2. 10-2
Revenue Recognition
Revenue is defined as inflows or other enhancements
of assets of an entity or settlements of its liabilities
(or a combination of both) from delivery or producing
goods, rendering services, or other activities that
constitute the entity’s major or central operations.
LO# 1
3. 10-3
Overview of the Revenue
Process
Purchases
Inventory
Credit sales
Account
receivable
Cash
collection
Purchases
Inventory
Cash
sales
Cash Sale Credit Sale
LO# 2
4. 10-4
Types of Transactions and
Financial Statement Accounts
Affected
The revenue process affects numerous accounts in the
financial statements. The most significant accounts are:
LO# 3
6. 10-6
The Major Functions
Functions of the Purchasing Process
Order entry Acceptance of customer orders for goods and services into
the system in accordance with management criteria.
Credit authorization
Appropriate approval of customer orders for
creditworthiness.
Shipping Shipping of goods that has been authorized.
Billing
Issuanace of sales invoices to customers for goods
shipped or services provided; also, processing of billing
adjustments for allowances, discounts, and returns.
Cash receipts Processing of the receipt of cash from customers.
Accounts receivable
Recording of all sales invoices, collections, and credit
memoranda in individual customer accounts.
General ledger
Proper accumulation, classification, and summarization of
revenues, collections, and recivables in the financial
statement accounts.
LO# 5
7. 10-7
Key Segregation of Duties
Segregation of Duties for Revenue and Accounts
Receivable Functions by Department
LO# 6
8. 10-8
Inherent Risk Assessment
The four inherent risk factors that may affect the
revenue process are:
1. Industry-related factors.
2. The complexity and contentiousness of revenue
recognition issues.
3. The difficulty of auditing transactions and account
balances.
4. Misstatements detected in prior audits.
LO# 7
9. 10-9
Control Risk Assessment
Understand and document the revenue
process based on a reliance approach.
Plan and perform tests of controls on revenue
transactions.
Sett and document the control risk for the
revenue process.
LO# 8
10. 10-10
Assertions about Classes of
Transactions and Events for the
Period Under Audit
Occurrence
All revenue and cash receipt transactions and events
that have been recorded have occurred and pertain to
the entity.
Completeness
All revenue and cash receipt transactions and events
that should have been recorded have been recorded.
Authorization
All revenue and cash receipts transactions and events
are properly authorized.
Accuracy
Amounts and other data relating to recorded revenue
and cash receipt transactions and events have been
recorded appropriately.
Cutoff All revenue and cash receipt transactions and events
have been recorded in the correct accounting period.
Classification
All revenue and cash receipt transactions and events
have been recorded in the proper accounts.
LO# 9
13. 10-13
Control Activities and Tests of
Controls – Sales Returns and
Allowances
Sales returns and allowances is usually not a
material amount in the financial statements.
However, credit memoranda that are used to
process sales returns can also be used to cover an
unauthorized shipment of goods or conceal a
misappropriation of cash. As a result, all credit
memoranda should be properly authorized.
LO# 9
14. 10-14
Relating the Assessed Level
of Control Risk to Substantive
Procedures
The auditor’s testing of control for revenue
processing impacts the detection risk and
therefore the level of substantive procedures
impacted by the controls.
Cash
Accounts
receivable
Allowance
for bad
debts
Bad debts
expense
Sales returns
and
allowances
LO# 10
15. 10-15
Substantive Analytical Procedures
Ratios used for comparative purposes
include:
1. Receivables turnover and days outstanding
in accounts receivable.
2. Aging categories on aged trial balance of
accounts receivable.
3. Bad-debts expense as a percent of revenue.
4. Allowance for uncollectible accounts as a
percent of accounts receivable or credit
sales.
5. Large account balances compared to last
period.
LO# 11
16. 10-16
Tests of Details of Transactions
Occurrence
A sample of transactions from the sales journal should
be traced to the sales invoice, customer order, and
shipping document.
Completeness
A sample of shipping documents should be traced to
related sales invoice and customer's account.
Authorization
and Accuracy
Compare prices and terms for sample of sales
invoices with authorized price list.
Cutoff From a sample, compare date of sales invoice with
date of shipment and date sale was recorded.
Classification
For a sample of sales invoices, determine that each is
properly classified in the revenue accounts.
For Accounts Receivable, Allowance for Uncollectible
Accounts, and Bad-Debt Expense
LO# 12
17. 10-17
Tests of Details of Account
Balances and Disclosures
Existence
Confirmation of selected accounts receivable and
alternative procedures for exceptions and
nonresponses.
Rights and
Obligations
Review of bank confirmations for any liens on
receivables and inquiry of management.
Completeness
Agree aged trial balance to general ledger and trace
selected shipping documents to subsidiary ledger.
Valuation and
Allocation
Examine results of confirmations and review
adequacy of allowance for uncollectible accounts.
Disclosure
Review financial statements for proper presentation
and disclosure of receivables and related accounts.
For Accounts Receivable, Allowance for Uncollectible
Accounts, and Bad-Debt Expense
LO# 13
18. 10-18
Types of Confirmations
Positive
Confirmation
Requests that
customers indicate
whether they agree
with the amount due
to the client. A
response is expected
whether the customer
agrees or disagrees
with the balance
indicated.
Negative
Confirmation
Requests that the
customer respond only
when they disagree
with the amount due
to the client. Negative
confirmations are used
when the client has
many small account
balances and control
risk is assessed as low.
LO# 14
19. 10-19
Confirmation Procedures
The auditor should mail the confirmation
requests outside the client’s facilities. A
record should be maintained of the
confirmations mailed and those returned.
A second request may be necessary in
some cases.
For each exception received, the
auditor should examine the reasons
for the difference between the
balance on the client’s books and
the balance indicated by the
customer.
LO# 14
20. 10-20
Alternative Procedures
When the auditor does not receive responses
to positive confirmations, alternative audit
procedures are used. These alternative
procedures include:
1. Examination of subsequent cash receipts.
2. Examination of customer orders, shipping documents,
and duplicate sales invoices.
3. Examination of other client documentation.
LO# 14
21. 10-21
Auditing Other Receivables
Other types of receivables that are reported on the
balance sheet may include: (1) receivables from officers
and employees, (2) receivables from related parties, and
(3) notes receivable. The auditor’s concern with
satisfying the assertions for these receivables is similar
to that for trade accounts receivable. Each of these
types of receivables is confirmed and evaluated for
collectability. The transactions that result in receivables
from related parties are examined to determine if they
were at “arm’s length.” Notes receivable would also be
confirmed and examined for repayment terms and
whether interest income has been properly recognized.
LO# 15
22. 10-22
Evaluating the Audit Findings
When the auditor has completed the planned
substantive procedures, the likely misstatement
(projected misstatement plus an allowance for
sampling risk) for accounts receivable is determined.
Likely misstatement
less than tolerable
misstatement
Likely misstatement
greater than tolerable
misstatement
Accept the account
as fairly presented.
Account is not fairly
presented.
LO# 16
