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Auditing III - Revenue and Receivables

Audit and Assurance (Association of Chartered Certified Accountants)

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AUDITING III
(ACCN 3015/6)
Revenue and
receivable cycle

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TABLE OF CONTENTS
1. Objectives....................................................................................................... 3
2. References and disclaimer..............................................................................3
3. Process followed............................................................................................. 3
4: Scope.............................................................................................................. 4
5. Purpose of the sales and receivables business process.................................5
6. Understanding the cycle................................................................................5

6.1: Nature of the cycle.................................................................................... 7

6.2: Forms of transactions................................................................................7

6.3 How transactions are initiated..................................................................8

6.4: Accounts affected by the cycle.................................................................8

6.5: Accounting treatment in the cycle............................................................8

6.6: Relevant Companies Act sections.............................................................9

6.7: IT and Information systems used in the cycle.........................................10

6.8. Risks in the cycle...................................................................................11

6.9. Control objectives...................................................................................12

7: Functional areas linked to controls and considerations................................13
8: Integrated example...................................................................................... 14

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1. OBJECTIVES

The overall objective of this course is to obtain an understanding of the inventory

and production cycle to perform the following tasks:

a) To identify weaknesses and/or deficiencies in a revenue and receipts cycle

and make recommendations;
b) To identify risks in a revenue and receipts cycle and make
recommendations to mitigate the risks; and
c) To identify risk of material misstatement in a revenue and receipts cycle
and respond to the risks in terms of ISA 330

2. REFERENCES AND DISCLAIMER

These notes present an outline of the course topic to assist the students in their
preparation for assessments. References have been made to relevant areas in
the text book to assist the student in working through the literature.

When you have completed studying these notes and the relevant sections of the
text and you have completed the set tutorials without referring to the solutions,
you should be able to meet the outcomes of this topic.

Referenced Text book: Auditing fundamentals in a South African

context (Prinsloo et al.)Chapter 6

3. PROCESS TO BE FOLLOWED

1
5 To understand the
Control objectives and
To understand purpose of the
business process
functional process areas ISA 200, ISA 315R & Ch 6
ISA 200, ISA 315R &
Ch 6

Objective To understand the

To understand the IT
and other Risks
ISA 200, ISA 315R & Ch
6
s types of transactions in
the business process
ISA 200, ISA 315R, Ch
2
6.

4
To understand the
accounting treatment and
functional areas
ISA 200, ISA 315R & Ch 6

4: SCOPE
3
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Figure 1: Overview of the notes

Purpose of the cycle ISA 200,

315R, Ch
REQ 1 6.1.1

ISA 200,
Types of transactions in the cycle ISA 315

REQ 2 R, Ch
614

ISA 315R,
Accounting treatment and functional areas IAS’s, Ch
REQ 3 6.1.6

IT and other risks ISA 315R,

Ch 6.4

REQ 4

Control objectives and functional cycle areas ISA 315R,

REQ 5 Ch6.6

5. PURPOSE OF THE SALES AND RECEIVABLES BUSINESS

PROCESS

Revenue is generated through the sale of goods or the delivery of services. In

exchange for the sale of goods and the delivery of services, cash is received from
customers. This is the main purpose of a profit-driven entity as this is a top-line
item in the financial statements and an indicator of growth in an entity. The
course notes will focus on the accounting function of the business process.
The primary purpose of this cycle is to ensure:

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1. That revenue generates from sale of goods or rendering of services is

recorded correctly;
2. Cash generated from the revenue activities is collected and recorded and
3. That all related activities are accounted for correctly.

ACTION POINT

Please refer to Section 6.3.6 (Auditing fundamentals in a South

African context (Prinsloo et al, 2015) for an overview of the
sales and receivable cycle.

6. UNDERSTANDING THE CYCLE

ISA 315 deals with the auditor’s responsibility for gaining an understanding of
the entity, its environment and internal controls in order to identify and assess
the risk of misstatement in the financial statements (ISA 315, para 1-3). The
standard specifies the different ‘elements’ or aspects of the entity on which the
auditor should focus. Following on from this base, we will form an understanding
of the cycle based on analysing the elements below:

1) The nature of the cycle

2) Forms of transactions
3) How transactions in the cycle are initiated
4) Accounts affected by the cycle
5) Accounting treatment in the cycle
6) Relevant Companies Act and accounting sections and standards
7) IT and Information systems used in the cycle
8) Risks in the cycle
9) Control objectives in the cycle

