On 17th December 2018, the Competition and Markets Authority (CMA) published an update paper outlining serious competition concerns and proposing changes to legislation to improve the audit sector for the benefit of savers and investors alike.
Boludo
Week5-Revenue_Cycle_and_Controls.pdf
Auditing Week 5 – Revenue Cycle and Controls
Use with Auditing 10e by Alan Millichamp and John Taylor
ISBN 9781408044087
© 2012 Cengage Learning EMEA
Professional scepticism
Auditors should approach their work with an attitude of professional scepticism.
Auditors must adopt a questioning mind and not accept easy explanations or assurances in the absence of corroborating evidence.
Use with Auditing 10e by Alan Millichamp and John Taylor
ISBN 9781408044087
© 2012 Cengage Learning EMEA
Professional scepticism
Where possible auditors must
◼ Obtain corroborative evidence for statements made to them and obtain sufficient reliable evidence to support their conclusions.
◼ Follow up anomalies or unusual transactions uncovered during the audit and, if necessary carry out some additional procedures in order to verify explanations given to them.
Use with Auditing 10e by Alan Millichamp and John Taylor
ISBN 9781408044087
© 2012 Cengage Learning EMEA
Systems approach
▪ Check efficiency of internal controls on a test basis
▪ Look at sales, purchases and wages cycles in totality
(‘cycle approach’)
▪ Substantive tests of account balances
▪ Use of analytical procedures
▪ Can still be costly
▪ Small frauds and errors often missed but not considered
material to accounts
Use with Auditing 10e by Alan Millichamp and John Taylor
ISBN 9781408044087
© 2012 Cengage Learning EMEA
Balance sheet approach
Where risk based auditing ends and substantive testing
takes over
Linked to analytical review and business risk evaluation
Test balance sheet items – if balance sheet is OK than
transactions and profit elements s/be OK
Need to ensure opening position is correct i.e. is closing
position from last year
Use with Auditing 10e by Alan Millichamp and John Taylor
ISBN 9781408044087
© 2012 Cengage Learning EMEA
Transaction cycle approach
Remember transaction cycles from F8 – purchases , sales , wages
This approach is similar to systems based approach but is confined to
substantive testing of transactions in cycle
Examine transactions, check to books and vouchers to obtain evidence
– now only used for small organisations or where internal control is
poor
Danger is – over auditing
- understatement – need directional testing and
subsequent events reviews to
ensure completion
Generally costly approach
Use with Auditing 10e by Alan Millichamp and John Taylor
ISBN 9781408044087
© 2012 Cengage Learning EMEA
Substantive testing
Two categories
▪ Detailed tests
▪ Analytical review
The purpose of substantive tests is to provide sufficient
reliable evidence to validate the assertions on which
the financial statements are based
Use with Auditing 10e by Alan Millichamp and John Taylor
ISBN 9781408044087
© 2012 Cengage Learning EMEA
Basis of substantive testing
Auditors obtain audit evidence by one or more of the
following procedures:
▪ inspection,
▪ observation,
▪ enquiry and confirmation,
▪ computation
▪ analytical procedures.”
Use with Auditing 10e by Alan Millichamp and John Taylor
ISBN 9781408044087
© 2012 Cengage Learning EMEA
Analytical procedures
◼ Analytical review is a form of substantive procedure which uses ratio
analysis and other statistical information to confirm that figures in the
financial statements make sense in view of the auditor’s knowledge
and evidence from other sources.
◼ The technique can provide an initial indication of audit risk at the
planning stage.
◼ It can also provide proof in total of the accuracy and reliability of the
financial statements during the final year audit.
