PM550–4 Revenue Recognition. Audit Excellence 2008 Partners in Learning ©2000-2008 Deloitte Touche Tohmatsu Slide 2 Objectives You will be able to: • Describe the objective and significance of revenue recognition. • Discuss the practical issues and challenges when auditing the risk related to revenue recognition. • Implement an efficient and effective process on engagements to identify and pinpoint risks related to revenue recognition. • Outline the documentation appropriate to support the assessment of the risk of revenue recognition. • Direct engagement teams to develop tailored audit procedures that respond to the risk of revenue recognition. Partners in Learning ©2000-2008 Deloitte Touche Tohmatsu Slide 3 What we already know Revenue recognition is a presumed specific risk due to fraud • We should ordinarily presume that there is a specific risk of material misstatement due to fraud related to revenue recognition and consider which types of revenue, revenue transactions, or potential errors may give rise to such risk. <Audit Approach Manual G045.02> Exception - rebutting the presumed risk • If we have not identified a specific risk of material misstatement due to fraud related to revenue recognition, we should document the reasons supporting our determination. <Audit Approach Manual G045.05> Partners in Learning ©2000-2008 Deloitte Touche Tohmatsu Slide 4 Why revenue recognition is still topical Revenue Recognition Be mindful of deficiencies and plan towards a better audit Fraud cases Economic factors Regulators’ concerns/ Practice review findings Evolving business models/practices ISA Partners in Learning ©2000-2008 Deloitte Touche Tohmatsu Slide 5 Regulators’ concerns Key findings from PCAOB: • Evaluate compliance with GAAP & address complex or specialized revenue-recognition accounting principles. • Deficiencies in performing audit procedures: – Inadequate substantive procedures to test the existence, completeness, and valuation of revenue. – Examining significant contractual arrangements. – Performing cutoff procedures. – Applying confirmation procedures. Partners in Learning ©2000-2008 Deloitte Touche Tohmatsu Slide 6 Common fraud schemes used for improper revenue recognition • Side agreements • Channel stuffing • Round tripping sales • Bill and hold transactions • Fictitious sales to existing or nonexistent customers • Contract accounting scheme • Sham related party transactions • Contract with multiple deliverables • Consignment sales Partners in Learning ©2000-2008 Deloitte Touche Tohmatsu Slide 7 Process overview of revenue recognition WPs in Large Man pack Step 1: Determine the overall audit strategy Step 2: Discuss the possibility of fraudulent financial reporting Step 3: Understand the entity and its environment Step 6: Pinpoint the presumed specific identified risk Step 4: Understand the revenue significant flow of transactions Step 5: Perform preliminary analytical review 1230 1410 1535 1611 1832/1811 1213 Partners in Learning ©2000-2008 Deloitte Touche Tohmatsu Slide 8 Revenue recognition criteria – IAS 18 No managerial involvement or control Reliable measurement Economic benefits probable Transfer of risks and rewards Goods Partners in Learning ©2000-2008 Deloitte Touche Tohmatsu Slide 9 Revenue recognition criteria – IAS 18 No managerial involvement or control Reliable measurement Economic benefits probable Transfer of risks and rewards Goods Percentage completion Reliable measurement Economic benefits probable Services Partners in Learning ©2000-2008 Deloitte Touche Tohmatsu Slide 10 Analyze and disaggregate the revenue account Type B: Retailing Type A: Distribution Type C: Wholesale [...]... Rental income is recognized on a straight line basis over the lease term Can we rebut the presumed revenue recognition risk? Partners in Learning ©2000-2008 Deloitte Touche Tohmatsu Slide 14 Rebuttal of the presumed specific identified risk It is unusual to be able to rebut the presumption of revenue recognition risk • Document the reasons of the rebuttal in the text box of “Audit Plan by Account”... to specific transactions Type C: Wholesale Slide 11 Process overview of revenue recognition Step 1: Determine the overall audit strategy AS/2 common documentation in a large pack 1230 Step 2: Discuss the possibility of fraudulent financial reporting 1213 Step 3: Understand the entity and its environment 1410 Step 4: Understand the revenue significant flow of transactions 1535 Step 5: Perform preliminary... subsidiary of its parent entity • Sales are priced on arm’s length basis and in line with the standard pricing policy of the group • Sales are recognized when title passes Can we rebut the presumed revenue recognition risk? Partners in Learning ©2000-2008 Deloitte Touche Tohmatsu Slide 13 Example 2 You’re Trumped • “You’re Trumped” is a property investment company • It owns one leasehold property for... Document the reasons of the rebuttal in the text box of “Audit Plan by Account” Partners in Learning ©2000-2008 Deloitte Touche Tohmatsu Slide 15 Examples of audit responses dealing with specific risk of revenue recognition Perform substantive analytical procedures Confirm with customers Inquiries of sales and marketing, legal counsel Attend year-end inventory count Perform cut-off procedures Test operating... Tohmatsu Slide 16 Other efficiency and effective considerations to achieve a focused level of substantive assurance Performing tests of details using a focused level of substantive assurance for the entire revenue balance is usually not efficient or effective May be effective to apply nonrepresentative selections in tests of details Perform substantive analytical procedures, with a maximum level of substantive . and significance of revenue recognition. • Discuss the practical issues and challenges when auditing the risk related to revenue recognition. • Implement. pinpoint risks related to revenue recognition. • Outline the documentation appropriate to support the assessment of the risk of revenue recognition. • Direct