Accounts Receivable, Notes Receivable and Revenue

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Accounts Receivable, Notes Receivable and Revenue
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Revenue Recognition

• FASB (SFAC No. 5) requires that before revenue is
  recognized it must be realized and earned.
• The SECs SAB No. 101 requires the following
  criteria for revenue recognition
• Persuasive evidence of an arrangement exists.
• Delivery has occurred or services have been
  rendered.
• The seller's price to the buyer is fixed or
  determinable.
• Collectibility is reasonably assured.

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Revenue Recognition Practices and Financial
Statement Misstatements

• Treadway Commission sponsored study of incidences
  of fraudulent financial reporting from 1985 to
  1997 found 50 due to inappropriate revenue
  recognition.
• Study by FEI found 464 financial statement
  restatements from 1998-2000. The most frequent
  cause of misstatements was improper revenue
  recognition practices.

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Overview Of The Revenue Process

• The process for revenue
• order from a customer
• exchange of goods or services for a promise to
  pay
• the payment of cash

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Auditors Objectives in Auditing Receivables and
Revenue

• Consider inherent risks of material misstatement,
  including fraud risks.
• Consider internal control over receivables and
  revenue.
• Substantiate the existence of receivables and the
  occurrence of revenue transactions.
• Establish the completeness of receivables and
  revenue transactions.
• Determine that the client has rights to recorded
  receivables.
• Establish the clerical accuracy of records and
  supporting schedules of receivables and revenue.
• Determine the valuation of receivables and
  revenue is at appropriate net realizable values.
• Determine that the presentation and disclosure of
  receivables and revenue are adequate
• Separation of receivables into appropriate
  categories
• Adequate reporting of any receivables pledged as
  collateral
• Disclosure of related party sales and
  receivables.

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Functions In The Revenue Process

• Order entry (sales)
• Credit authorization
• Warehousing (maintaining inventory)
• Shipping
• Billing
• Cash receipts
• Accounts receivable
• General ledger

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Revenue Cycle Documents

• Customer purchase order
• Sales order
• Bill of lading (shipping document)
• Invoice
• Control listing
• Credit memo

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Revenue Cycle Controls

• Segregation of duties
• Matching of sales invoices and shipping documents
• Clerical accuracy checks on invoices
• Credit approval for sales transactions
• Mailing of monthly statements
• Reconciliation of bank accounts
• Use of control listing of cash receipts
• Use of budgets and analysis of variances
• Control over shipping and billing documents
• Use of authorized credit memoranda
• Use of chart of accounts and review of account
  codings

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Potential Misstatements of Revenue

• Recording unearned revenue
• Ethical environment created by top management
• Effective billing process (tied to shipping
  function)
• Effective controls for testing invoices, computer
  reconciliations
• Early (late) recognition of revenue
• Ethical environment created by top management
• Effective cutoff procedures in shipping
  department

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Potential Misstatements of Revenue

• Recording revenues with significant uncertainties
• Ethical environment created by top management
• Recording revenues when significant services
  still must be performed
• Ethical environment created by top management
• Overestimation of the amount of revenue earned
• Ethical environment created by top management

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Audit Program for Receivables and Revenue

• Internal Controls
• Obtain an understanding of internal control over
  receivables and revenue.
• Assess control risk and design additional tests
  of controls for receivables and revenues.
• Perform additional tests of controls as necessary
• Examine significant aspects of a sample of sales
  transactions.
• Compare a sample of shipping documents to related
  sales invoices
• Review the use and authorization of credit
  memoranda
• Reconcile selected cash register tapes with sales
  journals.
• Test computer application controls
• Examine evidence of review and approval of
  revenue estimates
• Reassess control risk and modify substantive
  tests for receivables and revenue.

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Audit Program for Receivables and Revenue

• Substantive Procedures

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Audit Program for Receivables and Revenue
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Audit Program for Receivables and Revenue
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Confirmation of Receivables

• Receivables should be confirmed, unless
• Accounts receivable are immaterial
• The use of confirmations would be ineffective
• The auditors combined assessment of inherent and
  control risk is low, and audit risk can be
  reduced to acceptably low level with substantive
  tests

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Confirmation of Receivables

• Useful in establishing existence and gross
  valuation of receivables.
• Provides evidence that lapping of receivables
  is not taking place.
• Integrity of the confirmation process requires
• Confirmations requests should be signed by client
• Auditors should mail confirmations.
• Confirmations should be returned directly to
  auditors.

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Confirmation of Receivables

• Two types of confirmations
• Positive confirmations
• Balance included on form
• Blank form
• Negative confirmations
• Should only be used in certain circumstances
• Low assessed level of inherent and control risk
• Large number of accounts with relatively small
  balances
• No reason to expect non-response

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Flowchart of the Confirmation Process
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Prepare and Mail the Requests
Send 2nd requests for positive confirmations
Perform alternative procedures for non-respondents
Resolve exceptions
Document the procedures and results
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Alternative Procedures for Non-responding
Confirmations

• Examination of subsequent cash receipts.
• Examination of customer orders, shipping
  documents, and duplicate sales invoices.