1. Revenue and Collection Cycle
Chapter 7
Revenue and Collection Cycle
“It is better to have a permanent income than to be fascinating”
Oscar Wilde
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Learning Objectives
Discuss inherent risks related to the revenue and collection cycle with a focus on improper revenue recognition
Describe the revenue and collection cycle, including typical source documents and controls.
Give examples of tests of controls over customer credit approval, delivery, and accounts receivable accounting
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3. Learning Objective (continued)
Give examples of substantive procedures in the revenue and collection cycle and relate them to assertions about account balances at the end of the period.
Describe some common errors and frauds in the revenue and collection cycle, and design some audit and investigation procedures for detecting them.
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Inherent Risks
Improper Revenue Recognition
Cut-off
Bill and Hold
Returns and Allowances
Collectibility of Receivables
"Lapping”
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Revenue Recognition
Must be (1) realized or realizable and (2) earned
SEC guidance (SAB 101)
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, and
Collectibility is reasonably assured
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7. Exhibit 7.1 Revenue Recognition Rogues
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8. Exhibit 7.2 Revenue and Collection Cycle: Typical Activities
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9. REVENUE AND COLLECTION CYCLE: KEY control procedures
SEGREGATION OF DUTIES
Separate functions for recording, authorization, custody
AUTHORIZATION OF TRANSACTIONS
Write-offs
EDI transactions
Credit checks prior to approval of sale
ACCESS TO ASSETS
Shipping department
Lock box account
ADEQUATE DOCUMENTS AND RECORDS
Pre-numbered sales orders, shipping documents (bills of lading), sales invoices
Remittance advice
INDEPENDENT CHECKS ON PERFORMANCE
A/R subsidiary ledger to general ledger
Monthly statement to customer
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10. Audit Evidence in Management Reports and Data Files
Pending order master file
Credit check files
Price list master file
Sales detail file (sales journal)
Sales analysis report
Accounts receivable aged trial balance
Cash receipts listing
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Tests of Controls
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12. Exhibit 7.5 Dual Direct of Test Audit Samples
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13. AUDITING ACCOUNTS RECEIVABLE
Obtain Aged Listing of Accounts Receivable
Listing of AR by date due
Foot and Test aging
Used to evaluate reasonableness of ALLOWANCE FOR BAD DEBTS
Confirm
Perform analytical procedures
Test sales cut-off
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14. Exhibit 7.7 Accounts Receivable Aged Trial Balance
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USING CONFIRMATIONS
Especially useful for verifying EXISTENCE OR OCCURRENCE and RIGHTS AND OBLIGATIONS assertions.
Confirmation testing may also be designed to verify COMPLETENESS
Factors are likely to affect the reliability of confirmations
Previous audit experience
Intended recipient of the confirmation
Type of information being confirmed
The auditor may confirm entire BALANCES or TRANSACTIONS.
Type of confirmation being sent
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16. USING CONFIRMATIONS (Continued)
Positive Confirmations
small number of accounts are involved
large number of errors are anticipated
Negative Confirmations
the combined assessed level of inherent and control risk is low
a large number of small balances is involved
the auditor has no reason to believe that the recipients of the requests are unlikely to give them consideration.
Blank Confirmations should be used if the recipient is likely to return a positive confirmation without verifying the accuracy of the information.
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17. Exhibit 7.8 Positive Confirmation Letter
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18. Exhibit 7.9 Negative Confirmation Letter
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19. USING CONFIRMATIONS (Continued)
Responses to positive and blank confirmations provide more reliable evidence than negative non-responses.
Recipients of accounts receivable confirmations might not report understatements.
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20. USING CONFIRMATIONS (Continued)
Non-response to Positive/blank confirmation requests
Follow up with second and sometimes third requests.
A lower than expected response rate could be indicative of fictitious customer accounts.
Alternative procedures.
Non-response to negative confirmation requests
Only limited evidence concerning financial statement assertions.
Alternative procedures are not necessary for unreturned negative confirmation requests.
Follow-up on all exceptions
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21. ALTERNATIVE PROCEDURES
Vouch subsequent cash collections
usually sufficient evidence of validity, valuation.
Examine shipping documents
Examine client-generated supporting documentation, such as invoices.
Depends on internal controls
Inspect correspondence files
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22. Exhibit 7.10 Responses to Positive Confirmations (December 31)
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23. Other Matters Related to Confirmation
There are three sets of circumstances that could justify the omission of the confirmation of a client's accounts receivable.
Not material to the financial statements.
If the combined level of inherent risk and control risk is low, and the assessed level of evidence from analytical procedures and other tests of details is sufficient to reduce audit risk to an acceptably low level, confirmation of accounts receivable may be inefficient.
Confirmation of accounts receivable is expected to be ineffective (based on previous years' audit experience).
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24. UNCOLLECTIBLE ACCOUNTS
Inspect AR for collectibility
Recalculate ALLOWANCE and BAD DEBT EXPENSE
Verify reasonableness of ALLOWANCE and BAD DEBT EXPENSE
Verify appropriateness of accounts written off
Verify attempts to collect receivable
Verify authorization is appropriate.
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25. ANALYTICAL PROCEDURES
Sales Revenue
Comparisons with previous periods
Comparisons with industry
Allowance for Doubtful Accts, Bad Debt Expense
Bad Debt Expense as a percentage of Sales
Allowance for Doubtful Accounts as a percentage of Gross Receivables
Accounts Receivable
Days Sales in Accounts Receivable
Accounts Receivable Turnover
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26. SALES CUTOFF PROCEDURES
Used to verify whether Sales/Revenues recorded in the CORRECT ACCOUNTING PERIOD.
Examine SALES INVOICES and SHIPPING DOCUMENTS shortly prior to and after year-end.
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