1. AUDITING THE REVENUE CYCLE AND RELATED ACCOUNTS

2. REVENUE RECOGNITION
Before revenue is recognized (recorded), it must be realized and earned. Revenue is realized when a product or service is exchanged for cash, a promise to pay cash, or other assets that can be converted into cash. Revenue is earned when a product has been delivered or a service has been provided.

3. OVERVIEW OF THE REVENUE CYCLE
An overview of the revenue cycle is presented, beginning with an order from a customer, proceeding to the exchange of goods or services for a promise to pay, and ending with the receipt of cash.
Figure 10-1 presents a flowchart for a reasonably sophisticated revenue cycle.

4. TYPES OF TRANSACTIONS
The sale of goods or rendering a service for cash or credit.
The receipt of cash from the customer in payment for the goods or services.
The return of goods by the customer for credit or cash.

5. FINANCIAL STATEMENT ACCOUNTS
Sales transactions:
Trade accounts receivable
Sales
Allowance for uncollectible accounts
Bad debt expense
Cash receipts transactions:
Cash
Cash discounts
Sales return and allowance transactions:
Sales returns
Sales allowances

6. DOCUMENTS AND RECORDS Customer sales order Credit approval form
Open-order report
Shipping document
Sales invoice
Sales journal
Customer statement
Accounts receivable subsidiary ledger
Aged trial balance of accounts receivable
Remittance advice
Cash receipts journal
Credit memorandum
Write-off authorization

7. FUNCTIONS IN THE REVENUE CYCLE
Order entry
Credit authorization
Shipping
Billing
Cash receipts
Accounts receivable
General ledger

8. KEY SEGREGATION OF DUTIES
The credit function should be segregated from the billing function.
The shipping function should be segregated from the billing function.
The accounts receivable function should be segregated from the general ledger function.
The cash receipts function should be segregated from the accounts receivable function.

9. STRATEGIC SYSTEMS APPROACH
Must understand the client’s
Ability to create value
Realize and recognize revenue
Generate future cash flows

10. INHERENT RISK ASSESSMENT
Industry-related factors.
The complexity and contentiousness of revenue recognition issues (see Table 3-4).
The difficulty of auditing transactions and account balances.
Misstatements detected in prior audits.

11. CONTROL RISK ASSESSMENT
Understanding and documenting
the revenue internal control system based
on the planned level of control risk
Planning and performing tests of controls
on revenue cycle transactions
Assessing and documenting the
control risk for the revenue cycle

12. UNDERSTANDING AND DOCUMENTING INTERNAL CONTROL
Control environment
Risk assessment
Control activities
Information and communication
Monitoring

13. CONTROL PROCEDURES AND TESTS OF CONTROLS - REVENUE TRANSACTIONS
Table 10-5 summarizes the internal control objectives, possible misstatements, internal control procedures, and selected tests of controls for revenue transactions.

14. CONTROL PROCEDURES AND TESTS OF CONTROLS - CASH RECEIPTS TRANSACTIONS
Table 10-6 summarizes the internal control objectives, possible misstatements, internal control procedures, and tests of controls for cash receipts transactions.

15. CONTROL PROCEDURES AND TESTS OF CONTROLS - SALES RETURNS AND ALLOWANCES TRANSACTIONS
Each credit memorandum should be approved by someone other than the individual who initiated it.
A credit for returned goods should be supported by a receiving document indicating that the goods have been returned.

16. RELATING THE ASSESSED LEVEL OF CONTROL RISK TO SUBSTANTIVE TESTING
The results of the auditor’s testing of internal control for the revenue cycle directly impacts on detection risk and the level of substantive testing that will be required for the accounts affected by the cycle.
When the results of the testing controls support the planned assessed level of CR, the auditor can conduct the substantive tests at the planned level.
If the results of the tests of controls do not support the planned level of CR, DR will have to be set lower.

