Professional Documents
Culture Documents
Lecturer:
Taufikur Rahman, SE, MBA, Akt.
Group Members:
Ignatius Denny Kurniawan S. / 296514
1
Table of Contents
Table of Contents............................................................................................................................. 2
2
2) Granting sales returns and allowances ........................................................................................... 30
3) Determining uncollectible accounts ................................................................................................. 30
Other Controls in the Revenue Cycle ................................................................................................31
References: ...................................................................................................................................... 46
3
Introduction – The Nature of the Revenue Cycle
The revenue cycle is a recurring set of business activities and related information
processing operations associated with (1) providing goods and services to customers and (2)
collecting their cash payments. Or in another word, an entity’s revenue cycle consists of
activities related to the exchange of goods and services with customers and to the collection
of the revenue in cash. The primary objective of the revenue cycle is to provide the right
product in the right place at the right time for the right price.
For a merchandising company, the classes of transactions in the revenue cycle include:
The classes of transactions in the revenue cycle affect the accounts, as depicted in the figure
below.
4
Develop Audit Objectives
The audit objectives for the revenue cycle relate to obtaining sufficient competent evidence
about each significant financial statement assertion that pertains to revenue cycle transaction
and balances. These audit objectives for the revenue cycle are shown in the figure, as follows.
5
Transaction Specific
Assertion Class or Audit
Category Balance Objective
Transaction Specific
Assertion Class or Audit
Category Balance Objective
Rights and Transaction The entity has rights to the receivables and cash
Obligations resulting from recorded revenue cycle transactions.
Balance Accounts receivable at the balance sheet date
represent legal claims of the entity on customers for
payment.
Valuation or Transaction All sales and cash receipts and sales adjustments are
Allocation valued using GAAP and correctly journalized,
summarized, and posted.
Balance Accounts receivable represent gross claims on
customers at the balance sheet date and agree with
the sum of the accounts receivable subsidiary ledger.
The allowance for uncollectable accounts represents
a reasonable estimate of the difference between gross
receivables and their net realizable value.
Transaction Specific
Assertion Class or Audit
Category Balance Objective
6
Understanding the Client’s Business and Industry
Auditors develop audit strategy based on the risk of material misstatement. The first step in
assessing risk is obtaining an understanding of the client’s business and industry because it
assists the auditor in:
Moreover, the process of generating revenues drives many expenses, such as cost of good
sold or selling expenses. Thus, understanding the revenue cycle assists in developing
expectations of an entity’s expenditures associated with other transaction cycles and
assessing the risk of material misstatements in unaudited earnings.
Materiality
Revenues are a measure of volume of activity for every entity. Revenues usually have a high
volume of transactions and total revenues are so important to the financial statements that
they are often used as a gauge of overall materiality for the engagement. Revenues also give
rise to accounts receivable and eventually cash and cash flow from operations. The accounts
receivable produced by credit sales transactions are almost always material to the balance
sheet.
The transaction classes and account balances comprising the revenue cycle normally have
material effects on the financial statements. To enhance the auditor’s effectiveness and
efficiency in meeting specific audit objectives in this cycle, careful attention should be given
to considering inherent risk, analytical procedures risk, and control risk when choosing
the audit strategy for each audit objective.
7
factors that may pertain only to specific assertions in the revenue cycle. These include factors
that provide incentive for management to misstate revenue cycle assertions and fraudulent
financial reporting, such as:
Meanwhile, other factors that might contribute to misstatements in revenue cycle assertions
include the following:
The volume of sales, cash receipts, and sales adjustment transactions is often high,
resulting in numerous opportunities for errors to occur.
The timing and amount of revenue to be recognized may be contentious owing to
factors such as ambiguous accounting standards, the need to make estimates, the
complexity of the calculations involved, and purchasers’ rights of return.
When receivables are factored with recourse, the correct classification of the
transaction as a sale or a borrowing may be contentious.
