Revenue
Inflows or other enhancements of assets or settlements of liabilities from the production of goods, rendering of services, or other activities that constitute major or central operations (SFAC No. 6)
Revenue is recognized when
Both (SFAS No. 5)
-Realized or realizable: Product or service is exchanged for cash, a promise to pay cash, or other assets that can be converted to cash
-Earned: Product has been delivered or service provided
SEC Staff Accounting Bulletin (SAB) No. 101
-Criteria for revenue recognition
-Persuasive evidence of an arrangement exists
-Delivery has occurred or services have been rendered
-Selling price to buyer is fixed or determinable
-Collectability is reasonably assured
Why does revenue recognition pose significant risk to auditors?
-Investors care deeply about revenue
-Generally a risk of material misstatement due to fraud
Fraud risk with revenue
Look at new revenue recognition standard
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Revenue Recognition fraud risks
Existence of side agreements
Channel stuffing
Related-party transactions
Bill and hold sales
Existence of side agreements
-Used to (informally) alter terms and conditions to entice customers to accept delivery of goods and services
Channel stuffing
-Attempts to induce suppliers to buy substantially more inventory than that needed for immediate demand
Related-party transactions
-True related party sales should be eliminated in consolidation
Can be difficult to identify
Bill and hold sales
Buyer agrees to purchase goods, but seller retains possession until buyer requests shipment
-Delivery is generally criterion for rev rec
Sales transaction accounts affected
Trade accounts receivable
Sales (revenue)
Allowance for uncollectible accounts
Bad-debt expense
Cash receipts transaction accounts affected
Cash
Trade accounts receivable
Cash discounts
Sales returns and allowances
Sales returns (debit to sales)
Sales allowances
Trade accounts receivable
Customer sales order
Details type and quantity of products or services ordered
Credit approval form
Customer credit quality is considered when determining credit limit (limit must be approved)
Open-order report
Lists orders placed but not yet filled (delivered)
Shipping document (bill of lading)
Details quantity of product shipped and other relevant info
Sales invoice
Used to bill the customer
Includes type of product or service, quantity, price, date, payment terms
Sales journal
Record of each sales transaction
Customer statement
Periodic statement sent to customer summarizing purchase and payment activity
Accounts receivable subsidiary ledger
Details transactions with each customer
Inherently linked to sales and cash receipts journals
Aged trial balance of accounts receivable
Summarizes customer (or invoice) balances by age (grouped into buckets)
Remittance advice
Document returned with customer's payment
Cash receipts journal
Records cash receipts (cash inflows)
Credit memorandum
Document used to issue credits to customers for returns or discounts
Write-off authorization
Approval for write-off of an uncollectible account
Functions in the revenue process (Order Entry)
Acceptance of customer orders for goods and services into the system in accordance with mgmt criteria
Functions in the revenue process (Credit authorization)
Appropriate approval of customer orders for creditworthiness
Functions in the revenue process (Shipping)
Shipping of goods that has been authorized
Functions in the revenue process (Billing)
Issuance of sales invoice, processing of billing adjustments (e.g., discounts, returns), as applicable
Functions in the revenue process (Cash receipts)
Processing of payment from customers
Functions in the revenue process (AR)
Recording of invoices, payments, and credits in individual customer accounts
Functions in the revenue process (General Ledger)
Proper accumulation, classification, and summarization of revenue, collections, and receivables in FS accounts
Segregation of duties
Segregation of duties particularly important in revenue process due to risks of misappropriation and fraud
CAR acronym, separate functions
How do we asses inherent risk
Industry-related factors
-Profitability and health of industry, technological change, competition, government regulation
--May cause management to be more prone to activities that result in misstatement
Affect authorization and accuracy assertions
Complex
Assessing control risk
Understand and document internal controls
-Consider how various control environment factors (from Chapter 6) may affect individual processes
-What risks are relevant to revenue process and how should they be addressed?
-What controls ensure that assertion
Relevant assertions for revenue-related accounts (Classes of transactions)
Occurrence
-Have all revenue and cash receipts transactions occurred and do they pertain to the company?
Completeness
-Has everything that should have been recorded been recorded?
Authorization
-Who approves shipments and application of cash receipts to c
Relevant assertions for revenue-related accounts (Account Balances)
Existence
-Do A/R and related accounts exist?
Rights and obligations
-Does the company control the rights to A/R and related accounts?
Completeness
-Have all A/R and related accounts that should have been recorded, in fact been recorded?
Valuation and all
Relevant assertions for revenue-related accounts (Presentation and disclosure)
Occurrence and rights and obligations
-Have all disclosed events, transactions, and other matters related to A/R and other accounts occurred and do they relate to company?
Completeness
-Have all disclosures related to A/R and other accounts been included
Substantive Analytical Procedures over Revenue-Related Accounts
Useful because they provide sufficient evidence at low cost
-When results are consistent with the auditor's expectations
Require auditor to develop expectation
Are there red flags compared to industry or last year
Examples of Substantive Analytical Procedures over Revenue-Related Accounts
-By product line, compare gross profit % to previous years and industry data
-Compare aging categories for A/R to previous years
-Compare inventory in distribution channel with prior periods as an indication of channel stuffing
LOOK AT TEST OF DETAILS OVER REVENUE RELATED ACCOUNTS
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Accounts receivable confirmations
Direct written response from a third (confirming) party to the auditor
Relevant assertions
-Definitely existence
-Valuation if dollar amount confirmed
-Maybe cutoff and completeness
Confirmation should be completed by person with sufficient competence, kn
Types of confirmations
Positive
-Request response indicating agreement with the amount due
--Response is required
Negative
-Requests response only if disagree with the amount due
--Non-response may be due to apathy or non-receipt
--Can't be used as sole source of audit evidence
Confirmation procedures
Send confirms as of year-end or as of interim date
-Year-end increases risk of non-timely response
-As of interim date requires rollforward procedures
Considerations
-Mail confirms from outside client facility
-Have confirms returned directly to auditor
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Alternative Confirmation Procedures
For unreturned or incorrect confirms
Examine specific subsequent cash receipts
--Subsequent payment may indicate agreement
Examination of shipping documentation
--Were the underlying goods actually shipped?
Examination of other client documentation