confirmed balance
A disagreement is not automatically a misstatement. The examinable reasons:
| Reason | Explanation | Auditor action |
|---|---|---|
| Cut-off / goods in transit | Goods dispatched before the year end but received by the customer afterwards | Agree to dispatch documentation and terms of delivery |
| Cash in transit | Customer paid before the year end; the client banked it afterwards | Agree to the after-date bank statement and paying-in slip |
| Disputed invoice | Quality, quantity or pricing dispute | Review correspondence; consider the allowance for expected credit losses |
| Netting of credit notes | Customer has offset a credit note the client has not yet processed | Agree the credit note and check the period it belongs in |
| Clerical error | Posting to the wrong customer account | Trace the posting; test for similar errors |
| Teeming and lading | Receipts misappropriated and concealed by later receipts | Escalate immediately as suspected fraud |
5. Worked application
A Chattogram apparel exporter reports revenue of BDT 2,400 million and trade receivables of BDT 610 million, up from BDT 380 million, while revenue rose only 8%. Receivables days have moved from 58 to 93.
The disproportionate movement points at valuation and cut-off. A defensible programme:
- Obtain the aged receivables analysis; agree the total to the control account and the financial statements.
- Identify the balances driving the increase and confirm them directly with customers.
- Examine after-date receipts to the reporting date of fieldwork, matched to specific invoices.
- Test cut-off on the last two weeks of dispatches and the first two weeks of after-date credit notes.
- Review correspondence with the major buyers for disputes or renegotiated terms.
- Challenge the allowance for expected credit losses against actual write-off experience.
- Consider whether the pattern indicates channel stuffing near the year end, which would be a fraud risk factor requiring escalation to the engagement partner.
An auditor selects a sample of pre-numbered goods dispatch notes issued during the year and traces each one forward to a sales invoice and the sales ledger. Which assertion does this test, and what misstatement does it detect?
A customer replies to a receivables confirmation disagreeing with the balance because it paid the invoice three days before the year end, but the company banked the cheque four days after the year end. What is the correct characterisation and response?
Which single procedure provides the strongest evidence of both the existence and the recoverability of a year-end trade receivable balance?