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44 Cards in this Set
- Front
- Back
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revenue cycle Process of:
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Process of: Receiving a customer’s order Approving credit for a sale Determining whether goods are available for shipment Shipping the goods Billing the customers Collecting cash Recognizing effect of this process on other related accounts |
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Revenue Cycle Significant accounts include
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Significant accounts include revenue and accounts receivable Evidence is obtained for each financial statement assertions Relevance of assertions varies with accounts and clients More relevant assertions:Have risk of material misstatementRequire higher-quality audit evidence |
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Performing Risk Assessment Procedures in the Revenue Cycle Requires information about: |
Requires information about: Inherent risks at the: Financial statement levelAccount and assertion levels Fraud risks Feedback from audit team’s brainstorming session Strengths and weaknesses in internal control Results from preliminary analytical procedures |
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Inherent risk: revenue Recognition Criteria determined by SEC for revenue recognition |
Criteria determined by SEC for revenue recognition: Persuasive evidence of an arrangement should exist Delivery should have occurred, or services should have been rendered The seller’s price to the buyer should be fixed or determinable Collectability should be reasonably assured A new revenue recognition standard will soon be in place; read the Emerging Issues feature on this topic. |
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Revenues: Identifying Inherent Risks Timing of revenue recognition - |
Important inherent risk related to revenue transactions
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Following information is required to audit revenue cycle
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Organization’s principal business Earnings process and nature of obligations that extend beyond normal shipment of goods Impact of unusual terms, and when title passes to customer |
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Revenues: Identifying Inherent Risks
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Right of customer to return a product, as well as returns history Contracts that are combinations of leases and sales Proper treatment of sales transactions made with recourse or that have an abnormal or unpredictable amount of returns |
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Accounts Receivable: Inherent Risks
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Receivables pledged as collateral against specific loans with restricted use Receivables incorrectly classified as current when likelihood of collection during next year is low Collection of a receivable contingent on specific events that cannot currently be estimated Payment not required until purchaser sells product to its end customers Accounts receivable aged incorrectly, and potentially uncollectible amounts not recognized Orders accepted from customers with poor credit, but allowance for doubtful accounts not increased accordingly |
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Some Fraud Schemes uncovered by the SEC and PCAOB
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Recognition of revenue on shipments that never occurred Hidden side letters giving customers an irrevocable right to return the product Recording consignment sales as final sales Creation of fictitious invoices Shipment of more product than customer ordered Early recognition of sales that occurred after end of fiscal period |
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AUDITOR’S ROLE IN IDENTIFYING FRAUD RISK FACTORS
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Assessing motivation to enhance revenue because of either internal or external pressuresReviewing financial statements through preliminary analytical procedures Recognizing that not all of the fraud will be instigated by management Becoming aware of representations made by management to analysts Determining whether company’s performance is significantly different from rest of the industry or economy Determining whether company’s accounting is being investigated by organizations such as the SECConsidering management compensation schemes Determining whether accounting functions are centralizedIf not, assessing if decentralization is appropriate Assessing whether company engages in complex sales arrangements Assessing whether company has a history of aggressive accounting interpretations Determining that an uninterrupted history of growth in earnings per share or revenue might provide incentives to continue to show that growth Determining if client has numerous manual journal entries affecting revenue process |
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Lapping – Common Fraud Technique
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Technique used to cover up embezzlement of cash Stealing cash collection from a customer and crediting him from another customer's paymentThis process continues and at least one customer’s account is always overstated Occurs when duties are inadequately segregated |
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Identifying Control Risks
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Requires understanding of internal controls for integrated audits and financial statement only audits. Important note is that an understanding is required by GAAS for ALL audits Such understanding is gained by means of:Walkthrough of the processInquiryObservationReview of client’s documentation |
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Controls Related to Existence/Occurrence Providing reasonable assurance that sale and accounts receivable are recorded only when: |
Shipment has occurred Primary revenue producing activity has been performed
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Mitigating risk that unearned revenues are recorded
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Distributing monthly statements to customersUnusual transactions require a high level of management review
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Controls Related to Completeness
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Using prenumbered shipping documents and sales invoices and its subsequent accounting Immediate online entry into computer system and assignment of unique identification numberReconciliation of shipping records with billing recordsSupervisory review Reconciliation of inventory with sales |
