MODULE 3:

REVENUE AND
RECEIPTS CYCLE

CHAPTER 6: AUDITING FUNDAMENTALS

MS T KOZA
What are the nature, purpose and accounting implications of the cycle?

Selling goods,
rendering of
services

NB: Sales is
included in the
financial Receiving of
statements as cash in
‘Revenue”. On exchange
credit or for
cash

Record Sales returns,

transaction in writing off bad
the debts (Credit
accounting management)
records
 Forms of revenue from sale of goods and rendering of services

Retail Entity

Wholesale entity

Manufacturing entity

Resource entity

Service entity

Municipality

To whom does each of the above types of entities

sell to?
Varied nature of the cycle

The nature, purpose and accounting implications of the cycle

 Cycle differs across entities
• Also different risks
 However: purpose, overall
objectives of internal controls
remain same for all
 Typical transactions in cycle

Transaction triggers

 What triggers a revenue transaction in the cycle?

An order should be placed for a revenue transaction to commence

 What triggers a receipt transaction?

Cycle starts
when a person
places an order

Ends when transaction recorded in accounting records and posted to general ledger.
 Typical transactions in cycle

Wholesale entity
Deliver Invoice Receive
Customer Pick goods customer payment,
goods to
orders goods (warehouse) for sale of issue
customer goods receipt

Record Record
sale payment

Retail entity
Receive Customer
Customer selects
payment, issue leaves with
goods
receipt goods
Record sale
and payment
Major accounts in cycle

Statement of Comprehensive Income

Revenue Sales returns
Bad Debts
(Income from (Decrease in
Written off
sale/services) revenue)

Statement Of Financial Position

Accounts receivable
Cash and cash equivalents
/trade debtors
Revenue recognition and IFRS 15 (IAS18)

• Measurement
 Fair value of consideration received or receivable.

• Recognition

risks and rewards of

 From goods – only when
ownership transferred
 From service – stage of completion, reliable estimate of
outcome.
 Recognise revenue when a performance obligation is
satisfied

Consequences of incorrect/inappropriate measurement or recognition of revenue…

Revenue recognition and IFRS 15 …..continued
 What functional area exist in this cycle

Purpose-To grant To ensure that orders Ensure that sales are

1.CREDIT MANAGEMENT

2.RECEIVING ORDERS FROM

credit to creditworthy received from made to only

3.AUTHORISATION OF
customers. customers are acted approved customers

SALES ORDERS
Set credit limits. upon who can settle their

CUSTOMERS
Receiving orders debts
Ongoing review of
customer’s from customers Manual and/or
creditworthiness Creating back orders computerised
authorisation of sales
Recommending to Checking inventory
management levels
debtors to be written
off
 What functional area exist in this cycle…..continued

To select or pick Ensure that goods Create and Issue an

5. DISPATCH AND DELIVERY

4. PICKING OF GOODS

goods from ordered are invoice to customers

FROM WAREHOUSE

warehouse; dispatched and notifying them of

delivered their obligation to

6.INVOICING
In a timely manner;
Activities; pay for goods
In accordance with received
what has been Packaging goods
for dispatch Main activity is to
ordered by the
create and send
customer Safely storing goods invoice to customer
Loading goods
Security checks on
goods leaving
premises
 What functional area exist in this cycle…..continued

Purpose-Record To receive and Ensure all receipts

THE ACCOUNTING RECORDS

9. RECORDING OF RECEIPTS IN
7. RECORDING OF SALES IN

8. RECEIPT OF CASH FROM

THE ACCOUNTING RECORDS

sale transaction promptly bank from customers
in the accounting cash from are accurately
records customers accounted for

CUSTOMERS
Send out monthly Receiving cash Posting receipts to
statements from customers the cashbook and
Posting a sale to Recording (general ledger)
the sales journal (Issuing) a Performing bank
Performing receipt reconciliations
debtors
reconciliation
What functional area exist in this cycle…..continued

