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Revenue and Revenue and Collection CycleCollection Cycle

Chapter 7Chapter 7

“What at first was plunder assumed the softer name of revenue.” Thomas Paine

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Inherent Risks of RevenueInherent Risks of Revenue

Improper RecognitionImproper RecognitionCut-offCut-off

Bill and HoldBill and Hold

Channel StuffingChannel Stuffing

Returns and AllowancesReturns and Allowances

Collectibility of ReceivablesCollectibility of Receivables

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Revenue RecognitionRevenue Recognition

Must be (1) realized or realizable and Must be (1) realized or realizable and (2) earned(2) earned

SEC Guidance (SAB 104)SEC Guidance (SAB 104)Persuasive evidence of an arrangement exists,Persuasive evidence of an arrangement exists,

Delivery has occurred or services have been rendered, Delivery has occurred or services have been rendered,

The seller's price to the buyer is fixed or determinable, and The seller's price to the buyer is fixed or determinable, and

Collectibility is reasonably assured Collectibility is reasonably assured

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Revenue CycleRevenue Cycle

Receive customer purchase orderReceive customer purchase order

Check inventory stock status --- Generate back Check inventory stock status --- Generate back order if item not in stockorder if item not in stock

Obtain credit approvalObtain credit approval

Prepare shipping and packing documentsPrepare shipping and packing documents

Ship and verify shipment of goodsShip and verify shipment of goods

Prepare the invoicePrepare the invoice

Send monthly statements to customersSend monthly statements to customers

Receive paymentReceive payment

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REVENUE AND COLLECTION CYCLE:REVENUE AND COLLECTION CYCLE:Key Control ProceduresKey Control Procedures

SEPARATION OF DUTIESSEPARATION OF DUTIESSeparate functions for recording, authorization, custodySeparate functions for recording, authorization, custody

AUTHORIZATION OF TRANSACTIONSAUTHORIZATION OF TRANSACTIONSWrite-offs Write-offs EDI transactionsEDI transactionsCredit checks prior to approval of saleCredit checks prior to approval of sale

PricingPricing

ACCESS TO ASSETSACCESS TO ASSETSShipping department Shipping department Lock box accountLock box account

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

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

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Sources of Audit EvidenceSources of Audit Evidence

Pending Order Master FilePending Order Master File

Credit check/approval filesCredit check/approval files

Price List Master FilePrice List Master File

Sales JournalSales Journal

Sales Analysis ReportSales Analysis Report

Accounts Receivable Aged Trial BalanceAccounts Receivable Aged Trial Balance

Cash Receipts ListingCash Receipts Listing

Customer StatementsCustomer Statements

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ControlsControlsNo Sales Order without Customer OrderNo Sales Order without Customer OrderCredit Approval ProcessCredit Approval ProcessRestricted Access to InventoryRestricted Access to InventoryRestricted Access to Terminals and Restricted Access to Terminals and

InvoicesInvoicesDocumentation in order to Record SalesDocumentation in order to Record SalesProper DatingProper DatingInvoices compared to BOLs and OrdersInvoices compared to BOLs and OrdersPending Order File ReviewedPending Order File Reviewed

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Accounts in Revenue CycleAccounts in Revenue Cycle

SalesSales

CashCashsalessales

Sales onSales onaccountaccount

Accounts ReceivableAccounts Receivable

Cash receiptsCash receipts

Sales returnsSales returnsand allowancesand allowances

Charge-off ofCharge-off ofuncollectibleuncollectibleaccountsaccounts

BeginningBeginningbalancebalance


EndingEndingbalancebalance

Cash in BankCash in Bank

Cash DiscountsCash DiscountsTakenTaken

Bad DebtBad DebtExpenseExpense

Sales ReturnsSales Returnsand Allowancesand Allowances

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Accounts in Revenue CycleAccounts in Revenue Cycle

Accounts ReceivableAccounts Receivable

Cash receiptsCash receipts

Sales returnsSales returnsand allowancesand allowances





Allowance forAllowance forUncollectible AccountsUncollectible Accounts



Estimate ofEstimate ofbad debtbad debtexpenseexpense


Bad DebtBad DebtExpenseExpense

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Sources of Accounts Sources of Accounts ReceivableReceivable

Claims against customers from sale of goodsClaims against customers from sale of goods

Loans to officers or employeesLoans to officers or employees

Loans to subsidiariesLoans to subsidiaries

Claims against various other refundsClaims against various other refunds

Claims for tax refundsClaims for tax refunds

Advances to suppliersAdvances to suppliers

Shown on balance sheet at Shown on balance sheet at Net Realizable Net Realizable ValueValue

