Rittenberg schwieger johnstone auditing a business risk approach sixth edition chapter 11
Download
1 / 41

Edition - PowerPoint PPT Presentation


  • 885 Views
  • Updated On :

Rittenberg/Schwieger/Johnstone Auditing: A Business Risk Approach Sixth Edition Chapter 11 Auditing Revenue and Related Accounts Copyright © 2008 Thomson South-Western, a part of the Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license.

loader
I am the owner, or an agent authorized to act on behalf of the owner, of the copyrighted work described.
capcha
Download Presentation

PowerPoint Slideshow about ' Edition' - omer


An Image/Link below is provided (as is) to download presentation

Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author.While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server.


- - - - - - - - - - - - - - - - - - - - - - - - - - E N D - - - - - - - - - - - - - - - - - - - - - - - - - -
Presentation Transcript
Rittenberg schwieger johnstone auditing a business risk approach sixth edition chapter 11 l.jpg

Rittenberg/Schwieger/JohnstoneAuditing: A Business Risk ApproachSixth EditionChapter 11

AuditingRevenue and Related Accounts

Copyright © 2008 Thomson South-Western, a part of the Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license.


Why are revenue cycle accounts important l.jpg
Why are revenue cycle accounts important?

  • Sales transactions are always material to a company's financial statements

  • According to the SEC, a majority of financial statement manipulations and audit failures involve overstated revenues

  • Therefore, revenue cycle accounts must be examined with great care


What is the cycle approach l.jpg
What is the cycle approach?

  • Revenue cycle transactions include all the processes ranging from the sale to shipping a product, billing the customer, and collecting cash

  • A company's revenue cycle transactions reflects its operations

  • A cycle approach is one way to help the auditor focus on the important account balances surrounding a transaction to ensure that sufficient audit evidence is gathered and evaluated


List the financial transactions processing cycles l.jpg
List the Financial Transactions Processing Cycles

  • Revenue

  • Acquisition and payment of goods and services

  • Payroll

  • Financing: debt and equity

  • Cash and short-term investments


Overview of the revenue cycle sales made on account l.jpg
Overview of the Revenue Cycle (Sales made on Account)

  • 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


Discuss business risk and business environment l.jpg
Discuss Business Risk and Business Environment

Revenue recognition

  • SAS 99 - Consideration of Fraud in a Financial Statement Audit

    • Auditor should presume risk of material misstatement due to fraud related to revenue recognition

    • Research shows over half of frauds involve overstating revenues


Some improper revenue recognition schemes l.jpg
Some 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


What are some fraud risk factors for revenue recognition l.jpg
What are some fraud risk factors for revenue recognition?

There are a number of types of 'red flags' which signal the potential for fraud in the financial statements

  • External risk indicators

  • Internal red flags

  • Unusual financial results

    Auditor deals with red flags by

  • Examining external pressures that could lead to financial reporting fraud

  • Examining the financial statements to determine if account balances seem out of line


What analytical analysis can be done for possible misstatements l.jpg
What analytical analysis can be done for possible misstatements?

Compare client revenue trend with economic conditions and industry trends

Compare cash flow from operations with net income

Perform analytical procedures

  • Ratio analysis

  • Trend analysis

  • Reasonableness tests


Assessment of environment risk l.jpg
Assessment of misstatements?Environment Risk

Risk assessment is ongoing process in every audit

Audit steps to assess environment risk for the revenue cycle:

  • Update information on business risk

  • Perform analytical procedures to look for unexpected relationships

  • Develop understanding of internal controls

  • Analyze business risk for motivations and methods to misstate sales


Assessment of environment risk continued l.jpg
Assessment of misstatements?Environment Risk (continued)

  • Document operation of accounting applications and important controls

  • Develop preliminary assessment of environment risk

  • If control risk is high, determine likely types of misstatements

  • If control risk is lower, develop procedures to test operation of controls

  • Perform tests of controls, document results

  • Based on the results of testing, reassess control risk


Inherent risk with regard to sales l.jpg
Inherent Risk with misstatements?Regard to Sales

While sales transactions are routine for most organizations and do not represent an abnormally high risk, for other organizations, revenue recognition may be complicated

Difficult audit issues include:

  • When to recognize revenues

    • Auditor must understand client's operations and related GAAP issues

    • Example: point of sale revenue recognition vs. percentage of completion


Inherent risk with regard to sales continued l.jpg
Inherent Risk with misstatements?Regard to Sales (continued)

  • Impact of any unusual sales terms and whether title passed to customer

    • Example: related party transactions

  • Goods recorded as sales have been shipped

  • Sales made with recourse or that have significant returns

    • Example: irrevocable right to return goods

      The presence of these issues increase inherent risk and the probability of material misstatement


Inherent risk in receivables l.jpg
Inherent Risk in Receivables misstatements?

