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Auditing-Revenue And Receipts Cycle
Auditing 3B (Management College of Southern Africa)
Studocu is not sponsored or endorsed by any college or university
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Revenue And Receipts Cycle
1.1. Introduction
In this Unit we will be taking a closer look at the revenue and receipts cycle, what makes up
their component parts, the different types of revenue and the receipts that one could
experience within companies operating within different industries and business sectors. We
will also be looking at the different types of controls that companies put in place during the
different stages of the revenue and receipts cycle and how these will impact on the amount
of substantive audit procedures that will need to be performed.
1.2. Accounting system and control activities
The accounting standard IAS 18 defines revenue as <the gross inflow of economic benefits
during the period arising in the course of the ordinary activities of an entity when those
inflows result in increases in equity, other than increases relating to contributions from
equity participants=. Revenue can be in the form of goods sold or services rendered, or
both. Both goods sold or services rendered can be further broken down into the following
types:
Cash sales: businesses receive cash for the goods sold or services rendered. Cash can take
the form of physical bank notes or coins, or by way of a credit card payment. The simplest
example would be when you go to purchase groceries from Pick n Pay, you pay with cash or
with your credit card.
Sales on credit: businesses can allow customers to put their purchase on account. These
traditionally come with agreed repayment terms, for example: they are allowed to pay
within 30 days. Additional revenue can also be earned by businesses that provide sales on
credit. This can be by way of interest charged on accounts when they become overdue.
Over the past few years we have seen that legislation has started to play a significant role in
the revenue and receipts cycle. For example, we have seen the introduction of the
Consumer Protection Act that governs the way retailers sell to customers, the National
Credit Act for purchases on credit, and so the list goes on. Therefore, the legislative impact
on the revenue and receipts cycle has to be taken into account when designing the process
flow, what controls need to be put in place and with how the cycle is audited (Adams, Daile
and Richard, 2019).
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Basic process flow for the revenue and receipts cycle
Although each manufacturing company will have its own unique process flow, the functions
can be broadly categorised into the following:
Ordering: where do the orders come from? Are they received via the company’s website,
over the phone, or via aggregators?
Validation of the order: certain checks are performed in order to determine whether the
order is valid and that the company will be paid for selling the goods.
Gathering the stock: the goods are located in the store / warehouse and gathered together
based on the details of the order placed
Despatch: once the goods have been set aside (i.e.: <picked=) they need to be sent to the
customer. The customer can receive the goods over the counter, or have the goods
delivered
Invoicing: the invoice serves to inform the customer of the type of goods purchased,
together with price of the goods purchased. Invoicing can:
Occur before the goods are despatched
Accompany the goods that are being despatched
Be sent after the goods have been received by the customer
The timing of the invoicing is a matter or preference and may differ from company to
company. As a general rule of thumb the earlier the invoice gets generated the earlier you
get payment.
The recording of the sale in the accounting records: is it a cash sale or is it a sale on account?
The receipt of monies: when the payment is received can it be correctly identified, has it
been allocated to the correct debtor, and processed correctly through the cashbook?
Credit control: how are the debtors managed? Is credit extended to those with poor credit
history? How does the company go about collecting outstanding amounts? (Adams, et al.,
2019)
You might have come up with more steps in the process, and that’s great! We will be
focusing on the broad points listed above in this unit.
The above functions can be a manual process or it can be automated / computerised. For
example invoicing can be done by:
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Handwriting an invoice out in an invoice book with carbon copy paper. The original invoice is
provided to the customer and the copy remains in the invoice book to be captured into the
accounting system at a later stage, or
Making out the invoice on the system. When the invoice is printed a copy is given to the
customer and at the same time the invoice is automatically captured in the accounting
system
Control activities within the cycle
In developing controls over the revenue and receipts cycle one first needs to assess the risks
associated at each stage of the revenue and receipts cycle. Once the risks have been
identified the appropriate controls can be designed and put in place. For example, cash
being received for the sale of goods can accumulate and therefore present a risk of armed
robberies occurring. The control that can be put in place to mitigate this risk is that cash is
banked on a regular basis and cash on hand is kept at a minimum (Adams, et al., 2019). This
is all good and well, but we also need to assess whether the company has a process in place
to identify the potential risks that affect the revenue and receipts cycle. Normally if a
company does not have a formal risk assessment process in place it will potentially indicate
that the company does not have strong, or the necessary controls in place over the cycle
and there could be control gaps within the cycle. The converse is also true, a detailed formal
risk assessment process would normally indicate that the company has thought about, and
assessed the majority of the risks affecting the cycle and has designed and implemented the
relevant controls to mitigate the risks identified to an acceptable level.
