Revenue Cycle

Audit of the Revenue Cycle Test of Controls Typical Transactions in the Sales and Collection Cycle Five major classes of Transactions: • Sales • Cash receipts • Sales returns and allowances – Technically two distinct transactions • The write-off of uncollectible accounts • Bad-debt expense An Overview of Functions, Documents, and Accounting Systems It is important to notice the separate departments It shows good segregation of duties • Order Entry Department = Good control point – The starting point By phone, internet or mail Signed by the customer, except for telephone or internet orders Sales order Credit Manager signs the sales order for credit approval Okra Development Corp Copy Purchase Order 6-3378 8924 Bailey Road Salem, OR 92117 Date: Ship By: Terms: To: Faragut Sales, Inc 3812 Briar Drive Salem, OR 92115 Quantity Number 10 Model 317 August 5, 201X September 12, 201X 2/10, n/30 FOB Shipping Point Ship to: Okra Development Corp 8924 Bailey Road, Salem, OR 92117 Description Roller Bearing for Price Amount 48.00 480.00 Model 3118 Ripper Purchase order number must appear on all shipments and invoices Spangler Ordered By Margaret Prenumbered Sales Order Controlled numerically • Shipping involves the Shipping Department Approved by Credit Manager Order Entry Approved Sales Order Billing and A/R Prepare Multi-Part Bill of Lading Customer A legal document that the carrier is required to have Common Carrier Always useful to have a numerical file Kept in Shipping Dept Prenumbered Bill of Lading Controlled numerically • Sales order & Bill of Lading goes to • Billing/Accounts Receivable Department A numerical file that shows approval of the sale, proof of shipment, and billing Good for testing internal controls Pricing checked Account coding checked Shipping Department SO Authorized Price List BL INV INV Summary by invoice number N Prepare Sales Invoice & Sales Summary INV Cost Department for Perpetual Inventory Sales Summary General Accounting Customer Faragut Sales, Inc D8-9912 Copy 3812 Briar Drive, Salem, OR 92115 Sales Invoice Prenumbered Sales Invoice Controlled numerically Sold Shipped to Freight Bill No Okra Development Corp 8924 Bailey Road Salem, OR 92117 8924 Bailey Road Salem, OR 92117 229-237441 FOB Shipping Point Quantity 10 We are pleased to serve you Model 317 Key controls Initials are evidence of control being performed In total or sample Price 48.00 Pricing and Math Amount 480.00 J.D Account Coding S.A.L 10 What if Control Testing Yielded Many Errors? • The first step is to determine whether the errors or exceptions – were due to a particular circumstance – or restricted to a particular time period 47 • If the errors are systemic • If this alternative control achieves the same purpose and is functioning correctly • If no compensating control? 48 Material Error • If there is no compensating control • Want to quantify the extent of the error 49 Results of Quantifying the Error • If it turns out that the results of the weakness could result in immaterial error • If a material error could result 50 Performing the Audit Program • The initial audit program is organized by audit assertion • In performing for maximum efficiency • The use of automated working paper software facilitates this process 51 Computer-Assisted Audit Tests • Where there are a large number of transactions • E.g In internal controls testing, the auditor could use automated sampling routines 52 Suitability of Test Data • Batch systems: – Test data may be inappropriate • Online systems – Test data is useful 53 Suitability of Generalized Audit Software • Best suited for analytical review, tests of detail, or dualpurpose tests, for example: 54 Problem 11-1, Page 472 Cash Receipts: Control Objectives and Control Examples Required: Prepare a table similar to Exhibit 11-4 on internal control for cash receipts General Specific Validity Completeness Authorization Accuracy Classification Accounting Proper period 55 Problem The following are auditor judgments and audit sampling results for six populations Assume large population sizes EPER (in percentage) 1 TER (in percentage) 20 15 ARACR (in percentage) 5 10 10 10 100 100 60 100 20 60 Actual sample size Actual number of exceptions in the sample REQUIRED a.For each population, did the auditor select a smaller sample size than is indicated by using attribute sampling tables for determining sample size? Evaluate, selecting either a larger or smaller size than those determined in the tables b.Calculate SER and CUER for each population c.For which of the six populations should the sample results be considered unacceptable? What options are available to the auditor? d.Why is analysis of the exceptions necessary even when the populations are considered acceptable? 