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AUDIT OF THE REVENUE

CYCLE USING ACL


Why are revenue cycle accounts important?

▧ Sales transactions are always material to a


company's financial statements
▧ According to the SEC, a majority of financial
statement manipulations and audit failures
involve overstated revenues
▧ Therefore, revenue cycle accounts must be
examined with great care

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List the Financial Transactions Processing Cycles

▧ Revenue
▧ Acquisition and payment of goods and
services
▧ Payroll
▧ Financing: debt and equity
▧ Cash and short-term investments

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Steps in the Revenue Process

1. Receiving customer orders


2. Authorizing credit terms and
shipment
3. Confirming orders
4. Executing orders
5. Recording the shipments or services
performed

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Steps in the Revenue Process

1.Receiving customer orders


• Computer controls:
■ Customer checks
• Valid customer number
• Self-check algorithm
■ Field checks
• Key characteristics
• Completeness of required fields
■ Reasonableness checks
• Order quantities
• Product combinations
• Clear procedures for resolving computer red flags
• Periodic reports on Open Orders

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Steps in the Revenue Process

2. Authorizing credit terms and shipment


• Computer controls
■ Credit check for repeat customers
■ Inventory availability
• Credit review for new customers
■ Credit worthiness
■ Existence
• Separation of Credit & Sales Departments
• When approved a Sales Order is produced
■ Prenumbered and controlled

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Steps in the Revenue Process

3. Confirming orders
• Customer verification of sales order accuracy
• Items
• Quantities
• Price
• Confirm shipping date

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Steps in the Revenue Process

4. Executing orders
• Assembling goods for shipment
• Picking list (sales order)
• Verify items picked and update inventory
• Move items to shipping dock
• Ship ordered goods
■ Packing slip (sales order)
■ Verify items packed (agree picking & sales order)
■ Shipping report and bill of lading
• Prenumbered and controlled
■ Periodic reports on Open Shipments
• Separation of Warehousing & Shipping

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Steps in the Revenue Process

5. Bill the customer and record the sale


• Agree information on and existence of customer
order, sales order, and shipping report.
• Prepare a Sales Invoice
• Prenumbered and controlled
• Computer controls
• Send sales invoice to customer
• Investigation of missing or repeated document
numbers

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Business Risk and Business Environment

Revenue recognition
 SAS 99 - Consideration of Fraud in a Financial
Statement Audit
 Auditor should presume risk of material misstatement
due to fraud related to revenue recognition
 Research shows over half of frauds involve
overstating revenues

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Improper Revenue Recognition Schemes

▧ Recognize revenue on fictitious shipments


▧ Hidden side letters that give customers
unlimited right to return product
▧ Record consignment sales as final sales
▧ Accelerated recognition of sales occurring
after year-end
▧ Ship unfinished goods
▧ Ship goods before date agreed to by
customer

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Improper Revenue Recognition Schemes

▧ Create fictitious invoices


▧ Ship goods never ordered
▧ Ship more goods than ordered
▧ Record shipments to company's warehouse
as sales
▧ Record shipments of replacement goods as
new sales

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Inherent Risks
1. General incentive to overstate revenues and
receivables
2. High volume of transactions
3. Efforts to increase customer value, may
increase accounting complexity:
• Bundled services
• Rights of return
• Financing options

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AUDIT OBJECTIVES
Occurrence: Recorded sales represent goods
shipped during the period.
Completeness: All sales made during the
period were recorded.
Accuracy: All sales are accurately valued using
GAAP and correctly journalized, summarized,
and posted.
Cutoff: All sales have been recorded in the
correct accounting period.
Classification: All sales have been recorded in
the proper accounts.

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AUDIT OBJECTIVES
Existence: Accounts receivable represents
amounts owed by customers on the balance
sheet date.
Rights & Obligations: Accounts receivable at
the balance sheet date represents legal
claims of the entity on customers for
payment.
Valuation & Allocation: Accounts receivable
represent gross claims on customers at the
balance sheet date, and agrees with the sum
of the accounts receivable subsidiary ledger.

