AUDITING THE REVENUE CYCLE

REVENUE CYCLE AUDIT OBJECTIVES, CONTROLS, AND TEST OF CONTROLS

A. Input Controls are designed to ensure that transactions are valid, accurate, and complete.

Input controls related to revenue cycle operations:

 Credit Authorization Procedures – only customer transactions that meet the

organization’s credit standards are valid and should be processed further
 Testing Credit Procedures
o Determine that effective procedures exists
o Creating dummy accounts – Test data or Integrated Test Facility (ITF)
o Performing substantive tests of details

 MANAGEMENT ASSERTIONS AND REVENUE CYCLE AUDIT OBJECTIVES

• Existence / Occurrence
– VERIFY AR balance represents amounts actually owed as of Balance Sheet date
– Establish sales represents goods shipped and/or services rendered during period of
financials
• Completeness
– Determine all amounts owed organization are included in AR
– VERIFY shipped goods, services rendered, and/or returns and allowances for
period are included in financials
• Accuracy
– VERIFY revenue transactions are accurately computed, based on correct prices
and quantities
– Ensure AR subsidiary ledger, sales invoice file, remittance file are mathematically
correct .. And agree with GL accounts
• Rights & Obligations
– Determine organization has legal right to AR
– VERIFY accounts sold or factored have been removed from AR
• Valuation or Allocation
– Determine AR balance stated in net realizable value
– Establish allocation for uncollectible accounts is appropriate
• Presentation and Disclosure
– VERIFY AR and revenues for period are properly described and classified

A. Input Control
Data Validation Controls – to detect transcription errors in transaction data before
they are processed
Testing Validation Controls
 Testing the data editing controls
 Reviewing error listings and error logs
Batch Controls – to manage high volumes of transaction data through a system
Testing Batch Controls
 Reviewing transmittal records of batches processed
 Reconciling transaction listings, error logs, and logs of resubmitted records
 
B. Process Controls are computerized procedures for file updating and restricting access to
data.
 File Update Controls
 Transaction Code Controls
  Sequence Check Controls
Tests of these controls provide the auditor with evidence relating to the assertions of
existence, completeness, and accuracy.

B. Access Controls prevent and detect unauthorized and illegal access to the firm’s assets. In the

absence of controls, invoices can be deleted, added, or falsified.

C. Physical Controls

• Segregation of Duties

• Supervision

• Independent Verification

Inadequate segregation of duties and the lack of effective supervision and independent
verification can result in fraud and material errors.

D. Output Controls are designed to ensure that information is not lost, misdirected, or corrupted
and that system processes function as intended.

• A/R Change Report

• Transaction Logs

• Transaction Listings

• Log of Automatic Transactions

• Unique Transaction Identifiers

• Error Listing

SUBSTANTIVE TESTS OF REVENUE CYCLE ACCOUNTS

Purpose : Determine the nature, timing, and extent of substantive tests using the auditor’s
assessment of inherent risk, unmitigated control risk, materiality considerations, and the
need to conduct the audit in an efficient manner.

Audit Concern

Potential for overstatement of revenues and accounts receivable

• Overstatement – can result from material errors in the processing of normal transactions
that occur throughout the year.

• Focus on large and unusual transactions at or near period – end.

Specific Issues :

• Recognizing revenues from sales transactions that DID NOT OCCUR, or from sales
transactions BEFORE they are realized

• Failing to recognize period – end cutoff points

• Underestimating allowance for doubtful accounts

 • Shipping unsolicited products to customers in one period that are returned in a
subsequent period

• Billing sales to the customer that are held by the seller

Resolve

 Test of Controls

o General
o Application

Integrated Test Facility (ITF)

-Positive results may reduce the degree of substantive testing BUT no assurance about
the collectability of the accounts receivable.

- can provide assurance that an organization’s credit policy is being properly

implemented BUT provides no evidence that proper cutoff procedures were followed.

 Substantive Tests

- Quality of internal controls bears on the nature and extent of substantive tests
determined to be necessary.

 UNDERSTANDING THE DATA

 The auditor must verify that he or she is working with the correct version of the file to be
analyzed.

 Most sequential files and relational database tables can be directly read by the ACL.

 Complex file structures may require “flattening” before they can be analyzed.

 The auditor must verify that the correct version of the original file was used and
that all relevant records from the original were transferred to the copy for
analysis.

File Structures

• Customer File – contains address and credit information about customers

• Sales Invoice File – contains summary data for each invoice.

• Line Item File – contains a record of every product sold.

• Inventory File – contains quantity, price, supplier, and warehouse location data for each
item of inventory.

• Shipping Log File – contains a record of all sales orders shipped to customers.

File Preparation Procedures

• Preliminary step : Each file needs to be defined.

– Physical location – specifies the name and where it resides

 – Structure – in terms of length of each field and the data type contained in each
field

• File definition is saved under a unique name.

• All future file access is accomplished by simply selecting the file definition from an ACL
menu.

• ACL automatically locates the file and presents it on screen.

TESTING THE ACCURACY AND COMPLETENESS ASSERTIONS

Analytical Review of account balances often precedes substantive tests of details.

– Provides the auditor with an overall perspective for trends in sales, cash receipts,
sales returns, and accounts receivable.

– Does not necessarily require computer technology.

– Provides assurance that transactions and accounts are reasonably stated and
complete

– May permit the auditor to reduce substantive tests of details.

SUBSTANTIVE TESTS THAT CAN BE PERFORMED USING ACL

REVIEW SALES INVOICES FOR UNUSUAL TRENDS AND EXCEPTIONS

 Scanning data files for unusual transactions and account balances

 ACL’s stratify feature – groups data into predetermined intervals and counts the number
of records that fall into each interval.

REVIEW SALES INVOICE AND SHIPPING LOG FILES FOR MISSING AND DUPLICATE
ITEMS

• This may be evidence of over- or understated sales and accounts receivable

• ACL is capable of testing a designated field for out-of-sequence records, gaps in

sequence numbers, and duplicates for the entire file

REVIEW LINE ITEM AND INVENTORY FILE FOR SALES PROCE ACCURACY

• -pricing inconsistency in such setting may indicate a computer program error or the use
of obsolete pricing data

• - Using the ACL features, the auditor can calculate the total price variance and make a
determination as to its materiality, if material, it is a need to be pursued with the
management

TESTING FOR UNMATCHED RECORDS

Possible causes

1. Value of the Item Number is incorrect and does not match the Inventory record

2. Presence of Inventory records in the unmatched file means that there is no corresponding
records in the Line Item file.
Testing the Existence Assertions

Confirmation of Accounts Receivables

Auditors should request confirmations of accounts receivable except in the following

three situations:

(1) Accounts receivable are immaterial;

(2) Based on a review of internal controls, the auditor has assessed control risk to be low; or

(3) The confirmation process will be ineffective.

3 Stages of Confirmation Process

1. Selecting the accounts to confirm

• Consolidated Invoices

 Joint Files
 Select a Sample of Accounts

- Random (Record) Sampling

- Monetary Unit Sampling (MUS)

2. Preparing Confirmation Requests

2 Types of Confirmation

a. Positive Confirmation

b. Negative Confirmation

3. Evaluating and Controlling The Responses

Testing the Allocation/Valuation Assertion

Auditor’s objective: to corroborate or refute that accounts receivable are stated at net realizable
value.

Aging Accounts Receivable 

• Key issues for auditors to resolve:

-Whether allowance for doubtful accounts reasonable compared to prior years and based
on composition of AR portfolio

-Review past-due balances