Chapter 10
Auditing Revenue Processes: Sales,
Billing, and Collection in the
Health-Care Provider and Retailing
Industries
Prepared by Richard J. Campbell
Copyright 2011, Wiley and Sons
Learning Objectives
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.
Chapter 10-1
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
OVERVIEW
 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
Chapter 10 -3
Learning Objective #1
HEALTH-CARE PROVIDERS
 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.
Chapter 10 -4
Learning Objective #1
RETAILING
 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.
Chapter 10 -5
Learning Objective #1
Credit Card Sale
EXHIBIT 10-1
Chapter 10 -6
Learning Objective #1
Sale on Trade Credit with Shipping
EXHIBIT 10-2
Chapter 10-7
Learning Objective #1
Revenue Recognition
 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.
Chapter 10 -8
Learning Objective #2
Sales
 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.
Chapter 10 -9
Learning Objective #2
Documents and Processes
 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.
Chapter 10 -10
Learning Objective #3
Shipping Document
Chapter 10 - 11
Learning Objective #3
INVOICE
Chapter 10-12
Learning Objective #3
Monthly Statement
Chapter 10-13
Learning Objective #3
Remittance Advice
Chapter 10-14
Learning Objective #3
Aged Accounts Receivable Trial Balance
Chapter 10-15
Learning Objective #3
Business Activities and Related Documents
EXHIBIT 10-3
Chapter 10-16
Learning Objective #3
Scannable Bar Code
Chapter 10-17
Learning Objective #3
Medical Record
Chapter 10-18
Learning Objective #3
Potential Misstatements and Controls
 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.
Chapter 10-19
Learning Objective #3
Potential Misstatements and Controls
 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.
Chapter 10-20
Learning Objective #3
Potential Misstatements and Controls
 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
Chapter 10-21
Learning Objective #3
MANAGEMENT ASSERTIONS IN AN INTEGRATED AUDIT
EXHIBIT 10-4
Financial Statement
Assertions and Audit
Evidence-Gathering
Activities
Chapter 10-22
Learning Objective #4
AUDIT TESTS AND PROCEDURES
 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.
Chapter 10-23
Learning Objective #5
AUDIT TESTS AND PROCEDURES
 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.
Chapter 10-24
Learning Objective #5
Examples of Tests of Controls for Sales
EXHIBIT 10-5
Chapter 10-25
Learning Objective #5
Examples of Tests of Controls for Sales
EXHIBIT 10-5
Chapter 10-26
Learning Objective #5
Examples of Tests of Controls for Sales
EXHIBIT 10-5
Chapter 10-27
Learning Objective #5
Examples of Tests of Controls for Sales
EXHIBIT 10-5
Chapter 10-28
Learning Objective #5
Examples of Tests of Controls for Sales
EXHIBIT 10-5
Chapter 10-29
Learning Objective #5
Tests of Controls for Cash Receipts
EXHIBIT 10-6
Chapter 10-32
Learning Objective #5
Tests of Controls for Cash Receipts
EXHIBIT 10-6
Chapter 10-31
Learning Objective #5
Tests of Controls for Cash Receipts
EXHIBIT 10-6
Chapter 10-32
Learning Objective #5
Tests of Controls for Cash Receipts
EXHIBIT 10-6
Chapter 10-33
Learning Objective #5
Tests of Controls for Cash Receipts
EXHIBIT 10-6
Chapter 10-34
Learning Objective #5
SUBSTANTIVE PROCEDURES: DUAL PURPOSE TESTS, ANALYTICAL PROCEDURES,
AND TESTS OF DETAILS OF BALANCES
 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.
Chapter 10-35
Learning Objective #5
Examples of Dual Purpose Tests for Sales Activities and
Related Accounts
EXHIBIT 10-7
Chapter 10-36
Learning Objective #5
Examples of Dual Purpose Tests for Sales Activities and
Related Accounts
EXHIBIT 10-7
Chapter 10-37
Learning Objective #5
Examples of Dual Purpose Tests for Sales Activities and
Related Accounts
EXHIBIT 10-7
Chapter 10-38
Learning Objective #5
Examples of Dual Purpose Tests for Cash Receipts Activities and
Related Accounts
EXHIBIT 10-8
Chapter 10-39
Learning Objective #5
Examples of Dual Purpose Tests for Cash Receipts Activities and
Related Accounts
EXHIBIT 10-8
Chapter 10-40
Learning Objective #5
Substantive Analytical Procedures
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
Chapter 10-41
Learning Objective #5
Examples of Substantive Analytical Procedures for Sales, Cash Receipts, and
Related Accounts
EXHIBIT 10-10
Chapter 10-42
Learning Objective #5
External Confirmations
 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
Chapter 10-43
Learning Objective #5
An Example of a Positive Accounts Receivable Confirmation
Chapter 10-44
Learning Objective #6
An Example of a Negative Accounts Receivable
Confirmation
Chapter 10-45
Learning Objective #6
Bank Confirmations
Chapter 10-46
Learning Objective #7
Tests of Details of Balances Sales and
Collections Cycle
EXHIBIT 10-11
Chapter 10-47
Learning Objective #7
Tests of Details of Balances Sales and
Collections Cycle
EXHIBIT 10-11
Chapter 10-48
Learning Objective #7
Tests of Details of Balances Sales and
Collections Cycle
EXHIBIT 10-11
Chapter 10-49
Learning Objective #7
Tests of Details of Balances, Cash in
the Bank
EXHIBIT 10-12
Chapter 10-50
Learning Objective #7
Tests of Details of Balances, Cash in
the Bank
EXHIBIT 10-12
Chapter 10-51
Learning Objective #7
Tests of Details of Balances, Cash in
the Bank
EXHIBIT 10-12
Chapter 10-52
Learning Objective #7
Review Question
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
Chapter 10-53
Review Question
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.
Chapter 10-54
Review Question
For which assertion does a confirmation
of an account receivable provide the
most evidence?
(a) Existence
(b) Valuation
(c) Completeness
(d) Presentation and disclosure
Chapter 10-55
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