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Paper 3 - Revenue Cycle
Paper 3 - Revenue Cycle
Paper 3 - Revenue Cycle
Group Members:
Ignatius Denny Kurniawan S. / 296514 Fathan Sabartian / 320291 Novi Prastia Kusumastuti / 320299
Table of Contents
2) 3)
Granting sales returns and allowances ........................................................................................... 30 Determining uncollectible accounts ................................................................................................. 30
References: ...................................................................................................................................... 46
Specific Audit Objective Recorded sales transactions represent goods shipped or services provided during the period. Recorded cash receipt transactions represent cash received during the period. Recorded sales adjustment transactions during the period represent authorized discounts, returns and allowances, and uncollectable accounts.
Accounts receivable representing amounts owed by customers exists at the balance sheet date. All sales, cash receipts, and sales adjustments made during the period were recorded. Accounts receivable include all claims on customers at the balance sheet date.
Specific Audit Objective The entity has rights to the receivables and cash resulting from recorded revenue cycle transactions. Accounts receivable at the balance sheet date represent legal claims of the entity on customers for payment. All sales and cash receipts and sales adjustments are valued using GAAP and correctly journalized, summarized, and posted. 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.
Valuation or Allocation
Transaction
Balance
Specific Audit Objective The details of sales, cash receipts, and sales adjustments support their presentation in the financial statements including their classification and related disclosures. Accounts receivable are properly identified and classified in the financial statements. Appropriate disclosures have been made concerning accounts receivable that have been assigned or pledged.
Balance
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 auditors 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.
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: 1. Pressures to overstate revenues in order to report achieving announced revenue or profitability targets or industry norms that were not achieved in reality owing to such factors as global, national, or regional economic conditions, the impact of technological developments on the entitys competitiveness, or poor management. 2. Pressures to overstate cash and gross receivables or understate the allowance for doubtful accounts in order to report a higher level of working capital in the face of the need to meet debt covenants.
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.
auditors 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. The first step in performing analytical procedures is obtaining an understanding of total revenues given (1) the clients capacity and (2) the clients market place for those products. 1. The Clients Capacity The auditor should obtain an understanding of the clients capacity, which is the maximum volume of sales that it could generate if it fully utilized its facilities and employees to manufacture and deliver products or services. Auditors should be sensitive to the volume of sales that an entity records given its capacity, the number of shifts that an entity operates, and seasonal variations in the industry. It is much more effective to evaluate total revenues towards a measure of business activity (comparing financial with non-financial information) than comparing current revenues with prior-year revenues. 2. The Clients Market Place The auditor must also be sensitive to trends in the marketplace for the clients products. The auditor must be able to assess the reasonableness of revenue increases. Another important analytical procedure is auditor understands the clients market share, which compares the clients revenues with total revenues in the market for the clients product. This is particularly important because companies with dominant market shares often obtain premium gross margins.
Finally, it is important for the auditor to evaluate the clients accounts receivable turn days, or average collection period, and be able to compare the collection period with industry norms. Increase in the clients 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.
Formula Net Sales Nonfinancial Measure of Capacity Clients Net Sales Net Sales of Industry
Audit Significance Helpful in assessing the reasonableness of total revenues. Helpful in assessing the reasonableness of both total revenues and gross margins. Larger market share is often associated with larger gross margins. This ratio is useful for manufacturing and other asset-based companies. Describes the relationship between assets and sales revenues. Ratios larger than 1.0 indicate that receivables are growing faster than sales. Large ratios may indicate possible collection problems.
Audit Significance Useful in comparing with industry averages. Longer collection periods may indicate collection problems. Prior experience and current sales volumes may be useful in estimating current net receivables. Useful in evaluating the reasonableness of uncollectable accounts expense. Smaller ratios may indicate an inadequate provision for uncollectable accounts. Useful in evaluating the reasonableness of uncollectable accounts expense. Smaller ratios may indicate an inadequate provision for uncollectable accounts. Companies with a high proportion of revenues from new products may earn a premium gross margin due to the ability to innovate.
Uncollectable Accounts Expense to Accounts Receivable Writeoffs New Product Revenues to Total Revenues
Revenues from New Products Introduced During the Year Total Revenues
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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. Commitment to integrity and ethical values It is a key control environment factor in reducing the risk of fraudulent financial reporting, such as through overstatement of revenues and receivables. Management philosophy and operating style It is described as attitudes and actions towards financial reporting. This characteristic includes whether management is conservative or aggressive in selecting the alternative accounting principles and developing accounting estimates.
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 managements risk assessment procedures, risk identified, and managements response in placing controls in operation.
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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: customers concerning billing errors, regulatory agencies concerning disagreements on revenue recognition policies or related internal control matters, and External auditors concerning reportable conditions or material weaknesses in relevant internal controls found in prior audits.
