Chapter 9 Edited

9
AUDIT OF
REVENUE CYCLE
Learning Outcomes
After studying this chapter, you should be able to:

Explain the nature of revenue and receivables
Identify the audit objectives applicable to revenue
and receivables
Explain the business functions and fundamental
control procedures, and related documents, records
and accounts
Design tests of controls and substantive tests for
sales and receivables
FUNDAMENTALS OF AUDITING All Rights Reserved

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Introduction
 The revenue cycle includes selling transactions that

begin with receiving orders from customers,
delivering and billing to customers, and recording
and collecting accounts receivable.

Audit Objectives
 Audit objectives for revenue and receivables are

concerned with obtaining sufficient audit evidence for
the transactions and balances
 The key issues in auditing sales and receivables are
to ensure that:
(a) The sales are neither understated nor overstated, and
the sales are genuine;
(b) The receivables are in existence and are collectible;
and
(c) Provisions for doubtful debts are adequately provided.
Audit Objectives (cont.)

Nature of Revenue and
Receivables
 The information flows in the cycle through

numerous accounts such as:
(a) Sales;
(b) Cash receipts;
(c) Accounts receivable; and
(d) Sales returns and allowances.

Nature of Revenue and
Receivables (cont.)
 The auditor shall obtain an understanding of the

entity and its environment to enable the auditor to
understand the classes of transactions, account
balances, and disclosures to be expected in the
financial statements (ISA 315, para 11).

The Accounting System and
Control Activities
 Implementing adequate control activities is crucial

for sales and receivable accounts because they
affect the business as a whole.
 The three main components of the revenue cycle:

– Sales,
– Cash receipts
– Sales adjustments.

Control Activities (cont.)

Customer’s Orders
A sales order is the first transaction trail of
documentary evidence.
The authenticity of the order needs to be checked
so that there are no fictitious transactions created
or to ensure the occurrence of sales
transactions
Audit objective: occurrence

Credit Approval
 Credit approval is entrusted to an independent
department from the sales department to avoid
making credit sales to customers with poor credit
risks.
 The manager only approves the credit sales amount
to the customer up to the authorized credit limit.
 Audit objective : accuracy and valuation and
allocation.

Issuing Goods
The approved sales orders will be sent to the
warehouse where stocks are maintained by a
storekeeper.
The storekeeper prepares stocks for shipment.
The shipment of goods is enclosed with a shipping
document such as a bill of lading (pre-numbered).
Audit objective: cut-off, occurrence,
completeness

Invoicing Customers
 A sales invoice will be prepared and sent by the
accounting or finance department after the customer
has received the goods.
 Controls should be established to ensure that:
(a)All shipments to customers are properly invoiced and
sent (audit objective: completeness);
(b)No fictitious sales transactions or duplicate invoices are
issued and recorded (audit objective: occurrence), and
(c)Invoice amounts are accurately calculated at an
authorized price (audit objective: accuracy).

Recording the Sales

 Controls should be established in recording sales to
ensure that:
• All sales transactions are recorded (audit objective:
completeness)
• No overstatement of or fictitious sales (audit
objective: occurrence).
• The amounts of sales should be recorded
accurately (audit objective: accuracy)
• In the proper period (audit objective: cut-off).
Collection of Cash Sales and Receivables

The process of cash receipts from sales and
receivables involves the following functions:
(a)Receiving cash;
(b)Depositing cash in bank, and
(c)Recording the receipts.

Adjustments to Sales and Receivables

Controls over adjustments to sales and
receivables for discounts, sales returns and
allowances, and write-offs of accounts receivable
are important to ensure the validity of
transactions (audit objective: occurrence).

Developing the Audit Plan

Understanding the Entity to Identify Inherent Risks

An understanding of the entity and its
environment is important in audit planning.
It helps to determine the potential misstatements
on the financial report.

(cont.)
The types of products or services

01 Gross margins can be determined by
understanding the products
The target markets and customers

the level of receivables can be estimated by
understanding the customer classes & the industry
average collection periods
02
Pricing, sales returns, discounts, credit
03 sales and payment policies

potential fictitious adjustments or transactions can
be determined

(cont.)
Obtaining an Understanding of Internal Controls

over Sales and Receivables
Inherent risks related to sales and receivables
can be reduced by establishing appropriate and
effective internal controls.
The auditor should understand controls over
sales and receivables.
The auditor may determine if the internal controls
over sales and receivables are implemented
appropriately and effectively

(cont.)
Assessing Risks of Material Misstatements

Auditing revenue is often a significant risk area,
thus the professional standards indicate that the
auditors should presumably consider that there is
a risk of material misstatement due to fraud
relating to revenue recognition.