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Controls Related to Valuation
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Sales made from authorized price listsValuation issues arise with:Unusual or uncertain sales termsReturns and allowances Policies and procedures for identifying and recording returned goodsApproving RecordingValue of goods received |
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PROCEDURES USED IN CONTROLLING A COMPANY’S CREDIT RISK
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Formal credit policyAutomated for most transactionsRequires special approval for large and/or unusual transactions Continuous monitoring of receivables for evidence of increased risk Adequate segregation of duties in credit department |
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Documenting Controls
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AGAIN – An important note is that this is required for ALL audits. IDENTIFYING AND DOCUMENTING is required for BOTH public and private audits!!!Therefore required for:Integrated audits Financial statement only audits
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Performing planning Analytical Procedures
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Step 1: Identify Suitable Analytical ProceduresStep 2: Evaluate Reliability of Data Used to Develop Expectations Step 3: Develop Expectations Step 4 and Step 5: Define and Identify Significant Unexpected Differences Step 6 and Step 7: Investigate Significant Unexpected Differences and Ensure Proper Documentation |
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Develop an audit approach that contains substantive procedures and tests of controls
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Sufficiency and appropriateness of selected procedures will vary for each relevant assertion (especially related to the findings in the control assessment/tests) Customize audit program based on assessment of risk of material misstatement |
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Tests of transaction controls Controls are often tested on audits |
For public companies, financial controls are tested as part of the integrated audit ALWAYS For private companies, controls are tested if the auditor wants to rely on them to reduce substantive testing. |
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Tests of transaction controls General types of controls testing |
Inquiry of personnel performing the control Observation of control performance Inspection of documentation confirming control performance Reperformance of control |
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tests of controls, examples
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Selecting samples of transactions and obtaining supporting documents Reviewing monitoring controls Testing computer access controls Using generalized audit software (GAS) to match documents and look for gaps Reviewing customer complaints Reviewing documents such as reconciliations and management reports noting timely action taken Reviewing sales contracts |
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Analyzing the Results of Tests of Controls If control deficiencies are identified: |
If control deficiencies are identified: Assess to determine their severity Modify the preliminary control risk assessmentDocument the implications of control deficiencies For a public company – consider affect on the audit opinion For all companies – more substantive audit procedures will be needed to provide assurance on the financial statement numbers |
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Analyzing the Results of Tests of Controls If no control deficiencies are identified: |
If no control deficiencies are identified: Determine that preliminary assessment of control risk as low is still appropriate Determine the extent that controls can provide evidence on correctness of account balances Determine planned substantive audit procedures |
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Obtaining Substantive Evidence in the Revenue Cycle Substantive tests are performed to provide evidence that: |
Substantive tests are performed to provide evidence that: All five of the management assertions are applied properly to Sales, Accounts Receivable and the Allowance Some important assertions in this cycle:Sales transactions do exist and are properly valuedAccounts receivable existBalance in allowance account is reasonably valued |
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Revenue - Substantive Analytical Procedures
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Typical audit approach is to test the balance sheet with more with tests of details. While the income statement accounts are mostly tested with analytical tests. Therefore revenue accounts are tested as follows Perform reasonableness test or regression analysis If expectations Differ significantly - Follow up with sufficient appropriate tests of details Do not differ significantly - Reduce tests of details |
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Revenue - Substantive Tests of Details
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Primarily involve inspection of relevant client documentation Focused on existence and valuation assertions (why??) although all five must be tested |
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Revenue - Existence and Valuation Assertions
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Most relevant for revenue accounts Compare quantities billed and shipped with customer orders Verify clerical accuracy of sales invoices to provide assurance on valuation Useful technique - Computerized audit processGAS can be used to:Look for gaps in recorded sales invoice numbersVerify that missing numbers are appropriate and do not represent unrecorded salesProvide evidence on both existence and completion assertions |
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Revenue - Completeness Assertion
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Assures completeness in: Prenumbered shipping Billing documents Audit software can be used to: Look for gaps in recorded sales invoice numbersVerify that missing numbers are appropriate and do not represent unrecorded sales |
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Substantive Testing of Accounts Receivable
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Accounts receivable, on the other hand, is a balance sheet account that is generally tested directly.See some of the standard substantive tests of A/R on the next set of slides.
