Post on 16-Dec-2015
transcript
Chapter 10Auditing the
Revenue Process
McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
Revenue Recognition
Revenue is defined as inflows or other enhancements of assets of an entity or settlements of its liabilities (or a combination of both) from delivery or producing
goods, rendering services, or other activities that constitute the entity’s major or central operations.
LO# 1
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Revenue Recognition CriteriaSAB 101
1. Persuasive evidence of an arrangement exists.
2. Delivery has occurred or services have been rendered.
3. The seller’s price to the buyer is fixed or determinable.
4. Collectibility is reasonably assured.
LO# 1
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Fraud Risks in Revenue Recognition
1. Side agreements
2. Channel stuffing
3. Related party transactions
4. Bill and hold sales
LO# 1
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Overview of the Revenue Process
Purchases
Inventory
Credit sales
Accountreceivable
Cashcollection
Purchases
Inventory
Cashsales
Cash SaleCash Sale Credit SaleCredit Sale
LO# 2
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Types of Transactions and Financial Statement Accounts
Affected
Three types of transactions are typically processed through the revenue process:
1. The sale of goods or rendering of a service for cash or credit.
2. The receipt of cash from the customer in payment for goods or services.
3. The return of goods by the customer for credit or cash.
LO# 3
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Types of Transactions and Financial Statement Accounts
AffectedThe revenue process affects numerous accounts in the financial statements. The most significant accounts are:
LO# 3
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LO# 3
Figure 10-2 Flowchart of the Revenue Process—EarthWear Clothiers, Inc.
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Figure 10-2 Flowchart of the Revenue Process—EarthWear Clothiers, Inc. (continued)
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LO# 3
Figure 10-2 Flowchart of the Revenue Process—EarthWear Clothiers, Inc. (continued)
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Customer Sales Order
Contains the details of the type and quantity of products or services ordered by the customer.
Customer Sales Order
Contains the details of the type and quantity of products or services ordered by the customer.
Credit Approval Form
For credit sales, the client must have a formal procedure for investigating the creditworthiness of the customer.
Credit Approval Form
For credit sales, the client must have a formal procedure for investigating the creditworthiness of the customer.
Types of Documents and RecordsLO# 4
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Open-Order Report
A report of all customer orders for which processing has not been completed.
Open-Order Report
A report of all customer orders for which processing has not been completed.
Shipping Document
This document generally serves as a bill of lading and contains information on the type of product shipped, the quantity shipped, and other relevant information.
Shipping Document
This document generally serves as a bill of lading and contains information on the type of product shipped, the quantity shipped, and other relevant information.
Types of Documents and Records
LO# 4
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Sales Invoice
The document is used to bill the customer. This document contains information on the type of product or service, the quantity, the price, and the terms of trade.
Sales Invoice
The document is used to bill the customer. This document contains information on the type of product or service, the quantity, the price, and the terms of trade.
Sales Journal
Once a sales invoice has been issued, the sale needs to be recorded in the accounting records. The sales journal is used to record information about the sales transaction.
Sales Journal
Once a sales invoice has been issued, the sale needs to be recorded in the accounting records. The sales journal is used to record information about the sales transaction.
Types of Documents and RecordsLO# 4
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Customer Statement
This document is mailed to the customer and contains details of all sales, cash receipts, and credit memorandum transactions.
Customer Statement
This document is mailed to the customer and contains details of all sales, cash receipts, and credit memorandum transactions.
Accounts Receivable Subsidiary Ledger
This ledger contains an account and the details of transactions for each customer.
Accounts Receivable Subsidiary Ledger
This ledger contains an account and the details of transactions for each customer.
Types of Documents and Records
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Aged Trial Balance of Accounts Receivable
This report summarizes all the customer balances in the accounts receivable subsidiary ledger. Each account is classified as current or placed into one of several past due categories.
