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AUDITING THE REVENUE PROCESS. Major Processes in the Sales & Collections Cycle. Sale of goods and services (Revenue) Payments received for goods and services (Collection) Goods returned by and claims received from customers (Returns). Steps in the Revenue Process. Receiving customer orders
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Major Processes in the Sales & Collections Cycle • Sale of goods and services (Revenue) • Payments received for goods and services (Collection) • Goods returned by and claims received from customers (Returns)
Steps in the Revenue Process • Receiving customer orders • Authorizing credit terms and shipment • Confirming orders • Executing orders • Recording the shipments or services performed
Steps in the Revenue Process (Cont.) • Receiving customer orders • Computer controls: • Customer checks • Valid customer number • Self-check algorithm • Field checks • Key characteristics • Completeness of required fields • Reasonableness checks • Order quantities • Product combinations • Clear procedures for resolving computer red flags • Periodic reports on Open Orders
Steps in the Revenue Process (Cont.) • Authorizing credit terms and shipment • Computer controls • Credit check for repeat customers • Inventory availability • Credit review for new customers • Credit worthiness • Existence • Separation of Credit & Sales Departments • When approved a Sales Order is produced • Prenumbered and controlled
Steps in the Revenue Process (Cont.) • Confirming orders • Customer verification of sales order accuracy • Items • Quantities • Price • Confirm shipping date
Steps in the Revenue Process (Cont.) • Executing orders • Assembling goods for shipment • Picking list (sales order) • Verify items picked and update inventory • Move items to shipping dock • Ship ordered goods • Packing slip (sales order) • Verify items packed (agree picking & sales order) • Shipping report and bill of lading • Prenumbered and controlled • Periodic reports on Open Shipments • Separation of Warehousing & Shipping
Steps in the Revenue Process (Cont.) • Bill the customer and record the sale • Agree information on and existence of customer order, sales order, and shipping report. • Prepare a Sales Invoice • Prenumbered and controlled • Computer controls • Send sales invoice to customer • Investigation of missing or repeated document numbers
Understanding the Entity & Its Environment • Develop an expectation concerning total revenues and gross margin based on general economy, competitive environment, and market position. • Identify and understand difficult revenue recognition issues: • Long-term construction/contracts • Bundled services/revenues • Potential for unearned revenue and collection difficulties
Inherent Risks • General incentive to overstate revenues and receivables • High volume of transactions • Efforts to increase customer value, may increase accounting complexity: • Bundled services • Rights of return • Financing options
Entity-Level Controls Control Environment: • Integrity & Ethical Values • Management Aggression • Revenue and profit centered incentives • Revenue recognition policies • Competence and Commitment • Various control responsibilities • Accounting personnel • Audit committee/BOD Risk Assessment: • What has been identified and what actions have been taken? • Changes to the environment (Competition, Regulation, Reporting Req.)? • Additional monitoring, training, incentives, or reports? Monitoring: • Verify that monitoring activities are operating effectively. • Consider any problems uncovered that could impact the audit of revenues: • Billing errors • Regulatory inquiry • Actions to address previous auditor concerns
Auditor Objectives Transaction Objectives • Occurrence:Recorded sales represent goods shipped during the period. • Completeness:All sales made during the period were recorded. • Accuracy:All sales are accurately valued using GAAP and correctly journalized, summarized, and posted. • Cutoff:All sales have been recorded in the correct accounting period. • Classification:All sales have been recorded in the proper accounts. Balance Objectives: • Existence:Accounts receivable represents amounts owed by customers on the balance sheet date. • Completeness:Accounts receivable includes all claims on customers at the balance sheet date. • Rights & Obligations:Accounts receivable at the balance sheet date represents legal claims of the entity on customers for payment. • Valuation & Allocation: Accounts receivable represent gross claims on customers at the balance sheet date, and agrees with the sum of the accounts receivable subsidiary ledger.
Potential Misstatements Transaction Objectives Occurrence: (Overstatement) • A single sales invoice recorded twice or a cancelled sales invoice recorded. • Fictitious customer and sale recorded. • Shipments without the consent and agreement of the customer. • The earnings process is not complete: • Recording a sale before shipment or other prerequisites of being earned. • Unearned revenue recorded as earned. • The amount may not be realizable: • Substantial uncertainty exists about collectibility. • Customer obligations are contingent on other actions (financing, resale, etc.). • Completeness: (Understatement) • Shipped orders have not been billed and recorded. • Accuracy: • Transactions are recorded for incorrect amounts (Over- and Understatements). • Cutoff: • Books left open too long (Overstatement) or closed too early (Understatement). • Classification: • Transactions are recorded in incorrect accounts (Over- and Understatements).
Objectives & Controls Activities Transaction Objectives • Occurrence: • Sales invoice sequencing (double entry) • Customer validity check (not fictitious) • Authorized customer order and shipping document (not fictitious & earning process complete) • Credit check (collectibility) • Completeness: • Prenumbered and controlled documents • Accuracy: • Computer input controls • Authorized customer order and shipping document (independent agreement) • Posting and updating of accounts done automatically through computer technology • Cutoff: • Prenumbered and controlled documents • Periodic review of Open files • Classification: • Computer input controls • Are there any special financing arrangements or rights of return? • What are the control procedures for cancelled orders? • How likely are unearned revenues, and what are the client’s control procedures for these liabilities? What did we miss?