Receivables may be misclassified as current or noncurrent owing to difficulties in
estimating the likelihood of collection within the next year or the source of events on
which collection is contingent.
Cash receipt transactions generate liquid assets that are particularly susceptible to
misappropriation.
Sales adjustment transactions may be used to conceal thefts of cash received from
customers by overstating discounts, recording fictitious sales returns, or writing off
customers’ balances as uncollectable.
8
auditor’s knowledge of the business and industry. They are not only effective in identifying
potential misstatements in the financial statements, but they are also effective in identifying
issues that may result in providing other assurance services in addition to the audit report.
Finally, it is important for the auditor to evaluate the client’s accounts receivable turn days,
or average collection period, and be able to compare the collection period with industry
norms. Increase in the client’s collection period are indicators that receivables are growing
faster than sales volumes, which means that operating cash flows are consumed, and this may
lead to liquidity problems. The table below will present other analytical procedures that the
auditor might assess in the revenue cycle, as follows.
9
Audit
Ratio Formula Significance
Sales to Capacity Net Sales ÷ Nonfinancial Helpful in assessing the
Measure of Capacity reasonableness of total revenues.
Market Share Client’s Net Sales ÷ Net Sales Helpful in assessing the
of Industry reasonableness of both total
revenues and gross margins.
Larger market share is often
associated with larger gross
margins.
Sales to Total Sales ÷ Average Total Assets This ratio is useful for
Assets manufacturing and other
asset-based companies.
Describes the relationship
between assets and sales
revenues.
Accounts ((Accounts Receivable n ÷ Ratios larger than 1.0 indicate
Receivable Accounts Receivable n-1) - that receivables are growing
Growth to Sales 1) ÷ ((Sales n ÷ Sales n-1) – 1) faster than sales. Large ratios
Growth may indicate possible collection
problems.
Audit
Ratio Formula Significance
Accounts Average Accounts Receivable ÷ Useful in comparing with industry
Receivable Turn Sales x 365 averages. Longer collection
Days periods may indicate collection
problems. Prior experience and
current sales volumes may be
useful in estimating current net
receivables.
Uncollectable Uncollectable Accounts Useful in evaluating the
Accounts Expense Expense ÷ Net Sales reasonableness of uncollectable
to Net Credit accounts expense. Smaller ratios
Sales may indicate an inadequate
provision for uncollectable
accounts.
Uncollectable Uncollectable Accounts Useful in evaluating the
Accounts Expense Expense ÷ Actual Accounts reasonableness of uncollectable
to Accounts Receivable Writeoffs accounts expense. Smaller ratios
Receivable may indicate an inadequate
Writeoffs provision for uncollectable
accounts.
New Product Revenues from New Products Companies with a high proportion
Revenues to Total Introduced During the Year ÷ of revenues from new products
Revenues Total Revenues may earn a premium gross
margin due to the ability to
innovate.
10
Consideration of Internal Control Components
The auditor should also consider the applicability of four internal control components to the
revenue cycle – the control environment, risk assessment, information and communication
(including accounting system), and monitoring. The understanding of these components is
required under either a primarily substantive audit strategy or a lower assessed level of
control risk approach.
1) Control Environment
The control environment consists of several factors that might mitigate several of the
inherent risks related to the revenue cycle. In addition, these factors may enhance or
negate the effectiveness of other internal control components in controlling the risk of
misstatements in revenue cycle assertions.
2) Risk Assessment
Management should assess business risk, inherent risk, and fraud risks and place
controls to address those risks, reducing the risk of misstatements. The important
aspect of planning the audit involves obtaining an understanding of management’s
risk assessment procedures, risk identified, and management’s response in placing
controls in operation.
