W6 Flashcards (Auditing Revenue Cycle + F/S Fraud Considerations)

Why is the revenue cycle a critical process?

• represents the earning process for companies

  • this is the primary driver for net income

• revenue is what users of F/S look at

  • make decisions based on revenue data

• Usually involves a high volume of transactions

  • → internal controls are important

Why are I/Cs important in the revenue cycle?

• usually involves high volume of transactions

How does the auditor approach the revenue process?

• start with understanding how the entity earns revenue and the particular revenue recognition issues that may be relevant given the nature of their revenues

  • diff industries vary in how they earn revenues

  • → the RMM may vary for diff accounts and diff assertions by industry

What’s a good starting point to understand the entity’s revenues?

• look at the disaggregated revenue in the I/S

• shows which products/services generate how much revenue

Steps: Testing Revenue Process using Cycle Approach

For each business cycle, the auditor:

1. follows a methodical approach to understand the process/cycle

2. identifies RMM

3. develops appropriate audit strategy

How is the cycle approach efficient?

• efficient b/c it helps the auditor consider both the B/S and I/S accounts that are impacted when a transaction is recorded

  • e.g., if you are going to test the credit to revenues, you can also gather evidence about the debit to A/R at the same time and vice versa

What do auditors have to understand about the entity?

understand:

• nature of the entity

• industry

• key activities that comprise the accounting cycle

• the flow of transactions and what key accounts are impacted

How is RMM assessed for each account and assertion in the cycle?

The auditors must identify critical assertions for each account.

• Assess IR

• Asses CR

• Set DR based on the RMM

What does it mean to Assess IR?

• to consider risk of an error in the first place 

What does it mean to Assess CR?

Based on the IR assessment:

• identify what controls are in place to mitigate the risks

• perform compliance tests (focus is often on control activities over the processing of transactions)

  • using inquiry, observation, re-performance, inspection of documents:

    • To gather sufficient and appropriate evidence on the effectiveness of ICFR

How is DR set based on RMM?

• gather sufficient and appropriate substantive evidence on accounts balances 

  • using substantive tests of transactions, balances, or substantive analytical procedures

What are typical revenue process activities? What are the related accounts?

Activity

• Credit Sales (Dr: A/R + COGS, Cr: Sales and Inv)

• Cash Receipts (Dr: Cash and Sales Discounts, Cr: Inv)

• Sales adjustments (Dr: Sales returns and allowances, Cr: A/R)

  • sales returns

  • allowances

• Allowance for bad debts (Dr: BDE, Cr: Allowance for BDE)

• Bad Debts Write-off (Dr: Allowance BDE, Cr: A/R)

In the revenue cycle, what are the significant accounts?

• Sales

• A/R

• Cash

What assertions must the auditor gather evidence and evaluate for these significant revenue cycle accounts

• Existence and occurrence

• Valuation/accuracy

• Completeness and cut-off

• Rights and obligations

• Presentation and disclosure

Def: Existence and occurrence (Revenue Cycle)

• Assertion: management asserts that accounts receivable exist at the B/S date and that sales transactions recorded in revenues occurred during the year

To review

• Sales: Did those sales actually occur?

• A/R: did those A/R actually exist?

Def: Valuation/accuracy (Revenue Cycle)

• Assertion: A/R receivable are valued properly and sales transactions are accurate

To review

• Sales: were the sales recorded accurately?

• A/R: are the A/R at year-end valued properly?

Def: Completeness and cut-off (Revenue Cycle)

Assertion:

• all sales transactions and A/R that should be recorded are included in the correct period

Review:

• All sales and A/R should be recorded in the correct period 

Def: Rights and Obligations (Revenue Cycle)

Assertion:

• company has the right to collect the A/R balance

Review:

• (typically around A/R): do they have the rights to their A/Rs

Def: Presentation and Disclosure (Revenue Cycle)

Assertion:

• all info is appropriately presented, classified, and described; 

• disclosures are clearly expressed 

  • ex: disclosure of related party sales and receivables, reporting of receivables pledged as collateral, etc.

Review

• have all disclosures been included in the F/S notes?

• are the data clearly disaggregated to diff types of sales, etc.

Important Data Files (for Revenue Cycle)

• customer master file

• price list master file

• sales detail (journal) file

• pending order and back-order master file

Important Documents (for Revenue Cycle)

• sales order

• shipping document

• sales invoice

• credit memo

• customer statements

Important Management Reports (for Revenue Cycle)

• A/R listing 

• A/R aging

• cash receipts listing

• daily sales report

• back-order report

• sales analysis report

(from class) What are we testing for by vouching?

Occurrence