Aged Trial Balance of Accounts Receivable
This report summarizes all the customer balances in the accounts receivable subsidiary ledger. Each account is classified as current or placed into one of several past due categories.
Remittance Advice
This is usually the part of the customer’s bill that should be returned with the payment.
Remittance Advice
This is usually the part of the customer’s bill that should be returned with the payment.
Types of Documents and Records
LO# 4
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Cash Receipts Journal
This journal is used to record the cash receipts of the entity.
Cash Receipts Journal
This journal is used to record the cash receipts of the entity.
Credit Memorandum
This document is used to record credits for the return of goods by a customer.
Credit Memorandum
This document is used to record credits for the return of goods by a customer.
Types of Documents and Records
LO# 4
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Write-Off Authorization
This document authorizes the write-off of an uncollectible account receivable. Final authorization is generally received from the treasurer.
Write-Off Authorization
This document authorizes the write-off of an uncollectible account receivable. Final authorization is generally received from the treasurer.
Types of Documents and RecordsLO# 4
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The Major FunctionsFunctions of the Revenue Process
Order entry Acceptance of customer orders for goods and services into the system in accordance with management criteria.
Credit authorizationAppropriate approval of customer orders for creditworthiness.
Shipping Shipping of goods that has been authorized.
BillingIssuanace of sales invoices to customers for goods shipped or services provided; also, processing of billing adjustments for allowances, discounts, and returns.
Cash receipts Processing of the receipt of cash from customers.
Accounts receivableRecording of all sales invoices, collections, and credit memoranda in individual customer accounts.
General ledgerProper accumulation, classification, and summarization of revenues, collections, and recivables in the financial statement accounts.
LO# 5
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Key Segregation of DutiesLO# 6
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Inherent Risk Assessment
The four inherent risk factors that may affect the revenue process are:1. Industry-related factors.
2. The complexity and contentiousness of revenue recognition issues.
3. The difficulty of auditing transactions and account balances.
4. Misstatements detected in prior audits.
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Control Risk Assessment
Understand and document the revenue process based on a reliance strategy.
Plan and perform tests of controls on revenue transactions.
Set and document the control risk for the revenue process.
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Control Environment
Understanding the control environment is generally completed on an overall entity basis.
Control Environment
Understanding the control environment is generally completed on an overall entity basis.
Understanding and Documenting Internal Control
The Entity’s Risk Assessment Process
The auditor must understand how management considers risks that are relevant to the revenue
process. The auditor should estimate the significance of the risk and assess the likelihood of occurrence.
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Understanding and Documenting Internal Control
Control Activities
The auditor identifies what controls ensure that the assertions for transactions and events are being met. Documentation of the auditor’s understanding of the
revenue process can be accomplished by using:
Procedures manuals
Narrative descriptions
FlowchartsInternal control
questionnaires
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Information Systems and Communication
Auditor’sknowledgeAuditor’s
knowledge
Process by which sales, cash receipts, and sales returns and allowances
transactions are initiated.
Process by which sales, cash receipts, and sales returns and allowances
transactions are initiated.
Accounting records, supporting documents, and
accounts that are involved in sales, cash receipts, and sales
returns.
Accounting records, supporting documents, and
accounts that are involved in sales, cash receipts, and sales
returns.
The flow of each transaction from initiation
to inclusion in the financial statements.
The flow of each transaction from initiation
to inclusion in the financial statements.
The process used to prepare estimates for
accounts such as bad debts and sales returns.
The process used to prepare estimates for
accounts such as bad debts and sales returns.
LO# 8
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The auditor must understand how management assesses the design and operation of controls in the revenue process. This understanding should include how supervisory personnel review the personnel who perform the controls and evaluate the performance of
the entity’s IT function.
Monitoring of ControlsLO# 8
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Plan and Perform Tests of Controls
The auditor systematically examines the client’s revenue process to identify relevant controls that help to prevent,
or detect and correct, material misstatements.