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misstatement, and proceed with the design of substantive test (or choose to plan a primarily substantive approach).
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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. 5. Authorized price list. It is a listing or computer master file containing authorized prices for goods offered for sale. 6. Sales transactions file 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 is a journal listing completed sales transactions. 8. Customer master file It contains the customers shipping and billing information and the customers credit limit. 9. Accounts Receivable master file It contains information on transactions with, and the balance due from, each customer, and serves as the basis for the accounts receivable subsidiary ledger. 10. Customer monthly statement It is a form of report sent to each customer showing the beginning balance, transactions during the month, and the ending balance.
1) Authorizing Sales
It is a request by an entity for a sales transaction with another entity, including: 1. Accepting customer orders Sales orders from customers should be accepted only in accordance with managements authorized criteria. The criteria generally provide for specific approval of the order in the sales order department using a computer terminal to determine that the customer exists in a customer master file with approved credit
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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 The process of approving credit is important in minimizing credit risk and ensuring that goods shipped are paid for on a timely basis. Well managed entities take actions that ensure strong operating cash flows. The credit department gives credit approval in accordance with managements credit policies and authorized credit limits for each customer. Usually the computer can be programmed to compare a customers outstanding receivable balance, plus the anticipated sale, with the customers credit limit in the approved customer master file. Segregating responsibility for initiating a sale and approving credit prevents sales personnel from subjecting the company to undue credit risks to boost sales. 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.
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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 auditors 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 auditors major concerns regarding billing are that customers are billed, For all shipments Only for actual shipments (no duplicate billings or fictitious transactions) 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-programmed checks on the mathematical accuracy of sales invoices Comparison of control totals for shipping documents with corresponding totals for 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. Run-to-run totals match the sum of beginning receivables balances, plus posted sales, with ending receivables balances.
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
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important manual controls should be also in place in a system of well-designed internal control: Monthly statements should be mailed to customers with instructions to report any exceptions to a designated accounting supervisor not otherwise involved in the execution or recording of revenue cycle transactions (all revenue cycle objectives). The entity should establish an appropriate level of regular review and accountability by sales executives for sales analyses by product, division, salesperson, or region, and comparisons with budgets (all sales transaction objectives). Sales executives should also be held accountable for gross margins and subsequent collection of sales and accounts receivable write-offs.
It is a formal recognition of revenue by an entity. Each of these major functions should be assigned to different individual or department, providing for adequate segregation of duties.
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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 customers balance to exceed the customers 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. The approved sales order is electronically forwarded to the warehouse as authorization to release goods to shipping. The warehouse completes a packing slip and forwards goods to shipping. In shipping, personnel first make an independent check on agreement of the goods received with the accompanying sales order form. They then use their on-line terminals and a shipping program to retrieve the corresponding sales order from the open order file and add appropriate shipping data. The perpetual inventory system is also
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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 controllers 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.
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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.
The customers expectation of a printed receipt and supervisory surveillance of overthe-counter sales transactions helps to ensure that all cash sales are processed through the cash registers or terminals. In addition, supervisors may be assigned responsibility for performing independent checks on the accuracy of cash count sheets and verifying agreement of cash on hand with totals printed by the register or terminal. The cash, count sheets, and register or terminal-printed totals then are forwarded to the cashiers department for further processing and inclusion in the bank deposit. Meanwhile, in the case of mail receipts, as to minimize the likelihood of diversion of mail receipts, most companies request customers to pay by check. Some companies 24
with a large volume of mail receipts use a lockbox system. A lockbox is a post office box that is controlled by the companys 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: Immediately restrictively endorse checks for deposit only List the checks on a multi-copy prelist.
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.
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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. In the case of credit sales transactions, segregation of duties in performing those functions is important internal control activity. Many of the controls related to receiving and depositing cash involve manual checks and balances rather than computer checks and balances. However, computer controls are most effective in controlling the recording sub function.
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The cash receipts transactions flowchart explanation: 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.
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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 officers 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.
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of total cash discounts can be tested by comparing cash received plus the cash discount to the amount credited to accounts receivable.
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o Authorization of all write-offs of uncollectible accounts by treasurers 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. In addition, management should establish controls over accounting estimates such as the provision for bad debt expense. Management should ordinarily establish a process for monitoring aging and the collectability of receivables. Hindsight should be used to evaluate the adequacy of prior provisions for bad debt expense compared with subsequent receivables that go bad. It is essential that the data used to develop a provision for bad debt expense should be reliable. In addition, a qualified and independent disclosure committee should review the allowance on a regular basis. These controls are necessary to determine the adequacy of the allowance.
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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.
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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.