Primary risk is net receivables will be overstated, because either receivables have been overstated, or the allowance for uncollectible accounts has been understated

Risks affecting receivables include:

  • Sales of receivables recorded as sales rather than financing transactions

  • Receivables pledged as collateral

  • Receivables classified as current when likelihood of collection is low

  • Collection of receivable contingent on uncertain future events

  • Payment not required until purchaser sells the product


The control environment and sales l.jpg
The Control Environment and Sales misstatements?

An organization's control environment affects revenue and related transactions more than most accounts

The auditor must consider:

  • Management's integrity

  • Financial condition of the organization

  • Financial pressures on the organization

  • Management incentives to achieve financial results


Understanding internal controls l.jpg
Understanding Internal Controls misstatements?

Although the auditor must understand all components of internal controls, particular attention is paid to significant control procedures and monitoring controls

The auditor obtains an understanding of the controls by

  • Walk-through of the processing of transactions

  • Inquiry

  • Observation

  • Review of client documentation

    It is critical this understanding be documented in the work papers


Understanding internal controls continued l.jpg
Understanding Internal Controls misstatements?(continued)

Internal control procedures should be sufficient to ensure the management assertions are achieved:

  • Existence/Occurrence: sales are recorded only when shipment has occurred and the primary revenue producing activity has been performed

  • Completeness: all valid sales transactions are recorded

  • Rights/obligations

  • Valuation

  • Presentation and disclosure


What are the three components of evaluating control risk l.jpg
What are the three components of evaluating control risk? misstatements?

1. Monitoring Controls

2. Control Structure for Returns, Allowances, and Warranties

3. Importance of Credit Policies Authorizing Sales


Monitoring controls l.jpg
Monitoring Controls misstatements?

Designed to signal failures in transaction processing, and determine if timely, corrective action is taken

Monitoring controls applicable to revenue transactions include:

  • Compare sales and cost of good sold with budgeted amounts

  • Exception reports generated 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


Documenting testing and assessing environment risk l.jpg
Documenting, Testing, and Assessing Environment Risk misstatements?

Develop understanding of the accounting system and control procedures

  • Evidence is gathered through inquiry, review of client accounting manuals, and review of prior year audit workpapers

  • Documentation includes questionnaires, flowcharts, and narratives

  • Determine whether the application control procedures are sufficient to achieve the control objectives

  • Based on control design, make preliminary assessment of control risk


Documenting testing and assessing environment risk continued l.jpg
Documenting, Testing, and Assessing Environment Risk misstatements?(continued)

  • The auditor must document those controls that support an assessment of control risk below maximum

  • If the auditor plans to rely on the internal controls, the controls are tested to see if they are operating as designed

  • If testing indicates the control is not operating effectively,

    • Auditor will increase assessed control risk, lower detection risk, and perform more rigorous substantive testing

    • If the control is working effectively, control risk assessment is unchanged


Linking environment risk assessment substantive testing l.jpg
Linking Environment Risk Assessment & Substantive Testing misstatements?

The rigor of substantive testing is inversely related to the assessed level of environment risk

The auditor learns three things during the assessment of environment risk that affects the design of substantive audit procedures:

1. The nature of the accounting system, controls used, and documents generated in the client's processing

2. Existence of fraud risk factors

3. Effectiveness of controls and types of misstatements likely to occur


Substantive testing in the revenue cycle l.jpg
Substantive Testing in the Revenue Cycle misstatements?

Planning for Direct Tests of Transactions and Account Balances

  • Audit objectives and assertions

  • Account balance relationships

  • Risk of material misstatement

  • Composition of the account

  • Persuasiveness of audit procedures

  • Cost of audit procedures

  • Timing of audit procedures

  • Determining optimal mix of audit procedures


What are some substantive tests of revenue l.jpg
What are some substantive tests of revenue? misstatements?

Assertions related to revenue transactions:

  • Occurrence: Have the transactions occurred and pertain to the entity

  • Completeness: Have all transactions been recorded

  • Accuracy: Have transactions been accurately recorded

  • Cutoff: Have transactions been recorded in the correct accounting period

  • Classification: Have transactions been recorded in the proper accounts


Substantive tests of revenue for occurrence accuracy and valuation l.jpg
Substantive Tests of Revenue misstatements?for Occurrence, Accuracy, and Valuation

Vouch recorded sales transaction back to customer order and shipping document

  • Compare quantities billed and shipped with customer order

  • Special care should be given to sales recorded at the end of the year

  • Scan sales journal for duplicate entries


Substantive tests of revenue cutoff tests l.jpg
Substantive Tests of Revenue misstatements?Cutoff Tests

Can be performed for sales, sales returns, cash receipts

  • Provides evidence whether transactions are recorded in the proper period

  • Cutoff period is usually several days before and after balance sheet date

  • Extent of cutoff tests depends on effectiveness of client controls


Substantive tests of revenue cutoff tests27 l.jpg
Substantive Tests of Revenue misstatements?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

    • Auditormay 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


Substantive tests of revenue for completeness l.jpg
Substantive Tests of Revenue misstatements?for Completeness

  • Use of pre-numbered documents is important

  • Analytical procedures

  • Cutoff tests

  • Auditor selects sample of shipping documents and traces them into the sales journal to test completeness of recording of sales


Substantive tests of accounts receivable existence occurrence l.jpg
Substantive Tests of Accounts Receivable Existence & Occurrence

Valuation

  • Are sales and receivables initially recorded at their correct amount?