In order to properlyset control risk, theauditor must testcontrols over therevenue process.Such tests may
include . . .
In order to properlyset control risk, theauditor must testcontrols over therevenue process.Such tests may
include . . .
Inquiry of client personnel.
Inspection of documents and records.
Observations of the operation of the control.
Walkthroughs.
Reperformance of the control procedures.
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Set and Document the Control Risk
If the results of the tests of controls support the planned level of control risk, the auditor conducts the planned
level of substantive procedures for the account balances.
The level of control risk for the revenue process canbe set using either quantitative amounts or
qualitative terms such as “low,” “medium,” or “high.”
The level of control risk for the revenue process canbe set using either quantitative amounts or
qualitative terms such as “low,” “medium,” or “high.”
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Control Activities and Tests of Controls – Revenue Transactions
Assertions about Classes of Transactions and Events for the Period under Audit
OccurrenceAll revenue and cash receipt transactions and events that have been recorded have occurred and pertain to the entity.
Completeness All revenue and cash receipt transactions and events that should have been recorded have been recorded.
AuthorizationAll revenue and cash receipts transactions and events are properly authorized.
AccuracyAmounts and other data relating to recorded revenue and cash receipt transactions and events have been recorded appropriately.
Cutoff All revenue and cash receipt transactions and events have been recorded in the correct accounting period.
Classification All revenue and cash receipt transactions and events have been recorded in the proper accounts.
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Table 10-6: Example Tests of Controls for Revenue Transactions
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Table 10-6: Example Tests of Controls for Revenue Transactions
LO# 9
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Table 10-6: Example Tests of Controls for Revenue Transactions
LO# 9
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Occurrence of Revenue Transactions
The auditor is concerned about two major types of material misstatements:1. Sales to fictitious customers.
2. Recording revenue when goods have not been shipped or services have not been performed.
The auditor needs assurance that all recordedrevenue transactions are valid.
The auditor needs assurance that all recordedrevenue transactions are valid.
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Completeness of Revenue Transactions
The major misstatement that concerns both management and the auditor is that goods are
shipped or services are performed and no revenue is recognized.
The major misstatement that concerns both management and the auditor is that goods are
shipped or services are performed and no revenue is recognized.
Controls concerning completeness include: (1) accounting for numerical sequence of shipping documents and sales invoices, (2) matching shipping documents with sales invoices, (3) reconciling sales invoices to daily sales reports, and (4) maintaining and reviewing the open-order file.
Controls concerning completeness include: (1) accounting for numerical sequence of shipping documents and sales invoices, (2) matching shipping documents with sales invoices, (3) reconciling sales invoices to daily sales reports, and (4) maintaining and reviewing the open-order file.
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Authorization and Accuracy of Revenue Transactions
Possible misstatements due to improper authorization include shipping goods to, or performing services for,
customers who are bad credit risks and making sales at unauthorized prices or terms.
LO# 9
The presence of an authorized price list and terms of trade reduces the risk of
inaccuracies. The sales invoice should also be verified for mathematical accuracy before
being sent to the customer.10-34
Cutoff and Classification of Revenue Transactions
Sales may be recorded in the wrong accounting period unless proper controls are in place. All
shipping documents should be forwarded to the billing department daily.
LO# 9
The use of a chart of accounts and proper codes for recording transactions should provide
adequate assurance about the proper classification of revenue transactions.
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Table 10-7: Example Tests of Controls for Cash Receipts Transactions
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Table 10-7: Example Tests of Controls for Cash Receipts Transactions
LO# 9
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Occurrence of Cash Receipts Transactions
The possible misstatement that concerns the auditor when considering the occurrence
assertion is that cash receipts are recorded but not deposited in the client’s bank account.
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Completeness of Cash Receipts and Authorization of Discounts
A major misstatement is that cash or checks are stolen or lost before being recorded in the cash
receipts records. Proper segregation of duties and a lockbox system are strong controls relating to
completeness.