Another area to consider is the control environment within the organisation, i.e.: what are
the directors and senior management stance towards the adherence to the controls that
have been put in place? Are the controls put in place merely a tick box exercise and are not
followed at all, or are controls taken seriously and not adhering to the control treated as a
serious offence? The assessment of the control environment will have an impact on the
audit approach and the amount of audit testing that will need to be performed in order to
obtain reasonable assurance over the accounts in the revenue and receipts cycle. It will also
have a direct bearing on the amount of substantive audit procedures that will need to be
performed (Adams, et al., 2019).
All the controls in the world will not be effective if they are not monitored on a regular
basis. The monitoring of the controls indicates:
That the controls are working, or not working, as they should. The desired outcome is being
obtained? For example, the risk identified is that not following up on outstanding debtors
could result in the company facing cash flow problems in the near future. Therefore, the
control would be to review the debtors’ age analysis on a monthly basis and to follow up on
long outstanding debtors. By implementing this control, the company is assured of maintain
its cash flow position in the months to come.
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Controls are amended, when required, for changes in the business. Controls have to be
relevant to the process in order to be effective. If controls are not updated for changes in
the process, they will be bypassed and therefore will no longer be effective.
Documents in the cycle
Purchase order: document received by the company selling the goods detailing the type of
goods ordered as well as the quantity required
Price list: an internal listing of the price of goods. This listing is referred to in when preparing
a quote
Quote: an indicative estimate of how much the customer will land up paying for the goods
ordered
Credit application: if the customer is planning to purchase the goods on credit, and they are
not an existing customer, a credit application form might need to be filled out to give the
company an indication as to whether the customer is able to fulfil their obligation
Picking slip: document generated internally and given to the warehouse / store in order for
the goods required to be gathered together ready for despatch
Invoice: final listing of the type of goods purchased and the price the goods have been
purchased for. As mentioned earlier it can be prepared before, with or after the goods are
despatched.
Delivery note: document prepared that is sent with the goods being delivered. It is signed by
the customer and returned to the company as proof that the customer has received the
goods and is satisfied that all goods order has been delivered satisfactorily
Goods returned voucher: if the goods are damaged upon delivery or the quantity delivered
does not agree with the order certain items might be returned. In this instance a good
returned voucher is prepared in order document the items returned
Receipt: document issued to the customer to confirm receipt of payment
Debtors’ statement: document sent to account holder indicating the amount due and
payable
Remittance advice: document sent with payment listing which invoices the payment is for
Credit note: document prepared and sent to the customer to indicate that the customer’s
account has been credited. This document is normally sent where goods have been
returned or exchanged
Proof of payment: document sent by the customer to prove that payment has been made
Bank statement: document used by the company to receipt payments received from
customers into the accounting system
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Age analysis: a listing from the accounting system that shows the outstanding balance of
each customer.
1.3. Narrative description of the revenue and receipts cycle
The narrative description of the cycle is aimed at giving you a glimpse of how the revenue
and receipts cycle works in a company setting.
Background to the company
The company, Tyres R Us (Pty) Ltd sells tyres, shock absorbers and batteries to various
clientele. The customers include individuals like you and me, companies and fleet operators.
Sales can be made for cash or on account. The company has a turnover of R1m per annum
and has about 20 debtors. Purchases are made from both foreign and local suppliers and
customers predominantly reside in South Africa. The company operates from one location
and all stock, sales and head office functions are conducted from this one location. The
company’s stock and point-of-sales system is fully computerised and it automatically
interacts with the accounting system on a daily basis.
The company has a strong control environment and this is driven by the owner of the
company. The control environment is monitored on a regular basis by senior management
to ensure that the controls are still effective and relevant.
The company’s stock and point-of-sales system, as mentioned earlier is fully computerised
and is a generic off-the-self product that is currently being used by many other companies
operating the in the same industry. The point-of-sale system used is i90. The company
makes use of Pastel Evolution as its accounting system and uses the Business Intelligence
Centre (<BIC=) Reporting tool for all management reporting. The company banks with
Standard Bank and the daily bank statements are uploaded daily into Evolution.
