Chapter 7
Revenue and
Collection Cycle
“What at first was plunder assumed the
softer name of revenue.”
Thomas Paine
Inherent Risks of Revenue
Improper Recognition
Cut-off
Bill and Hold
Channel Stuffing
Returns and Allowances
Collectibility of Receivables
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Revenue Recognition
Must be (1) realized or realizable and
(2) earned
SEC Guidance (SAB 104)
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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Revenue Cycle
Receive customer purchase order
Check inventory stock status --- Generate back
order if item not in stock
Obtain credit approval
Prepare shipping and packing documents
Ship and verify shipment of goods
Prepare the invoice
Send monthly statements to customers
Receive payment
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REVENUE AND COLLECTION CYCLE:
Key Control Procedures
SEPARATION OF DUTIES
Separate functions for recording, authorization, custody
AUTHORIZATION OF TRANSACTIONS
Write-offs
EDI transactions
Credit checks prior to approval of sale
Pricing
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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Sources of Audit Evidence
Pending Order Master File
Credit check/approval files
Price List Master File
Sales Journal
Sales Analysis Report
Accounts Receivable Aged Trial Balance
Cash Receipts Listing
Customer Statements
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Controls
No Sales Order without Customer Order
Credit Approval Process
Restricted Access to Inventory
Restricted Access to Terminals and
Invoices
Documentation in order to Record Sales
Proper Dating
Invoices compared to BOLs and Orders
Pending Order File Reviewed
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Accounts in Revenue Cycle
Sales
Cash
sales
Sales on
account
Cash in Bank
Accounts Receivable
Beginning Cash receipts
balance
Cash Discounts
Taken
Sales on
account
Sales returns
and allowances
Sales Returns
and Allowances
Ending
balance
Charge-off of
uncollectible
accounts
Bad Debt
Expense
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Accounts in Revenue Cycle
Accounts Receivable
Beginning Cash receipts
balance
Sales on
account
Sales returns
and allowances
Ending
balance
Charge-off of
uncollectible
accounts
Allowance for
Uncollectible Accounts
Charge-off of Beginning
uncollectible balance
accounts
Estimate of
bad debt
expense
Ending
balance
Bad Debt
Expense
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Sources of Accounts
Receivable
Claims against customers from sale of goods
Loans to officers or employees
Loans to subsidiaries
Claims against various other refunds
Claims for tax refunds
Advances to suppliers
Shown on balance sheet at Net Realizable
Value
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Inherent Risk in Receivables
Net receivables will be overstated, because
either receivables have been overstated, or
the allowance for uncollectible accounts has
been understated
Sales of receivables recorded as sales rather
than financing transactions
Receivables pledged as collateral
Receivables classified as current but likelihood
of collection is low
Collection of receivable contingent on uncertain
future events
Payment not required until purchaser sells the
product
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Accounts Receivable BalanceRelated Audit Objectives
Detail Tie-in
Existence
Completeness
Accuracy
Classification
Cutoff
Realizable
Value
Rights
Presentation
and Disclosure
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Substantive Tests of Accounts
Receivable
Obtain and evaluate Aging of Accounts
Receivable
Confirm receivables with customers
Perform cutoff tests
Review subsequent collections of
receivables
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Aging of Accounts Receivable
Receivables are at Net Realizable Value --- auditors
must evaluate management estimates of
uncollectible accounts
Obtain or prepare Schedule of Aged Accounts
Receivable --- If schedule is prepared by client, it is
tested for mathematical and aging accuracy
Use an Aging Schedule to
Agree detail to control account balance
Select customer balances for confirmation
Identify amounts due from related parties for disclosure
Identify past-due balances
Evaluate Percentages of Uncollectibility
Calculate the Balance in the Allowance Account
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Accounts Receivable Aged Trial Balance
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Types of Confirmation
Positive Confirmation
Blank Confirmation Form
Invoice Confirmation
Negative Confirmation
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Positive
Confirmation
Letter
7- 17
Negative
Confirmation
Letter
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Selection of the Items for Testing
When selecting a sample of accounts receivable
for confirmation, the auditor should be careful
to avoid being influenced by the client.
If a client tries to discourage the auditor from
sending confirmations to certain customers,
the auditor should consider the possibility
that the client is attempting to conceal
fictitious or known misstatements
of accounts receivable.
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Sample Size
Tolerable misstatement
Inherent risk
Control risk
Achieved detection risk from
other substantive tests
Type of confirmation
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Timing
The most reliable evidence from confirmations
is obtained when they are sent as close to the
balance sheet date as possible, as opposed
to confirming the accounts several months
before year-end.
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Maintaining Control
After the items for confirmation have been
selected, the auditor must maintain control
of the confirmations until they are returned
from the customer.
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Follow-up Procedures for
Exceptions Noted
Because misstatements are
projected to the population of
receivables, the auditor must
determine the reason for the
exception
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Exhibit 7.10
Responses to Positive Confirmations
7- 24
Analysis of Difference
Payment has already been made
Goods have not been received
The goods have been returned
Clerical errors and disputed accounts
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Follow-up on Nonresponses
When positive confirmations are used,
SAS 67 requires follow-up procedures
for confirmations not returned by
he customer.
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ALTERNATIVE PROCEDURES
Vouch Subsequent Cash Collections
Examine Shipping Documents
Examine Client-Generated Supporting
Documentation ----Depends on internal
controls
Inspect Correspondence Files
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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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Related-Party Receivables
Amounts due from related parties should
be separately disclosed
Audit procedures to identify related-party
transactions include:
o Review SEC filings
o Review the accounts receivable
subsidiary ledger and trial balance
o Management inquiry
o Communicate names of all known
related parties to audit team members
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Sold, Discounted, and Pledged
Receivables
Receivables sold with recourse,
discounted, or pledged as collateral
should be disclosed
Audit procedures to identify these items
o Management inquiry
o Scan cash receipts journal for large
cash inflows from unusual sources
o Bank confirmations, which include
information on obligations and terms
o Review board of director minutes,
which contain approval of these items
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Auditing of Allowance for Doubtful
Accounts
Obtain an understanding of how management
developed the estimate using one or more of
these approaches:

Review and test the process used by management to
develop the estimate
Test aging schedule
Evaluate estimated percentages of
uncollectibility used

Develop an independent model to estimate the
accounts

Review subsequent events such as subsequent
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Sales Transaction
Accounts
Business Functions
Documents and Records
 Sales
 Accounts
Receivable
 Processing Customer
Orders
 Granting Credit
 Customer Order
 Sales Order
 Shipping Document
 Sales Invoice
 Sales Transaction File
 Sales Journal or Listing
 Accounts Receivable
Master File
 Accounts Receivable
Trial Balance
 Monthly Statements
 Shipping Goods
 Billing Customers
and Recording ales
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Transaction-Related Audit
Objectives for Sales
Existence:
Recorded sales are for shipments actually made.
Completeness:
Existing sales transactions are recorded.
Accuracy:
Recorded sales are for the amount shipped.
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Transaction-Related Audit
Objectives for Sales
Classification:
Sales transactions are properly classified.
Timing:
Sales are recorded on the correct dates.
Posting and summarization:
Sales transactions are properly included
in the accounts receivable master file.
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Monitoring Controls
Comparison of sales and cost of good
sold with budgeted amounts
 Exception reports to identify unusual
transactions
 Internal audit of revenue cycle controls
 Computer reconciliation of transactions
entered with transactions processed
 Monitoring of accounts receivable for
quality
 Independent follow-up on customer
complaints
 Audits of sales tax collections

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Substantive Tests of Revenue
Cutoff Tests
Sales Cutoff
•
•
•
Auditor selects sample of sales recorded during cutoff period and
vouches back to sales invoice and shipping documents to
determine whether sales are recorded in proper period
Cutoff tests assertions of existence and completeness
Auditor may also examine terms of sales contracts
Sales Return Cutoff
•
Client should document return of goods using receiving reports
•
Reports should date, description, condition, quantity of goods
•
Auditor selects sample of receiving reports issued during cutoff
period and determines whether credit was recorded in the
correct period
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Shipping Documents
These are important in establishing whether
the shipment was actually made and as a
test of cutoff.
7- 37
Sales Returns and
Allowances Transaction
Accounts
Business Functions
 Sales Returns
and
Allowances
 Accounts
Receivable
 Processing and
recording sales
returns and
allowances
Documents and Records
 Credit Memo
 Sales and Returns and
Allowances Journal
7- 38
Fraud Indicators
Excessive credit memo or other adjustments to accounts
receivable just after year-end
Customer complaints and discrepancies in receivable
confirmations
Unusual entries to the receivable subsidiary ledger or sales
journal
Missing or altered source documents
Lack of operating cash flow when operating income has been
reported
Unusual reconciling differences between receivable subsidiary
ledger and control account
Sales in the last month with unusual terms
Pre- or post-dated transactions
Unusual adjustments to sales accounts just before or after
year-end
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Improper Revenue Recognition
Schemes











Recognize revenue on fictitious shipments
Hidden side letters that give customers unlimited
right to return product
Record consignment sales as final sales
Accelerated recognition of sales occurring after
year-end
Ship unfinished goods
Ship goods before date agreed to by customer
Create fictitious invoices
Ship goods never ordered
Ship more goods than ordered
Record shipments to company's warehouse as
sales
Record shipments of replacement goods as new
sales
7- 40
End of Chapter