Ensure that only authorised

AND RECORDING
10. PROCESSING
credits to debtors are

OF RETURNS
granted and recorded
Receiving returned goods
from customers
Recording Sales returns
and adjustments
Granting discounts
Class Question 1: Source Graded Questions
• The functions in a typical wholesaling company which sells on credit may be
described as follows:
• 1. Order department 2.Warehouse 3.Despatch
4.Invoicing
• 5.. Recording of Sale 6. Receipts mailroom/cashier 7.Recording of
Receipts 8. Credit Management
• The following control procedures are in place at Wildside (Pty) Ltd, a company
which wholesales a wide range of outdoor equipment. 1. A monthly age
analysis of debtors is printed off the system and debtors are contacted by
phone and mail if they have exceeded their credit terms.
• 2. The financial accountant, Syd Saddel inspects the daily bank deposit slips
and investigates any unexpected gaps in dates.
• 3. Every morning one of the cash book clerks downloads the bank statements
to identify and record EFTs from debtors.
• 4. The warehouse foreman checks goods picked to the picking slip.
Class Question 1: Source Graded Questions (continued)…

• 5. The gate controller confirms (by counting) that the number of boxes on the delivery
truck agrees to the number of boxes per the delivery notes held by the drive
• 6. Every Friday the senior sales clerk follows up on the list of ISOs which have not
“converted” to picking slips i.e. the goods to fill the order have not been picked.
• 7. The credit manager signs the ISOs before they are sent to the warehouse.
• 8. If a new sales order from a customer pushes the amount owed by the customer
past the customer’s credit limit, the order is written to a pending sales order file.
• 9. After suitable investigation the credit controller will approve sales orders on the
pending sales order file if he is satisfied that the debtor will pay despite being over his
credit limit.
• YOU ARE REQUIRED TO indicate the function under which each of the control
procedures listed above is most likely to occur at Wildside (Pty) Ltd
Summary of functional area by department
• 1. Credit management
• 2. Receiving orders from customers
Sales and • 3. Authorisation of sales orders
Credit • 10.Processing returns and other sale adjustments
Department

• 4. Picking of goods from warehouse

• 5. Despatch and delivery of goods to customers
Warehousing • 10. Processing returns and other sales adjustments

• 6. Invoicing
• 7. Recording of sales in the accounting records
• 8. Receipt of cash from customers
Accounting • 9. Recording of receipts in the accounting records
Department • 10. Recording of returns and other sales adjustments
 •ISO Sales journal General ledger
•DN INV
Debtors ledger

•Remitt adv.
Cash book General ledger
•Bank stmt.
•Dep. slip
•Receipt Debtors ledger

Trial balance
Reconciliations:
Bank recon: Bank statement & GL (cash book) Financial statements
Debtors recon: Debtors ledger & GL debtors control a/c
Supporting documents, journals and ledgers

• 1. Supporting documents

 Sales invoice
 Debtors statement
 Customer receipt
 Remittance advice and proof of payment
 Mail register
 Deposit slip
 Goods returned voucher
 Credit note
 Delivery Note
 Picking Slip
 Class Example 1: Source-Graded Questions on Auditing

The following documents are used in the revenue and receipts cycle
of Timberland (Pty) Ltd a wholesaler of camping equipment.
1. Delivery Note 2.Receipt 3.Picking Slip
4. Customer order 5.Credit Note 6.Sales Invoice
7. Internal Sales Order 8. Deposit slip 9. Statement
10. Customer remittance advice
You are required to:
a) Place the documents in the order in which they are most likely to
occur
b) Explain the purpose of each of the documents listed
Supporting documents, journals and ledgers

• 1. Examples of Supporting documents

Masterfile
Back-order Picking Slip Amendment
note form

Credit Internal Sales

application Order
Receipt form

Customer
Delivery Note Order form
Supporting documents, journals and ledgers….continued

