Audit Ch 7 - Revenue & Collection Cycle

Basic Activities in Revenue and Collection Cycle

1. receiving and processing customer orders;

2. delivering goods and services to customers;

3. billing customers and accounting for accounts receivable; and

4. collecting and depositing cash received from customers.

Audit Evidence in Management Reports and Data Files

• Pending order and back order master file

• Customer master file

• Price list master file

• Sales detail (journal) file

• Sales analysis report

• Accounts receivable listing and aging

• Cash receipts listing

• Customer Statements

Inherent Risks

• Improper Revenue Recognition

– Cut-off

– Bill and Hold

– Channel Stuffing

• Returns and Allowances

• Collectability of Receivables

Revenue Recognition

Must be (1) realized or realizable and (2) earned

FASB 5-step process for revenue recognition

1. Identify the contract(s) with a customer.

2. Identify the performance obligations in the contract.

3. Determine the transaction price.

4. Allocate the transaction price to the performance obligations in the contract.

5. Recognize revenue when (or as) the entity satisfies a performance obligation.

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

Other Tests of Controls in the Revenue Cycle

• Completeness of revenue and accounts receivable

• Accuracy of revenue and accounts receivable

• Accuracy of revenue

• Cutoff of revenue

• Classification of accounts receivable

Auditing Accounts Receivable

• Test Accounts Receivable Aged Trial Balance

• Confirm balances

• Perform analytical procedures

• Test sales cut-off

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

Factors likely to affect the reliability of confirmations

– Previous audit experience

– Intended recipient of the confirmation

– Type of information being confirmed

Types of Confirmations

Positive Confirmations, Negative Confirmations, Blank Confirmations

Positive Confirmations

– small number of accounts are involved

– large number of errors are anticipated

Negative Confirmations

– the combined assessed level of inherent and control risk is low

– a large number of small balances is involved

– the auditor has no reason to believe that the recipients of the

requests are unlikely to give them consideration.

Blank Confirmations

should be used if the recipient is likely to return a positive confirmation without verifying the accuracy of the information

Sales Cutoff Procedures

• Used to verify whether Sales/Revenues recorded in the correct accounting period

– Holding the books open

• Examine sales invoices and shipping documents shortly prior to and after year-end

• Examine returns after year-end