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In this chapter, the learning objectives are Understand why knowledge of an entitys revenue recognition policies is important to the audit, understand the revenue process, know the types of transactions in the revenue process and the financial statement accounts affected, be familiar with the types of documents and records used in the revenue process,…
Chapter Ten Auditing the Revenue Process McGraw-Hill/Irwin © The McGraw-Hill Companies 2010 Revenue Recognition (IAS 18) Revenue is defined as the gross inflow of economic benefits during the period arising in the course of the ordinary activities of an entity when those inflows result in increases in equity, other than increases relating to contributions from equity participants McGraw-Hill/Irwin © The McGraw-Hill Companies 2010 Overview of the Revenue Process Cash Sale Credit Sale Cash collection Purchases Cash sales Inventory Account receivable Inventory McGraw-Hill/Irwin Purchases © The McGraw-Hill Companies 2010 Credit sales Types of Transactions and Financial Statement Accounts Affected Three types of transactions are typically processed by the revenue process: The sale of goods or rendering of a service for cash or credit The receipt of cash from the customer in payment for goods or services The return of goods by the customer for credit or cash McGraw-Hill/Irwin © The McGraw-Hill Companies 2010 Types of Transactions and Financial Statement Accounts Affected The revenue process affects numerous accounts in the financial statements The most significant accounts are : McGraw-Hill/Irwin © The McGraw-Hill Companies 2010 Flowchart of the Revenue Process: EarthWear Clothiers McGraw-Hill/Irwin © The McGraw-Hill Companies 2010 Flowchart of the Revenue Process: EarthWear Clothiers (continued) McGraw-Hill/Irwin © The McGraw-Hill Companies 2010 Flowchart of the Revenue Process: EarthWear Clothiers (continued) McGraw-Hill/Irwin © The McGraw-Hill Companies 2010 Types of Documents and Records Customer Customer Sales Sales Order Order Contains Contains the the details details of of the the type type and and quantity quantity of of products products or or services services ordered ordered by by the the customer customer and and customer customer information information Credit Credit Approval Approval Form Form For For credit credit sales, sales, the the client client must must have have aa formal formal procedure procedure for for investigating investigating the the creditworthiness creditworthiness of of the the customer customer McGraw-Hill/Irwin © The McGraw-Hill Companies 2010 Types of Documents and Records Open-Order Open-Order Report Report A A report report of of all all customer customer orders orders for for which which processing processing has has not not been been completed completed Shipping Shipping Document Document This This document document generally generally serves serves as as aa bill bill of of lading lading and and contains contains information information on on the the type type of of product product shipped, shipped, the the quantity quantity shipped shipped and and other other relevant relevant information information McGraw-Hill/Irwin © The McGraw-Hill Companies 2010 Substantive Analytical Procedures Ratios used for comparative purposes include: Receivables turnover and days outstanding in accounts receivable Aging categories on aged trial balance of accounts receivable Bad-debts expense as a per cent of revenue Allowance for uncollectible accounts as a per cent of accounts receivable or credit sales Large account balances compared to last period McGraw-Hill/Irwin © The McGraw-Hill Companies 2010 Tests of Details of Transactions, Account Balances and Disclosure For Accounts Receivable, Allowance for Uncollectible Accounts and Bad-Debt Expense McGraw-Hill/Irwin © The McGraw-Hill Companies 2010 Completeness and Accuracy 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 McGraw-Hill/Irwin © The McGraw-Hill Companies 2010 Cut-off The cut-off test attempts to determine whether all revenue transactions and related accounts receivable are recorded in the proper period 31/12/10 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? McGraw-Hill/Irwin © The McGraw-Hill Companies 2010 Existence and Rights and Obligations Existence 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 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 McGraw-Hill/Irwin © The McGraw-Hill Companies 2010 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 adequacy of the allowance for uncollectible accounts The first step is to prepare an aged trial balance and discuss results with the credit manager Next, a comparison with last year’s results should be examined McGraw-Hill/Irwin © The McGraw-Hill Companies 2010 Classification and Understandability McGraw-Hill/Irwin © The McGraw-Hill Companies 2010 The Confirmation Process – Accounts Receivables Confirmation is the process of obtaining information from third parties about the account receivable balance Confirmation is a good source of evidence about the existence of the account receivable The confirmation process should be controlled by the auditor McGraw-Hill/Irwin © The McGraw-Hill Companies 2010 Types of Confirmations McGraw-Hill/Irwin Positive Positive Confirmation Confirmation Negative Negative Confirmation Confirmation Requests Requests that that customers customers indicate indicate whether whether they they agree agree with with the the amount amount due due to to the the client client A A response response is is expected expected whether whether the the customer customer agrees agrees or or disagrees disagrees with with the the balance balance indicated indicated Requests Requests that that the the customer customer respond respond only only when when they they disagree disagree with with the the amount amount due due to to the the client client Negative Negative confirmations confirmations are are used used when when the the client client has has many many small small account account balances balances and and control control risk risk is is assessed assessed as as low low © The McGraw-Hill Companies 2010 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 McGraw-Hill/Irwin © The McGraw-Hill Companies 2010 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 For each each exception exception received, received, the the auditor auditor should should examine examine the the reasons reasons for for the the difference difference between between the the balance balance on on the the client’s client’s books books and and the the balance balance indicated indicated by by the the customer customer McGraw-Hill/Irwin © The McGraw-Hill Companies 2010 Alternative Procedures When When the the auditor auditor does does not not receive receive responses responses to to positive positive confirmations, confirmations, alternative alternative audit audit procedures procedures are are used used These These alternative alternative procedures procedures include: include: 1 Examination Examination of of subsequent subsequent cash cash receipts receipts 2 Examination Examination of of customer customer orders, orders, shipping shipping documents documents and and duplicate duplicate sales sales invoices invoices 3 Examination Examination of of other other client client documentation documentation McGraw-Hill/Irwin © The McGraw-Hill Companies 2010 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 McGraw-Hill/Irwin © The McGraw-Hill Companies 2010 Evaluating the Audit Findings The auditor compares the aggregated identified misstatement to materiality to determine if the identified misstatement would affect the audit The auditor requests the client to correct the identified misstatements and then compares the uncorrected misstatements with materiality to conclude whether the financial statements are fairly stated If uncorrected misstatements in accounts receivable and, when considered together with other uncorrected misstatements, are less than materiality, the auditor may accept that the financial statements are fairly presented Conversely, if the uncorrected misstatement exceeds the materiality, the auditor should conclude that the financial statements are not fairly presented McGraw-Hill/Irwin © The McGraw-Hill Companies 2010 End of Chapter 10 McGraw-Hill/Irwin © The McGraw-Hill Companies 2010 ... : McGraw-Hill/Irwin © The McGraw-Hill Companies 2 010 Flowchart of the Revenue Process: EarthWear Clothiers McGraw-Hill/Irwin © The McGraw-Hill Companies 2 010 Flowchart of the Revenue Process: ... Set and document the control risk for the revenue process McGraw-Hill/Irwin © The McGraw-Hill Companies 2 010 Understanding and Documenting Internal Control Control Environment Understanding the. .. Contains the the details details of of the the type type and and quantity quantity of of products products or or services services ordered ordered by by the the customer customer and and customer