Customer Order Invoice

Form
Delivery Note
Supporting documents, journals and ledgers

Journals and ledgers

 Sales/service journal
 Sales returns journal
 Cashbook (cash receipts journal)
 General journal
 Debtors ledger
 General ledger (G/L).
Databases and master files

• Used to store • Contains the • Contains the

Information about product unit prices description and
each debtor used to bill quantity of
(Customer) such as customers inventory on hand
Address, ID number,
year to date
balances
Debtors Pricelist Inventory
Masterfile Masterfile Masterfile
Reports and reconciliations

Reports Reconciliations
– Debtors listing – Debtors
(summary list of all reconciliation
debtors:
computerised – Bank reconciliation
systems only)
– Debtors age
analysis (manual
and computerised
systems)

Debtors Age Analysis example

Debtor Current 30 Days 60 Days
Ricci (Pty) Ltd R120 R 180 R 20
Shoki R0 R 55 R 1 000
Transaction flow in the cycle

Refer to diagram in Chapter 6 for details of major

activities, documentation created and flow of
transactions in the cycle.
Financial reporting risks

• Examples of fraudulent manipulation of

account balances, classes of
transactions/events, disclosures
Revenue:
• Recording fictitious sales
• Incorrect accounting period
• Not recording all sales
• Not recognising in terms of the accounting
standards.
 What could go wrong in the cycle?

Financial reporting risks Financial Reporting Risks

• Examples of fraudulent manipulation • Specific fraudulent financial

(continued) reporting techniques
 Accounts receivable  Inappropriate revenue recognition

• Fictitious credit sales = fictitious • Presumption that there are risks

debtor accounts of fraud in revenue recognition
(ISA 240)
• Understated allowance for – Especially where sales contracts
credit losses. spanning over financial year-
end signed with customer
 Cash and cash equivalents
• Fictitious bank account  Round-trip dealing
balances  Channel-stuffing
• Not recording all cash
sales/receipts.  Cheque kiting
• Abuse of time it takes for
cheques to clear bank accounts
 What could go wrong in the cycle?
Misappropriation risks
1. Theft of cash
 Theft of physical cash or funds from
bank account
 By employees, management or
third parties
 Cash stolen while kept at entity or
while in transit
 Fraudulently withdrawn from bank
account by electronic means.
Leads to loss of assets
Misappropriation risks
2. Specific risks of misappropriation
 Lapping (rolling of cash)
• Cashier dishonestly takes Cheque / cash receipt
for self
• Shortfall in banking, but hidden in accounting
records
• Laps shortfall with subsequent debtor’s Cheque /
cash receipt
 Needs to keep rolling cash, or can
“pay in” the shortfall from
own pocket. If not, risk being
caught for embezzlement.
 Dishonoured cheques (applies only to
cheque payments)e.g. customer does
not have sufficient funds to honour the
cheque
 Fictitious deposits (electronic funds
transfers and direct deposits only).
What computer technologies are used in the cycle?

 Electronic cash register/computer till with

POS software
 Barcode scanner optional
 Connected to master files such as
pricelist and inventory
 Pricelist masterfile-displays the price
 Inventory masterfile-displays
Product description.
What computer technologies are used in the cycle?.....continued

Electronic funds transfer (EFT)

Transfer of money from one bank account

to another using a computer and network

Customer electronically transfers money

to entity

May send “proof of payment” to entity

after making EFT.
What computer technologies are used in the cycle?.....continued

Internet-based (web) sales

 Customer selects goods via internet on computer

screen
 Pays via bank card by furnishing card details on
website
 Goods are dispatched to customer by
courier/postal service.