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Identify the risk per assertion over the process and

develop response
Understand the relationship with other
The auditor must, after obtaining and understanding of the
business processes
process, identify if there are any risks associated with the
process per assertion and respond to the risk as part of their The auditor needs to understand that there is a
H – Risk A - Link relationship between revenue and receivables as
audit procedures. Please see Ch 6, S6.4
and with they affect one another, i.e. one is the debit and
assertio other the other the credit in the general ledger
Understand the controls over the process accounts.
The audit must obtain an understanding of the
ns cycles
controls in the process in place by management Understand the types of revenue sources
over the entire process and compare to and the nature there off
understanding obtained in other processes. The auditor needs to obtain an understanding of
Please see Ch6, S6.3.6, 6.6 &S6.7 G- B - Type
the types of revenue sources and the nature of
Understand the information system used in
Control of the revenue (i.e. whether the revenue is a sale or
the process flow and inventor service). The auditor also has to understand if the
process y revenue is on cash or credit terms or a
Entities must implement information systems for
all cycles, which includes accounting systems.
ISA 315 – combination of both. Please see Ch8, section
The auditor has to obtain an understanding of the
information systems as this could assist in
Under- 6.1.2 & 6.1.4

identifying additional risk. Please see Ch6,

section 6.3 for more information and pay
stand the
special attention to the following: F - IS cycle C-
Understand the accounting policy
IAS 18: Revenue and IFRS 15: Revenue from
Supporting documentation (S6.3.2.1) used in Account- Customer Contracts sets out the accounting
Journals and ledgers (S6.3.2.2) the ing treatment for the different types of revenue.
Databases and masterfiles (S6.3.3) cycle Policy Please see IFRS 15 notes from FinAcc and Ch8,
Reports (S6.3.4) Section 6.1.6 for the accounting treatments.
Reconciliations (S6.3.5)

E- D- Understand the accounts affected

Understand the functional areas in the process Function Major Understanding which accounts is affected by a
The auditor needs to understand what different functional areas s in the Account specific transaction will enable better
are involved in the revenue and Receipts process as all of these understanding of the risks involved in the
areas and activities take place to ensure that the transactions process s transactions throughout the cycle. Please see
are executed properly and are recorded accurately in the Ch6, section 6.1.5
accounting records. Please see Ch6, section 6.2 for a detailed
description of the different functional areas. Pay attention to the
purpose, activities and person(s) involved in each area of the
process as this will assist you in understanding the cycle

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6.1: NATURE OF THE CYCLE

The nature and purpose of the revenue cycle is summarised by Prinsloo et al (2015),
Section 6.1.

Nature and
Forms of
purpose of Varied nature
revenue
cylcle (Section (6.1.3)
(Section 6.1.2)
6.1.1)

Functional Accounting
areas implications
(Section 6.2) (see below)

6.2: FORMS OF TRANSACTIONS

IFRS 15 distinguishes between revenue from the satisfaction of a performance obligation

at a point in time and from satisfaction of a performance obligation over time.

. ACTION POINT

Refer to IFRS 15 and your second year accounting course notes.

 What is the definition of ‘revenue’ per IFRS 15?

 How do you distinguish between performance obligations

satisfied over time and those at a point in time?

 What types of transactions are specifically excluded from IFRS

15?

6.3: HOW TRANSACTIONS ARE INITIATED

The revenue cycle starts with an order that has been received from a customer.
The Receivables cycle starts once the revenue has been accounted for but the
cash consideration has not yet been received. The revenue cycle ends as the
receivable cycle begins. Please see Ch6, S6.1.4 for more details on how the
transactions are initiated and completed.

Reference: Auditing fundamentals in a South African context (Prinsloo et al)

Chapter 6.

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6.4: ACCOUNTS AFFECTED BY THE CYCLE

The transaction process will vary from client to client depending on the
complexity of the business process and the accounting software used. Prinsloo et
al, Section 6.3 provides an overview of a typical accounting system and a
diagrammatic representation of the accounting process.

ACTION POINT

Refer to the illustration of the transaction flows in Prinsloo et al

(2015), Section 6.3. What are the essential/key processes?

6.5: ACCOUNTING TREATMENT IN THE CYCLE

Accounting Requirements
IFRS 15 – Scope  Not all transactions are in the
scope of IFRS 15. These need
to be dealt with in
accordance with the relevant
IFRSs.
 IFRS 15 is only applicable to
transactions with customers
(IFRS 15, para 7)
IFRS 15 – Identification of performance  For each contract with a customer,
obligations performance obligations should be
identified.

