Final Exam: Lecture 9 Auditing revenue; technology in audit slides

Articulation and Cycle-based Auditing

Financial statements are linked together

•Double-entry accounting

•“Articulation” (inter-relationship and congruence)

Implication for auditing

•If the balance sheet accounts are fairly stated, this provides some comfort and evidence that the income statement accounts are also fairly stated

Auditors historically spend more time auditing balance sheet accounts

•Cash

•A/R

•Inventory

This provides some evidence on income statement accounts

•Revenue

•COGS

Articulation and Cycle-based Auditing (Continued)

•Auditors still need to specifically document evidence supporting income statement account/assertions

•The level of specific evidence varies

•COGS is a plug à substantive analytical procedures

•Revenue affects both Cash and A/R

•Substantive Analytical Procedures

•PCAOB also now requires firms to perform substantive tests of detail  over revenue (i.e. examining detailed documentation for a sample of individual transactions)

Revenue Cycle Accounts: affected by sales transactions

funny question on this chart on exam!!!!!

Revenue Cycle Accounts: affected by sales transactions2

ACG 4651 Approach

•Cash – Covered later in the semester

•Sales – Covered in these Lecture Slides

•A/R – Covered in these Lecture Slides

•Allowance – Covered briefly in these Lecture Slides

Bad Debt Expense:

•Generally tested through basic substantive procedures

•Bad Debt Expense = EB – BB + Write-offs

•We audit BB and EB (primary evidence for bad debt expense)

•This is our primary evidence for Bad debt expense

•We test write-offs separately (not covered in this class)

What about all the other stuff?:

•Sales discounts

•Sales returns and allowances

•Warranty expense

•Warranty liability

•Sales commission

•These are still important and you should understand that these accounts relate to the revenue cycle

•We will not specifically cover these accounts in this class

Understanding the Revenue Cycle

Understanding the revenue cycle is critical in auditing revenue.

•Inherent risk assessment – BY ASSERTION

•Preliminary control risk assessment – BY ASSERTION

Beyond the risk assessments required in planning, this understanding is critical in the control and substantive phases of the audit

•Control testing: Building an understanding of a process is critical for identifying key controls to test and determining how to test them.

•Substantive testing

—> In order to substantively test something, we need to gather evidence

—> This evidence generally requires an “audit trail”

—> In order to identify an audit trail, we need to understand the transaction cycle

—> Therefore, we must first figure out how a company earns revenue and how it is recorded.

—→ Even if we are testing revenue using substantive analytical procedures, we need to understand the process to develop our expectation

—→ Walkthroughs

-understanding where people can understate allowance or revenue and other accounts and what keeps auditors up at night. Valuation assertion: completness and existance for allowance and where all receivables are real and Valuation assertion is about collectibility

The worry with allowance account is the valuation assertion

The auditor does with valuation assertion when it comes to allowance to manager useing reasonalble collectibility precentages. Get help by valuation specalist

With A/R a partner worries about overstating current assets like AR. Also worried if AR is collectible (allowance account). Factoring receivables = management sells receivables to thrid party for a slight discount to get cash today and dont have to worry abt customers paying their bills. If the company doesnt tell us about it than thats scary for the Auditer. Rights and obligations issues of if the client still owns the receivables. Hard to audit

-worry that with revenue people will book fake sales

With AR and revenue the two assertions that keep the partner up at night is existance and rights and obligations. These assertions are imortant for ar and rev but they are still applicable to both

credit check

most important part of the revenue diagram because you cant recognize revenue if you dont collect from the customers

-example, making first time customers paying half up front and half at the end and then not running more ads for the radio station until they pay for the other one

example bank will need financial statemtns

It is really important that the client send the customer exaclty what they ordered and what the credit department said that they could

The only thing worse than sending a customer the wrong thing than charging the customer the wrong thing

pt 2 of doucment

THREE WAY MATCH THIS WILL BE AN OPEN RESPONSE QUESTION ON THE EXAM!!!!!!!! What are the three documents that an auditor looks at as part of a three way match? And what does each one show us? Where do we vouch each doucment to?

_vouching revenue because it delas with existance. pick transactions and look at documentation about those transactions to make sure it was an actual sale with and actual customer that you can collect real cash on at some point. To know customer is real, you can look at sales order to see customer name. To see there was an actual delivery of g/s to the customer, look at shipping document. To see that there is probable cash collection, look at the invoice. Taking those three documents, we can make sure the info matches and have solid evidence that the revenue is real.

