Audit Chapter 7

Exam two

Activities in the Revenue and Collection Cycle

1. Receiving and processing customer orders, including credit approval

2. Delivering goods and services to customers

3. Billing customers and accounting for accounts receivable

4. Collecting and depositing cash received from customers (Ch 6)

Activity 1 Receiving and Processing Customer Orders, Including Credit Approvals: Credit Sales

• Credit sales should be authorized to make sure the customer will be able to pay

• Customer master file- access limited to people who need it (w/ appropriate segregations of duties)

• poor controls could lead to sales to fictious customers, customers with bad credit or shipping documents for goods that do not exist

Activity 1 Receiving and Processing Customer Orders, Including Credit Approvals: Internal Control for sales docs

• Relevant sales documents (invoices and shipping documents) should be in prenumbered sequence as an internal controls

  • make sure all transactions are recorded (completeness assertion) primary purpose

  • make sure there are no duplicate transactions (occurrence)

Activity 2: Delivering Goods and Services to Customers: Controls

• physical custody of inventory goods starts in the storeroom or warehouse where the inventory is kept

• authorization of a shipping order to release inventory to shipping department

• employees sign for inventory when transferring custody

Activity 2: Delivering Goods and Services to Customers: Source Documents

• Bill of lading- contract between the shipper and the carrier; includes shipping information such as ship dates and origination, purchase order numbers and signatures for receipts of merchandise

  • Packing slip- Document included with a shipment that shows the description and quantity of the goods being shipped

Activity 3: Billing Customers and Accounting for Accounts Receivable: What is generated once delivery/shipment is complete

Sales Invoice- a bill sent to customers for payment showing the amount due and payment terms

Activity 3: Billing Customers and Accounting for Accounts Receivable: Separation of duties

• Authorization of the invoice

• Custody of receivables payments

• Recording of AR

• Reconciliation of AR subsidiary ledger to receivable control account

Pending Order Master File

Sales transactions initiated but not completed

Back order master file

orders for products that are out of stock

Customer master file

List of customers and their credit limits

Price list master file

list of prices for company products

Sales detail file (sales journal)

Detailed sales entries with invoice and shipping information

Sales analysis reports

Product, business segment, geographic segment

Accounts receivable listing and aging

List of customer balances owed and how long receivables have been outstanding

Cash receipts listing

detailed entries for cash deposits and credits to accounts

Customer statements

bills, receipts, monthly statements of amounts owed

What question do we ask when we are assessing RMM for each significant account and relevant assertions?

What could go wrong?

Revenue & Collections Cycle 2 Significant Accounts

Sales Revenue and Accounts Receivables

Sales Revenue top 3 Relevant Assertions

1. Occurrence- risk of overstatement/incentive to overstated, risk of fraud (management could record false sales)

2. Cutoff- tool to overstate revenue

3. Completeness- risk of error

Accounts Receivables top 3 Relevant Assertions

1. Existence- risk of understatement

2. Valuation- estimation risk in allowance for doubtful accounts (aggressive or reasonable)

3. Completeness- risk of errors

WCGW 3 primary concerns

1. Is revenue recognized when appropriate?

2. Is there a possibility of customers returning the goods?

3. Are the accounts receivable collectible?

WCGW: Inappropriate Revenue Recognition: Revenue Recognition

To be recognized, revenues must be realized or realizable and earned

WCGW: Inappropriate Revenue Recognition: SEC Criteria

• Persuasive evidence of an arrangement exists

• Delivery has occurred or services have been rendered

• The seller’s price to the buyer is fixed or determinable

• Collectability is reasonably ensured

What is the three way match?

three way match of the purchase order, shipping order and invoice before revenue is recognized

WCGW: Inappropriate Revenue Recognition: FASB ASC 606 Revenue Recognition Process

1. Identify the contract(s) w/ a customer

2. Identify the performance obligations in the contract

3. Determine the transaction price

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

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

WCGW: Inappropriate Revenue Recognition: Estimates

• Estimates must be made regarding:

  • Collectability of accounts receivable

  • Customer returns and allowance

  • Allocation of transaction price to performance obligations

Entity-Level Controls

• Tone at the top

  • Management integrity

  • Management’s involvement in continually reviewing revenue accounting

  • Regular comparisons to budgets and forecasts

• Active audit committee

Account & Assertion Level Controls

• Three way match before revenue recognition (order, shipment, invoice)

• Separation of duties

• Care over recording of shipping and payment dates

• Prenumbered documents

• Management review controls

  • Pending order file

  • Past-due receivables

  • Timely follow up on discrepancies

Test of controls

• Vouch sales JE to three-way matched documents

• Trace source docs (shipment, invoice, order) to sales JE

• Vouch invoice prices to price listing

• Observe whether quantity shipped & recorded is the same

• Trace date on shipping documents to sales JE

• Scan data files for numerical sequence in pre-numbered documents

• Inspect documents for whether customer approval procedures are followed.

• Exception test customer credit limits.

• Inspect documents for evidence of management review of estimates

Test of controls- Dual purpose tests

• Vouch sales JE to three-way matched documents

• Trace source docs (shipment, invoice, order) to sales JE

• Vouch invoice prices to price listing

• Observe whether quantity shipped & recorded is the same

• Trace date on shipping documents to sales JE

• Scan data files for numerical sequence in pre-numbered documents

What is the purpose of assessing RMM?

To determine the nature, timing and extent of substantive testing

What are the two types of substantive procedures

Substantive analytical procedures and tests of details

Why are substantive procedures always performed in the revenue cycle

Because of the presumptive risk of fraud in revenue recognition

Substantive Analytical Procedures in the Revenue Cycle

• Comparisons of asset and revenue balances with recent history

  • past performance can be a good indicator of future performance

• Comparisons of calculations/ratios to historical data and industry statistics

  • to check if your customers are better/worse at paying you to adjust allowance for doubtful accounts

Test of Details for Revenue: Occurrence Assertion

• Vouching details per the sales journal to invoices, shipping documents, and customer purchase orders

  • should vouch with all 3 but if only do one do shipping docs because its what triggers revenue recognition

• Tracing a sample of sales returns to journal entry (find the DR to revenue)

  • Tracing is usually related to completeness however returns is a contra account and has the incentive to understate

Test of Details for Revenue: Completeness & Cutoff Assertion

• Completeness: Tracing details per shipping documents to the sales journal

• Cutoff: Tracing shipping documents in the period near the year end date to the sales journal to ensure that sales were recorded in the correct period

Tests of details for Accounts Receivable

• Existence- Confirm accounts receivable w/ customers- generally required per GAAS

• Completeness- take revenue occurrence/cutoff testing to cash receipts

• Valuation- Assess reasonable of estimated inputs to AFDA calculations, recalculate allowance (aged AR)

Types of AR Confirmations

• Positive confirmations- customer response requested regardless of whether the balance is correct

• Negative confirmations- customer response requested only if balance is incorrect (rarely used)

  • b/c fake people don’t return receipts confirmations, or people might not receive the confirmation

AR Confirmations

• Mostly manual (unlike cash)

• Auditors need to control the entire confirmation process from mailing to receipt

• Confirmations provide evidence about existence and rights and obligations but not valuation

  • just b/c customer confirms does not mean they are going to pay it