How can trade receivables be effectively tested?

Using direct confirmations of balances with customers is an effective method for testing trade receivables because it provides independent evidence regarding the existence and accuracy of the amounts reported in the financial statements. This process involves obtaining written responses directly from customers regarding the outstanding amounts they owe. It helps in verifying not only the correctness of the recorded balances but also in assessing the collectibility of those receivables.

Direct confirmations can help identify any discrepancies between what the entity believes is owed and what the customer acknowledges, thus allowing auditors to detect potential misstatements or issues with the credit risk associated with trade receivables. This approach strengthens the reliability of the audit evidence obtained, as the information comes directly from an external party, removing potential biases or inaccuracies that may arise from internal records.

Other methods, such as conducting informal surveys of customer satisfaction or reviewing previous financial records alone, do not provide the same level of assurance regarding the existence and valuation of receivables. Assuming all balances are collectible disregards the risks related to credit losses and does not provide any substantive evidence to support the reliability of the amounts stated in the financial records. Hence, direct confirmations stand out as the most robust approach in testing trade receivables effectively.