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AUDITING REVENUE

CYCLE
& RELATED ACCOUNTS
TOPICS IN
REVENUE/RECEIPT
Relationship assertions & audit
CYCLE
procedures
Relationship audit risk, client strategies,
substantive tests
Substantive tests for assertions
Revenue recognition, earnings
manipulation, & channel stuffing
Audit sampling & accounts receivable
Computer-assisted audit techniques

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ASSERTIONS &
OBJECTIVES
Management assertions:
Recorded receivables & cash
balances
Exist
Include all transactions
(completeness)
Represent rights of entity
Are valued appropriately
Are presented & disclosed properly

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OBJECTIVES &
PROCEDURES:
Existence/Occurrence
Objective: determine whether all recorded
sales, receivables, cash balances
Procedures
Existence
Physical observation
Confirmation
Transactions occurred
Cutoff testing for proper period

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OBJECTIVES &
PROCEDURES:
Completeness
Objective: determine whether all
receivables, sales, cash of period are
presented in financial statements
Procedures
Examine documents
Apply analytical procedures
Cutoff bank statements, bank
reconciliations, etc.

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OBJECTIVES &
PROCEDURES:
Rights/Obligations
Objective: determine whether entity
has property rights to cash,
accounts receivable
Procedures
Examine documentation
Confirmations
Inquiries

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OBJECTIVES &
PROCEDURES:
Valuation, Allocation
Objective: determine whether entity
has recorded items in correct
amounts, accounts, & time periods
Procedures
Confirm balances
Verify mathematical accuracy
Examine details of recording

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OBJECTIVES &
PROCEDURES: Presentation,
Disclosure
Objective: determine whether
recorded transactions,
balances properly classified,
described, disclosed
Procedures
Compare presentation to GAAP
Annual updates of AICPA
guidelines

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AUDIT RISK MODEL

AR = CR x IR x DR
Detection risk (DR): likelihood that
error could occur & not be detected
Based on
Control risk (CR)
Likelihood of material error
Inherent risk (IR)
Strategies & threats

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DETECTION RISK

DR = ____AR___
IR x CR
Nature, extent, timing substantive
tests
Nature: more/less persuasive tests
Extent: larger/smaller samples
Timing: balance sheet date or interim

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ASSERTIONS & PROCEDURES
Accounts Receivable, Sales-1
Valuation
Verify mathematical accuracy AR
Obtain aged trial balance
Foot trial balance
Compare total AR per trial balance to
general ledger

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ASSERTIONS &
PROCEDURES
Accounts Receivable,
Existence, rights, valuation Sales-2
Confirm year-end accounts & notes
receivable with debtors
Positive: tell auditor if balance correct
Large balances, inaccuracies
Negative: tell auditor only if balance
incorrect
Control adequate, small balances

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ASSERTIONS &
PROCEDURES
Accounts Receivable, Sales-3
Existence or occurrence, completeness
Test cutoff to determine whether
sales, receivables recorded in proper
period
FOB shipping point
FOB destination

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ASSERTIONS &
PROCEDURES
Accounts Receivable,
Valuation, rights Sales-4
Review collectibility receivables
Determine adequacy allowance for
doubtful accounts

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ASSERTIONS &
PROCEDURES
Accounts Receivable,
Existence or occurrence, Sales-5
completeness,
valuation
Perform analytical procedures for
reasonableness of sales, receivables
balances
Collections problems
Overstated sales
Understated sales

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ASSERTIONS &
PROCEDURES
Accounts Receivable,
Presentation & disclosure Sales-6
Review financial statements to
determine
Accounts, notes receivable properly
classified, described
Disclosures adequate

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TESTING CUTOFF
Sales, Receivables
At or around end each quarter, the former
President directed his subordinates to hold
IGIs books open, to backdate invoices,
shipping documents. This caused IGI to
record out-of-period sales & to overstate
revenue, net income end each quarter.
Procedures
Trace recorded sales to shipping documents
before, after end of period

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ASSERTIONS &
PROCEDURES: Cash-1
Existence, rights, valuation
Confirm year end balances with all
banks