NB Study pages 180-182 of Auditing

Fundamentals
Class Discussion Question 1: Source Graded Questions on Auditing

Marcel Roux, the financial director of Paperwait (Pty) Ltd decided that
the company should connect to its bank (Stanwest Bank) via the Internet
to enable it to obtain “up to the minute” information about its bank
account, download bank statements and make electronic funds
transfers.
The major reason for this decision was that Paperwait (Pty) Ltd had
requested its debtors to pay their accounts by making payments directly
into Paperwait (Pty) Ltd’s bank account and not to send cheques
through the post. In late October, Stanwest Bank installed the necessary
software onto Paperwait (Pty) Ltd’s local area network. This menu driven
software is used with success by many of the bank’s clients.
YOU ARE REQUIRED TO:
Identify the controls which you would expect to find in place at
Paperwait (Pty) Ltd to prevent the unauthorized downloading of bank
statements via the Internet. (7)
What are the control objectives in the cycle?.......continued

Validity

Completeness Accuracy

A proper accounting system and related internal controls

will achieve the “control objectives” of Validity, Accuracy and
Completeness of financial information.

•Why does management want V, A and C of financial information?

•Why is an auditor interested in whether controls achieve V, A, C?
What are the control objectives in the cycle?....continued

Control objectives in the cycle: overview

• Validity, accuracy
Aim of the and completeness
control …of cycle transactions
recorded in the financial
objectives records

• Misstatement of amounts
Consequences in the financial records,
if fail i.e. financial statements
will be misstated
 Consequences if the control objectives in the cycle are not
achieved
• Consequences if controls are not achieved for revenue (sales/services)
Control Objective Consequence
Validity Overstatement of revenue and/or debtor
accounts
Accuracy Over- or understament of revenue and/or debtor
accounts
Completeness Understament of revenue and/or debtor
accounts

• What are the consequences if control objectives fail for ;

 Sales returns and
 Cash receipts from debtors?
How the control objectives are achieved in the cycle
 By implementing internal controls…
…to reduce risk of the control objectives failing.
 To ensure recorded sales transactions are:

Genuine: Require
customer Checks performed
signature on on recorded
delivery note. Complete amounts back to
delivery note
Authorised: sell (quantities) and
Delivery notes
goods only to pre- invoice (price) (for
followed
approved debtors. manual systems).
up for missing
documents.
All traced to sales
journal
to ensure were
recorded.
The link between the control objectives in the cycle and
management’s assertions

• Applicable to:
 Transactions and events: revenue/revenue
adjustments
 Account balances: accounts receivable.

Control objective Management assertion supported

• Occurrence, cut-off of revenue

Validity
• Existence, rights of accounts receivable
• Accuracy and classification of revenue
Accuracy • Valuation and allocation of accounts receivable

• Completeness of revenue
Completeness
• Completeness of accounts receivable
The link between the control objectives in the cycle and
management’s assertions

• Applicable to:
 Transactions and events: receipts
 (Transactions which make up the cash and bank
account balances).

Control objective Management assertion supported

Validity Occurrence, cut-off

Accuracy Accuracy, classification

Completeness Completeness
 Class Example 2: Control Objectives

Internal Control Control Objective

Guards at the exit gate perform security  Completeness of sales transactions
checks on the good in the delivery vehicles  (Assertion: Completeness of
leaving the premises by comparing the revenue)
delivery notes to the goods being dispatched  Accuracy of sales transactions
 (Assertion: Accuracy of revenue)

By Checking the goods leaving the

If the control objective of accuracy is
premises, the risk of goods not appearing
achieved, it means that internal controls
on a delivery note is reduced.
ensure revenue in the financial records
Goods not appearing on a delivery note,
was correctly recorded in terms of
but delivered to a customer, will not be
quantity, price and calculations.
invoiced to the customer leading to loss
Management’s assertion of accuracy of
of sales(not all sales are recorded)
revenue would thus be achieved.
Completeness assertion
What are the controls in the cycle?

Categories of control activities

Approval and authorisation
What level of staff should Segregation of duties
approve/authorize? Between execution, authorization,
custody of asset, recording.

Isolation of responsibility
Employee acknowledges performing duty

Access and custody controls (security)

Protecting assets and information

Independent checks and reconciliations

Between what? Who performs it?
 Internal control tables

• Control tables display:

 Most common activities.
 Related internal control for each activity (Both Manual and
Computerised).
 The link between “what could go wrong”/risks in the cycle, the
control objectives, assertions and internal controls.

