Chapter 11 The Revenues, Receivables and Receipts Process ...s3.amazonaws.com/prealliance_oneclass_sample/KZWwYxnr9o.pdf · Revenue, receivables and receipt process activities include:

Keval Shah Chapter 11 – AFM 451 1

Chapter 11 – The Revenues, Receivables and Receipts Process

Understanding the Revenue, Receivables and Receipts Process

The auditor must understand the business’s method of generating revenues and use of them in

operations in order to ASSESS the BUSINESS RISK AND RISK OF MISSTATEMENT.

o Management’s assertions regarding existence, ownership, completeness, valuation and

disclosure ALL present risks the auditor needs to consider.

Revenues, Receivables and Receipts Process: Typical Activities

Revenue, receivables and receipt process activities include:

o Receiving and processing customer orders.

o Delivering goods and services to customers.

o Billing customers and accounting for receivables.

o Collecting and depositing cash.

o Reconciling bank accounts.

Note: There will be different controls along the way to ensure all of these processes and activities are

correct, complete and accurate

Authorization

When a customer purchase order (PO) is received, a number of AUTHORIZATIONS need to be verified

BEFORE a sales order can be created.

o The customer status (new or current)

We have to understand whether the client is new or a continuing client.

o Their credit status

o Availability of inventory (backorder)

Is it available...if not can we backorder it

o Approved pricing of products

We have to ensure that the customer understood the pricing agreement

Note:

o Most important aspect is authorization.

o POs can be faxed in/emailed by customers. These represent a contract with our customers.

Sales Approval

Looking to see whether a sales order has the proper authorization for any differences in pricing


Once the authorizations are passed the system creates:

1. An open sales order (in the PENDING ORDER MASTER FILE)

2. A packing slip (will go to the stock keeper – very important document – allows shipping

department to ship those documents)

Authorizes the stock keeper to release inventory to shipping department

Authorized the shipping department to ship the goods

The system should also update the:

3. Inventory master file for the commitment of goods.

Note: The pending open sales order and packing slip SHOULD BE NUMBERED IN SEQUENCE so that the

system can determine if any transactions have not been completed (completeness)

***Important Control Activities***:

Control activities relate to:

1. CUSTODY of assets and records (Inventory) (***UFE Case Question – shipping dep. adjusting this)

Physical custody of inventory starts with the STOCKROOM or WAREHOUSE where inventory is

kept.

i. Custody is transferred to the shipping department only on the authorization of the

packing slips.

If stockkeepers or shippers have the ability to change quantities shown on packing slips, a

weakness in separation of duties is created. This can allow for inventory to be stolen.

2. Properly RECORDING transactions and events

When the shipment is complete, the open sales order is closed and the following documents

are created:

i. a BILL OF LADING shipping document – outlines what # of products were shipped

ii. a SALES INVOICE billing the customer for goods shipped – sent to the customer

Personnel with the ability to enter, alter, and/or physically intercept the sales invoice have a

combination of incompatible responsibilities (authorization, custody & recording).

3. Performing RECONCILIATION procedures to check completeness and integrity of records

A comparison of the total unpaid balances to the accounts receivable control account is a

common reconciliation. An aged trial balance is usually used for this reconciliation.

This should be performed by personnel who have no responsibility over authorization,

custody or recording of transactions.

i. i.e. Match Bill of Lading to SHIPPING INVOICE

ii. When we look at A/R match it to aged TB

Cash Receipts and Cash Balances

Most companies require little authorization to ACCEPT payments from customers.

Cash can be received in many ways, over the counter, mail, lockbox, or electronic funds transfer.

o Cheques provide an extra layer of security – cash no records kept

Authorization is required for approving discounts, returns and allowances.

o Receiving cash and approving discounts or allowances are incompatible functions. (because

they can pocket it)


Custody of Cash

At some point, someone has the cash and cheques in hand, and has physical custody.

o A number of controls should be considered, including forced vacations, rotation of staff,

technological controls and insurance (e.g., fidelity bond).

o Lock boxes are a great way to account for cash or cheques being stolen

It’s a good idea to record the cash/cheques ASAP in the process (i.e., REMITTANCE LISTS)

o Remittance Lists Having 2 people involved – why not have 2 people opening the mail. 2

people requires collusion …maybe one person will have a conscience and will want to steal

Recording of Cash Receipts

The accountants responsible for recording of cash into the accounting system should NOT also handle

cash.

