Cauzele Si Implicaliile Procesului Globalizarii Ec

Auditing Revenue Recognition
Presented by:
Larry L. Perry, CPA
CPA Firm Support Services, LLC
Learning Objectives
 Explain the basic principles of revenue recognition.

 Describe the basic procedures for auditing revenues.
 Explain the impact of audit strategies on revenues
auditing procedures.
 Outline the mix of evidence and the design of tests of
balances auditing procedures for revenues.
www.cpafirmsupport.com Slide 3
Understanding Revenue Recognition
Starting with FASB’s Accounting Standards

The recognition of revenue and gains involves
considering two factors—605-10-25-1:
1. Being realized or realizable—when products,
merchandise, or other assets are exchanged for
cash or claims to cash.
2. Being earned—when the entity has substantially
accomplished what it must do to be entitled to
the benefits represented by the revenues.
Installment and Cost Recovery Methods of
Revenue Recognition
 605-10-25-3: …unless the circumstances are such that
the collection of the sale price is not reasonably
assured, the installment method of recognizing
revenue is not acceptable.
 605-10-25-4: …where receivables are collectible over

an extended period of time and, because of the terms
of the transactions or other conditions, there is no
reasonable basis for estimating the degree of
collectability. When such circumstances exist, and as
long as they exist, either the installment method or cost
recovery method of accounting may be used.
SFAC No. 5—Additional Revenue
Recognition Guidelines
 If a sale precedes production and delivery, revenue is
recognized with production and delivery.
 If sale is by contract before production, percentage of
completion method may be used.
 Revenue may be earned as time passes if services or right to
use assets extend continuously.
 If there is a ready market, revenues and some gains and losses
may be recognized when production is completed or the price
of assets change.
 If product, services or other assets are exchanged for non-
monetary assets, revenues, or gains or losses may be
recognized assuming fair value can be determined.
 If collectability of assets received is doubtful, revenues may be
recognized on the basis of cash already received.
Sale of Product When Right of Return Exists
605-15-25-1: When right of return exists revenue can be

recognized at the time of sale if all conditions are met:
• Seller’s price is fixed or determinable
• The buyer has paid the seller or is obligated to do so
• The buyer’s obligation would not change if product
damaged or stolen
• A reseller has economic substance
• The seller doesn’t have to perform to bring about resale
• Returns can be reasonably estimated
Polling Question No. 1
Multiple-Element Arrangements
 All elements in such an arrangement must be evaluated
to determine if separate accounting is required.
 605-25-25-5: All these criteria must be met for separate

accounting:
 Delivered items have value on a standalone basis
 There is evidence of fair value
 If a general right of return exists, delivery or performance
is considered in the control of vendor
Extended Warranty and Product Maintenance
Contracts
 604-20-25-3: Sellers of extended warranty or
product maintenance contracts have an
obligation to the buyer to perform services
throughout the period of the contract and,
therefore, revenue shall be recognized in
income over the period in which the seller is
obligated to perform.
Principal vs. Agent
 Revenues can be recorded gross or net based on

circumstances
 Indicators of gross reporting
 The entity is the primary obligor, has general and physical
loss inventory risk, has pricing latitude, can change the
product or perform part of the service, can choose
supplier, sets product or service specifications, has credit
risk
 Indicators of net commission reporting
 The supplier is the primary obligor, the amount earned is
fixed, the supplier has credit risk
ASU 2014-09 Revenue Recognition (Topic
606) Revenue from Contracts with Customers
 Main provisions:
 Step 1: Identify the contract with a customer.
 Step 2: Identify the separate performance
obligations in the contract.
 Step 3: Determine the transaction price.
 Step 4: Allocate the transaction price to the
separate performance obligations in the
contract.
 Step 5: Recognize revenue when (or as) the
entity satisfies a performance obligation.
Auditing Revenue Recognition
 Occurs within the framework of the risk assessment
standards—see evidence sources in text
 Begins with questions about relevant assertions
 Completeness
 Occurrence and cutoff
 Valuation
 Existence
Audit Evidence and Auditing Procedures for
Revenues
 Nature, extent and timing of detailed tests of balances is
in response to the assessed risks at the financial
statement (assertion) level.
 Tests of controls should be performed when
 Controls are being relied upon to reduce control risk
 Substantive procedures alone are not sufficient to verify
relevant assertions
 Systems walk-through procedures are risk assessment
procedures that provide substantive evidence
More Evidence
 Performing highly-effective analytical procedures
reduce tests of balances procedures.
 Reading the General Ledger provides HUGE amounts