Use with Auditing 10e by Alan Millichamp and John Taylor
ISBN 9781408044087
© 2012 Cengage Learning EMEA
Analytical review – process
▪ Analysing of relationships
▪ Comparing actual with predicted, with comparatives of
previous years, comparable businesses or industrial
averages, etc
▪ Investigating variations
▪ Obtaining explanations for variations
▪ Evaluating results in relation to other audit evidence
Use with Auditing 10e by Alan Millichamp and John Taylor
ISBN 9781408044087
© 2012 Cengage Learning EMEA
Revenue recognition
Key issue is completeness
IAS 18 Revenue
Gross inflow of economic benefits during period arising from the
ordinary activities of the enterprise where those inflows result in an
increase in equity other than increases arising from contributions
from equity participants
Relates to
▪ Sale of goods
▪ Rendering of services
▪ Interest, royalties, dividends
Use with Auditing 10e by Alan Millichamp and John Taylor
ISBN 9781408044087
© 2012 Cengage Learning EMEA
Sale of goods
Should only recognise revenue when:
▪ Significant risks/rewards of ownership are transferred
▪ No continuing involvement with goods
▪ Revenue can be measured reliably
▪ Probable that economic benefits will flow to enterprise
▪ Costs incurred can be measured reliably
Use with Auditing 10e by Alan Millichamp and John Taylor
ISBN 9781408044087
© 2012 Cengage Learning EMEA
Rendering of services
Can recognise revenue depending on the stage of completion of the
transaction
▪ Revenue can be measured reliably
▪ Probable that economic benefits will flow to enterprise
▪ Costs incurred can be measured reliably
▪ Stage of completion at B/S date can be measured reliably
Reliable estimates possible when
▪ Each parties enforceable rights agreed
▪ Consideration remains unchanged
▪ Manner and items of settlement
Use with Auditing 10e by Alan Millichamp and John Taylor
ISBN 9781408044087
© 2012 Cengage Learning EMEA
Interest royalties and dividends
Recognise revenue when
▪ Revenue can be measured reliably
▪ Probable that economic benefits will flow to
enterprise
Recognise on basis
◼ Interest – time proportion basis
◼ Royalties – accruals basis per agreement
◼ Dividends – when shareholder has right to receive payment
Use with Auditing 10e by Alan Millichamp and John Taylor
ISBN 9781408044087
© 2012 Cengage Learning EMEA
Basis of auditing
Mainly by analytical review because
Lots of information e.g. budgets, monthly accounts, last year’s figures,
etc.
Logical relationships with other numbers e.g. stock, debtors, etc.
Difficult in case of complex transactions esp. construction companies.
In that case
▪ Consider if basis for recognising revenue is reasonable
▪ Agree revenue recognised with documentation, e.g.
certificates of work completed, etc.
Use with Auditing 10e by Alan Millichamp and John Taylor
ISBN 9781408044087
© 2012 Cengage Learning EMEA
Revenues system
Use with Auditing 10e by Alan Millichamp and John Taylor
ISBN 9781408044087
© 2012 Cengage Learning EMEA
Sales
Control objectives
▪ Sales made in accordance with company objectives
▪ Customer orders are authorised, controlled and recorded and are
completed promptly and fully
▪ Goods and services supplied are invoiced
▪ Goods returned and claims are recorded so as to determine any liability
▪ To ensure that all sales revenues are included in the accounting records
accurately
▪ Ensure all sales are paid for and to minimise losses through bad debts
and/or returns
Use with Auditing 10e by Alan Millichamp and John Taylor
ISBN 9781408044087
© 2012 Cengage Learning EMEA
Control activities for sales
◼ Sales order received Check numerical sequencing of orders
Check order for approval signatures of credit controller and sales order clerk
Check order details to copy despatch note
◼ Sales despatched with copy of despatch note Check customer’s signature as proof of delivery
Check numerical sequencing of delivery notes
Check despatch note details to copy of sales invoice
Use with Auditing 10e by Alan Millichamp and John Taylor
ISBN 9781408044087
© 2012 Cengage Learning EMEA
Control activities for sales
◼ Sales invoice sent
Invoice calculations are independently checked
Details are agreed to customer’s order
Details are agreed to copy despatch note
Check numerical sequencing of invoices
◼ Sales invoices listed in the sales journal / day book
All invoices entered in sales journal/day book –use of batch totals, processing controls
Check numerical sequence of invoices entered
◼ Individual sales journal entries posted to sales ledger
Individual postings from journal to individual sales ledger accounts confirmed
Use with Auditing 10e by Alan Millichamp and John Taylor
ISBN 9781408044087
© 2012 Cengage Learning EMEA
Control activities for sales
◼ Monthly total of sales journal posted to control account
Monthly postings of sales journal totals to debtors
control account in general / nominal ledger
Periodic reconciliation of control account with total
of debtors’ ledger balances
◼ Monthly statements sent to customers
Disputes and differences followed up
Use with Auditing 10e by Alan Millichamp and John Taylor
ISBN 9781408044087
© 2012 Cengage Learning EMEA
Control activities for sales
◼ Receipts entered in cash book and cash and cheques subsequently banked
Mail opening procedures and memorandum record of receipts reconciled to cash book.
Procedures to ensure prompt deposit
◼ Receipts posted to debtors’ ledger Control account reconciliations
Use with Auditing 10e by Alan Millichamp and John Taylor
ISBN 9781408044087
© 2012 Cengage Learning EMEA
Suggested ICQ questions for sales
◼ Are all sales orders signed by the credit controller as an indication that credit approval has been given?
◼ Are all sales orders signed or initialled by an authorised person as an indication that the order is accepted?
◼ Are sequentially numbered despatch noted prepared from sales orders, are details independently checked, and is the sequence checked for missing despatch notes?