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Inherent Risk in ReceivablesInherent Risk in Receivables

Net receivables will be overstated, because Net receivables will be overstated, because either receivables have been overstated, or either receivables have been overstated, or the allowance for uncollectible accounts has the allowance for uncollectible accounts has been understatedbeen understated

Sales of receivables recorded as sales rather Sales of receivables recorded as sales rather than financing transactionsthan financing transactions

Receivables pledged as collateralReceivables pledged as collateralReceivables classified as current but likelihood Receivables classified as current but likelihood

of collection is lowof collection is lowCollection of receivable contingent on uncertain Collection of receivable contingent on uncertain

future eventsfuture eventsPayment not required until purchaser sells the Payment not required until purchaser sells the

productproduct

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Accounts Receivable Balance-Accounts Receivable Balance-Related Audit ObjectivesRelated Audit Objectives

Detail Tie-inDetail Tie-inDetail Tie-inDetail Tie-in

RealizableRealizableValueValue

RealizableRealizableValueValue

ClassificationClassificationClassificationClassificationAccuracyAccuracyAccuracyAccuracy

ExistenceExistenceExistenceExistence

RightsRightsRightsRights

CompletenessCompleteness CompletenessCompleteness

Cutoff Cutoff Cutoff Cutoff

PresentationPresentationand Disclosureand DisclosurePresentationPresentation

and Disclosureand Disclosure

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Substantive Tests of Accounts Substantive Tests of Accounts ReceivableReceivable

Obtain and evaluate Aging of Accounts Obtain and evaluate Aging of Accounts ReceivableReceivable

Confirm receivables with customersConfirm receivables with customers

Perform cutoff testsPerform cutoff tests

Review subsequent collections of Review subsequent collections of receivablesreceivables

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Aging of Accounts ReceivableAging of Accounts Receivable

Receivables are at Net Realizable Value --- auditors Receivables are at Net Realizable Value --- auditors must evaluate management estimates of must evaluate management estimates of uncollectible accountsuncollectible accounts

Obtain or prepare Schedule of Aged Accounts Obtain or prepare Schedule of Aged Accounts

Receivable --- If schedule is prepared by client, it is Receivable --- If schedule is prepared by client, it is tested for mathematical and aging accuracytested for mathematical and aging accuracy

Use an Aging Schedule toUse an Aging Schedule toAgree detail to control account balanceAgree detail to control account balanceSelect customer balances for confirmationSelect customer balances for confirmationIdentify amounts due from related parties for disclosureIdentify amounts due from related parties for disclosureIdentify past-due balancesIdentify past-due balances

Evaluate Percentages of UncollectibilityEvaluate Percentages of Uncollectibility

Calculate the Balance in the Allowance AccountCalculate the Balance in the Allowance Account

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Accounts Receivable Aged Trial Balance

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Types of ConfirmationTypes of Confirmation

Positive ConfirmationPositive ConfirmationPositive ConfirmationPositive Confirmation

Blank Confirmation FormBlank Confirmation FormBlank Confirmation FormBlank Confirmation Form

Invoice ConfirmationInvoice ConfirmationInvoice ConfirmationInvoice Confirmation

Negative ConfirmationNegative ConfirmationNegative 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 TestingSelection of the Items for Testing

When selecting a sample of accounts receivableWhen selecting a sample of accounts receivablefor confirmation, the auditor should be carefulfor confirmation, the auditor should be carefulto avoid being influenced by the client.to avoid being influenced by the client.

If a client tries to discourage the auditor fromIf a client tries to discourage the auditor fromsending confirmations to certain customers,sending confirmations to certain customers,the auditor should consider the possibilitythe auditor should consider the possibilitythat the client is attempting to concealthat the client is attempting to concealfictitious or known misstatementsfictitious or known misstatementsof accounts receivable.of accounts receivable.

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Sample SizeSample Size

Tolerable misstatementTolerable misstatementTolerable misstatementTolerable misstatement

Inherent riskInherent riskInherent riskInherent risk

Control riskControl riskControl riskControl risk

Achieved detection risk fromAchieved detection risk fromother substantive testsother substantive tests

Achieved detection risk fromAchieved detection risk fromother substantive testsother substantive tests

Type of confirmationType of confirmationType of confirmationType of confirmation

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TimingTiming

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

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Maintaining ControlMaintaining Control

After the items for confirmation have beenAfter the items for confirmation have beenselected, the auditor must maintain controlselected, the auditor must maintain controlof the confirmations until they are returnedof the confirmations until they are returnedfrom the customer.from the customer.