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2/10, n/302/10, n/30Terms of trade generally include discounts for payment within a specified period as a way of
encouraging customers to pay on time.10-39
Accuracy of Cash TransactionsThe wrong amount of cash could be recorded
from the remittance advice, or the receipt could be incorrectly processed during data entry. To
minimize these types of errors, daily remittance reports should be reconciled to a control listing of remittance advices. All bank statements should be
reconciled monthly.
LO# 9
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Cutoff and Classification of Cash Receipts Transactions
If the client uses a lockbox system or if cash is deposited daily in the bank, there is a small
possibility of cash being recorded in the wrong accounting period.
LO# 9
The auditor seldom has major concerns about cash receipts being recorded in the wrong
financial statement account.10-41
Control Activities and Tests of Controls – Sales Returns and Allowances
Sales returns and allowances is usually not a material amount in the financial statements. However, credit memoranda that are used to
process sales returns can also be used to cover an unauthorized shipment of goods or conceal a misappropriation of cash. As a result, all credit
memoranda should be properly authorized.
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Relating the Assessed Level of Control Risk to Substantive Procedures
The auditor’s testing of control for revenue processing impacts the detection risk and
therefore the level of substantive procedures impacted by the controls.
CashAccountsreceivable
Allowancefor baddebts
Bad debtsexpense
Sales returnsand
allowances
LO# 10
Sales
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Auditing Revenue Related Accounts
Substantive analytical procedures are used to examine plausible relationships among revenue related accounts.Substantive analytical procedures are used to examine
plausible relationships among revenue related accounts.
Tests of details focus on transactions, account balances, or disclosures. Tests of details concentrate on the
ending balance for accounts receivable and related accounts as well as related disclosures.
Tests of details focus on transactions, account balances, or disclosures. Tests of details concentrate on the
ending balance for accounts receivable and related accounts as well as related disclosures.
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Substantive Analytical Procedures
Ratios used for comparative purposes include:
Ratios used for comparative purposes include:1. Receivables turnover and days outstanding
in accounts receivable.
2. Aging categories on aged trial balance of accounts receivable.
3. Bad-debts expense as a percent of revenue.
4. Allowance for uncollectible accounts as a percent of accounts receivable or credit sales.
5. Large customer account balances compared to last period.
1. Receivables turnover and days outstanding in accounts receivable.
2. Aging categories on aged trial balance of accounts receivable.
3. Bad-debts expense as a percent of revenue.
4. Allowance for uncollectible accounts as a percent of accounts receivable or credit sales.
5. Large customer account balances compared to last period.
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Substantive Tests of TransactionsFor Accounts Receivable, Allowance for Uncollectible
Accounts, and Bad-Debt Expense
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Tests of Details of Account Balances
For Accounts Receivable, Allowance for Uncollectible Accounts, and Bad-Debt Expense
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Completeness
The auditor’s primary concern is whether all accounts receivable have been included in the accounts receivable subsidiary ledger and the general ledger accounts receivable account.
Reconciliation of the aged trial balance to the general ledger account should detect an omission of a receivable from either the subsidiary or general ledger.
Reconciliation of the aged trial balance to the general ledger account should detect an omission of a receivable from either the subsidiary or general ledger.
LO# 12
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CutoffThe cutoff test attempts to determine whether all
revenue transactions and related accounts receivable are recorded in the proper period.
12/31/12
Test a few shipping documents just prior to year-end.
Test a few shipping documents just after year-end.
Are all transactions tested recorded in the proper period?
Are all transactions tested recorded in the proper period?
LO# 12
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Existence and Rights and ObligationsExistence is one of the more important assertions for
accounts receivable because the auditor wants assurance that this account balance is not overstated through the inclusion of fictitious customer accounts or amounts.
Confirmation is the major audit procedure used for testing this assertion.
LO# 12
The auditor must determine that all accounts receivables are owned by the entity. This is usually not a problem,
however, in some cases, accounts receivable may be sold or factored with or without recourse.