 This requires the provision of

distinct goods and services to the
customer (see IFRS 15, para 26-28)
IFRS 15 – Satisfaction of the  Performance obligations are either
performance obligation satisfied at a point in time or over
time (see IFRS 15, para 15).
 The determination of the timing of
the satisfaction of performance
obligations is important because
this will affect the amount and
timing of revenue recognition.

IFRS 15 – Measurement  Determination of the transaction

price of the goods/services provided

 Different methods for allocation

transaction prices to performance
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Accounting Requirements
obligations

 Effect of the time value of money

 Guidance on the accounting for

variable consideration
IFRS 15 – Contract costs  Accounting for costs incurred on
contracts with customers

 Note: construction contracts are

covered in detail in Financial
Accounting III
IFRS 15 – Presentation and disclosure  Extensive presentation and
disclosure requirements

6.6: RELEVANT COMPANIES ACT SECTIONS

Remember the provisions of the Companies Act covered in Auditing II. These can
be included as part of a test or exam question.

The figure below summarises some of the statutory or corporate governance

considerations which may be applicable in the context of the sales and
receivables process.

Pre- Limitations
incorporation on type of
contracts in revenue
scope of IFRS contracts by
15 MOI

Corporate
Board governance
considerations
approval for specific to the
material sales and
contracts receivable
process

6.7: IT AND INFORMATION SYSTEMS USED IN THE CYCLE

Prinsloo et al (2015), Chapter 6 deals with IT systems in the revenue and

receivable cycles.

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Refer to Section 6.3 for a discussion on information technologies and 6.5 for an
outline of computer technologies. In addition, Chapter 14 (Section 14.4) is
relevant:

Figure 4: CAATS
Auditing
Software
around,
checks and
Use of CAAT's through and
system
with the
descriptions
computer

Specifc test Reasons for

procedures using CAATs

See Prinsloo et al (2015), Chapter 14, Section 14.4

. ACTION POINT

Refer to Prinsloo et al (2015), Chapter 14, Section14.4.

The textbook refers to specific tests which an auditor might perform

using CAAT’s. Discuss how these could be modified to test controls
over the sales and receivable processes. Refer to Section 6.9 below
for control objectives.

6.8. RISKS IN THE CYCLE

The risk in the cycle is heavily dependent on the nature and type of revenue that is held
or produced by an entity. The main risks are indicated below but this is not a complete
list. Through the completion of tutorials and other questions, this list can be expanded.
Please see ch 6.4

Financial Reporting Missappropriation Stolen or damaged Incorrect cost

Inaccurate
Risks Risks Inventory
Overstatemnet allocations
Risk of fraud Theft of goods inventory
of inventory
valuation

6.9. CONTROL OBJECTIVES

A modern business cannot function without any information technology as information

technology has become more than just a mechanism for processing information. IT is
now regarded as a strategic resource. As the use of IT can open up an entity to the
following financial risks:

1. Transactions recorded are not valid transactions (Validity)

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2. Transactions recorded are not complete (Completeness)

3. Transactions have not been recorded accurately (Accuracy)

To address the above mentioned risk, management has to implement application control.
Refer to Chapter 5, section 5.9 for more information on the application controls.

The figure below indicates the control objectives of the cycle. Please see Chapter 6,
section 6.6 for more information on the control objectives.

Validity

Control
objectives

Completeness

Accuracy

7: FUNCTIONAL AREAS LINKED TO CONTROLS AND

CONSIDERATIONS

As with any other business process, there are generic controls that are applicable
to the cycle. These controls can be found in any other cycle. Students have to
ensure that they understand the controls as they will have to demonstrate their
understanding of these in assessments.

The internal controls are set out in figure 3 below and are applicable across the
entire business process, i.e. in each functional area of the process. Please see
the relevant sections as indicated in the section below

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Documentation Authorisation Access Controls Segregation of Independent

and records and approval Section 6.7.1.4 duties checks and
Section 6.7.1.1 Section 6.7.1.2 Section 6.7.1.3 reconciliations
Section 6.7.1.5

Figure 1 Controls in the business process

As you work through the course material and literature, please pay attention to
the following areas for each of the functional areas in the business process. This
will not only help you to understand the process in sufficient detail but will assist
you during assessments.

Who is responsible for the functional area?

Link to segregation of duties objectives
Who

What document is required?

Link this to documentation and authorisation objectives
What

When should approvals and reconciliations be given and performed?

Link to authorisation and independent review control objectives
When

Where are the assets being kept?

