Assumptions Used to Estimate the Allowance for DoubtfulAccounts

A commercial furniture wholesaler reserves for its allowance fordoubtful accounts based on standard reserve percentages supportedby historical collection experience. (An ageing of accountsreceivable approach) Management uses the same process forestimating the allowance for doubtful accounts (the “reserve”), asit did in the prior year. (They are consistent) As part of its riskassessment procedures, the engagement team identified the followingrisk of material misstatement related to the valuationassertion:

• The entity may not appropriatelyupdate its reserve policy (including updates to reservepercentages) for changes in circumstances.

Note that the engagement team may have identified additionalrisks of material misstatement related to the valuation assertionidentified as part of its risk assessment procedures; however, thisexample focuses on this specific risk of material misstatement forillustrative purposes. In addition, this risk was not identified asa fraud risk.

The engagement team obtained the following evidence from theaudit procedures performed to address this risk:

The current-year reserve as a percentage of gross receivables isconsistent with prior years, although there was an increase inrevenues, gross receivables, and the related reserve.

Bad debt expense has remained consistent as a percentage ofgross revenue over the past several years.

Retrospective review of receivable collections indicates thatmanagement’s reserves have historically been accurate.

Economic conditions have been fairly stable and are predicted toremain stable.

Revenues increased substantially year over year as a result ofthe introduction of a new product line.

The new product line is marketed toward customers in therestaurant industry, in which the entity does not currently have anestablished customer base.

The restaurant industry generally has a higher rate of businessfailure than other customer segments.

The entity’s collections experience has primarily been withcustomers in the retail and professional services industries; theentity has very little collections experience with the new productline, given the recent launch.

Approved sales terms have not changed year to year (e.g., salespersonnel may offer an extension of credit of up to 100 percent ofthe purchase price consistent with prior year, creditworthiness isdetermined in the same manner, payment terms are consistent withprior year).

Sales of the new product line are more frequently 100 percentfinanced versus sales of the existing product lines, resulting inan increase in gross receivables

Competitors who manufacture similar restaurant furnitureproducts have higher reserves as a percentage of their tradereceivables.

Required:

In a well-developed short report (I would suggest 3paragraphs):

1. Identify and summarize thecorroborative and contradictory audit evidence in the above case.(You may use a Table or bullet points)