11
3) Information and Communication (Accounting System)
The primary concern with this component pertains to the portion of the accounting
system used in processing cycle transactions and balances. An understanding of the
revenue accounting system requires knowledge of how:
4) Monitoring
This component should provide management with feedback as to whether internal
control pertaining to revenue cycle transactions and balances are operating as
intended. The auditor should obtain an understanding of this feedback and whether
management has initiated any corrective actions based on the information received
from the monitoring activities. Possibilities include information received from:
However, if significant weakness are noted in the control environment, the auditor might plan
to assess control risk at high or maximum, then the auditor assess the risk of material
12
misstatement, and proceed with the design of substantive test (or choose to plan a primarily
substantive approach).
13
Control Activities - Credit Sales Transactions
Sales orders may be taken over-the-counter, via telephone, mail order, traveling sales
representatives, fax, or electronic data interchange. The goods may be picked up by the
customer or shipped by the seller. Sales transactions are usually recorded using computer
systems that may process transactions in either a real-time or batch processing mode. Control
activities over sales transactions should be tailored to these varying circumstances.
Virtually every company that requires an audit has a computerized accounting system.
Recall that there are 2 types of computer controls:
General controls that relate to the computer environment and have a pervasive effect
on computer applications.
2. Sales order
It is a form showing the description, quantity, and other data pertaining to a customer
order. It serves as the basis for initiating the transaction and internal processing of the
customer order by the seller.
3. Shipping Document
It includes form used to show the details and date of each shipment. It may be in the
form of a bill of lading, which serves as a formal acknowledgment of the receipt of
goods for delivery by a freight carrier. Other shipping documents may include a
packing slip with details on the items included in a shipment.
4. Sales invoice
14
It is a form stating the particulars of a sale, including the amount owed, terms, and
date of sale. It is used to bill customers and provides the basis for recording the sale.
It is a listing or computer master file containing authorized prices for goods offered
for sale.
It includes a computer file of completed sales transaction used to print the sales
invoices and sales journal, and update the accounts receivable, inventory, and general
ledger master files.
7. Sales journal
It contains the customer’s shipping and billing information and the customer’s credit
limit.
It contains information on transactions with, and the balance due from, each customer,
and serves as the basis for the accounts receivable subsidiary ledger.
1) Authorizing Sales
It is a request by an entity for a sales transaction with another entity, including:
15
limits. If the customer is not listed, approval by a credit department supervisor is
usually required.
In many companies, the next step is preparing a prenumbered sales order form.
The prenumbered sales order form permit following each transaction from
initiation to delivery of goods and service, to recording the sale, to receipt of final
consideration. The sales order represents the start of transaction trail of
documentary evidence. Information on open (unfilled) and filled sales orders are
usually maintained in appropriate computer files.
2. Approving credit
A credit check should be made for all new customers, which may include
obtaining a credit report from a rating agency such as Dun & Bradstreet. Approval
or non approval of credit is indicated by an authorized credit employee following
prescribed procedures in having the new customer and credit information added to
the accounts receivable master file.
Controls over approving credit are designed to reduce the risk of initially
recording an individual revenue transaction at an amount in excess of the amount
of cash expected to be realized from the transaction. Thus, they relate to the
valuation or allocation assertion for sales transactions. Of course, the expectations
of realizability for some of these amounts will change over time, resulting in the
need for an allowance for uncollectable accounts. Controls over approving credit
will enable management to make a more reliable estimate of the size of the
allowance needed. Thus, these controls also relate to the valuation or allocation
assertion for the allowance for uncollectable accounts.
16
2) Delivery of Goods and Services
It is a physical shipment or delivery of a good or service, including:
Company policy generally prohibits the release of any goods from the warehouse
without an approved sales order. Furthermore, the computer may be programmed
to match items taken from the perpetual inventory with items on an approved sales
order. This control procedure is designed to prevent the unauthorized removal
items from inventory. The warehouse may receive an electronic copy of the
approved sales order as authorization to fill the order and release the goods to the
shipping department. When goods are pulled from inventory, a packing slip is
normally produced to detail the items that will be shipped to the customer.