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Valuation and Allocation
Accounts receivable should be shown on the balance sheet at net realizable value (gross amount
less allowance for uncollectible accounts).
The auditor must verify the adequacyof the allowance for uncollectibleaccounts. The first step is to prepare anaged trial balance and discuss resultswith the credit manager. Next, a comparison with last year’s results should be examined.
The auditor must verify the adequacyof the allowance for uncollectibleaccounts. The first step is to prepare anaged trial balance and discuss resultswith the credit manager. Next, a comparison with last year’s results should be examined.
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Classification
The major issues related to presentation, disclosure, and classification are:
The major issues related to presentation, disclosure, and classification are:
1. Identifying and reclassifying any material credits contained in accounts receivable.
2. Segregating short-term and long-term receivables.
3. Ensuring that different types of receivables are properly classified.
1. Identifying and reclassifying any material credits contained in accounts receivable.
2. Segregating short-term and long-term receivables.
3. Ensuring that different types of receivables are properly classified.
LO# 12
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The Confirmation Process – Accounts Receivable
Confirmation is audit evidence that is a direct written response from third parties about the
account receivable balance. Confirmation is a good source of evidence about the existence of
the accounts receivable. The confirmation process should be controlled by the auditor.
LO# 13
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Omitting Confirmations
Accounts receivable are immaterial. The use of confirmations would not
be effective. IR and CR are assessed “low” and
evidence gathered from other substantive tests is sufficient to reduce AR to an acceptably low level.
LO# 13
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Types of Confirmations
Positive Confirmation
Requests that customers indicate whether they agree with the amount due to the client. A response is expected whether the customer agrees or disagrees with the balance indicated.
Negative Confirmation
Requests that the customer respond only when they disagree with the amount due to the client. Negative confirmations are used when the client has many small account balances and control risk is assessed as low.
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Timing
Accounts receivable may be confirmed at an interim date or at year-end. The confirmation request
should be sent soon after the end of the accounting period in order to maximize the response rate.
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Confirmation Procedures
The auditor should mail the confirmation requests outside the client’s facilities. A record should be maintained of the confirmations mailed and those returned. A second request may be necessary in some cases.
For each exception received, the auditor should examine the reasons for the difference between the balance on the client’s books and the balance indicated by the customer.
For each exception received, the auditor should examine the reasons for the difference between the balance on the client’s books and the balance indicated by the customer.
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Alternative Procedures
When the auditor does not receive responses to positive confirmations, alternative audit procedures are used. These alternative
procedures include:
When the auditor does not receive responses to positive confirmations, alternative audit procedures are used. These alternative
procedures include:1. Examination of subsequent cash receipts.
2. Examination of customer orders, shipping documents, and duplicate sales invoices.
3. Examination of other client documentation.
1. Examination of subsequent cash receipts.
2. Examination of customer orders, shipping documents, and duplicate sales invoices.
3. Examination of other client documentation.
LO# 13
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Auditing Other Receivables
Other types of receivables that are reported on the balance sheet may include: (1) receivables from officers and employees, (2) receivables from related parties, and (3) notes receivable. The auditor’s concern with satisfying the assertions for these receivables is similar to that for trade accounts receivable. Each of these types of receivables is confirmed and evaluated for collectibility. The transactions that result in receivables from related parties are examined to determine if they were at “arm’s length.” Notes receivable would also be confirmed and examined for repayment terms and whether interest income has been properly recognized.
LO# 14
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Evaluating the Audit FindingsWhen the auditor has completed the planned
substantive procedures, the likely misstatement (projected misstatement plus an allowance for
sampling risk) for accounts receivable is determined.
Likely misstatementless than tolerable
misstatement
Likely misstatementgreater than tolerable
misstatement
Accept the accountas fairly presented.Accept the accountas fairly presented.
Account is not fairlypresented.
Account is not fairlypresented.
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