Chapter 10 - Auditing the Revenue Process

Question 1

What is the Five Step Approach to Revenue Recognition?

Answer 1

1. Identify the contract(s) with a customer
2. Identify the performance obligations in the contract
3. Determine the transaction price
4. Allocate the transaction price to the performance obligations in the contract
5. Recognize revenue when the entity satisfies a performance obligation

Question 2

! What are Fraud Risks in Revenue Recognition? !

Answer 2

1. Side agreements
2. Channel stuffing
3. Related party transactions
4. Bill and hold sales

Question 3

What are the 3 Types of Transactions Typically Processed through the Revenue Process?

Answer 3

1. The Sales 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

Question 4

Types of Documents and Records in the Revenue Process (1 - 7)

Answer 4

Credit Approval Forms
Customer Sales Orders
Open-Order Reports
Shipping Documents
Sales Invoice
Sales Journal
Customer Statement

Question 5

Types of Documents and Records in the Revenue Process (8 - 13)

Answer 5

Accounts Receivable Subsidiary Ledger
Aged Trial Balance of Accounts Receivable
Remittance Advice
Cash Receipts Journal
Credit Memorandum
Write-off Authorization

Question 6

!! What are the Major Functions of the Revenue Process? (7) !!

Answer 6

Order Entry
Credit Authorization
Shipping
Billing
Cash Receipts
Accounts Receivable
General Ledger

Question 7

!! What are the Four Inherent Risk Factors that may Affect the Revenue Process? !!

Answer 7

1. Industry-related factors
2. Complexity and Contentiousness of Revenue Recognition Issues
3. Difficulty of Auditing Transactions and Account Balances
4. Misstatements Detected in Prior Audits

Question 8

Which types of Major Material Misstatements are Auditors Concerned with in Regards to Occurence?

Answer 8

1. Sales to fictitious customers
2. Recording revenue when goods have not been shipped or services have not been performed.

Question 9

What are the Controls Concerning Completeness?

Answer 9

1. Accounting for numerical sequence of shipping documents and sales invoices
2. Matching shipping documents with sales invoices
3. Reconciling sales invoices to daily sales reports
4. Maintaining and reviewing the open-order file

Question 10

ESSAY QUESTION - What Inherent Risk Factors would an Auditor consider when Auditing the Revenue Process of a Computer Manufacturer?

Answer 10

Industry related factors such as the profitability and health of the industry, competition, and rate of technological change. A competitive industry can affect the entity’s pricing policies, credit terms, and product warranties. Gov. regulation may also affect inherent risk.

Revenue recognition shouldn’t be an issue as the revenue should be recognized when the products are shipped.

If there is difficulty in auditing transactions and account balances, that can increase inherent risk. Risk of misstatement increases with a more complex customer base.

If there are misstatements in prior audits, then that is a likely sign that inherent risk for that entity is high.

Question 11

Summary of Assertions, Possible Misstatements, Example of Control Activities, and Example of Tests of Controls for Revenue Transactions: Occurence

Answer 11

Misstatement: Fictitious revenue; revenue recorded, goods not shipped or services not performed.
Example control activity: Sales recorded only with approved customer order and shipping document.
Example Tests of Controls: Testing a sample of sales invoices for the presence of authorized customer order and shipping document.

Question 12

Summary of Assertions, Possible Misstatements, Example of Control Activities, and Example of Tests of Controls for Revenue Transactions: Completeness

Answer 12

Misstatement: Goods shipped or services performed, revenue not recorded.
Example control activity: Accounting for numerical sequences of shipping documents and sales invoices.
Example Tests of Controls: Review and testing of client procedures for accounting for numerical sequence of shipping documents and sales invoices.

Question 13

Summary of Assertions, Possible Misstatements, Example of Control Activities, and Example of Tests of Controls for Revenue Transactions: Authorization

Answer 13

Misstatement: Goods shipped for a customer who is a bad credit risk.
Example control activity: Proper procedures for authorizing credit and shipment of goods.
Example tests of controls: Examination of sales orders for evidence of proper credit approval.

Question 14

Summary of Assertions, Possible Misstatements, Example of Control Activities, and Example of Tests of Controls for Revenue Transactions: Accuracy

Answer 14

Misstatement: Revenue transaction recorded at an incorrect dollar amount.
Example control activity: Each sales invoice agreed to shipping document and customer order for product type and quantity.
Example tests of controls: Examination of sales invoice for evidence that client personnel verified mathematical accuracy.

Question 15

Summary of Assertions, Possible Misstatements, Example of Control Activities, and Example of Tests of Controls for Revenue Transactions: Cutoff

Answer 15

Misstatement: Revenue transactions recorded in the wrong period.
Example control activity: All shipping documents forwarded to the billing function daily.
Example tests of controls: Comparison of the dates on sales invoices with the dates of the relevant shipping documents.

Question 16

Summary of Assertions, Possible Misstatements, Example of Control Activities, and Example of Tests of Controls for Revenue Transactions: Classification

Answer 16

Misstatement: Revenue transaction not properly classified.
Example control activity: Chart of accounts
Example tests of controls: Review of sales journal and general ledger for proper classification.

Question 17

Summary of Assertions, Possible Misstatements, Example of Control Activities, and Example of Tests of Controls for Revenue Transactions: Presentation

Answer 17

Misstatement: Revenue transactions not properly presented and disclosed
Example control activity: Proper codes for different types of products and services
Example tests of controls: Review sales journal and general ledger for proper aggregation or disaggregation of revenue transactions, and determine if disclosure is needed.

Question 18

!! How does ASC 606 Define Revenue? !!

Answer 18

The inflows or other enhancements of assets or settlements of an entity’s liabilities from delivery or producing goods, rendering services, or other activities that constitute the entity’s major or central operations.