Segregating the responsibility for shipping from approving and filling orders will
help to prevent shipping clerks from making unauthorized shipments. In addition,
an important manual control requires that shipping clerks make independent
checks to determine:
- That the order was properly filled (goods received agree with the details of the
sales order)
Daily computer checks to account for all shipping documents and to determine
that all sales orders result in shipments and that a sales invoice was subsequently
prepared for each shipping document provide an important control for the
completeness assertion.
17
3) Recording Sales
The process of recording sales involves preparing and sending prenumbered sales
invoices to customers (billing customers) and recording sales invoices accurately and
in the proper accounting period (recording sales). The auditor’s primary concern s
pertaining to these function are that the sales invoices are recorded accurately and in
the proper period. The later pertains to when the revenue is earned, which is usually
when the goods are shipped.
The auditor’s major concerns regarding billing are that customers are billed,
- At authorized prices
Programmed application controls that reduce risk of misstatement in the billing and
recording process (and related specific audit objectives) include the following:
- Computer matching of sales invoice information with sales order and shipping
information
- Computer matching of sales prices on the sale invoice with an authorized price
list and sales order prices in preparing the sales invoices
- Computer comparison of date for recording the sales invoices with the time
period in which the goods were shipped.
- Computer comparison of the customer number on the sales invoice with the
account number on the sales order, which should have previously been
compared with the master customer file.
File copies of the sales invoices may be maintained in the billing department. A
computer record of the billings is maintained in a sales transactions file. Two
18
important manual controls should be also in place in a system of well-designed
internal control:
19
System Flowchart – Credit Sales Transactions
20
The illustration of the system flowchart:
In the illustrative system, as orders are received sales order clerks use on-line
terminals and an order program to determine that the customer has been approved and that
the order will not cause the customer’s balance to exceed the customer’s authorized credit
limit. If the customer is a new one, the order is transferred to the credit department, which
checks credit and enters customer information on the customer master file for approved
customers. The program also checks the inventory master file to determine that goods are on
hand to fill the order and prices the sales order based on information in an approved master
price file. If the order is accepted, the computer enters it into an open order file and a copy of
the sales order form is produced on a printer in the sales order department and sent to the
customer. When an order is not accepted, a message is displayed on the terminal indicating
the reason for the rejection.
21
updated for the shipment of goods. Next the computer transfers the transaction from the open
order file to the shipping file and produces a prenumbered shipping document on the printer
in the shipping department.
Sales invoices are automatically generated based on shipped goods. The computer
checks vendor information and data on goods shipped against data entered in the sales and
shipping. The computer prices the sales invoice based on information on the sales order and
checks the numerical accuracy of the sales invoice. The computer also checks the dates
shipped with dates on the sales invoice. As each billing is completed, the computer enters it
into a sales transaction file. After all transactions in the batch have been processed, the billing
program compares the total invoices with the total shipments for the day.
The transaction file is processed and posted to the sales transaction file, the accounts
receivable master file, and the general ledger master file. Run-to-run totals compare
beginning balances plus processed transactions with ending balances immediately prior to
posting the transactions. Exceptions are printed on an exception report, and these transactions
are held in a suspense file to be cleared by the billing supervisor.
The program also produces monthly statements. All customer inquiries on monthly
statements are directed to the controller’s office for follow up. A separate program also prints
daily sales reports with sales, gross margins, and inventory-on-hand by product for
management review. Management must also coordinate follow up on all past-due receivables
with the credit department.
22
Control Activities - Cash Receipts Transactions
Cash receipts result from a variety of activities. For example, cash is received from
revenue transactions, short-, and long-term borrowings, the issuance of capital stock and the
sale of marketable securities, long-term investments, and other assets (Boynton and Johnson,
2006).
1. Remittance advice
It is a document mailed to the customer with the sales invoices to be returned with the
payment showing the customer’s name and account number, invoice number, and
amount owed, for example the portion of telephone bill returned with payment.
Remittance advices are not mandatory. However they are seen as a courtesy because
they help the accounts-receivable department to match invoices with payments. The
remittance advice should therefore specify the invoice number(s) for which payment
is tendered (Wikipedia).
