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CHAPTER 14 AUDITING THE REVENUE CYCLE Fall 2007

CHAPTER 14 AUDITING THE REVENUE CYCLE Fall 2007. Nature of the Revenue Cycle Inherent Risk Factors Audit objectives Control Activities Standard Substantive Tests. Nature of the Revenue Cycle. For a merchandising company, the classes of transactions in the revenue cycle include:

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CHAPTER 14 AUDITING THE REVENUE CYCLE Fall 2007

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  1. CHAPTER 14AUDITING THE REVENUE CYCLEFall 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 ReceivableFigure 14-9

  16. Analytical Procedures Commonly Used to Audit the Revenue CycleFigure 14-4

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

  18. 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.

  19. 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 lowenough and analytical procedures expected to be effective enough to get audit risk to an acceptably low level.

  20. 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.

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