The following staff are involved in the process:
The owner of the company: Steven
Sales rep 1: Chris
Sales rep 2: Gareth
Admin assistant: Sue
Bookkeeper: Peggy
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1.4. Revenue – how the system works
One of the main focus points in the company is getting the it right at the start of the
process. Therefore, a lot of time is spent on getting the order right. Sales staff are measured
on the number of orders fulfilled.
How are orders received?
Orders are received in a number of different ways:
Over the counter – customers walk in and place an order directly with the sales staff
standing behind the counter
Over the phone – customers could telephone orders in, with collection and payment
occurring when they collect the goods
Via the company’s website – customers could place orders online. These online orders are
fed into the company’s i90 system for fulfilment
The company has 2 sales staff (Gareth & Chris) who manage the front desk and phone calls.
Orders that come through from the company’s website are picked up by the admin clerk
(Sue). The 2 sales staff and admin clerk have read only access to the master file on i90 and
cannot make any changes to this master data, for example, order selection is done mainly
by selecting the relevant items via drop down lists. The company has a varied debtor book
and debtors can range from large companies and groups of companies to schools.
It should be noted that all telephone calls coming in and out of the company are recorded
and back-ups are done to an offsite location once a week.
Taking orders
Over the counter orders together with telephone orders are entered directly onto the i90
system as a quote. The information, i.e.: the number of tyres, make, etc. are repeated back
to the customer to ensure that the order is captured correctly.
The sale person taking the order selects the relevant items from drop down lists which
automatically calculates the sales price based on the database tables in i90. Any discount
that is given has to be approved by Steven, who has to enter his password into the system in
order for the discount to be effective.
Each system generated quote has a sequential number and quotes are valid for 30 days.
After 30 days the status of the quote is automatically changed to <NTU= (not taken up) by
the system
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If the quote is accepted the quote is converted into an invoice
If the item is out of stock the item can be placed on back order and a manual note is made
on the quote.
A reminder is produced each week after which Gareth or Chris will contact the customer to
inform them of the progress of the order
When orders are received via the company’s website Sue will follow the same process in
generating the quote. Once the quote has been generated it is emailed back to the
customer based for acceptance or rejection. After 30 days the system will automatically NTU
the quote if no feedback has been received prior to that.
How are account holders validated?
If Gareth or Chris receive an order from a customer wanting to purchase on account, they
perform the following to validate account:
They enquire as to whether the customer has an existing account
If the customer says <yes= they do have an existing account Gareth or Chris will request the
customer’s account number or company name. Gareth or Chris will enter this information
into i90 to verify the existence of the account
Should the account number or company name exist on the debtor’s system Gareth or Chris
will ask for additional information in order to validate the account
If the information supplied by the customer does not correspond with the details on the
system, then the order is not taken
If the customer is not an approved customer and does not have an account with the
company, they are referred to Sue
Account holders
When Gareth or Chris have brought up the account holders details a pop-up box opens if
the account is overdue, or whether the customer has already reached their credit limit
These parameters are set up when the customer does their initial credit application and are
captured into i90’s debtor master file. Only Steven has access to the master file and all
amendments need 2 approvers before they can be saved.
New account applicants need to fill out an application form. This form is used to ascertain
their credit worthiness and ability to repay their debt. The application form will contain the
following basic information:
Business name and contact details
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Business registration number and VAT number
Details of majority shareholders and directors
Repayment terms and limits required.
Invoicing
The quote has been accepted the sales person will convert the quote on the i90 system into
an invoice.
A sequentially numbered invoice is generated
Once the invoice has been generated it can either be printed and handed to the customer
(where an over the counter sale has occurred), or it is email through to the customer for
payment
Fields on the invoice cannot be altered at all. If there is a mistake on the invoice a credit
note has to be issued and the order / invoice process has to be started again
Once the invoice has been generated i90 posts the invoice through the accounting records
(whether it is a cash sale or a sale on account) at the end of every day once the company
closes for the day
Delivery
In some instances, that customer will require the items purchased to be delivered
In these circumstances the following process is followed:
Once the order has been placed and accepted the items are picked ready for delivery
The company has its own vehicle and driver that makes deliveries
The driver will collect the items picked, together with the invoice and delivery listing and
proceed to drop them off
The customer is asked to sign the delivery listing to prove that they actually received the
goods as well as acknowledging that the items received are correct and correspond with the
order placed.
1.5. Receipts – how the system works
Receipts are received via 2 main sources, these being:
By cash or credit card, or
By EFT
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Recording of cash and credit card receipts
At the end of every day a cash count is performed by Peggy (bookkeeper).