◼ Are despatch note numbers evidenced on all sales orders?
◼ Are stock items selected for all orders independently checked to the despatch note details, and are all despatch notes signed by both the preparer and checker?
Use with Auditing 10e by Alan Millichamp and John Taylor
ISBN 9781408044087
© 2012 Cengage Learning EMEA
Suggested ICQ questions for sales
◼ Are goods being despatched checked at the gate against details on the authorised despatch note?
◼ Is the customer’s signature obtained on the proof of delivery copy of the despatch note as evidence of delivery?
◼ Are all sequentially numbered sales invoices prepared for all despatch notes, is the sequence checked for missing invoices, and are invoice details independently agreed:
For calculations?
To sales orders?
To despatch notes?
Use with Auditing 10e by Alan Millichamp and John Taylor
ISBN 9781408044087
© 2012 Cengage Learning EMEA
Suggested ICQ questions for sales
◼ Are sales invoice numbers evidenced on all despatch notes?
◼ Is there proper segregation of duties between those responsible for
the following functions:
The preparation of sales orders?
The authorisation of sales orders?
The custody and despatch of goods?
The preparation of sales invoices?
Use with Auditing 10e by Alan Millichamp and John Taylor
ISBN 9781408044087
© 2012 Cengage Learning EMEA
ICEQ questions for sales
◼ Can goods be sold without proper authorisation?
◼ Can goods be despatched without being invoiced?
◼ Can goods be invoiced without being recorded at the correct amounts?
◼ Can debtors accounts be improperly credited?
◼ Can debts go uncollected?
◼ Can cash and cheques be received but not be properly recorded?
◼ Can debtors be shown in the financial statements at amounts which are over or understated?
Use with Auditing 10e by Alan Millichamp and John Taylor
ISBN 9781408044087
© 2012 Cengage Learning EMEA
Audit approach for sales/debtors
Sales and receipts from customers approach will be
compliance testing of controls
Receivable accounts will be subject to substantive testing
of balances
Substantive tests such as debtors circularisation, aged debt
analysis will also validate sales system
Use with Auditing 10e by Alan Millichamp and John Taylor
ISBN 9781408044087
© 2012 Cengage Learning EMEA
Tests of controls
Sales orders
▪ Sequence check
▪ Evidence of approval from credit control
Despatch Notes
▪ Sequence check
▪ Customer signs for delivery – check signed delivery
notes
▪ Evidence of match to sales invoice/customer order
Use with Auditing 10e by Alan Millichamp and John Taylor
ISBN 9781408044087
© 2012 Cengage Learning EMEA
Tests of controls
Sales invoices
Test for sequence/numbering
Evidence of
▪ matching to despatch note and order
▪ checking of additions and calculations
▪ account coding
▪ initialling for work done
▪ approval for processing
Use with Auditing 10e by Alan Millichamp and John Taylor
ISBN 9781408044087
© 2012 Cengage Learning EMEA
Tests of controls
Credit notes
▪ Evidence of goods returned from customer
▪ Note reason why goods returned
Sales ledger
▪ evidence of reconciliation to control account
▪ evidence of statements sent to customers
▪ evidence of authorisation for adjustments
Use with Auditing 10e by Alan Millichamp and John Taylor
ISBN 9781408044087
© 2012 Cengage Learning EMEA
Use with Auditing 10e by Alan Millichamp and John Taylor
ISBN 9781408044087
© 2012 Cengage Learning EMEA
Homework
1. Suggest suitable controls for each stage of the sales cycle.
Risks Stage of
Cycle
Controls
(1) Order accepted from bad credit risks ORDER
(2) Orders taken down incorrectly ORDER
(3) Orders not fulfilled ORDER
(4)Orders not accepted at best prices ORDER
(1) Goods despatched without order DESPATCH
(2)No record kept of goods despatched DESPATCH
(2) Goods despatched are incorrect in quantity and
type
DESPATCH
(3) All payments are recorded in the nominal ledger DESPATCH
(4) Goods not despatched DESPATCH
(5) Goods despatched not received by customer DESPATCH
Use with Auditing 10e by Alan Millichamp and John Taylor
ISBN 9781408044087
© 2012 Cengage Learning EMEA
Homework(Continued)
1. Suggest suitable controls for each stage of the sales cycle.
Risks Stage of
Cycle
Controls
(1) Goods despatched not invoiced INVOICE
(2) Errors in invoicing INVOICE
(3) Invoices not recorded in accounting system INVOICE
(1) Remittances from customers not recorded RECEIPT
(2) Cash/cheques subsequently misappropriated RECEIPT
(2) Remittances not recorded in accounting systems RECEIPT
