McGraw-Hill/Irwin
Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
Chapter 07 Revenue and Collection Cycle
Learning Objectives
1.
2.
3.
4.
5.
Discuss inherent risks related to the revenue and collection cycle
with a focus on improper revenue recognition
Describe the revenue and collection cycle, including typical source
documents and control procedures.
Give examples of tests of controls over customer credit approval,
delivery, and accounts receivable accounting
Give examples of substantive procedures in the revenue and
collection cycle and relate them to assertions about account
balances at the end of the period.
Describe some common errors and frauds in the revenue and
collection cycle, and design some audit and investigation
procedures for detecting them.
7-2
Overall Audit Approach
CONTROL RISK
Low
Moderate
High
Low
High
Detection Risk
Moderate to High
Detection Risk
Moderate
Detection Risk
Moderate
Moderate to High
Detection Risk
Moderate
Detection Risk
Low to Moderate
Detection Risk
High
Moderate
Detection Risk
Low to Moderate
Detection Risk
Low
Detection Risk
INHERENT
RISK
INHERENT RISKS:
Improper Revenue Recognition
Cut-off
Bill and Hold
Channel Stuffing
Returns and Allowances
Collectibility of Receivables
7-3
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
7-4
REVENUE AND COLLECTION CYCLE:
Key Control Procedures
•
SEGPARATION 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
7-5
Audit Evidence in Management
Reports and Data Files
•
•
•
•
•
•
•
•
Pending order master file
Credit check/approval files
Price list master file
Sales detail file (sales journal)
Sales analysis report
Accounts receivable aged trial balance
Cash receipts listing
Customer Statements
7-6
Other Controls
•
•
•
•
•
•
•
•
No sales order without customer order.
Credit approval.
Restricted access to inventory.
Restricted access to terminals and invoices.
All documentation in order to record sales.
Proper dating.
Invoices compared to BOLs and orders.
Pending order files reviewed.
7-7
AUDITING ACCOUNTS RECEIVABLE
• Test Accounts Receivable Aged Trial Balance
(Exhibit 7.8)
• Confirm balances.
• Perform analytical procedures
• Test sales cut-off
7-8
USING CONFIRMATIONS
•
•
Especially useful for verifying EXISTENCE.
Factors likely to affect the reliability of confirmations
– Previous audit experience
– Intended recipient of the confirmation
– Type of information being confirmed
• The auditor may confirm entire BALANCES or individual TRANSACTIONS.
– Type of confirmation being sent
TYPES OF CONFIRMATIONS
•
•
•
Positive Confirmations
– small number of accounts are involved
– large number of errors are anticipated
Negative Confirmations
– the combined assessed level of inherent and control risk is low
– a large number of small balances is involved
– the auditor has no reason to believe that the recipients of the requests are unlikely to give them
consideration.
Blank Confirmations should be used if the recipient is likely to return a positive confirmation
without verifying the accuracy of the information.
7-9
CONFIRMATION CONSIDERATIONS
•
•
•
•
•
•
Responses to positive and blank confirmations provide more reliable
evidence than negative non-responses.
Recipients of accounts receivable confirmations might not report
understatements.
Auditors must have heightened professional skepticism for electronic
responses (fax or e-mail).
Non-response to Positive/blank confirmation requests
– Follow up with second and sometimes third requests.
– A lower than expected response rate could be indicative of fictitious
customer accounts.
– Alternative procedures.
Non-response to negative confirmation requests
– Only limited evidence concerning financial statement assertions.
– Alternative procedures are not necessary for unreturned negative
confirmation requests.
Follow-up on all exceptions
7-10
ALTERNATIVE PROCEDURES
• Vouch subsequent cash collections
– usually sufficient evidence of existence,
valuation.
• Examine shipping documents
• Examine client-generated supporting
documentation, such as invoices.
– Depends on internal controls
• Inspect correspondence files
7-11
Other Matters Related to
Confirmation
• There are three sets of circumstances that could justify the
omission of the confirmation of a client's accounts
receivable.
– Not material to the financial statements.
– If the RISK OF MATERIAL MISSTATEMENT is low, and the
assessed level of evidence from analytical procedures and other
tests of details is sufficient to reduce audit risk to an acceptably
low level, confirmation of accounts receivable may be inefficient.
– Confirmation of accounts receivable is expected to be ineffective
(based on previous years' audit experience).
7-12
UNCOLLECTIBLE
ACCOUNTS
• Inspect customer files for collectibility
• Recalculate ALLOWANCE and BAD DEBT
EXPENSE
• Verify reasonableness of ALLOWANCE and
BAD DEBT EXPENSE
• Verify appropriateness of accounts written off
– Verify attempts to collect receivable
– Verify authorization is appropriate.
7-13
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
7-14
SALES CUTOFF PROCEDURES
• Used to verify whether Sales/Revenues
recorded in the CORRECT ACCOUNTING
PERIOD.
• Examine SALES INVOICES and
SHIPPING DOCUMENTS shortly prior to
and after year-end.
• Examine returns after year-end.
7-15