of substantive evidence and can reduce tests of
balances procedures.
 Evaluating the completeness assertion may require

more than substantive tests.
AU-C 240 and Planning
AU-C 240
• Improper revenue recognition is always a potential fraud

risk.
• If not identified as a fraud risk, the auditor is required to
document why not.
• Requires planning and performing audits with
appropriate professional skepticism.
Conditions Increasing the Risk of
Misstatement
Key conditions that may increase the risk of
misstatement.
• Significant sales recorded at or near year-end
• Individually significant sales
• Unusual or complex revenue transactions
• Unusual volume of sales to distributors or resellers
• Sales billed prior to delivery
• Use of letters of authorization or intent instead of
contracts
• Transactions with related parties
Auditor’s Responses to Potential Revenue
Fraud Risks
 Comparing revenue  Scanning the general ledger,
with prior period at accounts receivable sub-
lowest level of detail ledger and sales journal
 Confirming contracts during year and for
 Inquiring about sales subsequent events period
near year-end  Analyzing deferred revenue
 Appropriate sales cutoff  Reviewing credit memos and
procedures other accounts receivable
 Testing controls for IT adjustments
systems  Reviewing large contracts at
 Detailed review of year-end for later changes
unusual client adjusting  Confirming sales agreements
entries terms that might affect the
period of recognition
Sales and Collection Cycle Flowchart
 May be most efficient annual IC documentation

 Facilitates systems walk-through procedures
 Can be easily replicated and carried forward
 In addition to all records, documents, data,
procedures and personnel, flowchart should include:
 Shipping terms, locations, carriers, drop ships, pick
ups
 Different types of customers
Focusing on Key Controls
 Key controls exist
 At both the entity and activity level for larger entities
 Primarily at the entity level for smaller entities
 Properly designed and operating key controls

 Can detect and prevent most misstatements
 Can be informal
 Can be performed by one or a few persons
 Are a primary defense against error or fraud occurring
and going undetected
Tests of Controls vs. Systems Walk-through
Procedure
 TOC are required by GAO, PCAOB; are not required for non-
public entities and NPOs
 For larger entities, TOCs would normally be required to
reduce control risk to moderate or low
 For smaller entities, some tests of key controls and other risk
assessment procedures may enable an auditor to assess
control risk at less than high to moderate
 SWT with larger number of transactions and other risk
assessment procedures may also enable auditor to assess
control risk less than high to moderate
Carrying Out the Audit Strategy
 Check the illustrative risk assessment documentation
 Internal Control Deficiency Worksheet
 Risk of Material Misstatement Form
 Linking Working Paper
 Modify the Tests of Balances Audit Program

 Consider the impact of evidence from risk assessment
and analytical procedures on financial statement
assertions
 Modify program before beginning fieldwork
 See illustrative programs in text
The End
What to do if you want more

• E-mail Larry Perry: larry@cpafirmsupport.com with
questions.
• Visit www.cpafirmsupport.com for more webcast
resources.
• Read Larry Perry’s weekly blog, Today’s World of
Audits, at www.accountingweb.com under the
Bloggers Crew tab for small audit and other subjects.

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Auditing Revenue Recognition

 Explain the basic principles of revenue recognition.

Starting with FASB’s Accounting Standards

 605-10-25-4: …where receivables are collectible over

605-15-25-1: When right of return exists revenue can be

 605-25-25-5: All these criteria must be met for separate

 Revenues can be recorded gross or net based on

 Reading the General Ledger provides HUGE amounts

 Evaluating the completeness assertion may require

• Improper revenue recognition is always a potential fraud

 May be most efficient annual IC documentation

 Properly designed and operating key controls

 Modify the Tests of Balances Audit Program

What to do if you want more

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