Cash should be initially recorded using CASH REMITTANCE LISTS, the accountant should record from

these lists.

A copy of the list is sent to A/R and GL accountants

The cash account + A/R control account + A/R subsidiary accounts are all updated.

o A/R Control Account = Involved all A/R transactions from ALL debtors = A/R Balance

o A/R Subsidiary Account = every debtor has an account. All of the sub A/R balances total up to

the control A/R receivable

Periodic Reconciliation

Bank reconciliations need to be prepared monthly

o Bank deposit slips should be traced to the cash remittance lists

o Paid cheques should be compared to the disbursements journal.

The reconciliations should be performed by personnel who do not have responsibility for recording

cash receipts (i.e., preparing remittance lists) or disbursements.

Audit EVIDENCE in Management Reports and Data Files

Audit evidence will be found in a number of reports created by management

o Pending order master file (completeness)

o Credit check files (up-to-date maintenance)

Case Always try to be EXTRA conservative…if its done on a regular basis don’t suggest

it should be done more

o Price list master file (must be correct for billing)

who has access to it should be different from the sales rep

o Sales detail (sales journal) file (compare to shipments and dates)

o Sales analysis reports (by product line, by employee and investigate unusual items)

One district had larger sales for one period and smaller sales for the next period. Red

Flag. Would not find this without checking for period vs. period.

o A/R aged trial balance (assessing bad debts and accounting for balances)

o Cash receipts journal (deposits, receipts, adjusting entries re: bank)


Whenever there are dates involved, check to see if the period is good enough (regular) – for CASE

Internal Control Objectives for Sales

1. VALIDITY – Sales are valid and documented

2. COMPLETENESS – No sales transactions are omitted

3. AUTHORIZATION – Sales are authorized

4. ACCURACY – Sales invoices are accurately prepared

5. CLASSIFICATION – Sales transactions are properly classified

6. ACCOUNTING – Sales transactions recorded conform to GAAP

7. PROPER PERIOD – Sales transactions are in the proper period

***Dual-direction testing tests for COMPLETENESS and VALIDITY at the same time.

Control Tests for Sales

***Know these tests and match to IC Objectives – what does it provide evidence for?***

1. Select a sample of shipping docs:

a. Scan for missing numbers (Provides evidence for – COMPLETENESS)

b. Trace to related sales invoices (COMPLETENESS)

2. Scan sales invoices for missing numbers in the sequence (COMPLETENESS)

3. Select a sample of sales invoices (Sales Journal)

a. Perform recalculations to verify arithmetic accuracy (ACCURACY)

b. Vouch to supporting shipping documents (VALIDITY, ACCURACY, PROPER PERIOD, AUTHO.)

c. Vouch prices to approved price list (AUTHORIZATION)

d. Vouch credit approval (AUTHORIZATION)

e. Trace posting to general ledger and customer account (ACCOUNTING)

4. Observe customer order handling (OVERALL CONTROL ENVIRONMENT)

Control Tests for Cash Receipts

1. Select a sample of recorded cash receipts (cash rec jrnl):

a. Vouch to deposit slip and remittance advices (VALIDITY)

b. Trace to bank statement (VALIDITY)

c. Trace posting to general ledger accounts (ACCOUNTING)

d. Trace posting to subsidiary accounts (ACCOUNTING)

2. Select a sample of remittance lists

a. Trace to cash receipts journal (COMPLETENESS)

b. Trace journal posting to general ledger (ACCOUNTING)

c. Trace to bank statement (ACCURACY)

3. Observe the work habits of cashiers and their interactions with persons keeping cash records

(OVERALL CONTROL ENVIRONMENT)

Control Tests for A/R

1. Trace sales invoices to accounts receivable (ACCOUNTING)

2. Trace cash receipts to accounts receivable posting (ACCOUNTING)


3. Select a sample of credit memos

a. Review for proper approval (AUTHORIZATION)

b. Trace to posting in customer accounts (ACCOUNTING)

4. Select a sample of customer accounts

a. Vouch debits to supporting sales invoices (VALIDITY)

b. Vouch credits to supporting cash receipts documents and approved credit memos (VALIDITY)

5. Observe mailing of monthly customer statements (VALIDITY)

Summary: Control Risk Assessment

Control Risk Assessment

Process that the auditor uses to understand the client’s IC that will be sufficient to identify and assess

the RMM of the F/S whether due to fraud or error, and to design and perform further audit

procedures; required to comply with the second examination standard of GAAS

The purpose of testing controls is to determine nature, extent, and timing of substantive procedures.