2. Prelist
It is the listing of cash receipts received through the mail.
3. Cash count sheets
These include the listing of cash and checks in a cash register. These are used in
reconciling total receipts with the total printed by the cash register.
4. Daily cash summary
It is a report showing total over-the-counter and mail receipts received by the cashier
for deposit.
5. Validated deposit slip
It includes the listing prepared by the depositor and stamped by the bank showing the
date and total of deposit accepted by the bank and the detail of receipts comprising the
deposit.
6. Cash receipts transactions file
23
It is a computer file of validated cash receipts transactions accepted for processing,
also used to update accounts receivable master file.
7. Cash receipts journal
It includes the journal listing cash receipts from cash sales and collections of accounts
receivable.
- Immediate visual display for the customer of the amount of the cash sale and the
cash rendered.
- A printed receipt for the customer and an internal record of the transaction on a
computer file or a tape locked inside the register.
- Printed control totals of the day’s receipts processed on the device.
24
with a large volume of mail receipts use a lockbox system. A lockbox is a post office
box that is controlled by the company’s bank. The bank picks up the mail daily,
credits the company for the cash, and sends the remittance advices and prelisting of
cash receipts to the company for use in updating accounts receivable. This system
expedites the depositing of checks, permits the company to receive credit for the
receipts sooner, and provides external evidence of the existence of the transactions. It
also eliminates the risk of diversion of the receipts by company employees and failure
to record the receipts.
In companies that process their own mail receipts, mailroom clerks should:
Immediate preparation of the prelist establishes accountability for the receipts and
provides a batch control total for use in independent checks on the completeness and
accuracy of processing. Remittance advices received with the checks, and a copy of
the prelisting of cash receipts, are forwarded to accounts receivable accounting for use
in updating customer accounts.
25
entered at the correct amounts. To ensure that only valid transactions are entered,
physical access to the accounting records or computer terminals used in recording
should be restricted to authorized personnel. Over-the –counter receipts are generally
recorded in general accounting based on the daily cash summary received from the
cashier. It is common for accounts receivable clerks to use a terminal to enter mail
receipts into a cash receipts transactions file, which is subsequently used in updating
both accounts receivable and general ledger master files. To ensure the completeness,
accuracy, and proper classification of recording the mail receipts, the computer can
check the agreement of the amount journalized and posted with the control totals of
the amounts shown on the deposit slip received from the cashier. In addition, periodic
bank reconciliations should be performed by an employee not otherwise involved in
executing or recording cash transactions.
26
System Flowchart – Cash Receipts Transactions
All receipts from customers are received by mail and are accompanied by a preprinted
remittance advice (bottom portion of the billing originally sent to the customer). In the
mailroom, the checks and remittance advices are separated. The checks are restrictively
endorsed (for deposit only) and sent t the cashier for deposit. The remittance advices are used
to create a listing (prelist) of checks identifying the customer, the amount, and the specific
invoices paid; the prelist is prepared in triplicate and totaled. One copy of the prelist is sent to
accounts receivable, and another copy to general accounting.
27
The cashier prepares a bank deposit slip in the duplicate and makes the daily bank
deposit. The cashier then logs on to the computer system and enters the amount of the daily
deposit. The cashier forwards the validated copy of the bank deposit slip (stamped and dated
by the bank) to general accounting and files the prelist by date. In accounts receivable, the
remittances are posted to the cash receipts transaction file based on the cash prelist, including
a control total for the total of the prelisting of cash.
A cash receipts program is run at the end of the day and compares the sum of
individual cash receipts with the control total and the amount from the deposit slip entered by
the cashier. An exception report of any differences is printed and forwarded to the chief
financial officer’s office. Transactions that do not match are held in the suspense file for
follow up. The master file update program then processes the cash receipts transaction file.