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sales order. 2. Perform credit check (authorization). 3. Approve credit for returns. 4. Follow up on old or past-due accounts. 5. Initiate write-offs, which should be approved by the treasurer. 1. Receive approved sales order from credit dept (must have approved sales order before release of goods from warehouse). 2. Pull inventory from warehouse and release to Warehouse & Shipping shipping. 3. Perform independent check of goods received from warehouse and approved sales orders in shipping department. 4. Prepare prenumbered bill of lading. 1. Receive approved sales order from credit dept (must have approved sales Billings and Account Receivables order before release of goods from warehouse). 2. Pull inventory from warehouse and release to shipping.
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procedure for new customers. From a population of approved sales orders (and returns), select a sample and inspect documents for evidence of credit check.
1. Observe warehouse personnel filling sales orders (existence). 2. Observe physical controls over inventory. 3. Observe evidence of independent checks (existence). 4. Inspect a sample of prenumbered shipping documents and: Agree to sales order Account for prenumbering
1. Vouch a sample of sales invoices (select approved sales orders from the sales journal) to shipping documents and approved sales orders. 2. Trace a sample of
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3. Perform independent check of goods received from warehouse and approved sales orders in shipping department. 4. Prepare prenumbered bill of lading. 5. Match shipping documents and sales orders before preparing invoice. 6. Periodically account for all prenumbered shipping documents. 7. Perform independent check 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. 2. Perform independent check Accounting of invoice batch totals and sales summary. 3. Review sales account
shipping documents (selection from prenumbered shipping documents) to sales invoice, sales journal, and A/R master file. 3. Observe and reperform procedures for a sample period. 4. Reperform pricing check: From a sample of sales invoices, check pricing with master price list. 5. Observe mailing process.
1. Observe and reperform the accounting process 2. Inspect customer exception file and
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disposition.
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Accounts Receivable
1. Match remittance advices and check deposit summary. 2. Update A/R master file. 3. Print CR journal/Updated A/R master file. 4. Print CR summary (copy to Accounting).
Accounting
1. Independent check: Compare the cash summary (Cashier), the prelisting of checks (Mailroom), and the CR summary (A/R). 2. Post to general ledger 3. Prepare bank reconciliation
1. Inspect evidence of independent check 2. Reperform independent check for selected dates 3. Inspect bank reconciliation
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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. Analytical procedures related to the completeness of sales and receivables would involve a comparison of sales to the underlying physical business such as a comparison of sales to capacity, sales to production levels, development of total assets or sales to fixed assets. If these tests show that all sales appear to be recorded, the auditor can reduce the extensiveness of other substantive tests. In this example the auditor assesses test of details risk very high. The auditor might assess the information about the completeness of sales obtained from sending confirmations, and perform cutoff tests on the recording of sales transactions at the end of the year.
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.
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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 entitys gross margins. Several analytical procedures that can be performed to provide evidence about accounts receivable are already presented in the introductory section.
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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.
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Confirm Receivables Confirmation of accounts receivable involves direct written communication between individual customers and the auditor. This substantive test is used extensively by the auditor. The confirmation of receivables is a generally accepted auditing procedure. AU 330, The Confirmation Process (SAS 67), states that there is an presumption that the auditor will request the confirmation of receivables during an audit unless: Accounts receivable are immaterial to the financial statements. The use of confirmations would be ineffective as an audit procedure. The auditors combined assessment of inherent risk and control risk is low and that assessment, in conjunction with evidence expected to be provided by analytical procedures or other substantive tests of details, is sufficient to reduce audit risk to an acceptably low level for the applicable financial statement assertions. In many situations, both confirmation of accounts receivable and other substantive tests of details are necessary to reduce audit risk to an acceptably low level of the applicable financial statement assertions. Forms of Confirmation There are 3 forms of confirmation request: The positive confirmation, which requires the customers to respond whether or not the balance shown is correct. The negative confirmation, which requires the customers to respond only when the balance shown is incorrect. The blank confirmation, which requires the customers to fill in the balance.
Timing and Extent of Requests 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. Controlling the Requests
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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 customers account. Maintaining custody of the confirmations until they are mailed. Using the firms oqn return address envelopes for the confirmations. Personally depositing the request in the mail. Insisting that the returns be sent directly to the auditor.
Summarizing and Evaluating Results The auditors 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 The confirmation of accounts receivables is the primary source of evidence in meeting the existence or occurrence assertion and also providing evidence concerning the rights and obligations assertion. In addition, when a customers response indicates agreement with the book balance, there is evidence that the balance is complete.
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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.
Alternatively, the aging of a customers balance can be tested by vouching the amounts shown in each aging category to the subsidiary ledger or master file.
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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-theRevenue-Cycle Remittance advice. Retrieved from http://en.wikipedia.org/wiki/
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