Link to Safeguarding of assets
Where

Consider the purpose of the control objective and if the control objective has been met
If the control is not present, consider if there is a control deficiency
Why Link the above to the assertions to determine if there is a risk for the inventory item

Refer to the Internal Control Tables – Auditing Fundamentals in a South African

Context: - Pages 215 - 239 for a description on the Revenue and Receivable cycle

8: INTEGRATED EXAMPLE

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You are a second year trainee accountant at MGPK and are currently
assigned to the audit of Free-Bee TV Limited (Free TV). Your firm has been
auditing this client for the past three years since Free TV’s incorporation.
Free TV is a subscription-based television channel distributor, providing
programming content in South Africa and the rest of Africa. Free TV was
set up as a competitor to DSTV.

The company’s year- end is 31 May.

Audit materiality has been set at R650 000. You noted from last year’s
audit file that the controls at the client were assessed as reliable in the
past.

You are currently auditing the revenue section and have identified the
following significant income streams:

 Sales of decoders to retailers. Decoders are sold to retailers in bulk and

these are then sold on to Free TV subscribers at R950 each.
Subscribers require a satellite dish to receive the Free TV signal. These
can be purchased and installed for a further R1000. It is possible to
purchase only one component, e.g. apartment blocks can purchase a
single satellite dish. As a result residents only have to purchase the
decoder.
 Subscription revenue is received from each subscriber who pays a
monthly subscription fee of R389 to view the programs on the TV
channels subscribed to. The subscription is received in advance.
 Free TV also has the option for subscribers who do not want to buy
their own decoder, to rent a decoder from Free TV over a five-year
contract period. The rental is R459 per month (this includes the
monthly rental of the decoder and the monthly subscription of R389).
At the end of the five–year contract, ownership of the decoder vests in
the subscriber.
You noted that in respect of the rental customers, Free TV raises an asset
for the decoders rented and impairs the cost of the decoders over the five-
year contract. If a decoder is not functional, Free TV will replace it at no
additional cost to the subscriber. If the decoder is stolen, however, the
loss is covered by insurance, for which a monthly premium of R25 is
included in the monthly rental of the decoder. Free TV replaces the
decoder and claims the loss from the insurance company.

Free TV has been growing rapidly and the number of subscribers has
increased from 890 000 last year to over 1 million in the current year.
Revenues from all income streams for the current financial year are
expected to exceed R4.8 billion.
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SUBSCRIPTION REVENUE

On reading the system notes in the previous year‘s audit file you noted
the following:

 A new subscriber can apply for a Free TV subscription:

 Online via the Internet at Free TV’s website by completing the
online registration form.
 Telephonically – an assistant at the call centre will complete
the details and register a subscription.
 By sending a fax – with all the required details.
 For each of the above, the subscriber’s name, address, (physical and
postal), contact telephone numbers, ID number and bank account
details are required. All this information is used in drawing up a
contract with the subscriber and a new subscriber file is opened on the
subscriber master file.
 An ITC credit check is performed on each potential subscriber. The
results of these checks are loaded against the subscriber file in the
master file.
 A standard contract is printed from the computer system and a
sequential Contract number is generated and the decoder serial
number is recorded. The contract is posted to the client for signature.
Once signed and returned the contracts manager, Mr Nadia, updates
the subscriber master file and activates the decoder electronically.
 Each subscriber has to pay a monthly subscription of R389 in order to
view all TV programmes. As new contracts may be taken out at any
time, the first payment could be made at any time in the month and
the subscription amount is pro- rated for the number of days
subscribed for in that month. Thereafter, subscriptions are run on the
1st business day of each month by debit order against the subscriber’s
bank account.
 The subscriber master file contains the decoder serial number so that
each subscriber and decoder can be identified.
 The computer system has been effective for the past three years, and
Mr Nadia monitors the effectiveness of the controls on an ongoing
basis. He is responsible for comparing the numerous reports generated
and for following up on any exceptions noted from these. Procedures
include the following:
 Ensuring that all contracts generated by the system from the
various methods of application have been signed and
returned.
 Cancellation of contracts not signed and returned within 30
days. The subscriber must then apply again.

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 Comparison of the subscriber master file to the sequenced

contract numbers issued to ensure there are no missing or
duplicate contract numbers.
 Inspection of reports of the number of decoders on rental
contracts which are replaced each month.