Run-to-run totals compare beginning receivables, plus cash receipts, with ending accounts
receivables before the routine is processed. It also updates the general ledger, generates the
Cash Receipts Journal (shows the individual transactions and daily totals for cash, discounts,
and posting to accounts receivable), accounts receivable aging, and daily cash balances. The
remittance advice, prelist, and summary report are the filed by date.
An assistant to the chief financial officer follows up on any exception reports and
reports the results to the chief financial officer. The chief financial officer also reviews daily
cash transactions (including cash receipts) for reasonableness and monitors daily cash
balances. The assistant to the chief financial officer also prepares monthly bank
reconciliations that are reviewed by the chief financial officer. The credit department receives
a weekly aging of receivables and follows up with customers regarding reasons for the delay
of payment on past-due accounts.
28
Control Activities - Sales Adjustment Transactions
29
of total cash discounts can be tested by comparing cash received plus the cash
discount to the amount credited to accounts receivable.
There should be adequate segregation of duties for authorizing sales returns, receiving
goods, and recording credit memos. Usually the sales adjustments transactions will be
accounted by the management accountable for the financial results.
30
o Authorization of all write-offs of uncollectible accounts by treasurer’s
office and supported by documentation, such as correspondence with the
customer or collection agencies.
o Appropriate review of journal entries to ensure the appropriateness of the
transaction.
Moreover, controls over the rights and obligations assertion relate to whether the
company has legal claim to receivables. A company normally gives up claims to receivables
when it sells the receivables or it pledges receivables as collateral. These transactions may
not exist in many entities. However, if entity sells its receivables, it should keep a
documentary record of receivables that have been sold. This record should be compared with
monthly statements sent by a bank or factoring company. This provides an independent check
on the accuracy of the company’s records.
Finally, management should establish controls over the occurrence and rights and
obligations and disclosures, the completeness of disclosures, the classification and
understandability of disclosures and the accuracy and valuation of information included in
disclosures. Public Companies normally accomplish this task through workings of a
disclosure committee that is independent of the CFO or controller who prepares the
31
disclosures, and includes individuals who are knowledgeable about GAAP and transactions
and disclosures relevant to the revenue cycle. If management uses spreadsheets to summarize
disclosures, such as sales by geographic region or product line, or receivables classified as
trade, related parties, or from employees, standard controls over the use of spreadsheets
should be in place.
32
Tests of Controls in Revenue Cycle
Most auditors plan to test controls that are effectively designed in the revenue cycle
because of the high volume of routine transactions in this cycle. Public company auditors test
controls to support opinion on internal controls. Private company auditors will test controls
that appear to be effective because of the audit efficiencies that exist with this strategy.
If the auditor plans to assess control risk as low for revenue cycle assertions covered by
computer controls, he or she will usually have to:
For example, the auditor might use test data to determine whether expected results appear on
exception reports when he or she submits:
The auditor might also used generalized audit software or a utility program to perform
sequence checks and print lists of sales orders, shipping documents, or sales invoices whose
numbers are missing in designated computer files.
33
sales order. procedure for new
2. Perform credit check customers.
(authorization). 2. From a population of
3. Approve credit for approved sales orders
returns. (and returns), select a
4. Follow up on old or sample and inspect
past-due accounts. documents for evidence
5. Initiate write-offs, which of credit check.
should be approved by the
treasurer.
1. Receive approved sales 1. Observe warehouse
order from credit dept personnel filling sales
(must have approved sales orders (existence).
order before release of 2. Observe physical
goods from warehouse). controls over inventory.
2. Pull inventory from 3. Observe evidence of
warehouse and release to independent checks
34
3. Perform independent check shipping documents
of goods received from (selection from
warehouse and approved prenumbered shipping
sales orders in shipping documents) to sales
department. invoice, sales journal,
4. Prepare prenumbered and A/R master file.
bill of lading. 3. Observe and reperform
5. Match shipping documents procedures for a sample
and sales orders before period.
preparing invoice. 4. Reperform pricing check:
6. Periodically account From a sample of sales
for all prenumbered invoices, check pricing
shipping documents. with master price list.