The cash that has been received plus the credit card slips are tallied and compared to the
total of the cash sales done for that day.
The reconciliation is signed off by Steven
A minimum cash float is kept in the till with the balance of the cash being put in a drop safe
The cash in the drop safe is collected every 2 weeks and deposited
Recording of EFT’s into the bank account
The bank statements are automatically uploaded into Evolution every morning
It is Peggy’s responsibility to allocate the receipts to the correct debtors account, and the
cashbook is required to be updated every morning by 10am
Persons making EFT’s into the company’s bank account are asked to use their account
number as their reference in order to make the allocation process easier
Unallocated deposits are captured to an unallocated receipts debtors account. These
unallocated amounts have to be cleared within 30 days of receipt
When a debtor over pays on their account Peggy will contact the customer to determine
whether they would like the excess funds to be refunded back to them or would they prefer
the credit to be allocated against their next purchase
Debtors statements are generated and sent out every month
Monitoring
At every month end the following reports are produced are reviewed by Steven:
Monthly sales volumes, split per sales person
Monthly debtors age analysis. Long outstanding debtors are highlighted and are followed up
on
Monthly bank reconciliation.
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1.6. Fraud within the cycle
Fraud within the revenue and receipts cycle can take many forms and can occur at any stage
within the cycle. The following is a list of some of the types of fraud that can occur:
Fictitious sales: fictitious invoices can be processed in order to meet certain sales targets.
This is especially prevalent where sales staff are rewarded by way of bonuses for meeting or
exceeding sales targets that are set.
Rolling of debtors: money received from debtors is paid into a bank account that is different
to the company’s bank account. When the next payment is received, it is allocated to the
debtors’ balance of a different debtor. For example:
Customer ABC wants to make a payment of R100 towards a sale done on credit. The
debtors’ clerk provides their personal banking details to customer ABC. Customer ABC then
pays the R100 into the debtors’ clerk’s bank account. Customer DEF wants to make a
payment of R350 towards a sale done on credit. The debtors’ clerk provides the correct
company banking details to customer DEF. Customer DEF then makes the payment. The
debtors clerk takes R100 of the R350 received and allocates it to customer ABC’s account
and the balance to customer DEF. This cycle can continue for a number of years before
being discovered.
Inflation of invoices: invoices are inflated and the customer pays more for the goods
purchased. When the money is received a <refund= is done to reflect the correct sale in the
accounting record. The <refund= is then paid to a party other than the original customer.
Understating sales: leaving out certain invoices so that the company shows a lower profit for
the year. This is potentially done in order to reduce the tax liability payable to SARS. (Adams,
et al., 2019)
These fraud risks will have to be taken into account when determining an audit approach.
1.7. Auditing the cycle
In auditing the cycle, the processes and procedures mentioned in the in IASs will apply. Risks
associated with the revenue and receipts cycle will need to be assessed and applied at a
financial statement level, at an account level and lastly at a transaction level. Once this
assessment has been concluded you will be able to design an audit approach that will
address the risk identified. One thing to bear in mind it that the audit approach designed at
the start of the audit can be modified as the audit goes on in order to address new risks that
may present themselves during the audit. Risks that may not have been evident at the start
of the auditing process.
The auditing assertions that might be applicable to the revenue and receipts cycle are:
Completeness: is the revenue recorded in the accounting records complete?
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Existence: is there evidence that the sale actually happened? Is there evidence that the
debtor actually exists?
Accuracy: has the revenue transaction been accurately recorded in the accounting records?
For example, has trade discounts been correctly calculated, has the VAT on the sale been
correctly calculated?
Valuation: is the valuation of the debtor’s balance accurate? Could any of the debtor’s
balances be impaired? Has the provision for doubtful debts being accurately calculated?
Ownership: this assertion is not really applicable to this cycle
Presentation: has the revenue and receipts (debtors) being correctly presented and
accounted for in the annual financial statements in terms of the relevant accounting
standards? For example, IFRS 4 – Insurance Contracts details how insurance companies are
to record premium income together with how the premium income is to be disclosed in the
annual financial statements. (Adams, et al., 2019)
The auditing assertions mentioned above work hand in hand with the relevant accounting
standard that may be applicable to the balance or transaction being audited. A good
example within the revenue and receipts cycle is the valuation and presentation of the
provision for doubtful debts in the financial statements. The accounting standard that
governs this is IFRS 9 – Financial Instruments. IFRS 9 sets out certain considerations that
must be taken into account when it comes to the valuation of this provision, and these
should form part of the audit programme (validation assertion). In addition, IFRS 9 also sets
out certain minimum disclosure that is required for presentation in the annual financial
statements of the company concerned which should also form part of the audit programme
(presentation assertion).
