American Institute of Accountants. Committee on Auditing Procedure

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University of MississippieGroveAmerican Institute of Accountants Deloitte Collection1942Confirmation of public utility accounts receivable;Statements on auditing procedure, No. 14American Institute of Accountants. Committee on Auditing ProcedureFollow this and additional works at: https://egrove.olemiss.edu/dl_aiaPart of the Accounting Commons, and the Taxation CommonsThis Article is brought to you for free and open access by the Deloitte Collection at eGrove. It has been accepted for inclusion in American Institute ofAccountants by an authorized administrator of eGrove. For more information, please contact egrove@olemiss.edu.Recommended CitationAmerican Institute of Accountants. Committee on Auditing Procedure, "Confirmation of public utility accounts receivable; Statementson auditing procedure, No. 14" (1942). American Institute of Accountants. 229.https://egrove.olemiss.edu/dl_aia/229Statements on Auditing Procedure December 1942 No. 14 • Issued by the Committee on Auditing Procedure, American Institute of Accountants, 13 East 41st Street, New York 17, N. Y. Confirmation of Public Utility Accounts Receivable Copyr igh t 1 9 4 2 by Amer i can I n s t i t u t e of Accoun tan t s Query: The XYZ Corporation is a utility with a satisfactory system of internal control and has approximately 50,000 residential, com-mercial, rural, industrial, and other customers. Is it practicable and reasonable to communicate directly with these customers as a matter of regular procedure in the examination of its financial statements, and if so, how extensive should the confirmation be? ON OCTOBER 18, 1939, the special committee on auditing pro-cedure of the American Institute of Accountants recommended that, wherever practicable and reasonable, confirmation of accounts receivable by direct communication with the debtors shall be re-garded as generally accepted auditing procedure in the examination of the accounts of a concern whose financial statements are accom-panied by an independent certified public accountant's report; and that the method, extent and time of confirming receivables in each engagement, and whether of all receivables or a part thereof, be de-termined by the independent certified public accountant as in other phases of procedure requiring the exercise of his judgment. The aggregate balance of all receivables of utilities usually aver-ages 2 per cent of all assets and about 10 per cent of annual revenues. Accumulations of receivables materially beyond these percentages re-sult from unusual conditions and would invoke inquiry, apart from the question of confirmation. The average account balance for all accounts receivable of utilities seldom averages more than $10 per customer. In dealing with the specific question, it is desirable to discuss it in relation to the receivables under two general categories, namely: I. The large accounts — Municipal, other utilities, industrial and miscellaneous accounts receivable II. The "mass" accounts—Residential, commercial, rural and merchandise accounts receivable 107 Statements on Auditing Procedure Experience indicates that on the average a little less than one-half of the aggregate electric utility receivables is represented by the first group of accounts, consisting of industrial and other large accounts, and that for utilities other than electric the proportion is usually lower. It is recognized that many utilities do not maintain general ledger control accounts classifying receivables into these two categories; however, most utilities ordinarily maintain sufficient subdivisions in the detail records to permit such a classification. I . T H E LARGE ACCOUNTS—MUNICIPAL, OTHER UTILITIES, INDUSTRIAL AND MISCELLANEOUS ACCOUNTS RECEIVABLE These large accounts are with organizations which maintain com-plete accounts and, accordingly, are in a position to express an in-formed opinion on the correctness of charges made against them. The methods of computation for service rendered to these customers are often very technical, complicated, and difficult to test-check. While internal control is important and must be considered in con-nection with these accounts, it cannot be relied upon as greatly by the auditor to serve his purposes as in the case of "mass" accounts dis-cussed later. Furthermore, because of the size of individual accounts it is possible for irregularities, if any should exist, to be confined to relatively few accounts. The committee accordingly believes that the extent of confirmation of these accounts receivable should be similar to that of the accounts of an industrial enterprise where comparable conditions prevail. I I . T H E "MASS" ACCOUNTS — RESIDENTIAL, COMMERCIAL, R U R A L AND MERCHANDISE ACCOUNTS There are many factors which distinguish this class of accounts from those of the first group. The average number of "mass" ac-counts of a utility is very large in relation to the gross revenues. The number of these accounts varies from a few thousand for a small pub-lic utility to hundreds of thousands in the larger utilities. The in-dividual balances average a few dollars each; even including mer-chandise instalment accounts an average of $5.00 per customer is 1 ordinary. Utilities follow the policy of disconnecting service if the "mass" accounts are not promptly paid and in many cases also grant more than ordinary discounts for prompt payment, with the result that the aggregate amount of utility service receivable balances not derived from the current month's billings is generally not significant. 