1. CHAPTER 14 AUDITING THE REVENUE CYCLE Fall 2007
Nature of the Revenue Cycle
Inherent Risk Factors
Audit objectives
Control Activities
Standard 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), and
3. 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 Industry
Develop an expectation of total revenues
Develop an expectation of gross margin
Develop an expectation of net receivables
Understanding industry accounting practices.

6. Consideration of IC: Obtaining an Understanding and Assessing CR
Control Environment
Risk Assessment
Information and Communication
Initiate transactions
Deliver (receive) goods or services
Record Transactions
Consideration
Control Activities
Monitoring

7. Credit Sales – Info & Commun.
Common 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

8. System Flowchart – Initiate Credit Sales

9. System Flowchart – Delivery of Credit Sales

10. System Flowchart – Recording Credit Sales

11. Cash Receipts – Info & Commun.
Common Documents and Records
Remittance advice
Prelist
Cash count sheets
Daily cash summary
Validated deposit slip
Cash receipts journal

12. Control Activities — Sales Adjustment Transactions
Sales adjustment transactions involve the following:
Granting cash discounts
Granting 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 procedures
Analytical procedures
Tests of transactions
Test details of sales transactions
Cut-off testing
Sales
Cash Receipts
Credit Memos
Tests of balances
Confirmations
Estimates
Presentation and disclosure

15. Substantive Tests of Accounts Receivable Figure 14-9

18. Analytical Procedures Commonly Used to Audit the Revenue Cycle Figure 14-4

22. Substantive Tests Revenue and Receivables Cycle: Cut-off Tests
Objective: Ensuring recording of transactions in the correct period
Types:
Sales
Credit memos
Cash receipts

25. 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.

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 Confirmation
There 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.