Download - Chapter 10
10-1
McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
Chap
ter
10CHAPTER 10AUDITING THE REVENUE PROCESS
10-2
McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
REVENUE RECOGNITION
Accounting standards (SFAS No. 5) requires that before revenue is recognized it must be realized and earned.
The SEC’s SAB No. 101 requires the following criteria for revenue recognition:Persuasive evidence of an arrangement exists.Delivery has occurred or services have been rendered.The seller's price to the buyer is fixed or determinable.Collectibility is reasonably assured.
10-3
McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
OVERVIEW OF THE REVENUE PROCESS
The "cradle to grave" process for revenue begins with an order from a customer, proceeds to the exchange of goods or services for a promise to pay, and ends with the payment of cash.
Figure 10-1: Flowchart for a revenue process
10-4
McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
TYPES OF TRANSACTIONS
The sale of goods or rendering of a service for cash or credit.
The receipt of cash from the customer in payment for the goods or services.
The return of goods by the customer for credit or cash.
10-5
McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
FINANCIAL STATEMENT ACCOUNTS
Sales Transaction:Trade accounts receivableSalesAllowance for uncollectible accountsBad debt expense
Cash Receipts Transactions:CashTrade accounts receivableCash discounts
Sales Return and Allowance Transaction:Sales returnsSales allowancesTrade accounts receivable
10-6
McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
DOCUMENTS AND RECORDS
Customer sales order Credit approval form Open-order report Shipping document Sales invoice Sales journal Customer statement
Accounts receivable subsidiary ledger
Aged trial balance of accounts receivable
Remittance advice Cash receipts journal Credit memorandum Write-off authorization
10-7
McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
FUNCTIONS IN THE REVENUE PROCESS
Order entry: Acceptance of customer orders into the system
Credit authorization: Approval of customer orders for creditworthiness
Shipping: Shipment of authorized goods
Billing: Issuance of sales invoices to customers for goods shipped or services rendered
10-8
McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
FUNCTIONS IN THE REVENUE PROCESS
Cash receipts: Processing cash receipts from customers
Accounts receivable: Recording sales invoices, collections and credit memoranda in customer accounts
General ledger: Proper accumulation, classification and summarization of revenues, collections and receivables in the financial statement accounts
10-9
McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
SEGREGATION OF DUTIES
Credit function should be segregated from Billing function.
Shipping function should be segregated from Billing function.
Accounts Receivable function should be segregated from General Ledger function.
Cash Receipts function should be segregated from Accounts Receivable function.
10-10
McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
INHERENT RISK ASSESSMENT
Industry-related factors.
Complexity of revenue recognition issues.
Difficulty of auditing transactions and accounts.
Misstatements detected in prior audits.
10-11
McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
CONTROL RISK ASSESSMENT
Planning and performing tests of controlson revenue transactions
Understanding and documenting the revenue process based
on the planned level of control risk
Assessing and documenting thecontrol risk for the revenue process
10-12
McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
CONTROL PROCEDURES AND TESTS OF CONTROLS -
REVENUE TRANSACTIONS
Table 10-5 (page 387 – 388) -- Revenue Transactions
Objectives Misstatements
10-13
McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
CONTROL PROCEDURES AND TESTS OF CONTROLS -
CASH RECEIPTS TRANSACTIONS
Table 10-6 (page 391) -- Cash Receipts Transactions
Objectives Misstatements
10-14
McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
CONTROL PROCEDURES AND TESTS OF CONTROLS - SALES RETURNS AND
ALLOWANCES TRANSACTIONS
Credit memos can be used to conceal unauthorized shipments or misappropriation of cash.
A credit memorandum should be approved by someone other than the individual who initiated the credit memorandum. (Segregation of Duties)
Credits for returned goods should be supported by a receiving document indicating that the goods have been returned. (Auditor should examine a sample)
10-15
McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
RELATING THE ASSESSED LEVEL OF CONTROL RISK TO SUBSTANTIVE TESTING
When the results of the tests of controls support the planned assessed level of CR, the auditor can conduct the substantive tests at the planned level.
If the results of the tests of controls do not support the planned assessed level of CR, DR will have to be set lower, and substantive tests increased.
10-16
McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
AUDIT OBJECTIVES FOR TESTING ACCOUNTS RECEIVABLE
Validity Completeness Cutoff Ownership Accuracy Valuation Classification Disclosure
10-17
McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
AUDITING ACCOUNTS RECEIVABLE AND RELATED ACCOUNTS
Substantive tests that are used to detect material misstatements in accounts receivable include:
Substantive tests of transactions
Analytical procedures
Tests of account balances
10-18
McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
SUBSTANTIVE TESTS OF TRANSACTIONS
Substantive tests of transactions are tests conducted on the individual transactions processed through the revenue process to detect monetary misstatements (Table 10-8 – Page 396).