87 Confirmation of Public Utility Accounts Receivable The characteristics of these accounts create a large volume of small and simple repetitive operations which require special skill and effi-ciency for economical performance. As a result these operations are ordinarily assigned to separate employees or departments which oper-ate independently of each other. In the particular case under con-sideration it was found that the more important separation of duties among employees and departments was as follows: (a) Installation and removal of meters or stations (b) Meter reading (c) Billing and maintenance of receivable ledgers (d) Receiving payment on accounts (e) Investigation and collection of delinquent accounts In addition to the above segregation of major duties among inde-pendent departments or employees, further secondary checks were employed; for example, rotation of meter readers among routes, checking of new accounts against those previously written off, main-tenance of control accounts by employees other than those assigned to detail accounts, requirements that vacations be taken by cashiers, and approval of discounts forfeited. These segregations of duties among dissociated employees create an internal control which prevents any particular employees from controlling a sufficient number of the operations to conceal material irregularities. Consequently, only relatively petty irregularities are experienced in these accounts and these are ordinarily detected in the normal operation of the system of internal control. It is believed in this case that a sufficient separation of duties exists to assure sub-stantial accuracy and to avoid significant irregularities in the main-tenance of the "mass" accounts. In reviewing such systems, the pres-ence or absence of a particular feature of the system should not be stressed unduly unless it is likely to be the source of a fundamental weakness. It is the effectiveness of the system as a whole which is important and which justifies reliance upon the resulting accounts. In all essential respects, where applicable, controls comparable with the foregoing are also maintained over merchandise accounts receivable. The company collects merchandise instalments as part of its monthly bill for service and, in addition to disconnecting service if the monthly bill is not paid, it follows the practice of repossessing the merchandise after an instalment is thirty days overdue. As a re-sult the amount of overdue accounts is negligible. Experience gained from reviews and certain test checks, where ap-plicable, of systems of internal control such as the one described indi-cates that the "mass" accounts receivable balances maintained by 97 Statements on Auditing Procedure most utilities are reliable for financial statement purposes, and that, where the system in operation is good, test confirmation is not neces-sary for the purpose of checking the credibility of the company's representations as to their authenticity. Where the conclusion is reached for a specific utility that the sys-tem in operation is good, experience has nevertheless indicated the desirability of making a small sample or test circularization as an additional check upon the functioning of the internal control. In the case of the XYZ Corporation, which has a satisfactory system of con-trol and approximately 50,000 "mass" accounts receivable with cus-tomers and approximately one-half that number of accounts having unpaid balances, it is believed that a confirmation of a few hundred accounts would be fully adequate for this purpose; and that, in view of the purpose of the test, namely, to provide an additional check upon the functioning of the internal control, such a test confirmation is desirable even in cases in which test confirmations may be made by internal auditors employed by the utility. The division of duties comprising internal control will vary among utilities according to type of utility and concentration of activities, and it should be borne in mind that where a satisfactory system of internal control does not exist, a larger portion of the accounts should be confirmed, the extent thereof being dependent upon the circumstances of the particular situation. COMMITTEE ON AUDITING PROCEDURE SAMUEL J . BROAD, Chairman J . N . AITKEN, J R . PERCIVAL F . BRUNDAGE FRED J . DUNCOMBE GEORGE P . ELLIS IRA N . FRISBEE FRANK W I L B U R M A I N P . W . R . GLOVER VICTOR H . STEMPF EDWARD A . KRACKE GEORGE WAGNER N O R M A N J . LENHART J O H N A . LINDQUIST J O H N L . CAREY, Secretary 89 

Confirmation of public utility accounts receivable; Statements on auditing procedure, No. 14

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Confirmation of public utility accounts receivable; Statements on auditing procedure, No. 14

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