Good controls = low control risk:

Smaller sample sizes, earlier timing for some substantive tests.

Poor controls = high control risk:

Larger samples, more work at year end.

Special Note: Evidence for THE EXISTENCE ASSERTION

For accounts receivables and other assets, auditors place their main emphasis on existence and rights

assertions.

Recalculation

o Focus on assets that DEPEND LARGELY ON CALCULATIONS (prepaid expenses, depreciation,

interest payments).

Inspection of Physical Assets

o Inventories and assets can be examined,

o Title to cars, land, buildings can be vouched,

o Securities held for investment can be inspected.

Confirmation

o Bank accounts, receivables can be confirmed.

o Assets at other locations or in the hands of custodians can also be confirmed.

Enquiry

o Enquire should be made as to agreements regarding minimum balances, pledging of

receivables, pledging of other assets.

**Not the most convincing of evidence

Inspection of Documents (VOUCHING)

o Examine title documents, collateral, pledges

Inspection of Documents (SCANNING)

o Look for misclassified assets, uncharacteristic balances, errors or overpayments, or related

party transactions and balances


Analysis (ANALYTICAL PROCEDURES)

o Comparison of assets to related revenues or expenses, expenses with revenues, contra

revenues with revenues, and write-offs.

Special Note: Confirmation of A/R and Notes Receivable

Confirmations can provide evidence about EXISTENCE and VALUATION of accounts and notes receivable.

Statistical methods can be used to determine the size and selection of accounts to be

confirmed.

Confirmations may make use of positive confirmations or negative confirmations.

Confirmations will NOT provide sufficient evidence regarding ownership.

e.g., A/R may be sold (factored) or collateralized

Positive Confirmations

A positive confirmation requires a response in all cases, whether the balance is correct or incorrect.

Used where individual balances are large, or where accounts are in dispute.

The confirmation may ask for information on balances or specific invoices depending on knowledge of

the customer’s accounting records.

Nonresponses are tolerated if the auditor can verify the info through other means.

Generally produces high quality evidence.

o Auditors need to consider alternative procedures when no response is provided.

Customer POs, Sales Invoices, Bills of Lading, Subsequent Collections

Response Rate = # of confirmations returned/# of confirmations sent

Detection Rate = # of misstatements reported/number of actual account misstatements

Negative Confirmations

The negative confirmation form only requires a response if the customer disagrees with the balance.

Useful when

o inherent and control risk are low,

o a large number of customers are involved, and

o where the auditor believes that the customers will handle the confirmations correctly.

Evidence collected from negative confirmations is considered far less reliable than from positive

confirmations.

Control over Confirmations

The auditor needs to maintain control over the entire confirmation process

o To ensure that confirmations reach the intended customers/lenders, and that they actually

exist.

o To ensure that responses are from actual customers/lenders

Summary: Confirmations


Confirmations of cash, loans and accounts and notes receivable are required unless auditors can justify

substituting procedures.

Auditors need to exercise care in ensuring that responses are received from real debtors.

Note that confirmations do not confirm collectability of receivables or ownership of receivables.

Special Note: Audit of Bank Reconciliation

Reconciliation EXPLAINS the difference b/w the amount on books vs. amt in bank

Bank reconciliations -

o Bank balance is confirmed with bank.

o The reconciliation is recalculated and re-footed.

o Reconciling items are VOUCHED 100% to supporting documentation.

Vouch all items on the reconciliation if doing monthly

o The auditor obtains cutoff bank statement directly from the client’s bank.

If auditor reperforms bank rec, it is A SUBSTANTIVE PROCEDURE

Accounts Receivable – LAPPING

Manipulation of accounts receivable to cover a theft or fraud.

o Receipts from one customer are applied to another customer’s account to cover

misappropriation payments received.

Lapping – person who is collecting the cash and they are also in charge of recording – I

am going to borrow it and pay it back ….oh I will apply the new customer’s payment to

the old one….stalling the payment

Audit procedures include comparison of cheques on a daily deposit slip to the detail of customer

accounts credited on that day.

o Looking for a customers credited for whom no payment was received.

