Auditing the Revenue

Cycle

Content
1. Accounting System (Legacy vs Real-time)
2. Controls: Input, Process, Output, Access,
Physical, IS
3. Substantive Test

MANUAL PROCEDURES
Processing shipping orders

4 copies of Sales Order to warehouse; packing slip, shipping

notice, stock release, file copy

Locate and pick goods using Stock Release; package them

with packing slip

Reconcile documents and goods, sign Shipping Notice,

prepare Bill of Lading multiple copies

Transfer custody of goods (packing slip inside) and 2 copies

of Bill of Lading to carrier

Record shipment in shipping log

Send shipping notice to Billing Dept.

File: Stock Release, 1 BoL, File Copy

LEGACY SYSTEM PROCEDURES

is an old method, technology, computer system, or

application program

Edit run program, correct any errors

Field checks
Limit tests (determine if the value in the field exceeds an

authorized limit)
Range tests (upper and lower limits to acceptable data
values).
Price times quantity extensions

AR update & billing run

Updates AR file becomes new AR file

Billing would be printing invoices to be mailed
Sales journal file or printout
Journal voucher for AR [DR] and sales [CR]

LEGACY SYSTEM PROCEDURES

Inventory update run

Reduce quantity on hand for items shipped, generate a new

Inventory file
Compare On Hand quantity with Reorder Point to identify
items needing replenishment; file or printout
Journal voucher for Cost of Goods Sold [DR] and Inventory
[CR]

Sort journal entries by GL

Run general ledger update
Management reports

REAL-TIME SALES ORDER ENTRY

AND CASH RECEIPTS

Sales procedures

Transactions are processed as they occur, separately

Credit check is performed online by the system
If approved, system checks availability of inventory
If available, system:

Transmits electronic stock release to warehouse

department
Transmits electronic packing slip to shipping
department
Updates inventory file records
Records sale in open sales order computer file

REAL-TIME SALES ORDER ENTRY

AND CASH RECEIPTS
Warehouse procedures

Produces hard copy of stock release

Clerk picks goods, sends them with a copy of stock release
to shipping dept.

Shipping procedures

Reconciles goods, stock release, packing slip from system.

Online, IS prepares Bill of Lading for shipment, and
shipping notice for DP Dept.
Select carrier and prepare goods for shipment, along with
packing slip and Bill of Lading
Stock release form is filed

FEATURES OF REAL-TIME
PROCESSING
Advantages

Greatly shortens the cash cycle of the firm

Can give a firm a competitive advantage (e.g., managing inventory
better)
Real-time editing permits the identification of many kinds of errors
as they occur, greatly reducing the efficiency and effectiveness of
business processes
Reduces the amount of paper documents
Electronic audit trails are possible in real-time computer-based
systems

MANAGEMENT ASSERTIONS AND

REVENUE CYCLE AUDIT OBJECTIVES

Existence / Occurrence

VERIFY AR balance represents amounts actually owed as of Balance Sheet date

Establish sales represents goods shipped and/or services rendered during period of
financials

Completeness

Determine all amounts owed organization are included in AR

VERIFY shipped goods, services rendered, and/or returns and allowances for period are
included in financials

Accuracy

VERIFY revenue transactions are accurately computed, based on correct prices and
quantities
Ensure AR subsidiary ledger, sales invoice file, remittance file are mathematically
correct .. And agree with GL accounts

Rights & Obligations

Determine organization has legal right to AR

VERIFY accounts sold or factored have been removed from AR

Valuation or Allocation

Determine AR balance stated in net realizable value

Establish allocation for uncollectible accounts is appropriate

Presentation and Disclosure

VERIFY AR and revenues for period are properly described and classified

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

Testing credit procedures

Verify effective procedures exist

Verify information is adequately communicated
Verify effectiveness of programmed decision rules (test data)
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

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

Missing data checks presence of blank fields

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

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

Testing data validation controls

Examine out-of-balance conditions and other errors to determine

cause of error
Review and reconcile transaction listings, error logs, etc.

PROCESS CONTROLS

Computerized procedures for file updating

Restricting access to data

ACCESS CONTROLS

Prevent and detect unauthorized and illegal access to firms

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

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

Supervision

Necessary for employees who perform incompatible

functions
Can be supplement when duties are properly segregated

PHYSICAL CONTROLS

Independent verification

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

Testing physical controls

Duties of design, maintenance, and operations for computers need

to be separated

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

Transaction listings successfully posted transactions

Unique transaction identifiers
Error listings

Testing output controls

Reviewing summary reports for accuracy, completeness, timeliness, and

relevance for decisions
Trace sample transactions through audit trails; including transaction
listings and error logs

SUBSTANTIVE TESTS OF REVENUE

CYCLE ACCOUNTS

PURPOSE: Determine the nature, timing, and extent of substantive tests

using auditors assessment of inherent risk, unmitigated control risk,
materiality considerations, and efficiency of the audit.

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
Underestimating allowance for doubtful accounts
Shipping unsolicited/unordered products to customers, subsequently
returned

SUBSTANTIVE TESTS OF REVENUE

CYCLE ACCOUNTS

Understanding data

VERIFY data used in CAATTs (computer assisted audit tools

and techniques) (e.g., ACL) is accurate
Relationships and data from:

Customer file
Sales Invoice file
Inventory file
Shipping log file

SUBSTANTIVE TESTS OF REVENUE

CYCLE ACCOUNTS

Accuracy & completeness assertion

Analytical review of account balances

Overall perspective for trends in sales, cash receipts,

sales returns, and AR
Provides first-level assurance that amounts are
reasonably stated and reasonably complete

Review sales invoices for unusual trends and

exceptions

Scanning data files using CAAT

SUBSTANTIVE TESTS OF REVENUE

CYCLE ACCOUNTS

Accuracy & completeness assertion

Review sales invoice and shipping log files

Missing and duplicate transactions

Questions/survey:

Are procedures in place to document and approve voided/invalid

invoices?

How are gaps in sales invoice numbers communicated to

management?

What physical controls exist over access to sales invoice source

documents?

Are transaction listings reconciled and reviewed by management?

Review line item and inventory files for pricing accuracy

SUBSTANTIVE TESTS OF REVENUE

CYCLE ACCOUNTS

Existence assertion

Confirmation of AR

Not required if:

AR is immaterial
Assessed Control Risk is low
Confirmation process will be ineffective

CAATTs to use for this function?

Select accounts to confirm

SUBSTANTIVE TESTS OF REVENUE

CYCLE ACCOUNTS

Valuation & allocation assertion

AR is stated at reasonable Net Realizable Value

AGING AR

AGE

Is allowance for doubtful accounts reasonable compared to

prior years and based on composition of AR portfolio

Review past-due balances

Conference with credit manager to determine collectability

Determine if methods used to estimate allowance for doubtful
accounts is adequate, not the collectability of each account
Determine if overall allowance is, therefore, reasonable

IS Controls
Access Controls
Site (Inventories storage etc)
System (program, data etc)
Record (Rights and privileges)

Controls for Automated

Systems

General and application controls for IS

Increased supervision
Online validation and authentication
Rotation of duties
Examples Quick Response Code/Matrix
Code scan or Booking Reference