## Audit of Trade Receivables (Debtors)

Trade receivables are susceptible to overstatement (fictitious sales, inadequate provisioning) and understatement of provisions (inflating profits by understating bad debt expense).

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### Two-Layer Approach: Test of Controls + Substantive Procedures

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#### A. Test of Controls

Purpose: Assess the effectiveness of internal controls over sales and debtor collection before deciding the extent of substantive testing.

Key controls to evaluate:

Control Area	What Good Controls Look Like
Authorisation	Sales made only to bonafide, approved customers
Recording	All sales properly and timely recorded
Segregation of Duties	Person recording sales ≠ person collecting cash
Follow-up Policy	Defined policy for following up overdue debtors and raising provisions
Collection	Debtors collected regularly on time
Settlement approval	Debts settled/written off only with authority of a designated official

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#### B. Valuation — Provision for Doubtful Debts

This is the highest-risk area in debtor auditing.

Step 1: Review the provisioning process

Review company's process to derive provision for doubtful debts.
Compare with the method used in the previous year — assess consistency.

Step 2: Obtain and Analyse the Ageing Report

Obtain an ageing report covering both debit and credit balances.
Credit balances in debtors (advances received, overpayments) must be assessed separately.

Step 3: Review Litigated Debtors

Obtain a list of debtors under litigation; compare with the prior year list.
Assess whether provisions against these debtors are adequate.

Step 4: Check Provision Rates

Verify provisions are made at appropriate rates relative to age of debt:

Ageing Bucket	Indicative Provision Rate
0 – 6 months	~5%
6 months – 1 year	~10%
1 year – 2 years	~20–50%

(Actual rates depend on company policy, industry, and debtor-specific assessment.)

Step 5: Movement Schedule Analysis

Prepare/obtain a schedule of movement of bad debts:
Opening provision + Additions − Utilisations (debts written off) = Closing provision
Compare bad debt / sales ratio of the current year vs. prior year — a declining ratio despite aging book may signal under-provisioning.

Step 6: Verify Write-offs

Verify that debt write-offs were done with proper authority (approval from designated official or Board).

Worked example

### Example 1

Example — Ageing Analysis and Provision Adequacy:

Ageing Report as at 31 March:

Bucket	Amount (₹ lakhs)	Policy Rate	Provision Required
0–6 months	200	5%	10
6m–1y	80	10%	8
1y–2y	40	30%	12
Total	320		30

Management has made a provision of ₹20 lakhs. Auditor identifies a shortfall of ₹10 lakhs — this is an audit finding requiring management to increase the provision.

### Example 2

Example — Consistency Test on Provisioning Method:

In PY, management used a flat 5% provision on all debtors. In CY, management switched to an ageing-based method without disclosing the change. The bad debt provision dropped from ₹25 lakhs to ₹18 lakhs despite gross debtors increasing.

Auditor raises: (1) Was the change in method justified? (2) Is the impact on profit material? (3) Has the change been disclosed as a change in accounting policy per AS 5?

### Example 3

Example — Segregation of Duties Weakness:

During test of controls, the auditor finds that the same person who raises sales invoices also posts cash receipts from debtors. This means one person could raise a fictitious invoice and then conceal it by posting a fictitious receipt.

Auditor response: This is a significant control deficiency → increase substantive testing on debtors (larger confirmation sample, more detailed review of journal entries on debtor accounts).

⚠️ Common exam mistakes

Only reviewing debit balances in the ageing report and ignoring credit balances in debtor accounts — credit balances may indicate advance receipts or potential fraud.
Accepting the provision method as consistent without comparing it to the prior year working — a change in method that reduces provisioning without disclosure inflates profits.
Not separately examining debtors under litigation — these require specific assessment rather than being pooled into the ageing buckets.
Treating debt write-off as an accounting matter only — failing to verify that write-offs were approved by a competent authority is a control failure that could mask misappropriation.
Comparing bad debt absolute amounts year-on-year without normalising for changes in sales volume — always use the bad debt/sales ratio for a meaningful comparison.
Not considering credit balances (i.e., customers who have overpaid or paid in advance) which sit within the debtor ledger — these need reclassification to creditors.

Reference:

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