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

1. Receiving customer orders

2. Authorizing credit terms and shipment

3. Confirming orders 4. Executing orders 5. Recording the shipments or services performed

Steps in the Revenue Process (Cont.)

1.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.)

2. 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.)

3. Confirming orders
Customer verification of sales order accuracy
Items Quantities Price

Confirm shipping date

Steps in the Revenue Process (Cont.)

4. 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

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Steps in the Revenue Process (Cont.)

5. 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

1. Develop an expectation concerning total revenues and gross margin based on general economy, competitive environment, and market position. 2. Identify and understand difficult revenue recognition issues:
Long-term construction/contracts Bundled services/revenues Potential for unearned revenue and collection difficulties

Inherent Risks
1. General incentive to overstate revenues and receivables 2. High volume of transactions 3. Efforts to increase customer value, may increase accounting complexity:
Bundled services Rights of return

Financing options

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Entity-Level Controls
Control Environment:
1. Integrity & Ethical Values 2. Management Aggression
Revenue and profit centered incentives Revenue recognition policies

3. Competence and Commitment

Various control responsibilities Accounting personnel Audit committee/BOD

Risk Assessment:
1. 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:
1. Verify that monitoring activities are operating effectively. 2. Consider any problems uncovered that could impact the audit of revenues:
Billing errors Regulatory inquiry Actions to address previous auditor concerns
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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.

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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).
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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) Are there any special financing arrangements or rights of return? Posting and updating of accounts done automatically through computer technology Cutoff: What are the control procedures for cancelled orders? Prenumbered and are unearned revenues, and what are the clients control How likely controlled documents Periodic review of Open files liabilities? procedures for these Classification: Computer input controls

What did we miss?

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Tests of Controls & Tests of Transactions

Transaction Objective Test of Control
Computer-assisted auditing techniques (CAATs) Examine Sales Invoice packets for supporting documentation Account for sequence of shipping documents Observe and review evidence for document control CAATs Confirm agreement between supporting documentation sources Account for sequence of supporting documents. Confirm period reviews of open files

Substantive Tests
Review sequence of sales invoices Review journal for unusual transactions Vouch from the sales journal to the supporting documents Trace from the shipping documents to the sales journal Recalculate prices and extensions on sales invoice Trace a few transactions from inception to completion Analyze Sales Invoices and Shipping Documents close to year end to confirm appropriate recording Trace transactions from Sales Invoice to the Sales Journal, verifying appropriate classification
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Occurrence

Completeness

Accuracy

Cutoff

Classification

CAATs

Analytical Procedures & Tests of Balances

Transaction Objective Analytical Procedures Substantive Tests
Review subsidiary ledger for unusual amounts Confirm receivables Alternative procedures Trace from the A/R master to the aging schedule Review BOD minutes for A/R pledging or factoring Review material sales contracts for terms and conditions Inquire of management Inquire as to likelihood of collection for older accounts Assess appropriateness based on independent estimates and other knowledge obtained regarding collection

Existence

Compare gross margins w/ prior years Consider monthly sales over time Compare A/R turnover w/prior years

Completeness

Rights & Obligations

N/A

Valuation & Allocation

Compare bad debts to prior years Compare allowance account to prior years Compare A/R turnover w/ prior years Compare amounts in aging categories w/ prior years

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Questions?

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