7. Perform independent check 5. Observe mailing process.
of sales order pricing.
8. Prepare prenumbered
sales invoice, batch and
total invoices.
9. Update A/R master file.
Agree input to invoice
batch totals.
10. Print sales journal.
11. Print sales summary.
Agree to invoice batch
totals (independent
check).
12. Mail monthly customer
statements.
1. Receive sales summary. 1. Observe and
2. Perform independent check reperform the
Accounting of invoice batch totals and accounting process
sales summary. 2. Inspect customer
3. Review sales account exception file and
35
classifications. disposition.
4. Post to general
ledger.
5. Follow-up customer
exceptions (independent
check).
36
Accounts Receivable 1. Match remittance advices Observe procedures in
and check deposit preparing the accounts
summary. receivables file
2. Update A/R master
file.
3. Print CR journal/Updated
A/R master file.
4. Print CR summary
(copy to Accounting).
37
Substantive Test of Accounts Receivable
Accounts receivable represent the primary balance in the revenue cycle. Receivables include
amounts due from customers, employees, and affiliates on open accounts, notes, and loans,
and accrued interest on such balances. The main consideration is directed at gross receivables
due from customers on credit sales transactions and the related contra account, the allowance
for uncollectable accounts. In general, the sales that are most likely to represent potential
misstatements are the uncollected sales. Thus, the auditor must (1) determine the acceptable
level of detection risk for each significant related assertion and (2) design substantive tests to
respond those risks.
Since the existence of accounts receivable represents significant inherent risk, the
auditor should not plan to obtain substantial assurance from analytical procedures. I f
the auditor simply compares current year with the prior year, without obtaining
information about the underlying business activity, analytical procedures risk should
probably be high. As a result, the appropriate level of detection risk for test of details
is moderate.
38
2) Completeness
The auditor might assess inherent risk for the completeness assertion as moderate. In
most cases there is a greater risk of overstatement of receivables and sales than of
understatement of receivables and sales.
When considering the combined control risk assessment for the completeness of
receivables, the auditor should evaluate the completeness assertion related to credit
sales (low in this example) with the existence and occurrence assertion for cash
receipts (low) and for sales adjustments (moderate). In this example, the conservative
combined control risk assessment would be moderate. Internal controls over the
completeness of sales would usually include daily follow up on items shipped that had
not resulted in sales invoices. Controls over the occurrence of cash receipts would
include comparison of recorded cash receipts with the underlying prelisting of cash.
Finally, controls over the occurrence of sales returns would include matching of credit
memo information with underlying receiving reports.
Auditors often use generalized audit software to scan the cash receipts journal for
large cash receipts. Receivables are usually sold in larger batches, and this might
39
provide evidence of selling receivables. If inquiry or other evidence shows that the
company has sold receivables, the auditor will confirm the sale or pledging of
receivable with the entity to which the receivables with customers because they rarely
know if their receivables have been sold.
Controls over the valuation and allocation assertion with respect to historical cost
involve the controls over valuation of sales, cash receipts, and sales adjustments.
These might include computer comparison of prices on sales invoices with the master
price list, comparison of recorded cash receipts with the cash prelist, or comparison of
prices on credit memos with sales invoice prices. Controls over the allowance for
doubtful accounts include control over the granting of credit, comparison of balances
plus orders to credit limits, the follow up on past due receivables, controls over the
accuracy of receivables aging, an dthe quality of work of a disclosure committee that
reviews the allowance for doubtful accounts. Control risk might be set at moderate
because of the complex nature of the work of the disclosure committee in evaluating
the adequacy of the allowance.
Analytical procedures usually involve computing the entity’s accounts receivable turn
days. This is a rather blunt tool for careful analysis of valuation issues, so analytical
procedures risk is often set at high or maximum. In this example, tets of details risk is
set at very low as a result of subjectivity of the assertion.
