Revenue and Collection Cycle
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Chapter 7
Revenue and Collection Cycle
“What at first was plunder assumed the softer name of revenue.” Thomas Paine
7-1
Learning Objectives
1. Discuss inherent risks related to the revenue and collection cycle with a focus on improper revenue recognition 2. Describe the revenue and collection cycle, including typical source documents and control procedures. 3. Give examples of tests of controls over customer credit approval, delivery, and accounts receivable accounting
7-3
Overall Audit Approach
Auditor assessment
Auditor accepts
7-4
Inherent Risks
• Improper Revenue Recognition
– Cut-off – Bill and Hold – Channel Stuffing
• Auditors must have heightened professional skepticism for electronic responses (fax or e-mail).
– Verify that the response came from an appropriate person
A/R subsidiary ledger to general ledger Monthly statement to customer
•
INDEPENDENT CHECKS ON PERFORMANCE
– –
7-9
Audit Evidence in Management Reports and Data Files
• Follow-up on all exceptions
7-22
Exhibit 7.11 -- Responses to Positive Confirmations
7-23
ALTERNATIVE PROCEDURES
• Vouch subsequent cash collections
Procedures in the Revenue and Collection Cycle
7-14
AUDITING ACCOUNTS RECEIVABLE
• Test Accounts Receivable – See Aged Trial Balance (Exhibit 7.8 on next slide)
•
ACCESS TO ASSETS
– Shipping department – Lock box account
•
ADEQUATE DOCUMENTS AND RECORDS
– – Pre-numbered sales orders, shipping documents (bills of lading), sales invoices Remittance advice
7-6
7-7
Exhibit 7.2 Revenue Recognition Rogues
7-7
Exhibit 7.3 Revenue and Collection Cycle
7-8
REVENUE AND COLLECTION CYCLE: Key Control Procedures
• SEPARATION OF DUTIES
• Pending order master file
• Credit check/approval files • Price list master file • Sales detail file (sales journal) • Salesccounts receivable aged trial balance
7-2
Learning Objectives (continued)
4. Give examples of substantive procedures in the revenue and collection cycle and relate them to assertions about account balances at the end of the period. 5. Describe some common errors and frauds in the revenue and collection cycle, and design some audit and investigation procedures for detecting them.
• • • • 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; and Collectibility is reasonably assured
• Returns and Allowances • Collectibility of Receivables
7-5
Revenue Recognition
• Must be: (1) realized or realizable; and (2) earned • SEC guidance (SAB 104)
• Restricted access to terminals and invoices.
• All documentation in order to record sales. • Proper dating. • Invoices compared to BOLs and orders. • Pending order files reviewed.
7-21
CONFIRMATION CONSIDERATIONS (continued)
• Non-response to Positive/blank confirmation requests
– Follow up with second and sometimes third requests – A lower than expected response rate could be indicative of fictitious customer accounts – Alternative procedures
Exhibit 7.9 Positive Confirmation Letter
7-19
Exhibit 7.10 Negative Confirmation Letter
7-20
CONFIRMATION CONSIDERATIONS
• All confirmations returned by the post office as nondeliverable must be investigated • Responses to positive and blank confirmations provide more reliable evidence than negative nonresponses • Recipients of accounts receivable confirmations might not report understatements
7-11
Exhibit 7.5 Assertions about Classes of Transactions and Events for the Period
7-12
Exhibit 7.6 Dual Direction of Test Audit Sample
7-13
Exhibit 7.7 -- Assertions and Substantive
– Separate functions for recording, authorization, custody
•
AUTHORIZATION OF TRANSACTIONS
– – – – Write-offs EDI transactions Credit checks prior to approval of sale Pricing
• Blank Confirmations should be used if the recipient is likely to return a positive confirmation without verifying the accuracy of the information.
7-18
– the combined assessed level of inherent and control risk is low – a large number of small balances is involved – the auditor has no reason to believe that the recipients of the requests are unlikely to give them consideration.
• Confirm balances
• Perform analytical procedures
• Test sales cut-off
7-15
Exhibit 7.8 Accounts Receivable Aged Trial Balance
7-16
USING CONFIRMATIONS
• Primarily for verifying EXISTENCE. • Factors likely to affect the reliability of confirmations: – Previous audit experience – Intended recipient of the confirmation – Type of information being confirmed • The auditor may confirm entire balances or individual transactions – Type of confirmation being sent
7-17
TYPES OF CONFIRMATIONS
• Positive Confirmations
– small number of accounts are involved – large number of errors are anticipated
• Negative Confirmations
• Non-response to negative confirmation requests
– Only limited evidence concerning financial statement assertions – Alternative procedures are not necessary for unreturned negative confirmation requests
• Cash receipts listing
• Customer Statements
7-10
Other Controls
• No sales order without customer order. • Credit approval. • Restricted access to inventory.