17. AUDITING ACCOUNTS RECEIVABLE AND RELATED ACCOUNTS
The auditor uses substantive tests that are used by the auditor to detect material misstatements in accounts receivable and related accounts. There are three categories :
Substantive tests of transactions
Analytical procedures
Tests of account balances

18. SUBSTANTIVE TESTS OF TRANSACTIONS
Substantive tests of transactions are tests conducted to detect monetary misstatements in the individual transactions processed through all accounting cycles.

19. AUDIT OBJECTIVES FOR TESTS OF ACCOUNT BALANCES
Accuracy
Validity
Completeness
Cutoff
Ownership
Valuation
Classification
Disclosure

20. TESTS OF ACCOUNT BALANCES - ACCOUNTS RECEIVABLE
Table summarizes the tests of accounts receivable for each audit objective.

21. ANALYTICAL PROCEDURES
Analytical procedures are useful audit tests for examining the fairness of accounts such as revenue, accounts receivable, allowance for uncollectible accounts, bad debt expense, and sales returns and allowances.

22. ANALYTICAL PROCEDURES - REVENUE
Examples :
Comparison of gross profit percentage by product line with previous years and industry data.
Comparison of reported revenue to budgeted revenue.

23. ANALYTICAL PROCEDURES – A/R, ALLOWANCE FOR UNCOLLECTIBLE ACCOUNTS AND BAD DEBT EXPENSE
Examples :
Comparison of receivables turnover and days outstanding in accounts receivable to previous years’ and/or industry data.
Comparison of aging categories on aged trial balance of accounts receivable to previous years’.
Comparison of bad-debt expense as a percentage of revenue to previous years’ and/or industry data.
Comparison of the allowance for uncollectible accounts as a percentage of accounts receivable or credit sales to previous years’ and/or industry data.
Examination of large customer accounts individually and comparison to previous year.

24. ANALYTICAL PROCEDURES - SALES RETURNS, ALLOWANCES, AND COMMISSIONS
Comparison of sales returns as a percentage of revenue to previous years’ and/or industry data.
Comparison of sales discounts as a percentage of revenue to previous years’ and/or industry data.
Estimation of sales commission expense by multiplying net revenue by average commission rate and comparison of recorded sales commission expense.

25. THE CONFIRMATION PROCESS
Confirmation is the process of obtaining and evaluating a direct communication from a third party in response to an auditor’s request for information about a particular item affecting financial statement assertions.

26. CONFIRMATION OF ACCOUNTS RECEIVABLE
Confirmation of accounts receivable is considered a generally accepted auditing procedure, and therefore the auditors will normally request confirmation of accounts receivable during an audit.

27. OMISSION OF CONFIRMATION OF ACCOUNTS RECEIVABLE
The accounts receivable are immaterial to the financial statements.
The use of confirmations would not be effective as an audit procedure (e.g., past response rates were low or the responses might not be reliable).
The auditor’s assessment of IR and CR is low, and evidence gathered from other substantive tests is sufficient to reduce audit risk to an acceptably low level.

28. RELIABILITY OF ACCOUNTS RECEIVABLE CONFIRMATIONS
The auditor should consider each of the following factors when using confirmations to test accounts receivable :
The type of confirmation request.
Prior experience with the client or similar engagements.
The intended respondent.

29. TYPES OF CONFIRMATIONS
Positive (see Exhibit 10-7)
Negative (see Exhibit 10-8)

30. TIMING
Interim
Year-end

31. CONFIRMATION PROCEDURES
Maintain control
Timing differences (Table 10-12)

32. ALTERNATIVE PROCEDURES
Examination of subsequent cash receipts.
Examination of customer orders, shipping documents, and duplicate sales invoices.
Examination of other client documentation.

33. AUDITING OTHER RECEIVABLES
Receivables from officers and employees.
Receivables from related parties.
Notes receivable.

34. EVALUATING THE AUDIT FINDINGS -ACCOUNTS RECEIVABLE AND RELATED ACCOUNTS
Compare total projected misstatement to tolerable misstatement.
Analyze misstatements for causes of errors.
Conclude