40
Designing Substantive Tests
1) Initial Procedures
Initial procedures are the starting point for every audit test to obtain an understanding
of the business and industry. It is important to understand the entity’s policies
regarding revenue recognition, as well as the entity’s underlying economic drivers
that impact total revenues and gross margin.
An important initial procedure for verifying accounts receivable and the related
allowance account is by using several audit procedures, as follows.
2) Analytical Procedures
Through analytical procedures, the goal of auditor is to develop expectations of the
accounts receivable balance, of the relationship of accounts receivable to sales, and of
the entity’s gross margins. Several analytical procedures that can be performed to
provide evidence about accounts receivable are already presented in the introductory
section.
41
detect overstatements in the accounting records (testing the existence or
occurrence of assertions). For example: the auditors select a debit in customers’
accounts and then vouch it to supporting documents, such as sales invoices,
and matching documents.
Trace Revenue Transaction
Tracing is an audit procedure to inspect documents and records from the
sources of document to accounting records (ledger). This test is performed to
detect understatements in the accounting records (testing the completeness of
assertions). For example: the auditors select a sample of sales order or bills of
lading and trace the transaction to the sales journal and general ledger.
Perform Cutoff Tests for Sales and Sales Returns
The sales cutoff test is designed to obtain reasonable assurance that (1) sales
and accounts receivable are recorded in the correct accounting period (the
transactions occurred) and (2) the corresponding entries for inventories and
cost of goods sold are made in the same period. For example: if January sales
are recorded in December, there is a misstatement of the existence or
occurrence assertions. Conversely, if December sales are not recorded until
January, there is a misstatement of the completeness assertions.
Meanwhile, sales return cutoff test is directed toward the possibility that
returns made prior to year-end are not recorded until after year-end, resulting
in the overstatement of receivables and sales.
Perform Cutoff Tests for Cash Receipts
The cash receipts cutoff test is designed to obtain reasonable assurance that
cash receipts are recorded in the accounting period in which received. A
proper cutoff at the balance sheet date is essential to the correct presentation of
both cash and accounts receivable. In addition, personal observation or a
review of documentation can provide evidence concerning the promptness of
the cutoff.
42
Confirm Receivables
Forms of Confirmation
The timing of requests can be divided into two categories as follows. When the
applicable detection risk is low or using primarily substantive approach, the auditor
usually requests confirmation of receivables as of the balance sheet date. On the other
hand, when the auditor follows a lower assessed level of control risk approach, the
confirmation date may be one or two months earlier.
The extent of request will depend on the types of confirmation request. Negative
confirmation request requires larger sample sizes than the positive request.
43
This means that the auditor must control every step in the confirmation process. For
instance:
Ascertaining that the amount, name, and address agree with the data in
customer’s account.
Maintaining custody of the confirmations until they are mailed.
Using the firm’s oqn return address envelopes for the confirmations.
Personally depositing the request in the mail.
Insisting that the returns be sent directly to the auditor.
The auditor’s working papers should contain a summary of the results from
confirming accounts receivable. The summary should provide, as minimum:
The number and dollar value of confirmations sent and response received
The proportion of the population total covered by the sample
The relationship between the audited and the book values of items included in
the sample.
Applicability to Assertions
Using generalized audit software to foot and crossfoot the aged trial balance
of accounts receivable and agreeing the total to the general ledger balance.
Testing the aging amounts shown in the aging categories on the aged trial
balance.
Considering evidence concerning the collectability of past-due amounts.
44
Identifying customers with past-due balances, and calculating credit histories
for customers with past-due balances.
Evaluating prior estimates of uncollectable accounts with the subsequent
experience and the benefit of hindsight.
45
References:
Boynton, W. C., & Johnson, R. N. (2006). Modern Auditing 8th edition. NJ:
John Wiley & Sons.
Garcia, Bien (2013). Test of Control Related to Revenue Cycle. Retrieved from
http://www.scribd.com/doc/134930364/Tests-of-Controls-Related-to-the-
Revenue-Cycle
46