Other factors that should be taken into consideration when auditing the revenue and
receipts cycle could be:
The complexity of the cycle. The more complex the cycle the more audit steps may be
required
The level of audit staff assigned to the auditing of the cycle. As mentioned above a more
complex cycle might require the expertise of an audit senior as opposed to it being audited
by a 1st year
Not just copying what was done in last year’s audit plan. An auditor should always approach
an existing audit with new eyes and be open to the fact that last year’s audit might have
missed something
The audit location of the cycle. There might be some instances where the revenue and
receipts cycle take place in different locations and this needs to be planned for. (Adams, et
al., 2019)
Once the factors above have been considered the auditor will need to determine the mix of
test of control vs the amount of substantive procedures that need to be performed. For
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example, a poor control environment, within a complex cycle, will require more substantive
procedures to be performed in order for the auditor to obtain reasonable, but not absolute,
assurance that the balances and transactions within the revenue and receipts cycle are
complete, exist, are accurate, are correctly valued and presented in the accounting records
of the company.
There are certain phrases or key words that should be used when compiling and audit
program. These are:
Inspection
Observation
External or 3rd party confirmation
Recalculation
Re-performance
Analytical procedure
Enquiry
Tests of controls
An analysis of the control environment will indicate the whether the controls within the
organisation as a whole, as well as the controls in place around the revenue and receipts
cycle are working or not, i.e.: is the control working to mitigate the risks identified?
The testing of the control environment normally happens first due to it having a direct
impact on the amount of substantive audit testing that will be performed. For example, if
assessing the controls over the invoicing system shows that the controls are working
effectively this reduces the risk that the sales recorded in the accounting system are not
complete and will therefore reduce the amount of testing required.
Another important step in assessing the control environment is to assess how long have the
controls been in place. If the controls have been in place for the entire audit period, then
this provides additional assurance to the auditor that the controls can be relied upon and in
turn will reduce the amount of substantive testing to be performed. The converse is also
true. If the controls have only been in place for a short period of time, then the question
arises as to can the same level of reliance be placed on the accuracy of the transactions
before the controls were put in place.
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The control environment can be assessed in the following ways:
By way of inspection – if the control states that all orders are authorised by the sales rep
before moving onto the next stage then the auditor can inspect the order for evidence of
the sales rep’s signature as proof that the order has been authorised
By way of enquiry – by asking the staff involved in the process the auditor will soon be able
to ascertain whether the controls are being followed or whether staff are doing their own
thing
By way of observation – the auditor can sit and observe the process being performed and
then compare this to the documented process to see whether the two are the same
(Adams, et al., 2019)
The testing of the control environment can usually be done before the financial year end.
Substantive audit procedures
Commonly known within auditing circles as <ticking and bashing= require a deeper look into
a balance, account or transaction. Substantive procedures are normally done in conjunction
with tests of control and as mentioned earlier the amount of substantive procedures that
need to be performed is determined by the strength of the controls and the control
environment. The auditor cannot totally rely on test of controls and will have to perform
some level of substantive procedures even though the cycle has the best controls in place
and all these controls are working 100%.
Substantive procedures are used to detect material misstatement in a balance, account or
transaction and will consist of:
Test of detail – for example, obtaining 3rd party confirmation to ensure that a specific
customers debtor balance is complete
Substantive analytical procedures – for example, if sales staff earn 20% commission on
every sale, then if the auditor takes the total sales for the year and multiplies it by 20% does
the result equal the commission paid to sales staff?
Substantive procedures are normally performed after the financial year end as they are
normally geared at providing assurance as to the balances at a point in time, i.e.: at balance
sheet date. However, there are instances where a <hard close= or interim audit is performed
just before financial year end. The auditor will then perform some substantive analytical
procedures on the audited balances to determine whether the year-end balance is in line
with expectation, these are normally referred to as roll-over procedures. This type of testing
normally occurs when there are extremely tight reporting deadlines, for example,
subsidiaries reporting to the holding company.
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Auditing software can aid in the substantive procedure testing in the following ways:
It can assist with the sample size to be tested
It can assist with error checking, for example, are there any missing or duplicate invoice
numbers
It can assist with recalculating balances, etc. (Adams, et al., 2019)
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