Auditing The Revenue Cycle

Prepared by: Sartini, S.E., M.Sc., Akt

Outline

Nature of the Revenue Cycle Inherent Risk Factors Audit objectives Control Activities Standard Substantive Tests

Nature of The Revenue Cycle

For a merchandising company, the classes of transactions in the revenue cycle include:

1. credit sales (sales made on accounts),2. cash receipts (collections on accounts

and cash sales), and3. sales adjustments (discounts, sales

returns and allowances, and uncollectible accounts [provisions and write-offs]).

Consider: How Can Revenue beManipulated?

Inherent Risk Assessment and Fraud Consideration

1. Pressures to overstate revenues to achieve announced revenue or profitability targets.

2. Pressures to overstate cash and gross receivables or understate the allowance for doubtful accounts for debt covenant working capital requirements.

3. Revenue recognition: ambiguous standards, estimates, complexity of the calculations, rights of return.

4. Receivables are factored with recourse: correct classification as a sale vs. a borrowing.

5. Cash receipts susceptible to misappropriation.6. Sales adjustments can conceal theft.7. Classification of AR as current vs. non-current

Inherent Risk Asessment

Understand the Client’s Businessand Industry1. Develop an expectation of total

revenues2. Develop an expectation of gross margin3. Develop an expectation of net

receivables4. Understanding industry accounting

practices.

Consideration of IC: Obtaining anUnderstanding and Assessing CR

Control Environment Risk Assessment Information and Communication

Initiate transactions Deliver (receive) goods or services Record Transactions Consideration

Control Activities Monitoring

Credit SalesCommon Documents and Records• Customer Order• Sales Order• Shipping Documents (Bill of Lading and Packing Slip)• Sales Invoice• Authorized Price List• Sales Journal• Customer Master File• Accounts Receivable Master File• Customer Monthly Statement

System Flowchart – InitiateCredit Sales

System Flowchart – Deliveryof Credit Sales

System Flowchart –Recording Credit Sales

Cash Receipt

Common Documents and Records• Remittance advice• Prelist• Cash count sheets• Daily cash summary• Validated deposit slip• Cash receipts journal

Control Activities —Sales Adjustment Transactions

Sales adjustment transactions involve the following:

1. Granting cash discounts2. Granting sales returns and

allowances (credit memo)3. Determining uncollectible

accounts (write-off authorization memo)

Substantive Tests ofRevenues and Receivable

Important Concept: The sales that are most likely to

represent potential misstatements are the uncollected sales.

To design substantive tests for these accounts, the auditor must first determine the acceptable level of tests of details risk for each significant related objective.

Standard Substantive Tests forRevenues & Receivables

1. Initial procedures2. Analytical procedures3. Tests of transactions

a) Test details of sales transactionsb) Cut-off testing

– Sales– Cash Receipts– Credit Memos

4. Tests of balancesa) Confirmationsb) Estimates

5. Presentation and disclosure

Substantive Tests ofAccounts Receivable

Analytical Procedures Commonly Used toAudit the Revenue Cycle

Test of Detail Transactions

Substantive Tests Revenue andReceivables Cycle: Cut-off Tests

Objective: Ensuring recording of transactions in the correct period

Types:1. Sales2. Credit memos3. Cash receipts

Substantive Tests of AR:Confirmations

Confirm Receivables Confirmation of accounts receivable

involves direct written communication between individual customers and the auditor. This substantive test is used extensively by the auditor.

Substantive Tests of AR:Confirmations

Confirmation of receivables is a generally accepted auditing procedure which should be performed unless:

1. AR is immaterial to the financial statements.2. The use of confirmations ineffective.3. Inherent risk and control risk are low enough

and analytical procedures expected to be effective enough to get audit risk to anacceptably low level.

Substantive Tests of AR:Confirmations

There are 2 forms of confirmation request:

1. the positive confirmation, which requires the debtor to respond whether or not the balance shown is correct,

2. the negative confirmation, which requires the debtor to respond only when the balance shown is incorrect.