Auditing &

Assurance
Services,
6e

Copyright 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Chapter 07
Revenue and Collection Cycle
What at first was plunder assumed the softer name of
revenue. Thomas Paine

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Learning Objectives
1. Discuss inherent risks related to the revenue and
collection cycle with a focus on improper
revenue recognition
2. Describe the revenue and collection cycle,
including typical source documents and control
procedures.
3. Give examples of tests of controls over customer
credit approval, delivery, and accounts
receivable accounting
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Learning Objectives (continued)

4. Give examples of substantive procedures
in the revenue and collection cycle and
relate them to assertions about account
balances at the end of the period.
5. Describe some common errors and frauds
in the revenue and collection cycle, and
design some audit and investigation
procedures for detecting them.
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Overall Audit Approach

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Inherent Risks
Improper Revenue Recognition
Cut-off
Bill and Hold
Channel Stuffing

Returns and Allowances

Collectibility of Receivables

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Revenue Recognition
Must be (1) realized or realizable and (2) earned
SEC guidance (SAB 104)
Persuasive evidence of an arrangement exists,
Delivery has occurred or services have been rendered,
The seller's price to the buyer is fixed or determinable,
and
Collectibility is reasonably assured

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7-8

Exhibit 7.2
Revenue
Recognition
Rogues

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Exhibit 7.3
Revenue and
Collection
Cycle

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REVENUE AND COLLECTION CYCLE:

Key Control Procedures

SEPARATION OF DUTIES
Separate functions for recording, authorization, custody

AUTHORIZATION OF TRANSACTIONS

Write-offs
EDI transactions
Credit checks prior to approval of sale
Pricing

ACCESS TO ASSETS

Shipping department
Lock box account
ADEQUATE DOCUMENTS AND RECORDS

Pre-numbered sales orders, shipping documents (bills of lading), sales invoices

Remittance advice

INDEPENDENT CHECKS ON PERFORMANCE

A/R subsidiary ledger to general ledger

Monthly statement to customer

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Audit Evidence in Management

Reports and Data Files

Pending order master file

Credit check/approval files
Price list master file
Sales detail file (sales journal)
Sales analysis report
Accounts receivable aged trial balance
Cash receipts listing
Customer Statements
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Other Controls

No sales order without customer order.

Credit approval.
Restricted access to inventory.
Restricted access to terminals and invoices.
All documentation in order to record sales.
Proper dating.
Invoices compared to BOLs and orders.
Pending order files reviewed.
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Exhibit 7.5 Assertions about Classes of

Transactions and Events for the Period

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Exhibit 7.6
Dual Direction of Test Audit Sample

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Exhibit 7.7
Assertions and Substantive Procedures in
the Revenue and Collection Cycle

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AUDITING ACCOUNTS RECEIVABLE

Test Accounts Receivable Aged Trial Balance
(Exhibit 7.8)
Confirm balances.
Perform analytical procedures
Test sales cut-off

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Exhibit 7.8
Accounts Receivable Aged Trial Balance

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USING CONFIRMATIONS
Primarily for verifying EXISTENCE.
Factors likely to affect the reliability of
confirmations
Previous audit experience
Intended recipient of the confirmation
Type of information being confirmed
The auditor may confirm entire BALANCES
or individual TRANSACTIONS.
Type of confirmation being sent
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TYPES OF CONFIRMATIONS
Positive Confirmations
small number of accounts are involved
large number of errors are anticipated

Negative Confirmations
the combined assessed level of inherent and control risk is low
a large number of small balances is involved
the auditor has no reason to believe that the recipients of the
requests are unlikely to give them consideration.

Blank Confirmations should be used if the recipient is

likely to return a positive confirmation without verifying
the accuracy of the information.

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Exhibit 7.9
Positive
Confirmation
Letter

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Exhibit 7.10
Negative
Confirmation
Letter

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CONFIRMATION CONSIDERATIONS
All confirmations returned by the post office as nondeliverable must be investigated
Responses to positive and blank confirmations
provide more reliable evidence than negative nonresponses.
Recipients of accounts receivable confirmations
might not report understatements.
Auditors must have heightened professional
skepticism for electronic responses (fax or e-mail).
Verify that the response came from an appropriate person
at the employer
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CONFIRMATION CONSIDERATIONS
(Continued)

Non-response to Positive/blank confirmation requests

Follow up with second and sometimes third requests.
A lower than expected response rate could be indicative of
fictitious customer accounts.
Alternative procedures.

Non-response to negative confirmation requests

Only limited evidence concerning financial statement
assertions.
Alternative procedures are not necessary for unreturned
negative confirmation requests.

Follow-up on all exceptions

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Exhibit 7.11
Responses to Positive Confirmations

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ALTERNATIVE PROCEDURES
Vouch subsequent cash collections
usually sufficient evidence of existence, valuation.

Examine shipping documents

Especially BOL (third-party evidence)

Examine client-generated supporting

documentation, such as invoices.
Depends on internal controls

Inspect correspondence files

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Other Matters Related to

Confirmation
There are three sets of circumstances that could justify the
omission of the confirmation of a client's accounts
receivable.
Not material to the financial statements.
If the RISK OF MATERIAL MISSTATEMENT is low
the assessed level of evidence from analytical procedures and other
tests of details is sufficient to reduce audit risk to an acceptably low
level
confirmation of accounts receivable may be inefficient.

Confirmation of accounts receivable is expected to be ineffective

(based on previous years' audit experience).

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UNCOLLECTIBLE
ACCOUNTS
Inspect customer files for collectibility
Recalculate ALLOWANCE and BAD DEBT
EXPENSE
Verify reasonableness of ALLOWANCE and BAD
DEBT EXPENSE
Inspect documentation for appropriateness of
accounts written off
Inspect documentation for additional collection procedures
Inspect documentation for appropriate authorization.
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ANALYTICAL PROCEDURES
Sales Revenue
Comparisons with previous periods
Comparisons with industry

Allowance for Doubtful Accts, Bad Debt Expense

Bad Debt Expense as a percentage of Sales
Allowance for Doubtful Accounts as a percentage of
Gross Receivables

Accounts Receivable
Days Sales in Accounts Receivable
Accounts Receivable Turnover
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SALES CUTOFF PROCEDURES

Used to verify whether Sales/Revenues
recorded in the CORRECT ACCOUNTING
PERIOD.
Holding the books open

Examine SALES INVOICES and SHIPPING

DOCUMENTS shortly prior to and after yearend.
Examine returns after year-end.
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