Lecture Auditing and assurance services (Second international edition) Chapter 10 Auditing the revenue process

Chapter Ten

Auditing the
Revenue Process

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Revenue Recognition (IAS 18)
Revenue is defined as the gross inflow of
economic benefits during the period arising in
the course of the ordinary activities of an entity
when those inflows result in increases in equity,
other than increases relating to contributions
from equity participants.

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Overview of the Revenue Process
Cash Sale

Credit Sale
Cash
collection

Purchases

Cash
sales

Inventory

Account
receivable

Inventory

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Purchases

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Credit sales


Types of Transactions and Financial
Statement Accounts Affected
Three types of transactions are typically processed
by the revenue process:
1. The sale of goods or rendering of a service for
cash or credit.
2. The receipt of cash from the customer in
payment for goods or services.
3. The return of goods by the customer for credit or
cash.

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Types of Transactions and Financial
Statement Accounts Affected
The revenue process affects numerous accounts in the
financial statements. The most significant accounts are :

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Flowchart of the Revenue Process:
EarthWear Clothiers

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Flowchart of the Revenue Process:
EarthWear Clothiers (continued)

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Flowchart of the Revenue Process:
EarthWear Clothiers (continued)

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Types of Documents and Records
Customer
Customer Sales
Sales Order
Order
Contains
Contains the
the details
details of
of the
the type
type and
and quantity
quantity of
of
products
products or
or services
services ordered
ordered by

by the
the customer
customer
and
and customer
customer information.
information.
Credit
Credit Approval
Approval Form
Form
For
For credit
credit sales,
sales, the
the client
client must
must have
have aa formal
formal
procedure
procedure for
for investigating
investigating the
the creditworthiness
creditworthiness of
of
the
the customer.
customer.

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Types of Documents and Records
Open-Order
Open-Order Report
Report
A
A report
report of
of all
all customer
customer orders
orders for
for
which
which processing
processing has
has not
not been
been
completed.
completed.
Shipping
Shipping Document
Document
This

This document
document generally
generally serves
serves as
as aa bill
bill
of
of lading
lading and
and contains
contains information
information on
on the
the
type
type of
of product
product shipped,
shipped, the
the quantity
quantity
shipped
shipped and
and other
other relevant
relevant information.
information.

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Types of Documents and Records
Sales
Sales Invoice
Invoice
The
The document
document is
is used
used to
to bill
bill the
the customer.
customer.
This
This document
document contains
contains information
information on
on the
the
type
type of
of product
product or
or service,
service, the
the quantity,

quantity, the
the
price
price and
and the
the terms
terms of
of trade.
trade.
Sales
Sales Journal
Journal
Once
Once aa sales
sales invoice
invoice has
has been
been issued,
issued, the
the sale
sale
needs
needs to
to be
be recorded
recorded in
in the
the accounting
accounting
records.

records. The
The sales
sales journal
journal is
is used
used to
to record
record
information
information about
about the
the sales
sales transaction.
transaction.
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Types of Documents and Records
Customer
Customer Statement
Statement
This
This document
document is
is mailed
mailed to
to the
the

customer
customer and
and contains
contains details
details of
of all
all
sales,
sales, cash
cash receipts,
receipts, and
and credit
credit
memorandum
memorandum transactions.
transactions.
Accounts
Accounts Receivable
Receivable Subsidiary
Subsidiary Ledger
Ledger
This
This ledger
ledger contains
contains an
an account
account and
and the
the
details

details of
of transactions
transactions for
for each
each customer.
customer.

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Types of Documents and Records
Aged
Aged Trial
Trial Balance
Balance of
of Accounts
Accounts
Receivable
Receivable
This
This report
report summarizes
summarizes all
all the
the customer
customer
balances
balances in

in the
the accounts
accounts receivable
receivable
subsidiary
subsidiary ledger.
ledger. Each
Each account
account is
is
classified
classified as
as current
current or
or placed
placed into
into one
one of
of
several
several past
past due
due categories.
categories.
Remittance
Remittance Advice
Advice
This
This is
is usually

usually the
the part
part of
of the
the customer’s
customer’s bill
bill
that
that should
should be
be returned
returned with
with the
the payment.
payment.
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Types of Documents and Records
Cash
Cash Receipts
Receipts Journal
Journal
This
This journal
journal is
is used
used to

to record
record the
the cash
cash
receipts
receipts of
of the
the entity.
entity.