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CONTROLD RELATED
TO THE REVENUE
CYCLE

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Although the auditor must understand all
components of internal controls,
particular attention is paid to significant
control procedures and monitoring
controls
The auditor obtains an understanding of
the controls by
 Walk-through of the processing of
transactions
 Inquiry
 Observation
 Review of client documentation
It is critical this understanding be
documented in the work papers
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Monitoring Controls
 Designed to signal failures in
transaction processing, and determine
if timely, corrective action is taken
 Monitoring controls applicable to
revenue transactions include:
 Compare sales and cost of good sold
with budgeted amounts
 Exception reports generated to
identify unusual transactions

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Monitoring Controls
 Internal audit of revenue cycle controls
 Computer reconciliation of
transactions entered with transactions
processed
 Monitoring of accounts receivable for
quality
 Independent follow-up on customer
complaints
 Audits of sales tax collections

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INPUT CONTROLS
Purpose
Ensure creditworthiness of customers
Control techniques vary considerably
between batch systems and real-time
systems
Credit authorization procedures
Credit worthiness of customer
Batch and manual systems use credit dept.
Real-time systems use programmed decision
rules
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INPUT CONTROLS
Testing credit procedures
Verify effective procedures exist
Verify information is adequately
communicated
Verify effectiveness of programmed decision
rules (test data, ITF)
Verify that authority for making credit
decisions is limited to authorized credit
personnel/procedures
Perform Substantive Tests of Detail
Review credit policy periodically and revise as
necessary
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INPUT CONTROLS
Data Validation Controls
To detect transcription errors in data as
it is processed
Batch: after shipment of goods
•Error logs
•Error correction computer processes
•Transaction resubmission procedures
Real-Time: Errors handled as they occur
Missing data checks – presence of
blank fields

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INPUT CONTROLS
Numeric-Alphabetic data checks – correct
form of data
Limit checks – value does not exceed max
for the field
Range checks – data is within upper and
lower limits
Validity checks – compare actual values
against known acceptable values
Check digit – identify keystroke errors by
testing internal validity

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INPUT CONTROLS
Batch controls
Manage high volumes of similar transactions
Purpose: Reconcile output produced by
system with the original input
Controls continue through all computer (data)
processes
Batch transmittal sheet:
Unique batch number
Batch date
Transaction code
Record count
Batch control total (amount)
Hast totals (e.g., account numbers)

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INPUT CONTROLS
Testing data validation controls
Failures of batch controls indicates data errors
Involves reviewing transmittal records of
batches processed and reconcile them to the
batch control log (batch transmittal sheet)
Examine out-of-balance conditions and other
errors to determine cause of error
Review and reconcile transaction listings,
error logs, etc.

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PROCESS CONTROLS
Computerized procedures for file
updating
Restricting access to data
Techniques:
File update controls -- Run-to-run batch
control data to monitor data processing steps
Transaction code controls – to process
different transactions using different
programming logic (e.g., transaction types)
Sequence check controls – sequential files,
proper sorting of transaction files required
Testing file update controls – results in errors
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PROCESS CONTROLS
Testing data that contains errors
(incorrect transaction codes, out of
sequence)
Can be performed in ITF or test data
CAATTs requires careful planning
Single audit procedure can be devised
that performs all tests in one operation.

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ACCESS CONTROLS
 Prevent and detect unauthorized and illegal access
to firm’s systems and/or assets
 Warehouse security
 Depositing cash daily
 Use safe deposit box, night box, lock cash drawers and
safes
 Accounting records
 Removal of an account from books
 Unauthorized shipments of goods using blank sales orders
 Removal of cash, covered by adjustments to cash account
 Theft of products/inventory, covered by adjustments to
inventory or cash accounts

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ACCESS CONTROLS

 Testing access controls – heart of


accounting information integrity
 Absence thereof allows manipulation of
invoices (i.e., fraud)
 Access controls are system-wide and
application-specific
 Access controls are dependent on effective
controls in O/S, networks, and databases

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PHYSICAL CONTROLS
Segregation of duties
Rule 1: Transaction authorization
separate from transaction processing
Rule 2: Asset custody separate from
record-keeping tasks
Rule 3: Organization structured such
that fraud requires collusion between two
or more people

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PHYSICAL CONTROLS
Supervision
Necessary for employees who perform
incompatible functions
Compensates for inherent exposure
from incompatible functions
Can be supplement when duties are
properly segregated
Prevention vs. detection of fraud and
crime is objective: supervision can be
effective preventive control