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ASSERTIONS &
PROCEDURES: Cash-2
Valuation
Verify mathematical accuracy
recorded cash balances
Foot cash journals
Trace totals to general ledger, year-
end bank reconciliations
Test cash on hand

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ASSERTIONS &
PROCEDURES: Cash-3
Existence, completeness, valuation
Test cutoff
Obtain cutoff bank statement
Verify accuracy
Examine & trace to bank reconciliations & cash journals
Proof of cash
Reconcile recorded cash with bank confirmation
Examine interbank, intercompany transfers

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ASSERTIONS &
PROCEDURES: Cash-4
Presentation & disclosure
Review financial statements to
determine
Cash balances properly classified,
described
Disclosures adequate

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TESTING CUTOFF FOR
CASH
Reconcile internal documents
Cash journals
General ledger
Bank reconciliations
With external documents
Year-end bank statement
Cutoff bank statements
Bank confirmations

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COMMON MEANS TO
MANIPULATE EARNINGS -
1Method Revenue Recognition
BillError
& hold Shipments to 3rd party
Cancelled orders warehouses Cancelled, duplicate
Conditional sales orders
Before contingencies resolved
Consignment
sales Goods on consignment, trial
Continuing Seller involved after delivery,
involvement e.g., installation
Improper cutoff Before title, risk ownership
passed

23 GBW 8th ed. Ch. 11


COMMON MEANS TO
MANIPULATE EARNINGS -
2Method Revenue Recognition
Error
Kickback sales Inflated selling price for kickback
Overstated Inflated % completion on
completion construction projects
Partial Not all goods ordered are
shipments shipped
Pre-invoicing Goods still in production
Premature Goods ordered but not
shipment authorized for shipment

24 GBW 8th ed. Ch. 11


COMMON MEANS TO
MANIPULATE EARNINGS -
3ethod
M Revenue Recognition
Error sales
Premature Goods ordered but not shipped
Sham sales False shipments
Side agreements To forestall completion earnings
process
Uncertain Sellers performance uncertain
performance Collection uncertain, unlikely
Uncertain
realization Shipments not authorized
Unauthorized
shipment
25 GBW 8th ed. Ch. 11
MANIPULATED EARNINGS
Channel Stuffing
Definition: incentives to induce
incremental demand
Examples
Bausch & Lomb
Told distributors to buy large amount of
inventory to maintain distributorship
B&L recognized extra $22 million
Sunbeam
Used price discounting to encourage
customers to hold 80 weeks of inventory

26 GBW 8th ed. Ch. 11


MANIPULATED EARNINGS
Asset Swaps
Definition: companies trading right
to use others asset
Examples
Global Crossing
Treated underseas cables as real estate
Recognized revenue by treating swap as
sale

27 GBW 8th ed. Ch. 11


MANIPULATED EARNINGS
Other
Improper expense capitalization
Chambers Development
Capitalized landfill expenses after
determining earnings necessary to meet
analysts expectations
MicroStrategy
Recognized revenue before all services
provided for software sales

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AUDIT SAMPLING &
ACCOUNTS
RECEIVABLE
Update assessment of control risk
Planning confirmations & selecting plan
Identify population, sampling unit,
anticipated error
Estimate tolerable error & risk incorrect
acceptance
Calculate sample size
Choose sample selection method
Evaluate results

29 GBW 8th ed. Ch. 11


COMPUTER ASSISTED
TESTS: AR Accuracy
Foot, crossfoot recorded amounts
within master file
Total balances
Display/print exceptions

30 GBW 8th ed. Ch. 11


COMPUTER ASSISTED
TESTS: AR Aging
Trace individual balances from
master file to sales journal
Classify balances by invoice
dates/age
Display/print aged trial balances

31 GBW 8th ed. Ch. 11


COMPUTER ASSISTED
TESTS: AR Credit Balances

Scan master receivables file for net


credit balances
Display/print listing credit balance
accounts

32 GBW 8th ed. Ch. 11


Theory Questions-Answers

1. D
2. B
3. A
4. D
5. D
Theory Questions-Answers

6. D
7. C
8. B
9. B
10. A
Theory Questions-Answers

11. D
12. B
13. -
14. -
15. -
end of AP.101