(cont.)
Designing Further Audit Procedures

Further audit procedures
• tests of controls
• substantive procedures.
Auditors should determine the tests to be
performed based on the assessed risk levels.
If they believe that control risks are high, a higher
level of substantive procedures should be
performed to obtain the required audit evidence.

Performing Further Audit
Procedures

Procedures (cont.)
PROCEDURES TO
DESIGNING SUBSTANTIVE ASCERTAIN ADEQUACY OF
PROCEDURES THE ALLOWANCE
To ensure that the type of FOR BAD DEBTS
procedures is effective to The risk of uncollectable
obtain appropriate audit amounts of receivables
evidence to determine the
existence of sales and
03 substantive 01 should be assessed by the
procedures auditor. The auditor should
receivables transactions. review and test the process
used by management to
estimate the allowance for
DISCLOSURE
The auditor should know 02 bad debts.
the disclosure
requirements of the
account receivable
disclosure.

Procedures (cont.)
Analytical procedures
Analytical procedures are used to
confirm expectations & performed
Test of details of in 3 stages:
•To review the understanding of an
balances. entity
• Concerned with obtaining •To determine any fluctuations
evidence about account •To determine ratios and trends
receivable balances. substantive
• Do not concerned about procedures
debit or credit transactions Test of details of
but the balance at the end of transactions,
the period. Test of transactions are used
• focus on the adequacy of the to corroborate test of details
allowance for doubtful debts of balances.
The tests of transactions are
normally performed during an
interim audit & in the form of
dual-purpose tests.

Audit Objectives for the Auditor’s
Substantive Procedures
Sales Receivables
To substantiate the occurrence of sales To substantiate the existence of
receivables
To establish completeness of sales To establish completeness of receivables
To verify cut-off of sales transactions To determine whether the client has the
rights to the receivables
To establish accuracy of sales transactions To verify that the client established a
proper valuation of receivables
To ensure that the presentation and To ensure that the presentation and
disclosure of sales are appropriate disclosure of receivables are appropriate


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9

After studying this chapter, you should be able to:

FUNDAMENTALS OF AUDITING All Rights Reserved

 The revenue cycle includes selling transactions that

FUNDAMENTALS OF AUDITING All Rights Reserved

 Audit objectives for revenue and receivables are

FUNDAMENTALS OF AUDITING All Rights Reserved

 The information flows in the cycle through

FUNDAMENTALS OF AUDITING All Rights Reserved

 The auditor shall obtain an understanding of the

FUNDAMENTALS OF AUDITING All Rights Reserved

 Implementing adequate control activities is crucial

 The three main components of the revenue cycle:

FUNDAMENTALS OF AUDITING All Rights Reserved

FUNDAMENTALS OF AUDITING All Rights Reserved

FUNDAMENTALS OF AUDITING All Rights Reserved

FUNDAMENTALS OF AUDITING All Rights Reserved

FUNDAMENTALS OF AUDITING All Rights Reserved

FUNDAMENTALS OF AUDITING All Rights Reserved

Recording the Sales

Collection of Cash Sales and Receivables

FUNDAMENTALS OF AUDITING All Rights Reserved

Adjustments to Sales and Receivables

FUNDAMENTALS OF AUDITING All Rights Reserved

FUNDAMENTALS OF AUDITING All Rights Reserved

Understanding the Entity to Identify Inherent Risks

FUNDAMENTALS OF AUDITING All Rights Reserved

The types of products or services

The target markets and customers

Pricing, sales returns, discounts, credit

03 sales and payment policies

FUNDAMENTALS OF AUDITING All Rights Reserved

Obtaining an Understanding of Internal Controls

FUNDAMENTALS OF AUDITING All Rights Reserved

Assessing Risks of Material Misstatements

FUNDAMENTALS OF AUDITING All Rights Reserved

Designing Further Audit Procedures

FUNDAMENTALS OF AUDITING All Rights Reserved

FUNDAMENTALS OF AUDITING All Rights Reserved

FUNDAMENTALS OF AUDITING All Rights Reserved

FUNDAMENTALS OF AUDITING All Rights Reserved

FUNDAMENTALS OF AUDITING All Rights Reserved

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