-The best place to go to look for these three documents can be found in the accounting department. Primary test of details over revenue

-go to accounting dept and ask them for the sales order, sales invoice, and shipping document

-Sales order: theres a real customer who wants to buy something from us; vouch to customer order dept

-Shipping document: the client provided those goods to their customer; vouch back to shipping dept

-sales invoice: the client is actively trying to get paid; vouch to billing department

If we are only working with the records in teh accounting department, that is most likely to have froad so we dont stop there. We also go abck and vouch each one to the original source

Revenue cycle matrix

make sure audit firms establishes clean communication line with clients customer that client cannot interfear with

-confirmation letters also testing revenue that led to the receivable

-substantive procedures: come up with expectation and compare recorded amount to that expectation to provide evidence that theres a financiel relationship that should hold and it does. Analytical procedures are weaker than test of deatail

-no black and white answer to know how to guarantee all revenue is good

-three way match is a primary control test

-billing of shipments: most people do not pay bills before they get bills. IF you dont send a bill to your customer, you probably wont get paid. the earlier companyies send bills, the more likely they are to get paid. To test if companies are sending bills to clients within a reasonable time. Just look at date for shiping doc and date from invoice and make sure they are consitantly sending bills during the same time period. Testing billing of shipments, look at info you already have from three way match

Credit approval: look at sales order and make sure credit dept signed off on it

-Pricing: make sure that company is charging the right price to their customers

Cutoff Case Study from class

Doc 487 —> looks pretty good, still get delivery conformation but not too worried about that

DOc

Technological progress

“waxing nostalgic about jobs lost to technology is little better than complaining that antibiotics put too many gravediggers out of work” -Garry Kasparov

“We always overestimate the chagne that will occur in the next years and underestimate the change that will occur in the next 10 - bill gates (human brain is really good about thinking linearly and bad at thinking exponentially)

Background: Technological capabilities

-Google neutral machine translation

-brief history: facebooks chatbots (pulled plug so bots dont take over facebook)

-AlphaGo and decision tree complexity (there are 10 to the 360 power possible scenarios in the game of go and yet there is a program that is able to beat humans in the game about 10 years ago)

-AI is technoligy, not magic

How does AI work anyway

Input—> BLACK BOX —> output

-in the black box, AI is just using statistical regression models, looking at what words associate with each other

-Conceptualy, the black box is fitting and refitting statistical models (minimizing error terms and maximizing explanations)

-detecting patters is higher-order interactions

—> one way effect: sunscreen prevents sunburn so we would expect someone who is wearing sunscreen would have lower sunburn

—> two way interaction: the effect of sunscreen would be stronger when waterproofing is present that when its not

3 way interaction: with adults, we know that when we get in and out of water, we have to reapply sunscreen more often. Kids do not know that. The effect of waterproofing and sunscreen is stronger in kids because they are putting more wear and tear on it, than adults that just reapply anyway

4 way interaction: how does reapplication affect waterproofing and sunscreen in children vs adult

Technological possibilities in accounting and auditing

as accountants and auditors, we are not playing games and we dont see outcomes until they occur and certainly can play out scenarious to wins, losses, and ties

-without this outcome feedback, out decisions are harder to model

-but wFINISH THESE NOTES!!

Advanced technologies in the audit

where weve been: computer assisted analytics

—> traditional machanical scanning software

—> sampling routines

Where we are: advanced audit delivery tools

-confirmations, inventory, google maps, RPA (data scrubbing), ‘off the shelf’ programs, proprietary GPT systems, cognative technologies, agentic AI

Where we could be heading: agentic audits (maybe but maybe not)

Data and analytics applications in auditing: 100% testing

use computer assisted autditing toos (CAATs) to test 100% of population

-three way match

—> data file with info for all customer order forms

—> data file with info for all shipping documents

—> data file with info for all sales invoices

-do all the fields match as they chould?

-What are t he exceptions

-in order to test the customer order file and the shipping document and the sales invoice file, the match happens autimatically

-From a three way match, we learn if it is a known or likely difference, an indiation that there is a problem, and where to look further to determine if we need to identify an audit difference

-We are able to find alll those by doing it manually, but computer doing it can only show us where the problems are, but we would still have to go and investigate it

-need to understnad the concept of a three way matchand what the computer is doing so that we can know what do do

Drones

drones give you the ability to go where humans cant or dont want to go and see more than what humans can see

but not everything is 100% accurate

-usually when we go back and make sure they are right, we are basically doing what we would have been doing if we were to do it ourselves