Revenue Process

What is the revenue cycle?

The business process that begins when a customer orders goods or services and ends when the company collects cash.

What are the basic steps of the revenue cycle?

Sales order → credit approval → picking/packing → shipping → billing → recording the sale/A/R → collecting cash → recording the collection.

What is a sales order?

A document or electronic record showing what a customer ordered, including items, quantities, prices, and customer information.

What is a purchase order?

A document created by the customer requesting specific goods or services at specified quantities and prices.

What is a sales invoice?

A document sent to the customer showing the goods or services provided, quantities, prices, and amount owed.

What is a bill of lading?

A shipping document that identifies goods being shipped and provides evidence that the goods were shipped.

What is a packing slip?

A document included with a shipment that identifies the goods and quantities included in the shipment.

What is a remittance advice?

Information sent by a customer identifying which invoice or account a payment is intended to settle.

What is a credit memo?

A document that reduces the amount a customer owes, commonly because of returns, allowances, or billing corrections.

What is the accounts receivable subsidiary ledger?

The detailed record showing how much each individual customer owes.

What is the accounts receivable control account?

The general ledger account that summarizes the total amount owed by all customers.

What is the sales journal?

A special journal used to record credit sales.

What is the cash receipts journal?

A special journal used to record cash received by the company.

What is the customer master file?

A database containing information about customers such as name, address, credit limit, and payment terms.

What is the credit department responsible for?

Approving customers for credit and establishing or modifying credit limits.

What is the shipping department responsible for?

Ensuring the correct goods are shipped to the correct customer and that the shipment is properly documented.

What is the billing department responsible for?

Preparing accurate invoices based on authorized shipments, prices, and terms.

What is the accounts receivable department responsible for?

Maintaining customer account balances and recording amounts owed by customers.

What is the cash receipts department responsible for?

Receiving customer payments and ensuring collections are properly deposited and recorded.

Why should credit approval be separate from the sales function?

To prevent sales employees from approving credit simply to increase sales and to reduce sales to customers who may not pay.

Why should custody of cash be separate from accounts receivable recordkeeping?

To prevent an employee from stealing cash and then altering customer accounts to conceal the theft.

Why should shipping be separate from billing?

To reduce the opportunity for an employee to both ship goods and create or manipulate invoices.

Why should billing be separate from cash collections?

To prevent an employee from stealing customer payments and manipulating billing records to conceal the theft.

What are the four basic segregation-of-duties functions?

Authorization, custody of assets, recordkeeping, and reconciliation/independent review.

What is authorization?

Approval by an appropriate person before a transaction or activity occurs.

What is an authorization control in the revenue cycle?

Credit sales should be approved by the credit department before goods are shipped.

What is the purpose of segregation of duties?

To reduce the opportunity for one person to commit and conceal an error or fraud.

What is an internal control?

A policy or procedure designed to prevent or detect misstatements, errors, or fraud.

What is a preventive control?

A control designed to prevent an error or fraud before it occurs.

What is a detective control?

A control designed to identify an error or fraud after it has occurred.

What is a compensating control?

A control that reduces risk when another desired control cannot be effectively implemented.

What is the occurrence assertion for revenue?

Recorded revenue transactions actually occurred and relate to the company.

What is the completeness assertion for revenue?

All revenue transactions that should have been recorded have been recorded.

What is the accuracy assertion for revenue?

Revenue transactions are recorded at the correct amounts.

What is the cutoff assertion for revenue?

Revenue transactions are recorded in the correct accounting period.

What is the classification assertion for revenue?

Revenue transactions are recorded in the appropriate accounts.

What is the existence assertion for accounts receivable?

Recorded accounts receivable actually exist.

What are rights and obligations for accounts receivable?

The company has the rights to the amounts recorded as accounts receivable.

What is valuation for accounts receivable?

Accounts receivable are recorded at amounts expected to be collected.

Which revenue assertion is especially important when testing for fictitious sales?

Occurrence.

Which revenue assertion is especially important when testing for unrecorded sales?

Completeness.

Which revenue assertion is especially important when testing sales around year-end?

Cutoff.

Which A/R assertion is especially important when testing whether customers actually owe the company money?

Existence.

Which A/R assertion is especially important when testing whether customers will actually pay?

Valuation.

Why is revenue vulnerable to fraud?

Management and employees may have incentives to make sales or profits appear higher than they really are.

What is a fictitious sale?

A sale that never actually occurred but is recorded as revenue.

What is premature revenue recognition?

Recording revenue before the requirements for recognizing revenue have been satisfied.

What is channel stuffing?

Sending excess goods to distributors or customers to inflate reported sales, sometimes using unusual return rights or terms.

What is a side agreement?

An undisclosed agreement that changes the actual terms of a sale and may affect whether revenue should be recognized.

What is a bill-and-hold arrangement?

A transaction where the customer has purchased goods but the seller temporarily retains physical possession; revenue recognition depends on whether the applicable requirements are satisfied.

Why are sales returns an audit concern?

Returns can be used to make current-period sales appear higher than they ultimately are, especially around year-end.

What is a sales allowance?