Revenue and Collection Cycle
“What at first was plunder assumed the softer name of revenue.” Thomas Paine
7-1
Learning Objectives
1. Discuss inherent risks related to the revenue and collection cycle with a focus on improper revenue recognition 2. Describe the revenue and collection cycle, including typical source documents and control procedures. 3. Give examples of tests of controls over customer credit approval, delivery, and accounts receivable accounting
7-3
Overall Audit Approach
Auditor assessment
Auditor accepts
7-4
Inherent Risks
• Improper Revenue Recognition
– Cut-off – Bill and Hold – Channel Stuffing
• Auditors must have heightened professional skepticism for electronic responses (fax or e-mail).
– Verify that the response came from an appropriate person
A/R subsidiary ledger to general ledger Monthly statement to customer
•
INDEPENDENT CHECKS ON PERFORMANCE
– –
7-9
Audit Evidence in Management Reports and Data Files
• Follow-up on all exceptions
7-22
Exhibit 7.11 -- Responses to Positive Confirmations
7-23
ALTERNATIVE PROCEDURES
• Vouch subsequent cash collections
Procedures in the Revenue and Collection Cycle
7-14
AUDITING ACCOUNTS RECEIVABLE
• Test Accounts Receivable – See Aged Trial Balance (Exhibit 7.8 on next slide)
•
ACCESS TO ASSETS
– Shipping department – Lock box account
•
ADEQUATE DOCUMENTS AND RECORDS
– – Pre-numbered sales orders, shipping documents (bills of lading), sales invoices Remittance advice
7-6
7-7
Exhibit 7.2 Revenue Recognition Rogues
7-7
Exhibit 7.3 Revenue and Collection Cycle
7-8
REVENUE AND COLLECTION CYCLE: Key Control Procedures
• SEPARATION OF DUTIES
• Pending order master file
• Credit check/approval files • Price list master file • Sales detail file (sales journal) • Salesccounts receivable aged trial balance
7-2
Learning Objectives (continued)
4. Give examples of substantive procedures in the revenue and collection cycle and relate them to assertions about account balances at the end of the period. 5. Describe some common errors and frauds in the revenue and collection cycle, and design some audit and investigation procedures for detecting them.
• • • • 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; and Collectibility is reasonably assured
• Returns and Allowances • Collectibility of Receivables
7-5
Revenue Recognition
• Must be: (1) realized or realizable; and (2) earned • SEC guidance (SAB 104)
• Restricted access to terminals and invoices.
• All documentation in order to record sales. • Proper dating. • Invoices compared to BOLs and orders. • Pending order files reviewed.
7-21
CONFIRMATION CONSIDERATIONS (continued)
• Non-response to Positive/blank confirmation requests
– Follow up with second and sometimes third requests – A lower than expected response rate could be indicative of fictitious customer accounts – Alternative procedures
Exhibit 7.9 Positive Confirmation Letter
7-19
Exhibit 7.10 Negative Confirmation Letter
7-20
CONFIRMATION CONSIDERATIONS
• All confirmations returned by the post office as nondeliverable must be investigated • Responses to positive and blank confirmations provide more reliable evidence than negative nonresponses • Recipients of accounts receivable confirmations might not report understatements
7-11
Exhibit 7.5 Assertions about Classes of Transactions and Events for the Period
7-12
Exhibit 7.6 Dual Direction of Test Audit Sample
7-13
Exhibit 7.7 -- Assertions and Substantive
– Separate functions for recording, authorization, custody
•
AUTHORIZATION OF TRANSACTIONS
– – – – Write-offs EDI transactions Credit checks prior to approval of sale Pricing
• Blank Confirmations should be used if the recipient is likely to return a positive confirmation without verifying the accuracy of the information.
7-18
– the combined assessed level of inherent and control risk is low – a large number of small balances is involved – the auditor has no reason to believe that the recipients of the requests are unlikely to give them consideration.
• Confirm balances
• Perform analytical procedures
• Test sales cut-off
7-15
Exhibit 7.8 Accounts Receivable Aged Trial Balance
7-16
USING CONFIRMATIONS
• Primarily for verifying EXISTENCE. • Factors likely to affect the reliability of confirmations: – Previous audit experience – Intended recipient of the confirmation – Type of information being confirmed • The auditor may confirm entire balances or individual transactions – Type of confirmation being sent
7-17
TYPES OF CONFIRMATIONS
• Positive Confirmations
– small number of accounts are involved – large number of errors are anticipated
• Negative Confirmations
• Non-response to negative confirmation requests
– Only limited evidence concerning financial statement assertions – Alternative procedures are not necessary for unreturned negative confirmation requests
• Cash receipts listing
• Customer Statements
7-10
Other Controls
• No sales order without customer order. • Credit approval. • Restricted access to inventory.