Credit
Credit Memorandum
Memorandum
This
This document
document is
is used
used to
to record
record
credits
credits for
for the
the return
return of
of goods
goods by
by aa
customer.
customer.

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Types of Documents and Records
Write-Off
Write-Off Authorization
Authorization
This
This document
document authorizes
authorizes the
the write-off
write-off of
of an
an
uncollectible
uncollectible account
account receivable.
receivable. Final
Final
authorization
authorization is
is generally
generally received
received from
from the
the

treasurer.
treasurer.

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Major Functions

Order
Order Entry
Entry
The
The initial
initial function
function in
in the
the
revenue
revenue process
process is
is the
the
entry
entry of
of aa new
new sales
sales order
order

into
into the
the system.
system.

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Major Functions
Credit
Credit Authorization
Authorization

Shipping
Shipping

The
The credit
credit authorization
authorization
process
process must
must determine
determine
that
that the
the customer
customer is

is able
able
to
to pay
pay for
for the
the goods
goods or
or
services
services purchased.
purchased.
Failure
Failure to
to properly
properly
authorize
authorize credit
credit can
can lead
lead
to
to extensive
extensive bad
bad debts
debts for
for
the
the entity.
entity.

Goods
Goods should
should not
not be
be
shipped,
shipped, nor
nor should
should
services
services be
be provided
provided
without
without proper
proper
authorization.
authorization. The
The
main
main control
control is
is
payment
payment or
or proper
proper
credit
credit authorization.

authorization.
Billing
Billing

The
The objective
objective of
of proper
proper billing
billing is
is to
to ensure
ensure that
that all
all goods
goods shipped
shipped and
and all
all
services
services rendered
rendered are
are billed
billed to
to the
the customer.
customer.
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Major Functions
Cash
Cash Receipts
Receipts

Accounts
Accounts Receivable
Receivable

All
All cash
cash collected
collected
must
must be
be properly
properly
identified
identified and
and
promptly
promptly
deposited
deposited intact
intact
at
at the
the bank.

bank.

All
All billings,
billings, adjustments,
adjustments,
and
and cash
cash collections
collections must
must
be
be properly
properly recorded
recorded in
in
the
the customers’
customers’ accounts
accounts
receivable
receivable records.
records.

General
General Ledger
Ledger
As
As related
related to

to the
the revenue
revenue process,
process, the
the general
general ledger
ledger
function
function must
must ensure
ensure that
that all
all revenues,
revenues, collections,
collections, and
and
receivables
receivables are
are properly
properly recorded
recorded and
and classified.
classified.
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The Major Functions

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Key Segregation of Duties

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Inherent Risk Assessment

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Control Risk Assessment
Understand and document the revenue process
based on a reliance approach.
Plan and perform tests of controls on revenue
transactions.

Set and document the control risk for the revenue
process.

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Understanding and Documenting
Internal Control
Control Environment
Understanding the control environment is generally
completed on an overall entity basis.
The Entity’s Risk Assessment Process
The auditor must understand how management
considers risks that are relevant to the revenue
process. The auditor should estimate the significance
of the risk and assess the likelihood of occurrence.
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Understanding and Documenting
Internal Control
Control Activities
The auditor identifies which controls ensure that the
assertions for transactions and events are being met.
Documentation of the auditor’s understanding of the
revenue process can be accomplished by using:

Procedures
manuals
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Narrative
descriptions

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Internal control
questionnaires

Flowcharts


Information Systems and
Communication
Process
Process by
by which
which
sales,
sales, cash
cash receipts
receipts
and
and credit
credit
memoranda
memoranda are
are
initiated.
initiated.

The
The flow
flow of
of each
each
transaction
transaction from
from
initiation
initiation to
to inclusion
inclusion
in
in the
the financial
financial
statements.
statements.

Auditor’s
knowledge
Accounting
Accounting records,
records,
supporting
supporting documents
documents
and
and accounts
accounts that

that are
are
involved
involved in
in sales,
sales, cash
cash
receipts
receipts and
and sales
sales
returns.
returns.
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The
The process
process used
used to
to
prepare
prepare estimates
estimates for
for
bad
bad debts
debts and
and sales

sales
returns.
returns.