A reduction in the amount owed by a customer because of damaged, defective, incorrect, or otherwise unsatisfactory goods.

Why can unauthorized credit memos be a problem?

They can improperly reduce A/R or be used to conceal stolen cash.

What is lapping?

The theft of one customer's cash receipt followed by using another customer's payment to cover the missing amount.

How does lapping work?

An employee steals Customer A's payment, leaves A's account unpaid, then applies Customer B's payment to A's account and continues shifting later payments to cover earlier thefts.

What is the key condition that makes lapping possible?

The same employee has access to customer payments and the ability to alter accounts receivable records.

What segregation-of-duties control helps prevent lapping?

Separate custody of cash from accounts receivable recordkeeping.

What control can help detect lapping?

Independently mailing customer statements and investigating customer complaints.

Why are customer statements useful in detecting lapping?

Customers may identify payments or balances that do not agree with the company's records.

What is a lockbox system?

A bank-operated system where customers send payments directly to a bank-controlled location for processing.

Why is a lockbox effective?

It reduces employees' access to incoming customer payments and therefore reduces the opportunity for theft.

What is a prelisting of cash receipts?

An independent list of customer payments prepared when cash or checks are initially received.

Why is a prelisting of cash receipts useful?

It creates an independent record that can be compared with deposits and accounting records.

What does "deposited intact" mean?

All cash and checks received are deposited without removing or using part of the collection.

Why should customer payments be deposited daily?

To reduce the opportunity for theft and ensure prompt recording of cash.

What is an independent bank reconciliation?

A reconciliation performed by someone who does not handle cash or maintain the related accounting records.

Why should bank reconciliations be performed independently?

The person reconciling the account is less able to conceal theft or errors.

What is a customer statement?

A periodic statement showing a customer's transactions and outstanding balance.

What is a positive confirmation?

A confirmation that asks the recipient to respond whether the information is correct.

What is a negative confirmation?

A confirmation that asks the recipient to respond only if the information is incorrect.

When is a positive A/R confirmation generally appropriate?

When individual balances are large, risk is high, controls are weak, or disputed balances are likely.

When is a negative A/R confirmation generally appropriate?

When assessed risk is low, many small balances exist, controls are effective, and recipients are expected to pay attention to the confirmations.

What is the key difference between positive and negative confirmations?

A positive confirmation requires a response regardless of agreement; a negative confirmation requires a response only when the customer disagrees.

What should an auditor do when a positive A/R confirmation is not returned?

Perform alternative procedures such as examining subsequent cash receipts and supporting shipping and sales documentation.

What is a subsequent cash receipt?

A payment received after year-end that can provide evidence about the existence and collectibility of an A/R balance.

Why are subsequent cash receipts useful audit evidence?

A later payment provides evidence that the receivable existed and was collectible.

What is tracing?

Starting with source documents and following them forward into the accounting records.

What is vouching?

Starting with accounting records and tracing them backward to supporting documents.

What assertion does tracing generally test?

Completeness.

What assertion does vouching generally test?

Occurrence or existence.

What is the easiest way to remember tracing versus vouching?

Trace = source to books = completeness. Vouch = books to source = occurrence.

Why does tracing test completeness?

Starting with evidence that a transaction occurred allows the auditor to see whether it was recorded in the accounting records.

Why does vouching test occurrence?

Starting with a recorded transaction allows the auditor to determine whether evidence exists that the transaction actually occurred.

If an auditor traces shipping documents to sales invoices, what is being tested?

Completeness of recorded sales.

If an auditor vouches sales invoices to shipping documents, what is being tested?

Occurrence of recorded sales.

If an auditor traces shipping documents into the sales journal, what assertion is primarily being tested?

Completeness.

If an auditor vouches recorded sales from the sales journal to shipping documents, what assertion is primarily being tested?

Occurrence.

If an auditor starts with recorded sales and looks for evidence that the goods were shipped, what assertion is being tested?

Occurrence.

If an auditor starts with shipping documents and looks for the related sales entry, what assertion is being tested?

Completeness.

What is the auditor's basic completeness question?

"What transactions actually happened that might be missing from the books?"

What is the auditor's basic occurrence question?

"Do the transactions recorded in the books actually represent real transactions?"

What is the auditor's basic cutoff question?

"Was this transaction recorded in the correct accounting period?"

What is the auditor's basic valuation question for A/R?

"How much of this receivable will the company actually collect?"

What is a prenumbered sales invoice?

An invoice assigned a unique sequential number to help identify missing or duplicate invoices.

Why should sales invoices be prenumbered?

Missing or duplicate invoice numbers can be identified and investigated.

What is a prenumbered shipping document?

A shipping document assigned a unique sequential number to help identify missing shipments.

Why should shipping documents be prenumbered?

Missing shipment numbers can be identified and investigated.

How can an auditor use sequential shipping documents to test completeness?

Select shipping documents and trace them to sales invoices and the accounting records.

How can an auditor use sequential sales invoices to test occurrence?

Select recorded invoices and trace them back to supporting shipping documents.

What is the risk of duplicate sales invoices?

The same shipment could be billed more than once, overstating revenue and A/R.