  • Will client collect full amount of recorded receivables?

    Rights and Obligations

  • Contingent liabilities associated with factor or sales arrangements

  • Discounted receivables

    Presentation and Disclosure

  • Pledged, discounted, assigned, or related party receivables


Substantive tests of accounts receivable l.jpg
Substantive Tests of OccurrenceAccounts Receivable

  • Obtain and evaluate aging of accounts receivable

  • Confirm receivables with customers

  • Perform cutoff tests

  • Review subsequent collections of receivables


Aging accounts receivable l.jpg
Aging Accounts Receivable Occurrence

Because receivables are reported at net realizable value, auditors must evaluate management estimates of uncollectible accounts

  • Auditor will obtain or prepare schedule of aged accounts receivable

    • If schedule is prepared by client, it is tested for mathematical and aging accuracy

  • Aging schedule can be used to

    • Agree detail to control account balance

    • Select customer balances for confirmation

    • Identify amounts due from related parties for disclosure

    • Identify past-due balances

  • Auditor evaluates percentages of uncollectibility

  • Auditor then recalculates balance in the Allowance account


Confirming receivables with customers l.jpg
Confirming Receivables with Customers Occurrence

Confirmations provide reliable external evidence about the

  • Existence of recorded accounts receivable and

  • Completeness of cash collections, sales discounts, and sales returns and allowances

    Confirmations are required by GAAS unless one of the following is present:

  • Receivables are not material

  • Use of confirmations would be ineffective

  • Environment risk is assessed as low and sufficient evidence is available from using other substantive tests


Types of confirmations l.jpg
Types of Confirmations Occurrence

Positive confirmations

  • Customers are asked to agree the amount on the confirmation with their accounting records and to respond directly to the auditor whether they agree with the amount or not

  • Positive confirmation requires a response

  • If customer does not respond, auditor must use alternative procedures


Types of confirmations continued l.jpg
Types of Confirmations Occurrence(continued)

Negative confirmations

  • Customers are asked to respond only if they disagree with the balance (non-response is assumed to mean agreement)

  • Less expensive since there are no additional procedures if customer does not respond

  • May be used when all of the following are present

    • Confirming a large number of small customer balances

    • Environment risk for receivables is assessed as low

    • Auditor believes customers will give proper attention to confirmations


What is the follow up procedures for non responses l.jpg
What is the follow-up procedures for non-responses? Occurrence

If customer does not respond to positive confirmation, auditor may send a second, or even third, request

If customer still does not respond, auditor will use alternative procedures

  • Examine the cash receipts journal for cash collected after year-end

    • Care is taken to ensure receipt is year-end receivable, not subsequent sale

  • Examine documents supporting receivable (purchase order, sales invoice, shipping documents) to determine if sale occurred prior to year-end

    • Evidence gathered from internal documents is not considered as reliable


What is the follow up procedures for exceptions noted l.jpg
What is the follow-up procedures for exceptions noted? Occurrence

Customers are asked to agree the amount on the confirmation to their accounting records; differences are called exceptions

Reasons for exceptions:

  • Timing differences

  • Disputed items

  • Customer errors

  • Client misstatement

    Because misstatements are projected to the population of receivables, the auditor must determine the reason for the exception


Related party receivables l.jpg
Related-Party Receivables Occurrence

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 related parties so all audit team members can be alert for related-party transactions


Sold discounted and pledged receivables l.jpg
Sold, Discounted, and Pledged Receivables Occurrence

Receivables sold with recourse, discounted, or pledged as collateral should be disclosed

Audit procedures to identify these items include:

  • 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 for these items


Fraud indicators and audit procedures l.jpg
Fraud Indicators and OccurrenceAudit Procedures

Potential 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


Fraud indicators and audit procedures continued l.jpg
Fraud Indicators and OccurrenceAudit Procedures (continued)

Substantive procedures that may highlight potential fraud indicators:

  • Review of source documents including invoices, shipping documents, customer purchase orders, etc

  • Review and analyze credit memos and other adjustments to receivables

  • Confirm sales terms with customers

  • Analyze large or unusual sales made near year-end

  • Scan the general ledger, receivables subsidiary ledger, and sales journal for unusual activity

  • Perform analytical review of credit memo and write-off activity

  • Analyze recoveries of written-off accounts


Explain auditing of allowance for doubtful accounts l.jpg
Explain Auditing of Allowance for Doubtful Accounts Occurrence

Accounts receivable should be reported at their net realizable value

The balance of the allowance for doubtful accounts is estimated and depends on a number of factors

Understating the allowance overstates net accounts receivable and net income

Where accounts receivable are material, the auditor should obtain an understanding of how management developed the estimate by 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


ad