A4-M1-REVENUE CYCLE
TRANSACTION CYCLES
Transaction cycles include cycles for revenue; expenditure; inventory; investment; property, plan, and equipment; payroll and personnel; and financing.
For each of these cycles, the auditor wants to answer two crucial questions:
Are controls operating effectively?
Have transactions, balances, and disclosures been recorded properly in accordance with GAAP?
In the textbook, you will see each transaction cycle presented in three ways: in written sentences, as a flowchart, and in a chart. Pay attention to the division of responsibilities as shown in the flowcharts, and how the auditor might test the controls shown in the charts. Transaction cycles are frequently tested on the audit exam.
It is the company’s responsibility to properly segregate duties and implement effective controls. The auditor’s responsibility is to evaluate those controls, decide whether to rely on them, and to determine the nature, extent, and timing of substantive audit procedures.
For each transaction cycle, be aware of whether the account being examined is an asset/ revenue or a liability/ expense. This usually dictates whether the assertion of existence or the assertion of completeness is being tested.
Existence assertion: for assets/ revenue, the focus is often on whether the account actually exists (i.e., making sure the accounts are not overstated).
Completeness assertion: for liabilities/ expenses, the focus is often on whether the items were actually recorded (i.e., making sure the accounts are not understated).
If a flowchart is presented on the examination, it will typically present various departments (showing segregation of duties), as well as show how a particular transaction starts with a source document (e.g., a sales order) and is processed to ultimate inclusion in the F/S.
To obtain audit evidence supporting the effective operation of controls, an auditor must obtain evidence regarding how controls were applied, the consistency with which controls were applied, and by whom or by what means controls were applied.
Mgmt override of I/C policies and procedures might cause the auditor to assess control risk as high.
The function of cash receipts is part of the treasurer’s department and should be separate from the role of posting credits to the AR ledger. Failure to separate the recordkeeping function from the custodial function allows an individual to misappropriate cash and then cover up the theft by posting credits against the related AR balance.
Shipping documents provide evidence that a sale occurred, and therefore selecting from a population of shipping documents allows the auditor to test whether corresponding invoices exist for each sale.
Detecting a possible understatement in sales is tantamount to testing completeness (i.e., if an understatement is found, sales are not complete). To test completeness, one needs to start with supporting documentation and trace forward to recording in the accounting records, such as the sales invoices and sales journal.