10-19
McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
ANALYTICAL PROCEDURES
Analytical procedures are useful audit tests for examining the fairness of accounts such as revenue, accounts receivable, allowance for uncollectible accounts, bad debt expense, and sales returns and allowances.
10-20
McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
ANALYTICAL PROCEDURES - REVENUE
Comparison of gross profit percentage by product line with previous years and industry data.
Comparison of reported revenue to budgeted revenue.
10-21
McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
ANALYTICAL PROCEDURES - ACCOUNTS RECEIVABLE, ALLOWANCE FOR
UNCOLLECTIBLE ACCOUNTS AND BAD DEBT EXPENSE
Comparison of receivables turnover and days outstanding in accounts receivable to previous years’ and/or industry data.
Comparison of aging categories on aged trial balance of accounts receivable to previous years’.
Comparison of bad-debt expense as a percentage of revenue to previous years’ and/or industry data.
Comparison of the allowance for uncollectible accounts as a percentage of accounts receivable or credit sales to previous years’ and/or industry data.
Examination of large customer accounts individually and comparison to previous year.
10-22
McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
ANALYTICAL PROCEDURES – SALES RETURNS, ALLOWANCES,
AND COMMISSIONS
Comparison of sales returns as a percentage of revenue to previous years’ and/or industry data.
Comparison of sales discounts as a percentage of revenue to previous years’ and/or industry data.
Estimation of sales commission expense by multiplying net revenue by average commission rate and comparison of recorded sales commission expense.
10-23
McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
TESTS OF ACCOUNT BALANCES - ACCOUNTS RECEIVABLE (Table 10-10)
Objectives Tests of Account Balance
10-24
McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
TESTS OF ACCOUNT BALANCES - ACCOUNTS RECEIVABLE (Table 10-10)
Objectives Tests of Account Balance
10-25
McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
THE CONFIRMATION PROCESS
Confirmation is the process of obtaining and evaluating a direct communication from a third party in response to a request for information about a particular item affecting financial statement assertions (AU 330).
10-26
McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
THE CONFIRMATION PROCESS - ACCOUNTS RECEIVABLE
The auditor will normally request confirmation of accounts receivable during an audit.
Confirmations address the following audit objectives:ValidityCompletenessCutoffValuation
10-27
McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
OMISSION OF CONFIRMATION OF ACCOUNTS RECEIVABLE
The accounts receivable are immaterial to the financial statements.
The use of confirmations would not be effective as an audit procedure (e.g., past response rates were low or the responses might not be reliable).
The auditor’s assessment of IR and CR is low, and evidence gathered from other substantive tests is sufficient to reduce audit risk to a low level.
10-28
McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
RELIABILITY OF ACCOUNTS RECEIVABLE CONFIRMATIONS
Factors that affect the reliability of accounts receivable confirmations: The type of confirmation request.
Prior experience on the client or similar engagements.
The intended respondent.
10-29
McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
TYPES OF CONFIRMATIONS
Positive Confirmation (Exhibit 10-7 – Page 407) A response is required May use a “blank” form Used when fewer customer accounts with large
balances or when errors are anticipated (high level of CR)
Any non-responses require alternate procedures
10-30
McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
TYPES OF CONFIRMATIONS
Negative Confirmation (Exhibit 10-8 – Page 408)Response is required only if the customer disagreesUsed when many customer accounts with small
balances, when CR is low, and when the auditor believes the customers will devote adequate attention to the confirmations
Non-responses generally assumed to be valid A/R
Can use a combination of Positive (for large balances) and Negative (for small balances)
10-31
McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
TIMING OF ACCOUNTS RECEIVABLE CONFIRMATIONS
Interim Year-end
10-32
McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
CONFIRMATION PROCEDURES
Maintain Control Minimize interference by client Auditor mails them directly with CPA’s address
as “return address” Can use fax if there are time pressures Responses should be addressed to CPA Maintain record of confirmations mailed and
returned Positive confirmations may require 2nd and 3rd
Requests
10-33
McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
CONFIRMATION PROCEDURES
Confirmation Exceptions (Table 10-12 – Page 409)
Exceptions Potential Cause
10-34
McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
ALTERNATIVE PROCEDURES
Examination of subsequent cash receipts.
Examination of customer orders, shipping documents, and duplicate sales invoices.
Examination of other client documentation.
10-35
McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
AUDITING OTHER RECEIVABLES
Receivables from officers and employees.
Receivables from related parties.
Notes receivable.
These receivables are usually confirmed and evaluated for collectibility.
10-36
McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
EVALUATING THE AUDIT FINDINGS -ACCOUNTS RECEIVABLE AND
RELATED ACCOUNTS
Compare total projected misstatement to tolerable misstatement.
Analyze misstatements for causes of errors.