Discuss the strength and weaknesses of debtor confirmations as audit evidence for MSHG.
As noted earlier, this suggested answer does not provide you with a reference to the applicable ASA which should guide your response … you should be able to locate the ASA and indicate which paragraphs are being illustrated by each type of evidence identified below … you have already been referred to the ASA on external confirmations (this is simply another specific example). Not everything in the suggestion below is in the ASA – some you need to connect with the discussion in the text (and your knowledge of business processes more generally).
Debtor confirmations would provide evidence about the existence assertion for accounts receivable at MSHG. If the debtor replies with an affirmative answer, they provide external evidence that they owe MSHG for services rendered.
Debtor confirmations also provide evidence about the rights and obligations assertion, because they give evidence about whether the amounts were owed to MSHG companies. They do not provide reliable evidence about the valuation and allocation assertion because the debtor does not provide any more assurance that they intend to pay the account, although they may note that there is an error in the account balance.
The balance of receivables for Shady Oaks is material, and although payment terms are 14 days, many of the smaller accounts are more than 60 days overdue. This suggests that procedures at Shady Oaks for approval of credit and collection of debtors are not very effective.
Debtors confirmations could be sent to the large balances (60% is owed by 5 medical practitioners) to obtain evidence about their existence. However, further procedures would be required to gather reliable evidence about their valuation. It is not stated how long these accounts have been outstanding. If they are within 14 days, it is less likely that there are significant doubts about their eventual recovery. However, a subsequent receipts review would provide additional evidence which would be necessary because of the material nature of the accounts.
The smaller accounts, 40% of the balance, appear to be more likely to be in doubt because most are well over the allowed 14 days. Debtor’s confirmations would provide evidence about their existence, but other procedures would be required for the valuation assertion. As the allowance for doubtful debts is taken directly against the trade receivables account, the auditor would need to review the transactions and assess their reasonableness in light of the apparently poor credit control. Subsequent receipts review and analysis of the characteristics of the debtors would also provide evidence about their valuation.