2. Chapter 10 Prepared by Richard J. Campbell Copyright 2011, Wiley and Sons Auditing Revenue Processes: Sales, Billing, and Collection in the Health-Care Provider and Retailing Industries

3. Learning Objectives Chapter 10-1 1. Understand the revenue-producing, billing, and collection activities of the health-care provider and retail industries. 2. Recognize the importance of revenue recognition as it relates to the audit and the potential for fraud. 3. Learn the business processes, transactions, documents, controls, and accounts associated with the sales and collection cycle. 4. Describe the relationships of management assertions, company controls, tests of controls, dual purpose tests, substantive analytical procedures and tests of details of balances for the sales and collections cycles.

4. Learning Objectives 5. Explain audit procedures for various management assertions of the revenue cycle. 6. Explain the use of confirmations including their purposes, use, responses, and value to the audit. 7. Learn how to audit cash accounts. Chapter 10 -2

5. OVERVIEW Learning Objective #1Chapter 10 -3  Virtually all businesses have a revenue and collection function that is fundamental to the primary productive activity of a company. As a result, the revenue cycle interacts with and depends on other cycles.  Typical transaction activities for sales, billing, and cash receipts are as follows.  Sales for cash and for accounts receivable  Cash receipts  Sales returns and allowances  Writing off uncollectible accounts receivable  Estimating bad debt expense

6. HEALTH-CARE PROVIDERS Chapter 10 -4Learning Objective #1  Health-care providers sell a service.  Health-care providers in the United States are often paid by third-party payers in addition to or instead of the patient who receives the service.  Accounting controls for billing are especially important because, under a fee-for-service plan, the insurance company typically pays the health-care provider based on a contract rate for a particular medical treatment or diagnosis.  An alternative to a fee-for-service plan is a capitation agreement.

7. RETAILING Chapter 10 -5Learning Objective #1  A retail entity’s primary business activity is selling finished goods inventory to a customer for cash or on credit.  The simplest retail transaction is one for cash, in which the customer exchanges cash for goods at the point of sale.

8. Credit Card Sale Chapter 10 -6Learning Objective #1 EXHIBIT 10-1

9. Sale on Trade Credit with Shipping Learning Objective #1Chapter 10-7 EXHIBIT 10-2

10. Revenue Recognition Chapter 10 -8Learning Objective #2  Revenue recognition is important because decisions about whether and when to recognize revenue have played a major role in numerous accounting frauds.  Improper revenue recognition is a problem that has been seen many times in financial statements. For public companies the primary concern is that revenue may be overstated.

11. Sales Chapter 10 -9Learning Objective #2  One of the first concerns regarding the revenue cycle is that all recorded sales entries are the result of real transactions that meet the criteria for revenue recognition.  Alternatively, it is important that no sales transactions go unrecorded.  Accurate posting of accounts receivable subsidiary ledgers is important.

12. Documents and Processes Chapter 10 -10Learning Objective #3  Some businesses use the term customer order to refer to any order document provided by the customer, and the seller may create a new document called a sales order.  The result of this formal credit-granting process is documented using some type of credit approval form.  Documents associated with the shipping process may be called shipping documents or bills of lading.  The document used by a company when it bills a customer directly for a credit sale is called an invoice.

13. Shipping Document Learning Objective #3Chapter 10 - 11

14. Learning Objective #3Chapter 10-12 INVOICE

15. Monthly Statement Learning Objective #3 Chapter 10-13

16. Remittance Advice Learning Objective #3 Chapter 10-14

17. Aged Accounts Receivable Trial Balance Learning Objective #3 Chapter 10-15

18. Business Activities and Related Documents Learning Objective #3 Chapter 10-16 EXHIBIT 10-3

19. Scannable Bar Code Learning Objective #3 Chapter 10-17

20. Medical Record Learning Objective #3 Chapter 10-18

21. Potential Misstatements and Controls Learning Objective #3 Chapter 10-19  Documentation plays a major role in internal controls.  The credit approval or insurance verification process must be completed and documented.  Authorization for the credit sale should come from a source that is independent of the person completing the sale.  Approved customer orders, sales orders, pick tickets, or similar documents authorize the release of goods from storage or warehousing.

22. Potential Misstatements and Controls Learning Objective #3 Chapter 10-20  Controls are needed to ensure that goods are shipped on a timely basis and bills are sent out for all goods that are shipped  When cash is received, the goal is to create an immediate record of its receipt and place it in safekeeping.  When checks are received in the mail, they should immediately be restrictively endorsed and a daily remittance list should be prepared concurrently.

23. Potential Misstatements and Controls Learning Objective #3 Chapter 10-21  Good segregation of duties requires separating the following activities: 1. Receiving the cash and making the deposit 2. Updating the accounts receivable records 3. Reconciling the initial cash records with the daily deposit ticket

24. MANAGEMENT ASSERTIONS IN AN INTEGRATED AUDIT Financial Statement Assertions and Audit Evidence-Gathering Activities EXHIBIT 10-4 Chapter 10-22 Learning Objective #4

25. AUDIT TESTS AND PROCEDURES Learning Objective #5 Chapter 10-23  Tests of controls provide evidence about whether an ICFR is operating as designed and whether the control is being performed by someone with appropriate authority and qualifications.  Some tests of controls are performed simultaneously with tests of details of balances that provide audit evidence on the amount and disclosure of the account balance.  When a test addresses both a control function and the amount or disclosure, it is called a dual purpose test.