NB: It is very crucial that you STUDY the internal control tables in your
prescribed textbook: Auditing Fundamentals Chapter 6 PAGES 215 to
240
Internal control tables

• Control tables display:

 Controls for
 Manual controls manufacturing entity
described in full, selling to customers
while the on credit. Controls
computerised will vary for other
controls are those in types of entities l but
addition or control objectives
alternative to manual
remain the same
controls.
in principle.
 Class to discuss
Examples from Internal Control Tables pages 215 to 240 other risks and
controls

Activity Risks(What can go Control Objective Manual (M)or

wrong Computerised (C)
Control
1.Signed DN received Customers receives All deliveries give rise Exception report to
by accounting to goods but is not to a corresponding indicate delivery notes
create invoice invoiced invoice(Completeness not matched to
) invoices (C)
2. Goods returned by Unauthorised (Invalid) Credit adjustments are Financial Manager
customer credit is granted e.g. authorised in term of scrutinizes supporting
for goods not returned company policy documents and
(Validity) authorise credit by
signing (M)
3.Goods are picked Goods picked not Goods picked are in Supervisory checks of
from warehouse with what has been terms of a authorised goods picked to
attached authorised ordered ISO and picking slip picking slips. (M)
picking slips Delays in picking • Promptly picking • Read-only access
goods goods on receipt of to picking slips for
a picking slip warehouse staff. (C)
 Internal control tables

• Functional areas

1. Credit management: page 215

2. Receiving orders from customers: page 219
3. Authorisation of sales orders: page 222
4. Picking of goods from warehouse: page 225
5. Dispatch and delivery of goods to customers: page 226

NB: It is very crucial that you STUDY the internal control tables in your
prescribed textbook: Auditing Fundamentals Chapter 6 PAGES 215 to 240
Internal Control Tables: Comprehensive Detail in Auditing Fundamentals
pages

• Functional areas
4. .

5. .

6. Invoicing: page 229

7. Recording of sales in the accounting records: page 230
8. Receipt of cash from customers: page 231
9. Recording receipts in the accounting records: page 233
10. Processing and recording of returns and other sales adjustments: page
237
NB: It is very crucial that you STUDY the internal control tables in your
prescribed textbook: Auditing Fundamentals Chapter 6 PAGES 215 to 240
Critical Exam Techniques when answering questions

When answering “weakness” questions, remember the following:

 Read the scenario and the ‘required’ very carefully!

 Know the difference between ‘identify’, ‘explain’ and ‘recommend’.

‘Weakness’ should be in detail and must be relevant to the scenario and required.

‘Explanation’ should explain “what can go wrong/what are the risks involved”.

 Recommendation must be in detail : specify the actual control procedure and

not simply the control objective:
e.g. “All sales should be recorded” (Completeness control objective)
vs.
“Sequential numbering of recorded invoices in the sales
journal should be reviewed by Mr Z Nrahi on a
regular basis for missing numbers (control procedure)

 Your answers should be brief and in point forms NOT PARAGRAPHS

The following is not acceptable when answering weakness questions:

 Stating the control activity category as a weakness;

 (e.g. “No division of duties”) rather than the control weakness in the activity
itself (e.g. “The person receiving orders from customers is the one who ships the
inventory items to customers”).

 Making vague references to responsibility levels;

 e.g. stating a control procedure should be performed by a “second clerk” or
“a senior staff member” if the scenario clearly indicates the titles of the
positions in the entity and the staff members’ names. (e.g. “financial
accountant”/Mr Z Nrahi.

 Making assumptions that are not relevant to the scenario or the type of business.

 Allocating tasks to incorrect levels of authority;

 , e.g. “financial manager should perform the bank reconciliation” while there
clearly is a bookkeeping clerk available to do so. Clerks are the staff
performing most functions and executing most controls!
 Senior staff and management approve, authorize and review etc.