All of us as a part of audit, verify and ask questions about outstanding debtors with the clients without knowing the concept and reson behind such verification. I will try to share my knowledge on this in a simple way.
We, generelly ask whether there are debtors oustanding more than 180 days and whether it is bad and to be written off. We will take an example of a company having 100 CR turnover, which will have marketing or sales persons operating for sales promotion. They bring in new customers, tie up them with the company and over a period of time as the sales order improves, company starts allowing them credit for 30 / 60 days. Now if the customer doesnt settle the account and if untraceable, company has to write off it as bad debt. Amount invloved may be around (apprx) 2 to 5 lakhs for that customer.
Assume the same amount is bad in 5 branches of the company having 20 cr turbover (100 CR total), total comes around 10 to 20 lakhs. Sometimes company has no other go than writing off the debt.
Now comes the actual question why we have to verify it. Out of 20 CR sales in a branch there will be 4-5 sales agents. And some agents having no ethics may offer the product to people known to them (but unknown to the company) may help them get the product on credit and may have some arrangements with them as pre planned. Company as a part of expansion may sometimes doesnt verify the background and without collateral sells the product on guarantee of the agent.
If the company writes off the debt in preperation of financials, agents may take advantage and indulge in such unethical behaviours further more. And if the company easily writes off the debt it thinking that its bad, company will suffer loss which will have impact on profit and in turn on taxes.
To avoid such practices, an audit is carried out with internal as well external confirmations. And any unusual transactions of such nature are questioned.
Hope it was useful!
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