Cheque KITING

Deliberate floating of funds using “hot cheques” to create apparent cash balances.

o Uses the time required for cheques to clear to obtain an unauthorized short-term loan.

o The depository bank does not know the cheque is on insufficient funds, and the deficiency will

be covered by a second hot cheque.

o If you are broke, you take a cheque from one account and you deposit it in the other – but you

are borrowing money – and making it look like you have more money in one account than you

actually do

Audit procedure is to review all interbank transfers and prepare a bank transfer schedule to ensure

that all transfers are recorded in proper period

Bank Transfer Schedule = An audit analysis summarizing all the transfers between the auditee’s bank

accounts in the days just before and after the period end, to verify each amount transferred is included

in only one account at the period end, not double counted

Window Dressing:


o The inappropriate manipulation of account balances by mgmt., usually at the end of a period,

to make the financial position or performance reported in the F/S appear more attractive to

users

o Often involves using accounting policies, JE, or actual cash transactions b/w related parties that

have no real business purpose, resulting in artificial embellishment of the company results or

liquidity

Lecture 15: A Walk through the Sales, Receivables and Cash Receipts Process

Customer Order Processing

1. When a customer’s purchase order is received, a number of important authorizations must occur

before product is shipped

o Prices should be pulled from a pre-authorized price list (price list master file) and populated on

the electronic order form.

Any deviations (i.e., discounts) from approved pricing should require authorization from

a sales manager or other

o Note: Pre-Authorized price lists ensure that authorized prices are charged to customers and

automatically populating the price list ensures accuracy (no human transposition errors)

2. Customer credit status should be checked and any orders exceeding credit limits should be put on

hold until a higher credit limit is authorized by a manager from either A/R or another established Credit

Department

o Likewise, all new customer orders should be placed on hold until proper credit checks are

completed as no credit has yet been established

If credit is not granted, customers is will need to pay cash on delivery (COD).

o Note: All credit granting/ increases should be approved by those outside the sales department

(sales dept’s have incentive to push product out the door) ensuring that the company is not

exposed to excessive credit risk

The whole credit approval process should be outside the sales department

You shouldn’t have the sales manager be able to override the credit terms…because

their incentive is based on the sales (commission)

3. The system should check to see if there is enough inventory to ship. If not, then a backorder is entered

and the customer should be notified


o This ensures that customers are aware of any lag times to get their goods (customer

satisfaction issue)

4. It is good practice to LIMIT credit for new customers until a reliable payment history is established

o Lower credit limits to start with help to limit exposure to credit risk from new customers

o Credit Ratings/Reports are good – often times the credit that we provide is based on the

relationship/history that we develop with them

Offering Credit is a risk to business so make sure it’s not too low from the beginning

Shipping/Fulfillment of Orders

After credit is authorized, an open sales order is created (updating the PENDING ORDER MASTER FILE

and INVENTORY MASTER FILE)

o Inventory Master File = The amount of product that the sales order is processing

1. PACKING SLIPS (3) are generated and routed to the Warehouse providing the inventory clerk

authorization to pick the goods and transfer their custody to the Shipping Dept.

o One copy of the packing slip should be kept in the warehouse

o Two other copies should be sent along with the inventory goods to the shipping dept.

o Note: System-generated packing slips help ensure authorization of custody transfer and the

proper amount of goods for release to shipping

o When the inventory clerk transfers the goods + packing slips to the shipping clerk…

2. The shipping clerk should compare the goods received with the attached PACKING SLIP and the

system-generated CUSTOMER ORDER before preparing shipment to customer

o The shipping clerk should initial the packing slip to indicate that this review was done

Very important to provide evidence along the way that this has been accomplished

o This ensures that the amounts that have been picked and that will be sent to the customer are

accurate

3. The shipping clerk can begin completion of the transaction

o The system should print three BILLS OF LADING based on the packing slip,

One copy is kept in shipping dept. with copy of packing slip,

One copy is sent to customer with shipped goods,

One copy is sent with copy of packing slip to A/R

o The system should now remove the pending order from the PENDING ORDER MASTER FILE,

record the sale and generate the CUSTOMER INVOICE

o This ensures that goods shipped to customers are accurately recorded and invoiced and also

that sales are recorded only when goods have shipped.

o Note: The bill of lading provides evidence of what should be in the box

4. The PENDING ORDER MASTER FILE should be reviewed on a regular basis by a customer service

manager/sales manager and followed up with the shipping department and the customer.

o This helps to ensure that goods ordered by customers are shipped in a timely manner and also

may uncover shipments that have been made but have not been recorded in system

(completeness).

