Chapter 9Chapter 9

Auditing Revenue and Auditing Revenue and Related AccountsRelated Accounts

IntroductionFinancial transactions processing cycles

•Revenue

•Acquisition/payment

•Payroll

•Financing

•Cash and short-term investments

Overview of Revenue Cycle

Internal Control Objectives

The Revenue Accounting System

•Receive a customer purchase order

•Check inventory stock status

•Generate back order

•Obtain credit approval

•Prepare shipping and packing documents

•Ship and verify shipment of goods

•Prepare the invoice.

•Send monthly statements to customers

•Receive payments

Assessment of Environment RiskAudit steps:

•update info on business risk

•understanding of internal controls

•document accounting applications

•preliminary assessment of environment risk

•if control risk at maximum; determine types of likely misstatements

•develop procedures to lower control risk

•perform audit tests, and modify control risk if justified.

Inherent Risk

Improper Revenue Recognition Schemes

•Recognition of revenue on shipments that never occurred.

•Hidden “side letters” allowing returns.

•Consignment sales shown as final sales.

•Shipment of unfinished products.

•Shipment of product before customers agreed to delivery.

Inherent Risks: Sales Transactions

Difficult Audit IssuesDifficult Audit Issues

When to recognize revenue.

Impact of unusual terms of sale.

All goods sold were shipped.

Handling of recourse sales.

The Control Environment: Effect on Sales

Focus On:

•Integrity of management

•Financial condition of the organization

•Financial pressures facing the organization

•Management incentives to achieve various financial goals

The Control Environment: Effect on Sales

Sources of useful information in evaluating control environment:

•Financial press articlesFinancial press articles

•Trade journal articlesTrade journal articles

•Industry growth statisticsIndustry growth statistics

•Preliminary analytical proceduresPreliminary analytical procedures

Understanding Internal Controls

Walk-through of the processing.

Inquiry.

Observation.

Review of the client’s system documentation.

MUST DOCUMENT IN WORKING PAPERS.MUST DOCUMENT IN WORKING PAPERS.

Developing an Understanding

Existence/Occurrence

Completeness

Rights/Obligations

Valuation

Presentation and Disclosure

Maintaining Accounting Integrity

Evaluating Control RiskMonitoring Controls.

Control Structure Regarding Returns, Allowances, and Warranties.

Importance of Credit Policies Authorizing Sales.

Assessing & Documenting Environment Risk

Testing for the Operating Effectiveness of Control Procedures.

Reassessment of Control Risk.

Linking Environment Risk Assessment and Substantive Testing.

Substantive Testing in the Revenue Cycle

Planning for Direct Tests of Account Balances.

•Account balance relationships.

•Risk of material misstatement.

•Makeup of the account balance.

•Persuasiveness of procedures.

•Cost of the procedures.

•Timing of procedures.

•Determining optimal mix of audit procedures.

Audit Objectives and Assertions

•Existence and Occurrence.

•Completeness.

•Valuation.

•Rights and Obligations.

•Presentation and Disclosure.

Standard Accounts Receivable Audit Procedures•Aging accounts receivable.

•Confirming receivables with customers.

•Related-party receivables

•Cutoff tests

•Non-current receivables

•Adjusting audit program to the environment.

•Confirmation of sales.

Confirmations•When required.

•Types of confirmations.

•As audit evidence.

•Accuracy and security of process.

•Sample selection.

•Sampling unit.

•Undeliverable confirmations.

Confirmations (cont.)•Follow-up to non-responses: Positive confirmations

•Alternative Procedures:

Subsequent collection.

Supporting documentation.

•Follow-up to non-responses.

•Follow-up procedures: exceptions noted.

•Interim date confirmations.

Confirmations (cont.)•Summarizing Confirmation Work

•Related Party Receivables.

•Cutoff Tests.

•Noncurrent Receivables.

•Sold, Discounted, and Pledged Receivables.

•Adjusted Audit Program to the Environment.

Allowance for Doubtful Accounts

•Review and test the process.

•Develop an independent model.

•Review subsequent events or transactions.

•Write-offs.

Analytical Procedures•Ratio Analysis

Notes Receivable

•Trend Analysis

•Reasonableness Tests