1. Revenue and Collection Cycle
Chapter 7
Revenue and Collection Cycle
“What at first was plunder assumed the softer name of revenue.”
Thomas Paine

2. Inherent Risks of Revenue
Improper Recognition
Cut-off
Bill and Hold
Channel Stuffing
Returns and Allowances
Collectibility of Receivables 2

3. Revenue Recognition Must be (1) realized or realizable and (2) earned
SEC Guidance (SAB 104)
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 3

4. Revenue Cycle Receive customer purchase order
Check inventory stock status --- Generate back order if item not in stock
Obtain credit approval
Prepare shipping and packing documents
Ship and verify shipment of goods
Prepare the invoice
Send monthly statements to customers
Receive payment

5. REVENUE AND COLLECTION CYCLE: Key Control Procedures
SEPARATION OF DUTIES
Separate functions for recording, authorization, custody
AUTHORIZATION OF TRANSACTIONS
Write-offs
EDI transactions
Credit checks prior to approval of sale
Pricing
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
INDEPENDENT CHECKS ON PERFORMANCE
A/R subsidiary ledger to general ledger
Monthly statement to customer 5

6. Sources of Audit Evidence
Pending Order Master File
Credit check/approval files
Price List Master File
Sales Journal
Sales Analysis Report
Accounts Receivable Aged Trial Balance
Cash Receipts Listing
Customer Statements 6

7. Controls No Sales Order without Customer Order Credit Approval Process
Restricted Access to Inventory
Restricted Access to Terminals and Invoices
Documentation in order to Record Sales
Proper Dating
Invoices compared to BOLs and Orders
Pending Order File Reviewed

8. Accounts in Revenue Cycle
Sales
Cash
sales
Sales on
account
Accounts Receivable
Cash receipts
Sales returns
and allowances
Charge-off of
uncollectible
accounts
Beginning
balance
Ending
Cash in Bank
Cash Discounts
Taken
Bad Debt
Expense
Sales Returns
and Allowances

9. Accounts in Revenue Cycle
Accounts Receivable
Cash receipts
Sales returns
and allowances
Charge-off of
uncollectible
accounts
Beginning
balance
Sales on
account
Ending
Allowance for
Uncollectible Accounts
Estimate of
bad debt
expense
Bad Debt
Expense

10. Sources of Accounts Receivable
Claims against customers from sale of goods
Loans to officers or employees
Loans to subsidiaries
Claims against various other refunds
Claims for tax refunds
Advances to suppliers
Shown on balance sheet at Net Realizable Value

11. Inherent Risk in Receivables
Net receivables will be overstated, because either receivables have been overstated, or the allowance for uncollectible accounts has been understated
Sales of receivables recorded as sales rather than financing transactions
Receivables pledged as collateral
Receivables classified as current but likelihood of collection is low
Collection of receivable contingent on uncertain future events
Payment not required until purchaser sells the product

12. Accounts Receivable Balance-Related Audit Objectives
Detail Tie-in
Existence
Completeness
Accuracy
Classification
Cutoff
Realizable
Value
Rights
Presentation
and Disclosure

13. Substantive Tests of Accounts Receivable
Obtain and evaluate Aging of Accounts Receivable
Confirm receivables with customers
Perform cutoff tests
Review subsequent collections of receivables

14. Aging of Accounts Receivable
Receivables are at Net Realizable Value --- auditors must evaluate management estimates of uncollectible accounts
Obtain or prepare Schedule of Aged Accounts Receivable --- If schedule is prepared by client, it is tested for mathematical and aging accuracy
Use an Aging Schedule to
Agree detail to control account balance
Select customer balances for confirmation
Identify amounts due from related parties for disclosure
Identify past-due balances
Evaluate Percentages of Uncollectibility
Calculate the Balance in the Allowance Account

15. Accounts Receivable Aged Trial Balance

16. Types of Confirmation Positive Confirmation Blank Confirmation Form
Invoice Confirmation
Negative Confirmation

17. Positive Confirmation Letter

18. Negative Confirmation Letter

19. Selection of the Items for Testing
When selecting a sample of accounts receivable
for confirmation, the auditor should be careful
to avoid being influenced by the client.
If a client tries to discourage the auditor from
sending confirmations to certain customers,
the auditor should consider the possibility
that the client is attempting to conceal
fictitious or known misstatements
of accounts receivable.

20. Sample Size Tolerable misstatement Inherent risk Control risk
Achieved detection risk from
other substantive tests
Type of confirmation

21. Timing The most reliable evidence from confirmations
is obtained when they are sent as close to the
balance sheet date as possible, as opposed
to confirming the accounts several months
before year-end.

22. Maintaining Control After the items for confirmation have been
selected, the auditor must maintain control
of the confirmations until they are returned
from the customer.