Billing of Orders


1. The A/R clerk matches up shipments made per the SALES DETAIL REPORT to the PACKING SLIPS and

BILLS OF LADING sent by shipping dept with customer invoices to ensure that

a. all shipments made have been invoiced (completeness)

b. customer invoices reflect the correct amount and type of goods that were shipped (accuracy,

completeness)

c. all customer invoices generated have corresponding shipment(s) (validity)

2. The A/R clerk should print the CUSTOMER INVOICES and match them to the BILL OF LADING and mail

both together to customers

a. Note: This ensures that customer invoices reflect goods that actually shipped and that they are

billed on a timely basis

Processing Payments

1. Customer payments should be recorded immediately upon receipt using CASH REMITTANCE LISTS by

an individual not also responsible for approving/recording discounts, returns or allowances (e.g.,

Cashier).

a. It is best to have two cashiers opening mail and recording receipts

b. Checks should be stamped “for deposit only in acct…”

i. This helps prevent theft of cash and/or cheques

2. Three copies of CASH REMITTANCE LIST are generated

a. One is sent with customer payments to the cash management clerk where discounts are

approved and taken to bank with a DEPOSIT SLIP

b. One is sent to A/R clerk to post to customer accounts (A/R SUBLEDGER)

c. One is sent to G/L accountant who posts to CASH RECEIPTS JOURNAL and then posts to G/L

control accounts

Monthly Reconciliation of Receipts

1. BANK DEPOSIT SLIPS should be traced to the CASH REMITTANCE LISTS

a. ensures that all money collected has been deposited

i. This rec should be performed by personnel who do not have responsibility for

recording cash receipts (i.e., preparing the remittance lists).

2. A/R SUBLEDGER should be traced to G/L CONTROL ACCOUNT (the GL)

a. ensures that the sum of customer’s unpaid balances are reflected

i. This rec should be performed by personnel who do not have responsibility over

authorization, custody or recording of transactions.

Audit Evidence Management Reports and Data Files (For Reference)

Pending Order Master File:

Contains SALES TRANSACTIONS started but not yet completed in the system not recorded as sales

and A/R


Old orders may represent shipments ACTUALLY MADE but for some reason the shipping department

did not enter the shipping information (or entered an incorrect code that did not match the pending

order)

Pending order backlog can be reviewed for evidence relating to the COMPLETENESS ASSERTION

Credit Check Files

Up-to-date maintenance of credit info is very imp

Customers’ credit status is concerned with possibly uncollectible A/R imp evidence about the

VALUATION ASSERTION

Credit checks on old or incomplete info are NOT good credit checks

Price List Master File

Customer system may produce customer invoices automatically but if the master price list is wrong,

the billings will be wrong

Computer file can be compared w/ official price source for accuracy and authorization

o Employee should perform comparison every time the prices are changed

Incorrect pricing revenues/A/R measured incorrectly VALUATION ASSERTION

Sales Detail (Sales Journal) File

Should contain detailed sales entries shipping references + dates

Can be scanned for entries without shipping references (fictitious sales) and for matching recording

dates with shipment dates (sales recorded before shipment)

Also contains the population of debit entries to A/R EXISTENCE ASSERTION FOR REVENUES/A/R

o CAAT = COMPUTER ASSISTED AUDITING TECHNIQUES

Sales Analysis Reports

Sales classified by product line or region is info for the business segment disclosures

Those classified by period or by sales employee can show unusually high or low volumes that may need

investigation if error is suspected COMPLETENESS, EXISTENCE OF REVENUES

Aged A/R Trial Balance

The list of A/R balance details is called the A/R SUBSIDIARY LEDGER

The summary of the subsidiary ledger by invoice dates is called the aged A/R trial balance

If the General Ledger Control Account > Sum in the Aged Trial Balance bad!

o A receivable amount not identified with a customer cannot be collected

The trial balance is used for CONFIRMATION

Existence, completeness and valuation assertions of A/R

Cash Receipts Journal

Contains all detail for cash deposits and credits to various accounts and is the population of entries

that should be the credits to A/R for customer payments


Also contains any adjusting or correcting entries resulting from bank rec

o These entries may signal the types of accounting errors/manipulations that happen in the cash

receipts accounting and provide evidence relating to existence and completeness of cash and

A/R