Revenue and Collection Cycle

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Revenue and Collection Cycle. Chapter 7. “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. Revenue Recognition. - PowerPoint PPT Presentation

Text of Revenue and Collection Cycle

  • Revenue and Collection CycleChapter 7What at first was plunder assumed the softer name of revenue. Thomas Paine

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    Inherent Risks of RevenueImproper RecognitionCut-offBill and HoldChannel StuffingReturns and AllowancesCollectibility of Receivables

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    Revenue RecognitionMust 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 orderCheck inventory stock status --- Generate back order if item not in stockObtain credit approvalPrepare shipping and packing documentsShip and verify shipment of goodsPrepare the invoiceSend monthly statements to customersReceive payment

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    REVENUE AND COLLECTION CYCLE:Key Control ProceduresSEPARATION OF DUTIESSeparate functions for recording, authorization, custody

    AUTHORIZATION OF TRANSACTIONSWrite-offs EDI transactionsCredit checks prior to approval of salePricing

    ACCESS TO ASSETSShipping department Lock box account

    ADEQUATE DOCUMENTS AND RECORDSPre-numbered sales orders, shipping documents (bills of lading), sales invoicesRemittance advice

    INDEPENDENT CHECKS ON PERFORMANCEA/R subsidiary ledger to general ledgerMonthly statement to customer

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    Sources of Audit EvidencePending Order Master FileCredit check/approval filesPrice List Master FileSales JournalSales Analysis ReportAccounts Receivable Aged Trial BalanceCash Receipts ListingCustomer Statements

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    ControlsNo Sales Order without Customer OrderCredit Approval ProcessRestricted Access to InventoryRestricted Access to Terminals and InvoicesDocumentation in order to Record SalesProper DatingInvoices compared to BOLs and OrdersPending Order File Reviewed

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    Accounts in Revenue Cycle

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    Accounts in Revenue Cycle

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    Sources of Accounts ReceivableClaims against customers from sale of goodsLoans to officers or employeesLoans to subsidiariesClaims against various other refundsClaims for tax refundsAdvances to suppliersShown on balance sheet at Net Realizable Value

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    Inherent Risk in ReceivablesNet receivables will be overstated, because either receivables have been overstated, or the allowance for uncollectible accounts has been understatedSales of receivables recorded as sales rather than financing transactionsReceivables pledged as collateralReceivables classified as current but likelihood of collection is lowCollection of receivable contingent on uncertain future eventsPayment not required until purchaser sells the product

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    Accounts Receivable Balance-Related Audit ObjectivesDetail Tie-inRealizableValueClassificationAccuracyExistenceRights CompletenessCutoff Presentationand Disclosure

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    Substantive Tests of Accounts ReceivableObtain 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 toAgree detail to control account balanceSelect customer balances for confirmationIdentify amounts due from related parties for disclosureIdentify 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 ConfirmationPositive ConfirmationBlank Confirmation FormInvoice ConfirmationNegative Confirmation

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    Positive Confirmation Letter

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    Negative Confirmation Letter

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    Selection of the Items for TestingWhen selecting a sample of accounts receivablefor confirmation, the auditor should be carefulto avoid being influenced by the client.If a client tries to discourage the auditor fromsending confirmations to certain customers,the auditor should consider the possibilitythat the client is attempting to concealfictitious or known misstatementsof accounts receivable.

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    Sample SizeTolerable misstatementInherent riskControl riskAchieved detection risk fromother substantive testsType of confirmation

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    TimingThe most reliable evidence from confirmationsis obtained when they are sent as close to thebalance sheet date as possible, as opposedto confirming the accounts several monthsbefore year-end.

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    Maintaining ControlAfter the items for confirmation have beenselected, the auditor must maintain controlof the confirmations until they are returnedfrom 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 7.10Responses to Positive Confirmations

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    Analysis of DifferencePayment has already been madeGoods have not been receivedThe goods have been returnedClerical errors and disputed accounts

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    Follow-up on NonresponsesWhen positive confirmations are used,SAS 67 requires follow-up proceduresfor confirmations not returned by he customer.

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    ALTERNATIVE PROCEDURESVouch Subsequent Cash Collections Examine Shipping Documents Examine Client-Generated Supporting Documentation ----Depends on internal controlsInspect Correspondence Files

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    ANALYTICAL PROCEDURESSales RevenueComparisons with previous periodsComparisons with industry

    Allowance for Doubtful Accts, Bad Debt ExpenseBad Debt Expense as a percentage of SalesAllowance for Doubtful Accounts as a percentage of Gross Receivables

    Accounts ReceivableDays Sales in Accounts ReceivableAccounts Receivable Turnover

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    Related-Party ReceivablesAmounts due from related parties should be separately disclosed

    Audit procedures to identify related-party transactions include:Review SEC filingsReview the accounts receivable subsidiary ledger and trial balanceManagement inquiryCommunicate names of all known related parties to audit team members

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    Sold, Discounted, and Pledged ReceivablesReceivables sold with recourse, discounted, or pledged as collateral should be disclosedAudit procedures to identify these itemsManagement inquiryScan cash receipts journal for large cash inflows from unusual sourcesBank confirmations, which include information on obligations and termsReview 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 usedDevelop an independent model to estimate the accountsReview subsequent events such as subsequent collections on account

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    Sales Transaction

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    Transaction-Related AuditObjectives for SalesExistence:Recorded sales are for shipments actually made.Accuracy:Recorded sales are for the amount shipped.Completeness:Existing sales transactions are recorded.

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    Transaction-Related AuditObjectives for SalesClassification:Sales transactions are properly classified.Timing:Sales are recorded on the correct dates.Posting and summarization:Sales transactions are properly includedin the accounts receivable master file.

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    Monitoring Controls

    Comparison of sales and cost of good sold with budgeted amountsException reports to identify unusual transactionsInternal audit of revenue cycle controlsComputer reconciliation of transactions entered with transactions processedMonitoring of accounts receivable for qualityIndependent follow-up on customer complaintsAudits of sales tax collections

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    Substantive Tests of RevenueCutoff TestsSales CutoffAuditor 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 periodCutoff tests assertions of existence and completenessAuditor may also examine terms of sales contracts

    Sales Return CutoffClient should document return of goods using receiving reportsReports should date, description, condition, quantity of goodsAuditor selects sample of receiving reports issued during cutoff period and determines whether credit was recorded in the correct period

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    Shipping DocumentsThese are important in establishing whether the shipment was actually made and as a test of cutoff.

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    Sales Returns and Allowances TransactionAccounts Sales Returns and Allowances Accounts Receivable

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    Fraud IndicatorsExcessive credit memo or other adjustments to accounts receivable just after year-endCustomer complaints and discrepancies in receivable confirmationsUnusual entries to the receivable subsidiary ledger or sales journalMissing or altered source documentsLack of operating cash flow when operating income has been reportedUnusual reconciling differences between receivable subsidiary ledger and control accountSales in the last month with unusual termsPre- or post-dated transactionsUnusual adjustments to sales accounts just before or after year-end

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    Improper Revenue Recognition Schemes Recognize revenue on fictitious shipmentsHidden side letters that gi