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Follow-up Procedures for Follow-up Procedures for Exceptions NotedExceptions Noted

Because misstatements are Because misstatements are projected to the population of projected to the population of receivables, the auditor must receivables, the auditor must determine the reason for the determine the reason for the

exceptionexception

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Exhibit 7.10Responses to Positive Confirmations

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Analysis of DifferenceAnalysis of Difference

Payment has already been madePayment has already been madePayment has already been madePayment has already been made

Goods have not been receivedGoods have not been receivedGoods have not been receivedGoods have not been received

The goods have been returnedThe goods have been returnedThe goods have been returnedThe goods have been returned

Clerical errors and disputed accountsClerical errors and disputed accountsClerical errors and disputed accountsClerical errors and disputed accounts

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Follow-up on NonresponsesFollow-up on Nonresponses

When positive confirmations are used,When positive confirmations are used,SAS 67 requires follow-up proceduresSAS 67 requires follow-up proceduresfor confirmations not returned by for confirmations not returned by he customer.he customer.

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ALTERNATIVE PROCEDURESALTERNATIVE 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 PROCEDURESANALYTICAL PROCEDURES

Sales RevenueSales RevenueComparisons with previous periodsComparisons with previous periodsComparisons with industryComparisons with industry

Allowance for Doubtful Accts, Bad Debt Allowance for Doubtful Accts, Bad Debt ExpenseExpenseBad Debt Expense as a percentage of SalesBad Debt Expense as a percentage of SalesAllowance for Doubtful Accounts as a percentage of Gross Allowance for Doubtful Accounts as a percentage of Gross

ReceivablesReceivables

Accounts ReceivableAccounts ReceivableDays Sales in Accounts ReceivableDays Sales in Accounts ReceivableAccounts Receivable TurnoverAccounts Receivable Turnover

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Related-Party ReceivablesRelated-Party ReceivablesAmounts due from related parties should Amounts due from related parties should

be separately disclosedbe separately disclosed

Audit procedures to identify related-party Audit procedures to identify related-party transactions include:transactions include:

o Review SEC filingsReview SEC filingso Review the accounts receivable Review the accounts receivable

subsidiary ledger and trial balancesubsidiary ledger and trial balanceo Management inquiryManagement inquiryo Communicate names of all known Communicate names of all known

related parties to audit team membersrelated parties to audit team members

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Sold, Discounted, and Pledged Sold, Discounted, and Pledged ReceivablesReceivables

Receivables sold with recourse, Receivables sold with recourse, discounted, or pledged as collateral discounted, or pledged as collateral should be disclosedshould be disclosed

Audit procedures to identify these itemsAudit procedures to identify these itemso Management inquiryManagement inquiryo Scan cash receipts journal for large Scan cash receipts journal for large

cash inflows from unusual sourcescash inflows from unusual sourceso Bank confirmations, which include Bank confirmations, which include

information on obligations and termsinformation on obligations and termso Review board of director minutes, Review board of director minutes,

which contain approval of these itemswhich contain approval of these items

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Auditing of Allowance for Doubtful Auditing of Allowance for Doubtful AccountsAccounts

Obtain an understanding of how management Obtain an understanding of how management developed the estimate using one or more of developed the estimate using one or more of these approaches:these approaches:

Review and test the process used by management to Review and test the process used by management to

develop the estimatedevelop the estimate

Test aging scheduleTest aging schedule

Evaluate estimated percentages of Evaluate estimated percentages of

uncollectibility useduncollectibility used

Develop an independent model to estimate the Develop an independent model to estimate the

accountsaccounts

Review subsequent events such as subsequent Review subsequent events such as subsequent

collections on accountcollections on account

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Sales TransactionSales Transaction

AccountsAccounts

SalesSales AccountsAccounts ReceivableReceivable

Business FunctionsBusiness Functions

Processing CustomerProcessing Customer OrdersOrders Granting CreditGranting Credit

Shipping GoodsShipping Goods Billing CustomersBilling Customers and Recording alesand Recording ales

Documents and RecordsDocuments and Records

Customer OrderCustomer Order Sales OrderSales Order Shipping DocumentShipping Document Sales InvoiceSales Invoice Sales Transaction FileSales Transaction File Sales Journal or ListingSales Journal or Listing Accounts ReceivableAccounts Receivable

Master FileMaster File Accounts ReceivableAccounts Receivable

Trial BalanceTrial Balance Monthly StatementsMonthly Statements

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Transaction-Related AuditTransaction-Related AuditObjectives for SalesObjectives for Sales

Existence:Existence:Recorded sales are for shipments actually made.Recorded sales are for shipments actually made.

