Presentation on theme: "CHAPTER 14 AUDITING THE REVENUE CYCLE Fall 2007"— Presentation transcript:
1 CHAPTER 14 AUDITING THE REVENUE CYCLE Fall 2007 Nature of the Revenue CycleInherent Risk FactorsAudit objectivesControl ActivitiesStandard Substantive Tests
2 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 uncollectable accounts [provisions and writeoffs]).
3 Auditing the Revenue Cycle Consider: How Can Revenue be Manipulated?
4 Inherent Risk Assessment and Fraud Considerations Pressures to overstate revenues to achieve announced revenue or profitability targets.Pressures to overstate cash and gross receivables or understate the allowance for doubtful accounts for debt covenant working capital requirements.Revenue recognition: ambiguous stds, estimates, complexity of the calculations, rights of return.Receivables are factored with recourse: correct classification as a sale vs. a borrowing.Cash receipts susceptible to misappropriation.Sales adjustments can conceal theft.Classification of AR as current vs. non-current
5 Inherent Risk Assessment Understand the Client’s Business and IndustryDevelop an expectation of total revenuesDevelop an expectation of gross marginDevelop an expectation of net receivablesUnderstanding industry accounting practices.
6 Consideration of IC: Obtaining an Understanding and Assessing CR Control EnvironmentRisk AssessmentInformation and CommunicationInitiate transactionsDeliver (receive) goods or servicesRecord TransactionsConsiderationControl ActivitiesMonitoring
7 Credit Sales – Info & Commun. Common Documents and RecordsCustomer OrderSales OrderShipping Documents (Bill of Lading and Packing Slip)Sales InvoiceAuthorized Price ListSales JournalCustomer Master FileAccounts Receivable Master FileCustomer Monthly Statement
11 Cash Receipts – Info & Commun. Common Documents and RecordsRemittance advicePrelistCash count sheetsDaily cash summaryValidated deposit slipCash receipts journal
12 Control Activities — Sales Adjustment Transactions Sales adjustment transactions involve the following:Granting cash discountsGranting sales returns and allowances (credit memo)Determining uncollectable accounts (write-off authorization memo)
13 Substantive Tests of Revenues 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.
14 Standard Substantive Tests for Revenues & Receivables Initial proceduresAnalytical proceduresTests of transactionsTest details of sales transactionsCut-off testingSalesCash ReceiptsCredit MemosTests of balancesConfirmationsEstimatesPresentation and disclosure
15 Substantive Tests of Accounts Receivable Figure 14-9
25 Substantive Tests of AR: Confirmations Confirm ReceivablesConfirmation of accounts receivable involves direct written communication between individual customers and the auditor. This substantive test is used extensively by the auditor.
26 Substantive Tests of AR: Confirmations Confirmation of receivables is a generally accepted auditing procedure which should be performed unless:AR is immaterial to the financial statements.The use of confirmations ineffective.Inherent risk and control risk are low enough and analytical procedures expected to be effective enough to get audit risk to an acceptably low level.
27 Substantive Tests of AR: Confirmations Forms of ConfirmationThere are 2 forms of confirmation request:the positive confirmation, which requires the debtor to respond whether or not the balance shown is correct,the negative confirmation, which requires the debtor to respond only when the balance shown is incorrect.