SUBSCRIPTION AND RENTAL RECEIPTS

 Payments for subscriptions and rentals are received via bank debit
orders. On registration of a contract, each subscriber signs a bank debit
order. Mr Nadia captures these details into the subscriber database.
 A tape of all the debit orders is sent monthly to Free TV’s bankers to
process the subscriptions.
 The computer system activates a signal to the decoders of account
holders that have paid so that TV programmes may be viewed.
 If a subscriber has not paid his / her decoder signal is de-activated on
the system. The subscriber service department may be contacted and,
once payment has been made, the viewer is connected again.
 Mr Nadia inspects exception reports of subscribers who have defaulted
on payment. This usually happens if a bank account is closed.
 Only Mr Nadia can capture any changes to bank details of subscribers.
Subscribers who subscribe on-line may not change this type of
information themselves.
 If a decoder is stolen, the serial number on the decoder is used to
deactivate the signal, so that the person who stole the decoder will not
be able to use it.

INFORMATION SYSTEMS

As per discussions with Mr Tobie, the IT manager, the computer systems

that are currently being used have been working well for the past three
years.

As the IT manager, he is responsible for any software program changes

that may be required by users. These changes are mostly very small as
the software used is an off the shelf package suited to their type of
business. The changes relate primarily to items such as the format of
reports. All program changes are documented.

Mr Tobie monitors that users change passwords regularly and that each
user only has access to the relevant module of the software pertaining to
his work. Entry to the office area is controlled via magnetic swipe cards.
He has additional responsibility for back-ups, and business continuity
plans, as ensuring a stable service to viewers is crucial to Free TV’s
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continued success. Off-site back-ups are maintained and updated on a

monthly basis to ensure continuity of the business and recovery of data in
case of a disaster.

YOU ARE REQUIRED TO:

a) Identify those controls you would place reliance on at Free TV in

your audit of the revenue streams.

b) Explain how you would test the controls identified above.

Revenue solution

(a) & (b)

Control Test of control

 Contracts are drawn up for  Inspect a sample of contracts for

each new subscriber (1) authorised signatures, relevant
customer information (name,
I.D., address, banking details)
(1)
 Completeness of contracts via  Perform CAATS on the
sequential numbering. (1) sequential numbers – for a
specific period (1)
 Investigate missing or duplicate
numbers and follow up on
discrepancies with
management. (1)
 Investigate cancelled contracts
to ensure they were cancelled-
should be within the missing
numbers (1)
 An ITC credit check is  Inspect a sample of subscribers
performed on new subscribers for the results captured on the
(1) master file (1)

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 Perform a CAAT to ensure that

each subscriber on the master
file has a matching ITC check
(1)
 Access to change information  Attempt to access and change a
that is crucial on the Internet is customer detail and ensure this
denied. (1) cannot be done. (1)

 Mr Nadia performs the  Schedule ad-hoc visits to

monitoring controls and follows observe that monitoring does
up on any queries (1) take place. (1)
 Examine a sample for his
signature as evidence (1)
 Subscriber master file has the  Inspect a sample of subscribers
decoder serial number (1) on the master file and ensure
there is a decoder serial number
(1)
 Perform a CAAT to ensure that
each subscriber on the master
file has a matching serial
number (1)
 Tape sent to banks for  Enquire from Mr Nadia and Mr
payments (1) Hope to ensure the information
on the tape is accurate (1)
 Observe a tape being sent,
returned and updated. (1)

 Exception report from tape  Enquire from Mr Nadia that this

update followed by Mr Nadia on control is performed by him (1)
customers that have not paid  Examine evidence of such an
(1) exception report being printed
and scrutinized –signature (1)

 Decoder is blocked if payment  Select a sample of customers

is not received (1) that have not paid subscriptions
and whether the viewing was
stopped-and resumed once
payment was received (1)

 Account holders that have paid  Enquire of Mr Nadia how often

their subscription, obtain the he inspects this report, or does
signal he only inspect the exceptions
(1) (1)
 Run a CAAT for a specified
period or number sequence to

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compare that the decoder

getting a signal matches a
payment (1)

 Stolen decoders are  Inspect a sample of the monthly

deactivated (1) reports of decoders on rental
contract that have been
replaced, and trace to the
decoder number that was
deactivated (1)

 Physical access with swipe  Attempt to enter restricted area

cards (1) without a swipe card (1)

 Password access to module  Observe access system via

required by staff to do their passwords through ad-hoc
work (1) unscheduled visit (1)

 Mr Tobie documents all program  Inspect documentation for Mr

changes (1) Tobie’s signature (1)

 Debit orders signed by  Review debit orders for

customers (1) signature (1)

 Only Mr Nadia can change bank  Review change control audit trail
details of debit orders (1) (if this exists) for evidence that
only Mr Nadia has changed
details (1)

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