23. Follow-up Procedures for Exceptions Noted
Because misstatements are projected to the population of receivables, the auditor must determine the reason for the exception

24. Exhibit 7.10
Responses to Positive Confirmations

25. Analysis of Difference
Payment has already been made
Goods have not been received
The goods have been returned
Clerical errors and disputed accounts

26. Follow-up on Nonresponses
When positive confirmations are used,
SAS 67 requires follow-up procedures
for confirmations not returned by
he customer.
Alternative Procedures

27. ALTERNATIVE PROCEDURES
Vouch Subsequent Cash Collections
Examine Shipping Documents
Examine Client-Generated Supporting Documentation ----Depends on internal controls
Inspect Correspondence Files 27

28. ANALYTICAL PROCEDURES
Sales Revenue
Comparisons with previous periods
Comparisons with industry
Allowance for Doubtful Accts, Bad Debt Expense
Bad Debt Expense as a percentage of Sales
Allowance for Doubtful Accounts as a percentage of Gross Receivables
Accounts Receivable
Days Sales in Accounts Receivable
Accounts Receivable Turnover 28

29. Related-Party Receivables
Amounts due from related parties should be separately disclosed
Audit procedures to identify related-party transactions include:
Review SEC filings
Review the accounts receivable subsidiary ledger and trial balance
Management inquiry
Communicate names of all known related parties to audit team members

30. Sold, Discounted, and Pledged Receivables
Receivables sold with recourse, discounted, or pledged as collateral should be disclosed
Audit procedures to identify these items
Management inquiry
Scan cash receipts journal for large cash inflows from unusual sources
Bank confirmations, which include information on obligations and terms
Review board of director minutes, which contain approval of these items

31. Auditing of Allowance for Doubtful Accounts
Obtain an understanding of how management developed the estimate using one or more of these approaches:
Review and test the process used by management to develop the estimate
Test aging schedule
Evaluate estimated percentages of
uncollectibility used
Develop an independent model to estimate the accounts
Review subsequent events such as subsequent collections on account

32. Sales Transaction Accounts Sales Receivable Business Functions
Processing Customer
Orders
Granting Credit
Shipping Goods
Billing Customers
and Recording ales
Documents and Records
Customer Order
Sales Order
Shipping Document
Sales Invoice
Sales Transaction File
Sales Journal or Listing
Accounts Receivable
Master File
Trial Balance
Monthly Statements

33. Transaction-Related Audit Objectives for Sales
Existence:
Recorded sales are for shipments actually made.
Completeness:
Existing sales transactions are recorded.
Accuracy:
Recorded sales are for the amount shipped.

34. Transaction-Related Audit Objectives for Sales
Classification:
Sales transactions are properly classified.
Timing:
Sales are recorded on the correct dates.
Posting and summarization:
Sales transactions are properly included
in the accounts receivable master file.

35. Monitoring Controls
Comparison of sales and cost of good sold with budgeted amounts
Exception reports to identify unusual transactions
Internal audit of revenue cycle controls
Computer reconciliation of transactions entered with transactions processed
Monitoring of accounts receivable for quality
Independent follow-up on customer complaints
Audits of sales tax collections

36. Substantive Tests of Revenue Cutoff Tests
Sales Cutoff
Auditor selects sample of sales recorded during cutoff period and vouches back to sales invoice and shipping documents to determine whether sales are recorded in proper period
Cutoff tests assertions of existence and completeness
Auditor may also examine terms of sales contracts
Sales Return Cutoff
Client should document return of goods using receiving reports
Reports should date, description, condition, quantity of goods
Auditor selects sample of receiving reports issued during cutoff period and determines whether credit was recorded in the correct period

37. Shipping Documents These are important in establishing whether
the shipment was actually made and as a
test of cutoff.

38. Sales Returns and Allowances Transaction
Accounts
Business Functions
Processing and
recording sales
returns and
allowances
Sales Returns
and
Allowances
Accounts
Receivable
Documents and Records
Credit Memo
Sales and Returns and
Allowances Journal

39. Fraud Indicators
Excessive credit memo or other adjustments to accounts receivable just after year-end
Customer complaints and discrepancies in receivable confirmations
Unusual entries to the receivable subsidiary ledger or sales journal
Missing or altered source documents
Lack of operating cash flow when operating income has been reported
Unusual reconciling differences between receivable subsidiary ledger and control account
Sales in the last month with unusual terms
Pre- or post-dated transactions
Unusual adjustments to sales accounts just before or after year-end

40. Improper Revenue Recognition Schemes
Recognize revenue on fictitious shipments
Hidden side letters that give customers unlimited right to return product
Record consignment sales as final sales
Accelerated recognition of sales occurring after year-end
Ship unfinished goods
Ship goods before date agreed to by customer
Create fictitious invoices
Ship goods never ordered
Ship more goods than ordered
Record shipments to company's warehouse as sales
Record shipments of replacement goods as new sales

41. End of Chapter