Introduction
Trade receivables are a critical component of a company’s current assets. They represent the amount owed to the company by customers for goods sold or services rendered on credit. Given their direct impact on liquidity, profitability, and financial stability, ensuring their accuracy, recoverability, and compliance with Indian laws is an essential part of a statutory audit.
This comprehensive guide provides a detailed approach to the statutory audit of trade receivables under Indian laws, addressing common queries and confusions. It also includes an extensive legal framework and practical case studies to illustrate real-world auditing challenges and solutions.
Objectives of Auditing Trade Receivables
- Existence: Confirm that recorded receivables actually exist.
- Valuation: Ensure receivables are recorded at realizable value after appropriate provisions.
- Cut-off Accuracy: Verify transactions are recorded in the correct accounting period.
- Recoverability: Assess the likelihood of collection and adequacy of bad debt provisions.
- Related Party Transactions: Identify and verify transactions with related parties.
- Compliance with Laws: Ensure adherence to relevant legal and accounting frameworks.
Audit Methodology
1. Understanding the Entity & Risk Assessment
- Analyze business model and credit policies.
- Identify risks such as high dependency on few customers, long credit cycles, and bad debts.
2. Substantive Audit Procedures
Existence & Confirmations
- Obtain direct confirmations from customers for outstanding balances.
- Perform alternative procedures for non-responding customers (e.g., reviewing invoices and payments received).
Valuation & Allowances
- Check aging analysis of receivables.
- Verify provisions for doubtful debts and bad debts written off.
Cut-off Testing
- Verify sales transactions around the year-end to ensure proper revenue recognition.
Related Party Transactions
- Identify receivables from related parties and check compliance with disclosure requirements.
Reconciliations
- Match trade receivables with general ledger, subsidiary ledgers, and sales register.
Write-offs and Provisions
- Ensure write-offs are authorized and supported by proper documentation.
Disclosure & Presentation
- Check classification under Schedule III of the Companies Act, 2013.
- Ensure proper disclosure of bad debts, related party transactions, and credit risks.
3. Testing Internal Controls
- Assess internal controls over credit approvals, collection follow-ups, and dispute resolutions.
4. Analytical Procedures
- Compare current year’s receivables with prior periods and industry benchmarks.
- Evaluate receivables turnover ratio and average collection period.
Legal Framework
1. Companies Act, 2013
- Section 128: Requires accurate maintenance of records for receivables.
- Section 129: Mandates fair presentation of trade receivables in financial statements.
- Schedule III:
- Trade receivables to be classified as current or non-current based on the operating cycle.
- Receivables from directors, key management personnel, and related parties must be disclosed separately.
2. Accounting Standards (AS) & Indian Accounting Standards (Ind AS)
- AS 9 (Revenue Recognition): Ensures sales and receivables are recognized when risks and rewards are transferred.
- AS 29 (Provisions, Contingent Liabilities & Contingent Assets): Guides recognition of bad debts and doubtful debts.
- Ind AS 109 (Financial Instruments):
- Requires trade receivables to be measured at amortized cost.
- Provision for expected credit losses (ECL) to be recognized.
3. Standards on Auditing (SAs)
- SA 500 (Audit Evidence): Guides procedures for obtaining sufficient evidence.
- SA 505 (External Confirmations): Deals with confirming receivable balances.
- SA 530 (Audit Sampling): Allows sampling techniques for receivable verification.
4. Income Tax Act, 1961
- Section 36(1)(vii) & Section 36(2): Allows deduction of bad debts only if written off in books.
5. Goods and Services Tax (GST) Compliance
- Ensure GST is accounted for correctly on taxable sales and input tax credits.
Practical Examples
Example 1: Confirmation Discrepancy
- Scenario: Customer balance confirmation shows ₹10 lakh, but books show ₹12 lakh.
- Audit Approach:
- Reconcile customer account and review supporting invoices.
- Identify and adjust any errors.
- Insight: Discrepancies can arise due to cut-off errors or unrecorded settlements.
Example 2: Long Outstanding Receivables
- Scenario: ₹50 lakh outstanding for over 2 years with no follow-ups.
- Audit Approach:
- Assess collectability and review correspondence with the customer.
- Verify provision for doubtful debts.
- Insight: Uncollectible amounts should be provided for or written off timely.
Example 3: Related Party Transactions
- Scenario: ₹5 crore receivable from a related entity with no movement.
- Audit Approach:
- Verify board approvals and disclosure compliance.
- Assess if the transaction is at arm’s length.
- Insight: Non-disclosure of related party transactions can lead to regulatory scrutiny.
Example 4: Fake Sales Entries
- Scenario: Sudden increase in sales just before year-end.
- Audit Approach:
- Review sales invoices, delivery notes, and payment receipts.
- Confirm sales reversals post year-end.
- Insight: Fake sales inflate revenue and profits.
Example 5: Incorrect Cut-Off Treatment
- Scenario: Sales of ₹20 lakh recorded in March but delivered in April.
- Audit Approach:
- Verify shipping documents and invoice dates.
- Adjust revenue recognition if necessary.
- Insight: Incorrect cut-off results in misstatement of profits.
Example 6: Misclassification of Advances as Receivables
- Scenario: ₹10 lakh advance from customers incorrectly classified as trade receivables.
- Audit Approach:
- Verify supporting documents and customer confirmations.
- Ensure correct classification as advances.
- Insight: Misclassification distorts working capital analysis.
Example 7: Bad Debt Provisioning
- Scenario: No provision for bad debts despite multiple defaulting customers.
- Audit Approach:
- Review aging analysis and default history.
- Ensure provision as per Ind AS 109.
- Insight: Understatement of bad debts inflates profitability.
Example 8: Trade Receivables Factoring
- Scenario: Company factors ₹2 crore of receivables but records them as outstanding.
- Audit Approach:
- Verify factoring agreements and cash receipts.
- Adjust books for derecognition of factored receivables.
- Insight: Non-recognition of factoring arrangements misrepresents financial health.
Example 9: Overstatement of Receivables
- Scenario: ₹1 crore of disputed receivables not written off.
- Audit Approach:
- Assess legal claims and chances of recovery.
- Recommend write-off if recovery is doubtful.
- Insight: Overstatement distorts liquidity position.
Example 10: Incorrect GST Accounting on Receivables
- Scenario: GST liability not accounted for on credit sales of ₹5 crore.
- Audit Approach:
- Verify GST invoices and tax filings.
- Ensure appropriate tax treatment.
- Insight: Incorrect GST accounting leads to tax penalties.
Conclusion
A thorough audit of trade receivables ensures accurate reporting, risk mitigation, and regulatory compliance. By employing substantive and analytical procedures, auditors can detect misstatements, fraud, and control weaknesses, ensuring the true financial health of a company is reflected in its books.
Author
CA Sourabh Kothari (C.A., B.Com)
He is currently working as Partner – Risk and Transaction advisory with a renowned firm in Jaipur having experience in Internal Audit, IFC Audit, Business consultancy, Due Diligence and Management consultancy.
E-mail: Sourabh.kothari@jainshrimal.in | LinkedIn: Sourabh Kothari
