Revenue and Receipts Cycle Audit PDF 2024

THE REVENUE AND RECEIPTS CYCLE AUDIT  Revenue & Receipts Cycle: Introduction  The revenue phase of the cycle is concerned with making sales of the company’s products, services or expertise;  The receipts phase is concerned with ensuring that the company is paid for supplying...

THE REVENUE AND RECEIPTS CYCLE AUDIT  Revenue & Receipts Cycle: Introduction  The revenue phase of the cycle is concerned with making sales of the company’s products, services or expertise;  The receipts phase is concerned with ensuring that the company is paid for supplying the product, service or expertise; and  Sales can be made in various ways, e.g. for cash, on credit, by instalment and can also be paid for in different ways, e.g. cash, credit card, electronic transfer.  Revenue & receipts cycle process The following functions, are essentially those required for most revenue and receipts cycles: Receiving a customer’s order (Cash/Credit sale) Approving credit for a sale Determining whether goods are available for delivery Delivering the goods Invoicing the customers Collecting cash Recognizing effect of this process on other related accounts  Performing risk assessment procedures in the revenue & receipts cycle In terms of ISA 315 (Revised), the auditor is required to identify and assess the risk of material misstatement at both financial statement level and at account balance and transaction level.  Performing risk assessment procedures in the revenue & receipts cycle  at financial statement level: if there is an incentive for the directors to manipulate the financial statements, one of the ways in which they may do so is by understating or overstating profits by manipulating sales. This can be done in a number of ways, e.g. by creating fictitious sales with related parties.  at account balance level: there may be an identified risk that the accounts receivable balance will be overstated because of an inadequate allowance for bad debts.  Performing risk assessment procedures in the revenue & receipts cycle at transaction level: risk assessment procedures may have revealed that the controls over cash sales are totally inadequate or that sales invoices are raised before the goods ordered by the customer have even been picked from the warehouse.  Performing risk assessment procedures in the revenue & receipts cycle Once the cumulative effect of the identified risk has been assessed, the auditor will be in a position to plan “further” audit procedures and “other” audit procedures.  The audit objective for revenue/sales transactions  Sales occurrence: recorded sales actually occurred (they are not fictitious) and they pertain to the entity accuracy: sales are recorded at the correct amount cut-off: sales are allocated to the proper accounting period completeness: all sales have been recorded classification: sales are recorded in the proper accounts.  The audit objective for receipts transactions  Receipts occurrence: recorded receipts were actually received for amounts owed to the entity accuracy: the receipts are recorded at the correct amount cut-off: receipts are allocated to the proper accounting period completeness: all receipts have been recorded classification: receipts are recorded in the proper accounts.  The audit objective for receivable balance  Trade and other receivables existence: trade receivables actually existed at reporting date rights: the company had the rights to the trade receivables; i.e. they are not encumbered in any way (if they are, disclosure must be made) completeness: all trade receivables are included valuation: trade receivables have been included in the annual financial statements at an appropriate carrying value (i.e. a suitable allowance has been made for non-recoverable debts).  Financial statement assertions and the revenue & receipts cycle Assertions pertaining to presentation and disclosure  In addition to the assertions identified above, the directors are also representing (asserting) that the presentation and disclosure of all matters pertaining to the balances and transactions in this cycle are complete in terms of the financial reporting standards, have been correctly classified and accurately presented and disclosed in an understandable manner.  Recognition of revenue A sale should only be recognized if : There is an approved contract to perform specific obligation and the obligation is satisfied (verbal or written contract) Each party’s rights can be identified per the contract. The payment terms of the contract can be identified. The contract has commercial substance. It is probable that the payment will be collected.  Fraud in the revenue & receipts cycle Fraudulent Financial Reporting  There are a number of ways in which management can manipulate account balances and totals in this cycle creating fictitious sales (occurrence) and the corresponding fictitious debtor (existence) understating sales (completeness) and the corresponding debtor (completeness)  Fraud in the revenue & receipts cycle Fraudulent Financial Reporting  There are a number of ways in which management can manipulate account balances and totals in this cycle understating the bad debt allowance (valuation) manipulating the recognition of revenue from sales (occurrence or completeness)  Fraud in the revenue & receipts cycle Misappropriation of Assets There are a number of ways in which management or employees can misappropriate assets relating to this cycle: theft of cash from the cash sales (completeness of sales) theft of payments (cash or cheques) received from debtors (existence/valuation of debtors)  Fraud in the revenue and receipts cycle Misappropriation of Assets There are a number of ways in which management or employees can misappropriate assets relating to this cycle:  arranging sales to customers at unauthorized reduced prices (accuracy of sales, completeness of debtors/cash)  theft of goods at the picking/despatch stage (existence of inventory)  not paying over VAT on all sales (completeness of liabilities)  Tests of control and substantive tests  The auditor’s further audit procedures will be a mix of tests of controls and substantive tests.  