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Assertions & ProceduresAccounts Receivable- Substantive Test 1
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Valuation Verify mathematical accuracy ARObtain aged trial balance (a subsidiary ledger by customer, with charges categorized by age such as 0-30 days, 31-60 days, etc.) Foot trial balance Compare total AR per aged trial balance to the general ledger |
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Assertions & ProceduresAccounts Receivable- Substantive Test 2
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Existence mainly, some rights and valuation alsoConfirm year-end accounts & notes receivable with debtors Confirmations are required by GAAS unless one of the following is present: Receivables are not material Use of confirmations would be ineffective Environment risk is assessed as low and sufficient evidence is available from using other substantive tests |
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The Confirmation Process
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Prepared using GAS Customers requested to return confirmations directly to auditor’s office Undeliverable confirmations raise auditor’s suspicion regarding existence of recorded receivable Confirmation.com is transforming the way that auditors complete the confirmation processTypes of confirmations Positive: returned to the auditor whether the balance is correct or not, may have the balance listed or may not, Negative: returned only if incorrect |
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Positive vs NegativeThe Confirmation Process, Cont.
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Positive vs Negative Which type provides the best evidence??? Positives are usually used for large balances, errors or irregularities expected To use a negative confirmation, the following must be true low control risk small balances no reason to believe that the confirmation will not be returned if the balance is incorrect Any faxed or telephone confirmations should be followed up by mail. Electronic methods are allowed if set up securely. |
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Unreturned Positive Confirmations If a positive confirmation is not returned, |
If a positive confirmation is not returned, a second and maybe a third are sent.If the confirmation is still not returned, the auditor performs “alternative audit procedures”- look at the client’s records for information on the accountreview accounts for any subsequent cash collections on the accountexamine shipping documentsexamine sales invoicesalso can look at customer purchase requests
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Additional Procedures When Accounts Are Confirmed at an Interim Date Roll-forward procedures include: |
Gathering additional evidence during roll-forward period if receivables confirmed at an interim date Roll-forward procedures include:Comparing customer balances at interim confirmation date with year-end balances and confirming their increaseChecking whether monthly sales, collections, sales discounts, and sales returns and allowances during the roll-forward period appear out of line compared with those of prior periods |
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Assertions & ProceduresAccounts Receivable- Substantive Test 3
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Existence or occurrence, completenessTest cutoff to determine whether sales, receivables recorded in proper period FOB shipping point FOB destination Cutoff is tested by taking a block sample around year end (looking at items a few days before and a few days after year end) |
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Assertions & ProceduresAccounts Receivable- Substantive Test 4
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Valuation, rights Test the allowance:Review collectibility of receivables – by looking at the aging of the accounts, discussion with client, looking at correspondence, subsequent cash receipts, etc.Determine adequacy of allowance for doubtful accountsKeep in mind that this account is an estimate, therefore risk is higher and the auditor needs to be even more careful than usual. |
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Assertions & ProceduresAccounts Receivable- Substantive Test 5
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Testing for Rights and Obligations (ownership and related disclosures):Reviewing all arrangements and obtaining confirmations from banks about contingent liabilitiesInquiring about activities related to receivablesScanning cash receipts journal for relatively large inflows of cash posted from unusual sourcesObtaining bank confirmations, including information on obligations to bank and loan collateralReviewing board of directors’ minutes, generally containing approval for these items
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Assertions & ProceduresAccounts Receivable- Substantive Test 6
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Existence or occurrence, completeness, valuation Perform analytical procedures for reasonableness of sales, receivables balances Collections problems Overstated sales Understated salesEtc. |
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Assertions & ProceduresAccounts Receivable- Substantive Test 7
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Presentation & disclosure Review financial statements to determine Accounts, notes receivable properly classified, described Receivables from related parties need to be disclosed separatelyReceivables sold with recourse, discounted, or pledged as collateral should be disclosed Audit procedures to identify these items include:Management inquiryScan cash receipts journal for large unusual cash inflowsAdditional information obtained from bank confirmations Review board of director minutes, which contain approval for these items Firms have disclosure checklists to follow. The ones for SEC clients are much more complicated than those for private companies. |
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Potential fraud risk factors in revenue cycle
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Excessive credit memos or other credit adjustments to accounts receivable after end of fiscal year Customer complaints and discrepancies in accounts receivable confirmations Unusual entries to accounts receivable subsidiary ledger or sales journal Missing or altered source documents or inability of client to produce original documents in a reasonable period of time Lack of cash flow from operating activities when income from operating activities has been reported Unusual reconciling differences between accounts receivable subsidiary ledger and control account Sales to customers in last month of fiscal period at terms more favorable than previous months Predated or postdated transactions Large or unusual adjustments to sales accounts just prior to or just after fiscal year end |
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