Accounting audit of receivables and payables

During its activities, a company deals with such concepts as accounts receivable and accounts payable.

The correct reflection of mutual settlements with customers, suppliers and other counterparties is as important as the correct maintenance of any other area of accounting.

Accounts receivable are debts to suppliers or goods/services lent to customers.

Accounts payable is a debt owed to a supplier or prepayment received from a buyer.

Accounts receivable and payable arise in the process of purchasing/supplying goods, receiving/supplying services, receiving/supplying financial assistance and other operations.

The amounts receivable and payable shall be reflected on the company's balance sheet and affect the:

• indicators of the company's financial condition;
• indicators of the company's solvency;
• investment attractiveness.

Errors and distortions in these figures mislead the owner and partners of the company (including supervisory authorities and banking institutions) about the real picture of the financial state of the business. For example, a company is confident that its financial statements are correct and applies for a loan. When the company verifies its financial statements, it becomes apparent that there is a discrepancy between the real and financial indicators, which either slows down the borrowing process or leads to a complete rejection by the banking institution.

This means that even before making a decision on a loan, for example, you should bring all your accounting records in order. The easiest way to do this is through auditing. It allows you to quickly identify deviations, violations, and eliminate them before the moment of reporting. 

The most common mistakes include:

• unlawful formation of accounts payable to suppliers (unconfirmed expenses) - the penalty is 18% of the transaction amount + 5%;
• incorrect calculations of personal income tax and social tax (underpayment or overpayment) - the amount of penalty depends on the essence of economic operation; 
• reversal of long-term and short-term accounts receivable (lack of discounting) - penalty 18% of the transaction amount + 5%.

We will give practical advice and recommendations for verifying your company's accounting.

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Which companies shall audit receivables and payables?

The Accounting Law requires all companies to conduct an annual inventory of all balance sheet items before filing their annual income tax return. An inventory of receivables and payables is included in the comprehensive annual inventory.

Therefore, companies shall conduct an audit of accounts receivable and payable at least once a year.

To reduce the risks we talked about at the beginning of the article, our experts recommend unscheduled audits once a quarter.

What documents are checked during the audit of accounts receivable and payable?  

The main purpose of the audit of accounts receivable and payable is not to detect mechanical errors of employees, but to identify such deviations as:

• identification of customers who do not fulfill the payment obligations under the agreement (late payments) and the reasons for these situations;
• the effectiveness of claims work;
• abuse of employees' official duties (a manager sold goods to "his" customer who is not going to pay for the goods);
• non-return / misuse of accountable funds.

The following documents (including but not limited to) will be needed for the audit:  

• accounting policies;
• internal policies;
• contracts;
• primary documents (bills of lading, certificates of work performed);
• calculation of allowance for doubtful debts;
• financial and tax reports (Balance sheet, Statement of financial results, Income tax return);
• other documents not included in the list, but directly related to the formation of debts.

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Stages of the audit, identifying deviations and options for their elimination

Let's focus on the express audit of receivables and payables of a distributor of medicines and medical devices. The company approached us with the task of conducting an express audit of receivables before applying for a loan from a bank.

The audit comprised several stages:

1. Study of the specifics of the company and the main business operations of the company.
2. Review of the accounting policy and internal regulations on accounts receivable and payable.
3. Audit of receivables.

Note: Our experts can draf your accounting policies or internal company policies.

After analyzing the company's balance sheet, we identified the items that will be subject to express audit.

Balance sheet items with receivables:

• Settlements with customers
• Other settlements with employees
• Budget settlements

Balance sheet items with accounts payable:

• Settlements with suppliers
• Reserve for vacations
• Other settlements with participants

Further, we will describe in more detail the procedure for auditing each balance sheet item.

Step 1. Audit of settlements with customers and suppliers

According to our client's internal policy:

• overdue debts are those whose maturity period has exceeded 20 days after the contractual maturity date;
• a debt is considered uncollectible if the limitation period has elapsed (1,095 days).

We made a selection of clients with doubtful debts, whose amount exceeded the threshold of UAH 50K. For each of these clients, we requested reconciliation acts and primary documents, which confirm the debts.

Audit results:

• absence of primary documents (waybills) on accounts receivable for the amount of UAH 560K - risk of recognition of income as fictitious;
• absence of reconciliation acts with 5 buyers for the total amount of receivables of UAH 3.6 mln - risk of non-confirmation of receivables and payables by buyers.