56 EXPECTED POPULATION DEVIATION RATE (IN PERCENTAGE) TOLERABLE DEVIATION RATE (IN PERCENTAGE) 10 15 20 PERCENT RISK OF OVER RELIANCE (ARACR) 0.00 0.25 0.50 0.75 1.00 1.25 1.50 1.75 2.00 2.25 2.50 2.75 3.00 3.25 3.50 3.75 4.00 5.00 6.00 7.00 149 236 99 157 157 208 74 117 117 117 156 156 192 227 59 93 93 93 93 124 124 153 181 208 49 78 78 78 78 78 103 103 127 127 150 173 195 42 66 66 66 66 66 66 88 88 88 109 109 129 148 167 185 36 58 58 58 58 58 58 77 77 77 77 95 95 112 112 129 146 32 51 51 51 51 51 51 51 68 68 68 68 84 84 84 100 100 158 29 46 46 46 46 46 46 46 46 61 61 61 61 61 76 76 89 116 179 19 30 30 30 30 30 30 30 30 30 30 30 30 30 40 40 40 40 50 68 14 22 22 22 22 22 22 22 22 22 22 22 22 22 22 22 22 30 30 57 37 EPDR 0.00 0.25 0.50 0.75 1.00 1.25 1.50 1.75 2.00 2.25 2.50 2.75 3.00 3.25 3.50 3.75 4.00 4.50 5.00 5.50 6.00 7.00 7.50 8.00 8.50 10 15 20 10 PERCENT RISK OF OVER RELIANCE (ARACR) 114 194 194 265 76 129 129 129 176 221 57 96 96 96 96 132 132 166 198 45 77 77 77 77 77 105 105 132 132 158 209 38 64 64 64 64 64 64 88 88 88 110 132 132 153 194 32 55 55 55 55 55 55 55 75 75 75 94 94 113 113 131 149 218 28 48 48 48 48 48 48 48 48 65 65 65 65 82 82 98 98 130 160 25 42 42 42 42 42 42 42 42 42 58 58 58 58 73 73 73 87 115 142 182 22 38 38 38 38 38 38 38 38 38 38 52 52 52 52 52 65 65 78 103 116 199 15 25 25 25 25 25 25 25 25 25 25 25 25 25 25 25 25 34 34 34 45 52 52 60 68 11 18 18 18 18 18 18 18 18 18 18 18 18 18 18 18 18 18 18 18 25 25 25 25 32 58 SAMPLE SIZE 25 30 35 40 45 50 55 60 65 70 75 80 90 100 125 150 200 ACTUAL NUMBER OF DEVIATIONS FOUND 11.3 9.5 8.2 7.2 6.4 5.8 5.3 4.9 4.5 4.2 3.9 3.7 3.3 3.0 2.4 2.0 1.5 17.6 14.9 12.9 11.3 10.1 9.1 8.3 7.7 7.1 6.6 6.2 5.8 5.2 4.7 3.7 3.1 2.3 PERCENT RISK OF OVER RELIANCE 19.5 16.9 14.9 18.3 13.3 16.3 19.2 12.1 14.8 17.4 19.9 11.0 13.5 15.9 18.1 10.1 12.4 14.6 16.7 18.8 9.4 11.5 13.5 15.5 17.4 19.3 8.7 10.7 12.6 14.4 16.2 18.0 19.7 8.2 7.7 6.8 6.2 4.9 4.1 3.1 10.0 9.4 8.4 7.6 6.1 5.1 3.8 11.8 11.1 9.9 8.9 7.2 6.0 4.5 13.5 12.7 11.3 10.2 8.2 6.9 5.2 15.2 14.3 12.7 11.5 9.3 7.7 5.8 16.9 15.8 14.1 12.7 10.3 8.6 6.5 18.4 17.3 15.5 14.0 11.3 9.4 7.1 20.0 18.8 16.8 15.2 12.2 10.2 7.7 10 18.1 16.4 13.2 11.0 8.3 59 Sample size ACTUAL NUMBER OF DEVIATIONS FOUND 10 10 PERCENT RISK OF OVER RELIANCE 20 25 30 35 40 45 50 55 60 70 80 90 100 120 160 200 10.9 8.8 7.4 6.4 5.6 5.0 4.5 4.1 3.8 3.2 2.8 2.5 2.3 1.9 1.4 1.1 18.1 14.7 12.4 10.7 9.4 8.4 7.6 6.9 6.3 5.4 4.8 4.3 3.8 3.2 2.4 1.9 19.9 16.8 14.5 12.8 11.4 10.3 9.4 8.6 7.4 6.5 5.8 5.2 4.4 3.3 2.6 18.1 15.9 14.2 12.9 11.7 10.8 9.3 8.3 7.3 6.6 5.5 4.1 3.3 19.0 17.0 15.4 14.0 12.9 11.1 9.7 8.7 7.8 6.6 4.9 4.0 19.6 17.8 16.2 14.9 12.8 11.3 10.1 9.1 7.6 5.7 4.6 18.4 16.9 14.6 12.8 11.4 10.3 8.6 6.5 5.2 18.8 16.2 14.3 12.7 11.5 9.6 7.2 5.8 17.9 15.7 14.0 12.7 10.6 8.0 6.4 19.5 17.2 15.3 13.8 11.6 8.7 7.0 18.6 16.6 15.0 12.5 9.5 7.6 60 Problem 11-3, Page 474 Cash Receipts: Weaknesses and Recommendations The Pottstown Art League operates a museum for the benefit and enjoyment of the community During hours when the museum is open to the public, two volunteer clerks positioned at the entrance collect a $5 admission fee from each nonmember patron Members of the Art League are permitted to enter free of charge on presentation of their membership cards At the end of each day, one of the clerks delivers the proceeds to the treasurer The treasurer counts the cash in the presence of the clerk and places it in a safe Each Friday afternoon, the treasurer and one of the clerks deliver all the cash held in the safe to the bank, and they receive an authenticated deposit slip that provides the basis for the weekly entry in the cash receipts journal The board of directors of the Pottstown Art League has identified a need to improve the system of internal control over cash admissions fees The board has determined that the cost of installing turnstiles or sales booths or otherwise altering the physical layout of the museum will greatly exceed any benefits that may have derived However, the board has agreed that the sale of admission tickets must be an integral part of its improvement efforts Required: The board of directors has requested your assistance Prepare a report for presentation and discussion at their next board meeting that identifies the weaknesses in the existing system of cash admission fees and suggest recommendations (AICPA adapted.) 61 ... • Use passwords to separate 24 Risk Assessment and the Sales Cycle Why risk assessment? Risk Type Impact upon Sales and Collection Cycle Client business risk Increased client business risk could... testing Identify significant risks Revenue recognition is considered a significant risk unless the auditor has evidence to the contrary; this means that controls over revenue recognition need to be... assertions that affect revenue recognition Remember that as risk increases 25 Effect of General Controls • General controls – Are pervasive and affect multiple transaction cycles – Typical examples