26. AUDIT TESTS AND PROCEDURES Learning Objective #5 Chapter 10-24  Tests of controls may be performed at an interim date.  Substantive procedures on account balances and disclosures may be sufficient for coming to conclusions for the financial statement audit.  The auditor must keep in mind the evidence needed for both aspects of the integrated audit when planning and conducting tests of controls.

27. Examples of Tests of Controls for Sales Learning Objective #5 Chapter 10-25 EXHIBIT 10-5

28. Examples of Tests of Controls for Sales Learning Objective #5 Chapter 10-26 EXHIBIT 10-5

29. Examples of Tests of Controls for Sales Learning Objective #5 Chapter 10-27 EXHIBIT 10-5

30. Examples of Tests of Controls for Sales Learning Objective #5 Chapter 10-28 EXHIBIT 10-5

31. Examples of Tests of Controls for Sales Learning Objective #5 Chapter 10-29 EXHIBIT 10-5

32. Tests of Controls for Cash Receipts Learning Objective #5Chapter 10-32 EXHIBIT 10-6

33. Tests of Controls for Cash Receipts Learning Objective #5Chapter 10-31 EXHIBIT 10-6

34. Tests of Controls for Cash Receipts Learning Objective #5Chapter 10-32 EXHIBIT 10-6

35. Tests of Controls for Cash Receipts Learning Objective #5Chapter 10-33 EXHIBIT 10-6

36. Tests of Controls for Cash Receipts Learning Objective #5Chapter 10-34 EXHIBIT 10-6

37. SUBSTANTIVE PROCEDURES: DUAL PURPOSE TESTS, ANALYTICAL PROCEDURES, AND TESTS OF DETAILS OF BALANCES Learning Objective #5Chapter 10-35  The three categories of substantive procedures are discussed in the remainder of the chapter: dual purpose tests, substantive analytical procedures, and tests of details of balances.  When a single audit procedure contributes audit evidence about both controls and account balances, it is called a dual purpose test.  Sometimes, dual purpose tests for sales may be the only detailed procedures the auditor performs that include examining the dollar amounts recorded for individual sales transactions and comparing them to the specific supporting documents.

38. Examples of Dual Purpose Tests for Sales Activities and Related Accounts Learning Objective #5Chapter 10-36 EXHIBIT 10-7

39. Examples of Dual Purpose Tests for Sales Activities and Related Accounts Learning Objective #5Chapter 10-37 EXHIBIT 10-7

40. Examples of Dual Purpose Tests for Sales Activities and Related Accounts Learning Objective #5Chapter 10-38 EXHIBIT 10-7

41. Examples of Dual Purpose Tests for Cash Receipts Activities and Related Accounts Learning Objective #5Chapter 10-39 EXHIBIT 10-8

42. Examples of Dual Purpose Tests for Cash Receipts Activities and Related Accounts Learning Objective #5Chapter 10-40 EXHIBIT 10-8

43. Substantive Analytical Procedures Learning Objective #5Chapter 10-41 A fundamental substantive audit procedure, sometimes called fluctuation analysis, compares a current account balance with that same account’s balance in the prior year or with its budgeted amount. EXHIBIT 10-9

44. Examples of Substantive Analytical Procedures for Sales, Cash Receipts, and Related Accounts Learning Objective #5 Chapter 10-42 EXHIBIT 10-10

45. External Confirmations Learning Objective #5 Chapter 10-43  External confirmation is “the process of obtaining and evaluating direct communication from a third party in response to a request for information about a particular item affecting financial statement assertions.”  The confirmation process involves the following: 1. Selecting the items to confirm 2. Designing the confirmation 3. Communicating directly with the third party from whom the confirmation information is requested 4. Receiving the response 5. Evaluating the information provided via the confirmation

46. An Example of a Positive Accounts Receivable Confirmation Learning Objective #6 Chapter 10-44

47. An Example of a Negative Accounts Receivable Confirmation Learning Objective #6 Chapter 10-45

48. Bank Confirmations Learning Objective #7 Chapter 10-46

49. Tests of Details of Balances Sales and Collections Cycle Learning Objective #7 Chapter 10-47 EXHIBIT 10-11

50. Tests of Details of Balances Sales and Collections Cycle Learning Objective #7 Chapter 10-48 EXHIBIT 10-11

51. Tests of Details of Balances Sales and Collections Cycle Learning Objective #7 Chapter 10-49 EXHIBIT 10-11

52. Tests of Details of Balances, Cash in the Bank Learning Objective #7 Chapter 10-50 EXHIBIT 10-12

53. Tests of Details of Balances, Cash in the Bank Learning Objective #7 Chapter 10-51 EXHIBIT 10-12

54. Tests of Details of Balances, Cash in the Bank Learning Objective #7 Chapter 10-52 EXHIBIT 10-12

55. Review Question Chapter 10-53 A company has a limited number of employees. When one person is absent due to illness, the cash receipts process has insufficient segregation of duties. The company vice president, who is both competent and otherwise independent of the cash receipts function, reconciles the cash accounts on a monthly basis. Which of the following controls is the type provided by the vice president’s activity? (a) Management (c) Compensating (b) Preventive (d) Overriding

56. Review Question Chapter 10-54 A retail entity sells its products in a traditional store environment and over the Internet via online transactions. How is this situation best described? (a) These two types of sales represent two major classes of transactions. (b) Management’s financial statement assertions differ for the two types of sales. (c) Because of the different processes none of the same ICFR procedures will be effective for both types of transactions.

57. Review Question Chapter 10-55 For which assertion does a confirmation of an account receivable provide the most evidence? (a) Existence (b) Valuation (c) Completeness (d) Presentation and disclosure

58. Copyright “Copyright © 2011 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.”