Accuracy:Accuracy:Recorded sales are for the amount shipped.Recorded sales are for the amount shipped.

Completeness:Completeness:Existing sales transactions are recorded.Existing sales transactions are recorded.

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Transaction-Related AuditTransaction-Related AuditObjectives for SalesObjectives for Sales

Classification:Classification:Sales transactions are properly classified.Sales transactions are properly classified.

Timing:Timing:Sales are recorded on the correct dates.Sales are recorded on the correct dates.

Posting and summarization:Posting and summarization:Sales transactions are properly includedSales transactions are properly includedin the accounts receivable master file.in the accounts receivable master file.

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Monitoring ControlsMonitoring Controls

Comparison of sales and cost of good Comparison of sales and cost of good sold with budgeted amountssold with budgeted amounts

Exception reports to identify unusual Exception reports to identify unusual transactionstransactions

Internal audit of revenue cycle controlsInternal audit of revenue cycle controls Computer reconciliation of transactions Computer reconciliation of transactions

entered with transactions processedentered with transactions processed Monitoring of accounts receivable for Monitoring of accounts receivable for

qualityquality Independent follow-up on customer Independent follow-up on customer

complaintscomplaints Audits of sales tax collections Audits of sales tax collections

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Substantive Tests of RevenueSubstantive Tests of RevenueCutoff TestsCutoff Tests

Sales CutoffSales Cutoff• Auditor selects sample of sales recorded during cutoff period Auditor selects sample of sales recorded during cutoff period

and vouches back to sales invoice and shipping documents to and vouches back to sales invoice and shipping documents to determine whether sales are recorded in proper perioddetermine whether sales are recorded in proper period

• Cutoff tests assertions of existence and completenessCutoff tests assertions of existence and completeness• Auditor may also examine terms of sales contractsAuditor may also examine terms of sales contracts

Sales Return CutoffSales Return Cutoff• Client should document return of goods using receiving reportsClient should document return of goods using receiving reports

• Reports should date, description, condition, quantity of goodsReports should date, description, condition, quantity of goods

• Auditor selects sample of receiving reports issued during cutoff Auditor selects sample of receiving reports issued during cutoff period and determines whether credit was recorded in the period and determines whether credit was recorded in the correct periodcorrect period

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Shipping DocumentsShipping Documents

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

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

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Sales Returns and Sales Returns and Allowances TransactionAllowances Transaction

AccountsAccounts

Sales ReturnsSales Returns andand AllowancesAllowances AccountsAccounts ReceivableReceivable

Business FunctionsBusiness Functions

Processing andProcessing and recording salesrecording sales returns andreturns and allowancesallowances

Documents and RecordsDocuments and Records

Credit MemoCredit Memo Sales and Returns andSales and Returns and Allowances JournalAllowances Journal

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Fraud IndicatorsFraud Indicators

Excessive credit memo or other adjustments to accounts Excessive credit memo or other adjustments to accounts receivable just after year-endreceivable just after year-end

Customer complaints and discrepancies in receivable Customer complaints and discrepancies in receivable confirmationsconfirmations

Unusual entries to the receivable subsidiary ledger or sales Unusual entries to the receivable subsidiary ledger or sales journaljournal

Missing or altered source documentsMissing or altered source documentsLack of operating cash flow when operating income has been Lack of operating cash flow when operating income has been

reportedreportedUnusual reconciling differences between receivable subsidiary Unusual reconciling differences between receivable subsidiary

ledger and control accountledger and control accountSales in the last month with unusual termsSales in the last month with unusual termsPre- or post-dated transactionsPre- or post-dated transactionsUnusual adjustments to sales accounts just before or after Unusual adjustments to sales accounts just before or after

year-endyear-end

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Improper Revenue Recognition Improper Revenue Recognition Schemes Schemes

Recognize revenue on fictitious shipmentsRecognize revenue on fictitious shipments Hidden side letters that give customers unlimited Hidden side letters that give customers unlimited

right to return productright to return product Record consignment sales as final salesRecord consignment sales as final sales Accelerated recognition of sales occurring after Accelerated recognition of sales occurring after

year-endyear-end Ship unfinished goodsShip unfinished goods Ship goods before date agreed to by customerShip goods before date agreed to by customer Create fictitious invoicesCreate fictitious invoices Ship goods never orderedShip goods never ordered Ship more goods than orderedShip more goods than ordered Record shipments to company's warehouse as Record shipments to company's warehouse as

salessales Record shipments of replacement goods as new Record shipments of replacement goods as new

sales sales

End of Chapter End of Chapter