If the auditor intends to rely on the operating effectiveness of controls in determining the nature, timing and extent of substantive tests, he cannot simply assume that the controls have operated effectively; he will need to design and perform tests of controls.  If controls prove to have operated effectively, the nature, timing and extent of planned substantive procedures may change, for example less testing (smaller samples) may be conducted.  Responses to assessed risks Perform risk assessment Further audit procedures procedures to obtain an designed and performed in understanding of the entity response to the assessed risks Are controls No operating Yes effectively? Substantive tests Perform test of control: Purpose: to detect material Purpose: to obtain sufficient misstatements at the assertion level. appropriate audit evidence that the controls were operating Include: effectively during the period tests of details of transactions, balances and disclosures, and substantive analytical procedures  The nature of tests of controls Controls in this cycle will vary from company to company and the auditor will need to select a suitable mix of procedures to achieve his overall objective of determining whether the controls implemented were (are) effective. Examples of test of control audit procedures are presented in the next slide…  Examples of tests of controls procedures Inquiry  Inquire of the despatch clerk as to what happens if goods are transferred from the warehouse to the despatch area for delivery without a picking slip. Inspection  A sample of recorded sales could be selected and the supporting internal sales order inspected for a valid authorising signature. Observation  Observe the despatch clerk counting and checking goods against the picking slip/despatch note before packing items into boxes for delivery. See pg.10/50-10/51 for more examples  Substantive testing audit procedures  The extent of substantive testing is generally determined by the assessed risk of material misstatement and the results of tests of controls.  In general, the greater the risk of material misstatement and the less effective the controls appear to be, the greater the amount of substantive testing.  The extent of testing is usually reflected in the size of samples used for testing.  Examples of substantive procedures (sales) Audit objective/Assertions Substantive audit procedures Occurrence – Recorded transactions have occurred and  Trace a sample of recorded sales transactions back they pertain to the company to the source and inspect the supporting documentation for the invoice, confirm that: an order was received from an approved customer Accuracy – The amounts of sales have been recorded  Confirm the mathematical accuracy of the invoice appropriately by recalculating all extensions, casts, discounts and VAT calculations Cut-off – The sales transactions have been accounted  At year end obtain the document numbers of the for in the correct accounting period last documents used in the financial year, for example sales invoices, despatch notes  at a later stage he should agree this number to the last entry in the sales journal and sequence test, say, the last two weeks of invoices before year end, for any missing invoice numbers  Examples of substantive procedures (receivables) Audit objective/Assertions Substantive audit procedures Assertion: Rights – the company controls or holds the By inspection of: rights to the trade receivable prior year work papers minutes of directors’ meetings loan agreements bank confirmations, and Assertion: Existence – trade receivables included in the The two major procedures for existence testing are: balance actually exist, debtors circularisation by which, with the consent of they are not fictitious management, independent confirmation is sought from the debtor the matching of amounts owed at year end (receivables) to payments from debtors received after year end.  Debtors circularisation procedures  The auditor takes control of all debtors statements immediately after they have been printed and:  tests from the statement to the debtors ledger  selects a sample of statements for circularisation. Two different types of confirmation may be used by the auditor:  positive confirmation requests that the debtor confirms with the auditor whether the balance on the statement is correct or not  negative confirmation requests that the debtor confirms with the auditor only if the balance on the statement is not correct.  Debtors circularisation procedures  The positive circularisation therefore provides better evidence supporting the existence assertion and  Very little evidence is provided by the negative circularisation.  See pg. 10/55 - 10/56 for more procedures on debtors circularisation.  Pg. 10/56 – 10/59 procedures for testing - Assertion: accuracy, valuation and allocation (gross amount) trade receivables.  QUESTION How would you audit sales transactions to ensure the accuracy, completeness, and validity of recorded revenue.  Laybuy Transactions  Under International Financial Reporting Standards, the seller only recognizes revenue when it delivers the goods. However, if the seller’s historical experience shows that most layaway transactions are converted into sales, then it can recognize revenue when it receives a significant deposit, provided that the goods are on hand, identified and ready for delivery. THANK YOU