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Chapter 10
Auditing the Revenue Process
McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
Revenue Recognition
Revenue is defined as inflows or other enhancements
of assets of an entity or settlements of its liabilities
(or a combination of both) from delivery or producing
goods, rendering services, or other activities that
constitute the entity’s major or central operations.
LO# 1
10-2
Overview of the Revenue
Process
Purchases
Inventory
Credit sales
Account
receivable
Cash
collection Purchases
Inventory
Cash
sales
Cash Sale Credit Sale
LO# 2
10-3
Types of Transactions and
Financial Statement Accounts
Affected The revenue process affects numerous accounts in the
financial statements. The most significant accounts are:
LO# 3
10-4
The Major Functions
Functions of the Revenue Process
Order entry Acceptance of customer orders for goods and services into
the system in accordance with management criteria.
Credit authorizationAppropriate approval of customer orders for
creditworthiness.
Shipping Shipping of goods that has been authorized.
Billing
Issuanace of sales invoices to customers for goods
shipped or services provided; also, processing of billing
adjustments for allowances, discounts, and returns.
Cash receipts Processing of the receipt of cash from customers.
Accounts receivableRecording of all sales invoices, collections, and credit
memoranda in individual customer accounts.
General ledger
Proper accumulation, classification, and summarization of
revenues, collections, and recivables in the financial
statement accounts.
LO# 5
10-6
Inherent Risk Assessment
The four inherent risk factors that may affect the
revenue process are:
1. Industry-related factors.
2. The complexity and contentiousness of revenue
recognition issues.
3. The difficulty of auditing transactions and account
balances.
4. Misstatements detected in prior audits.
LO# 7
10-8
Control Risk Assessment
Understand and document the revenue
process based on a reliance strategy.
Plan and perform tests of controls on revenue
transactions.
Set and document the control risk for the
revenue process.
LO# 8
10-9
Control Activities and Tests of
Controls – Revenue Transactions Assertions about Classes of Transactions and Events for
the Period under Audit
Occurrence
All revenue and cash receipt transactions and events
that have been recorded have occurred and pertain to
the entity.
CompletenessAll revenue and cash receipt transactions and events
that should have been recorded have been recorded.
AuthorizationAll revenue and cash receipts transactions and events
are properly authorized.
Accuracy
Amounts and other data relating to recorded revenue
and cash receipt transactions and events have been
recorded appropriately.
Cutoff All revenue and cash receipt transactions and events
have been recorded in the correct accounting period.
ClassificationAll revenue and cash receipt transactions and events
have been recorded in the proper accounts.
LO# 9
10-10
Control Activities and Tests of Controls –
Sales Returns and Allowances
Sales returns and allowances is usually not a
material amount in the financial statements.
However, credit memoranda that are used to
process sales returns can also be used to cover an
unauthorized shipment of goods or conceal a
misappropriation of cash. As a result, all credit
memoranda should be properly authorized.
LO# 9
10-13
Relating the Assessed Level of Control
Risk to Substantive Procedures
The auditor’s testing of control for revenue
processing impacts the detection risk and
therefore the level of substantive procedures
impacted by the controls.
Cash Accounts
receivable
Allowance
for bad
debts
Bad debts
expense
Sales returns
and
allowances
LO# 10
Sales
10-14
Substantive Analytical Procedures
Ratios used for comparative purposes
include: 1. Receivables turnover and days outstanding
in accounts receivable.
2. Aging categories on aged trial balance of
accounts receivable.
3. Bad-debts expense as a percent of revenue.
4. Allowance for uncollectible accounts as a
percent of accounts receivable or credit
sales.
5. Large customer account balances
compared to last period.
LO# 11
10-15
Substantive Tests of Transactions
For Accounts Receivable, Allowance for Uncollectible
Accounts, and Bad-Debt Expense
LO# 12
10-16
Tests of Details of Account
Balances For Accounts Receivable, Allowance for Uncollectible
Accounts, and Bad-Debt Expense
LO# 12
10-17
Types of Confirmations
Positive Confirmation
Requests that customers indicate whether they agree with the amount due to the client. A response is expected whether the customer agrees or disagrees with the balance indicated.
Negative Confirmation
Requests that the customer respond only when they disagree with the amount due to the client. Negative confirmations are used when the client has many small account balances and control risk is assessed as low.
LO# 13
10-18
Confirmation Procedures
The auditor should mail the confirmation
requests outside the client’s facilities. A
record should be maintained of the
confirmations mailed and those returned.
A second request may be necessary in
some cases. For each exception received, the
auditor should examine the reasons
for the difference between the
balance on the client’s books and
the balance indicated by the
customer.
LO# 13
10-19
Alternative Procedures
When the auditor does not receive responses
to positive confirmations, alternative audit
procedures are used. These alternative
procedures include:
1. Examination of subsequent cash receipts.
2. Examination of customer orders, shipping documents,
and duplicate sales invoices.
3. Examination of other client documentation.
LO# 13
10-20
Auditing Other Receivables
Other types of receivables that are reported on the
balance sheet may include: (1) receivables from officers
and employees, (2) receivables from related parties, and
(3) notes receivable. The auditor’s concern with
satisfying the assertions for these receivables is similar
to that for trade accounts receivable. Each of these
types of receivables is confirmed and evaluated for
collectibility. The transactions that result in receivables
from related parties are examined to determine if they
were at “arm’s length.” Notes receivable would also be
confirmed and examined for repayment terms and
whether interest income has been properly recognized.
LO# 14
10-21
Evaluating the Audit Findings
When the auditor has completed the planned
substantive procedures, the likely misstatement
(projected misstatement plus an allowance for
sampling risk) for accounts receivable is determined.
Likely misstatement
less than tolerable
misstatement
Likely misstatement
greater than tolerable
misstatement
Accept the account
as fairly presented.
Account is not fairly
presented.
LO# 15
10-22