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PHYSICAL CONTROLS
Independent verification
Review the work of others at critical
points in business processes
Purpose: Identify errors or possible
fraud
Examples:
Shipping dept. verifies goods sent from
warehouse dept. are correct in type and quantity
Billing dept. reconciles shipping notice with
sales notice to ensure customers billed correctly

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PHYSICAL CONTROLS
Testing physical controls
Review organizational structure for
incompatible tasks
Tasks normally segregated in manual
systems get consolidated in DP systems.
Duties of design, maintenance, and
operations for computers need to be
separated
Programmers should not be responsible for
subsequent program changes.
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OUTPUT CONTROLS
PURPOSE: Information is not lost, misdirected,
or corrupted; that the system output processes
function properly
Controls are designed to identify potential
problems
Reconciling GL to subsidiary ledgers
Maintenance of the audit trail – that is the primary way to
trace the source of detected errors
Details of transactions processed at intermediate points
AR change report
Transaction logs: permanent record of valid transactions
Transaction listings – successfully posted transactions
Log of automatic transactions
Unique transaction identifiers
Error listings
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OUTPUT CONTROLS
Testing output controls
Reviewing summary reports for
accuracy, completeness,timeliness, and
relevance for decisions
Trace sample transactions through audit
trails; including transaction listings, error
logs, and logs of resubmitted records
ACL is very helpful in this process

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SUBSTANTIVE TESTS

 PURPOSE: Determine the nature, timing, and


extent of substantive tests using auditor’s
assessment of inherent risk, unmitigated control
risk, materiality considerations, and efficiency of
the audit.

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SUBSTANTIVE TESTS
 Concern: Overstatement or understatement of revenues?
 Focus on large and unusual transactions, especially near
period-end
 Recognizing revenues from sales that did not occur
 Recognizing revenues BEFORE they are realized
 Failing to recognize cutoff points
 Underestimating allowance for doubtful accounts
 Shipping unsolicited products to customers, subsequently
returned
 Billings customers for products held by seller
 Tests of controls and substantive tests

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SUBSTANTIVE TESTS FOR OCCURRENCE,
ACCURACY AND VALUATION
Vouch recorded sales transaction back to
customer order and shipping document
▧ Compare quantities billed and shipped with
customer order
▧ Special care should be given to sales recorded
at the end of the year
▧ Scan sales journal for duplicate entries

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SUBSTANTIVE TESTS FOR CUTOFF

Can be performed for sales, sales returns, cash


receipts
▧ Provides evidence whether transactions are
recorded in the proper period
▧ Cutoff period is usually several days before and
after balance sheet date
▧ Extent of cutoff tests depends on effectiveness
of client controls

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SUBSTANTIVE TESTS FOR CUTOFF

▧ Sales cutoff
○ Auditor selects sample of sales recorded
during cutoff period and vouches back to
sales invoice and shipping documents to
determine whether sales are recorded in
proper period
○ Cutoff tests assertions of existence and
completeness
○ Auditor may also examine terms of sales
contracts

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SUBSTANTIVE TESTS FOR CUTOFF

▧ Sales return cutoff


○ Client should document return of goods using
receiving reports
○ Reports should date, description, condition, quantity
of goods
○ Auditor selects sample of receiving reports issued
during cutoff period and determines whether credit
was recorded in the correct period

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SUBSTANTIVE TESTS FOR COMPLETENESS

▧ Use of pre-numbered documents is


important
▧ Analytical procedures
▧ Cutoff tests
▧ Auditor selects sample of shipping
documents and traces them into the
sales journal to test completeness of
recording of sales

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SUBSTANTIVE TESTS OF ACCOUNTS
Valuation
RECEIVABLE
○ Are sales and receivables initially recorded at their
correct amount?
○ Will client collect full amount of recorded
receivables?
Rights and Obligations
○ Contingent liabilities associated with factor or sales
arrangements
○ Discounted receivables
Presentation and Disclosure
○ Pledged, discounted, assigned, or related party
receivables

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SUBSTANTIVE TESTS OF ACCOUNTS
RECEIVABLE
▧ Obtain and evaluate aging of accounts
receivable
▧ Confirm receivables with customers
▧ Perform cutoff tests
▧ Review subsequent collections of receivables

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Thanks!

Any questions?

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