Step 2: Checking the allowance for doubtful debts

Calculation of allowance for doubtful debts is made in accordance with accounting standards. Bad debt provision expenses are accrued and adjusted without deviations from legislative norms.

Audit results: No comments.

Step 3: Other settlements with employee

As of the audit commencement date the company in the accounting account "Settlements with employees and employees on other operations" accounts for the amounts of interest-free loans given to employees for UAH 9,843 mln. The whole amount of accounts receivable is classified by the company as other current receivables and is accounted for in the financial statements under line 1155 "Other current receivables" of Form No.1 "Balance Sheet".

Based on the date of debt repayment specified in agreements with employees, part of the debt, the maturity of which exceeds 12 months from the balance sheet date, should be classified as long-term accounts receivable.

Audit results:

• misclassification of receivables - distortion of data in financial statements;
• lack of discounting of long-term debt - risk of penalties.

Step 4: Budget settlements

The financial statements of the company contain information about the prepayment of taxes to the budget. The analysis of this item showed that the prepayment was made on personal income tax and military tax.

The process of analysis of accounting revealed operations involving the rental payment for vehicles to individuals. When paying the rent, there were withheld and paid personal income tax and military tax from the contractual cost, but no taxes were accrued in the accounts.

Audit results: no accrual of personal income tax and military tax in terms of the purchase of rental services, which led to an unlawful overstatement of taxes prepaid to the budget.

Step 5: Reserve for vacations

We recalculated the amount of vacation provision, which is based on the number of days of unused annual vacation for all employees of the company and the average daily pay per employee. According to the calculation, the amount of vacation reserve was UAH 1.784 mln. In the accounting records as of the date of the audit, the vacation provision in the amount of UAH 1,552 million was accounted for.

Audit results: the difference in vacation provision is UAH 232K

Step 6: Other settlements with shareholders

The company accounts for settlements with participants and settlements on accrued dividends in the accounting account "Settlements with shareholders". As a result, the accounting records show a net balance of settlements on accrued dividends in favor of the founders and settlements on dividends accrued in favor of the company. In addition, no analytical accounting for each member and debtor is maintained.

This does not correspond to the rules of accounting, because the account "Settlements with shareholders" is intended to generalize information about settlements with participants and founders of the company associated with the distribution of equity (dividends, return of shares, etc.). Accounting for accrued dividends, interest, royalties, etc. is carried out on the account "Accounting for accrued income".

However, the accounting records reflect the distribution of profits to pay dividends only in the amount of UAH 10 million, the rest of the profits are not distributed.

However, the number of dividends approved by the minutes of the company's shareholders in the amount of UAH 25.5 mln were accrued and paid amounts of personal income tax and military tax, namely:

• Personal income tax of UAH 25.5 mln x 5% = UAH 1.275 mln.
• Military tax of UAH 25,5 mln x 1,5% = UAH 382,5 thousand.

Only one member was paid UAH 3.576 mln out of the accrued dividends. The rest of the dividends were not paid.

Audit results: the inaccurate reflection of "Settlements with the shareholders". As of the audit date, the company's liabilities toward the shareholders should amount to UAH 20.266 mln.

As a result of the audit, our specialists provided the following recommendations:

1. Develop a receivables and payables policy that allows for "management" of accounts receivable and payable (for example, setting a threshold for the significance of a transaction or defining the parameters for which a transaction should be subject to additional controls).
2. Develop a procedure and rules for reconciliation of mutual settlements with clients, budget, and shareholders.
3. Revise the policy of issuing interest-free loans to employees (do not issue loans with a maturity period of more than one year or develop a mechanism for discounting long-term debts).
4. Automate the calculation of vacation provisions (automation of the accounting system).

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Advantages of auditing accounts receivable and payable and what does it include?

Business owner benefits from the audit of accounts receivable and payable:

• confirmation of the correctness of accounting and tax reporting;
• reducing the risk of non-return of cash financing from the debtor;
• analysis of own solvency and solvency of clients;
• reducing the risk of fraudulent transactions.

The audit of accounts receivable and payable includes:

1. Checking primary documents on the correctness of the receivables and payables.
2. Determination of the correctness of debt classification (short-term or long-term).
3. Confirming/refuting the accuracy of the balance sheet receivables.
4. Verifying the accuracy of bad debt provisioning.
5. Verifying the correctness of the expenses on the overdue debts.

Find out the cost of auditing accounting processes here.

Please see the cost of Robotic Process Automation (RPA) for accounting here.