5/03/15. Module 8: Revenue and collection cycle, and acquisition and expenditure cycle

Transcription

1 Instructor Michael Brownlee B.Comm(Hons),CGA Module 8: Revenue and collection cycle, and acquisition and expenditure cycle 8.1 The balance sheet approach 8.2 Revenue and collection cycle The basics 8.3 Revenue and collection cycle Tests of controls 8.4 Cash balances 8.5 Accounts receivable 8.6 Accounts receivable Substantive procedures 8.7 Accounts receivable Confirmations 8.8 Acquisition and expenditure cycle The basics Module 8: Revenue and collection cycle, and acquisition and expenditure cycle 8.9 Acquisition and expenditure cycle Tests of controls 8.10 Accounts payable and accrued liabilities Knowledge of the business 8.11 Accounts payable and accrued liabilities Substantive procedures 1

2 8.1 The balance sheet approach Explain how net income is indirectly audited through the balance sheet approach to auditing. (Level 1) Simply put, if you have sufficient appropriate audit evidence on all the balance sheet accounts we know the accounting equation is A= L+E; a main component of Shareholder or Owner equity is Net income. So if your balance sheet substantive procedures support the account balances, they also provides good evidence that Net Income (Rev Exp) is also appropriately stated providing opening retained earnings is correct. The other components of Equity don t usually have many transactions so don t require much audit work (dividends, capital stock, contributed surplus) 8.2 Revenue and collection cycle The basics Identify the main activities, accounts, sources of evidence, and functional responsibilities in the revenue and collection cycle, and explain how the responsibilities should be segregated. (Level 1) 2

3 Risk assessment revenue cycle Mainly concerned with revenue, cash receipt and A/R Assertion level risks existence; need to be careful of over aggressive revenue recognition policies (to meet bonus targets, etc) Ownership management moving revenues between inter-companies Completeness record keeping and custody of cash misappropriation is a common completeness risk in revenue process (two fraud techniques kiting and A/R lapping) Money laundering is an ownership risk and one that must be specifically addressed as part of the audit Valuation and ownership relating to foreign revenue (exchange rate, restriction on cash flow out of foreign country) Disclosure risk relate to revenue recognition policy/barter/ sale commitments at fixed price Etc, etc. Processes Receiving and processing customer orders Delivering goods and services Billing and accounts receivables Collection and depositing cash Reconciling bank statements The text goes through a good narrative around page 437 through 440 on custody/recording and reconciliation of the revenue process 3

4 Authorization When a customer order is received, a number of authorizations are required. Customer status, credit status and availability of inventory need to be verified before a sales order can be created. The proper price for the sale also needs to be determined. Once approved, an open sales order and a packing slip are created, and inventory may be updated for the commitment of goods Custody Physical custody of inventory starts with the stockroom or warehouse where inventory is kept. Custody is transferred to the shipping department on the authorization of the packing slips. If stock keepers or shippers have the ability to change quantities shown on packing slips, a weakness in separation of duties is created. Custody of accounts receivable implies the power to alter those records. Receivable balances can be altered directly, or by entering transactions such as returns, allowances or writeoffs. Personnel with this power may have a combination of incompatible responsibilities. Recording When the shipment is complete, several documents are created: a bill of lading as evidence of the actual delivery of goods, a sales invoice that bills the customer for the goods, and the open sales order is closed. Personnel with the ability to enter, alter, or physically intercept the sales invoice may have a combination of incompatible responsibilities. 4

5 Periodic reconciliation A comparison of the total unpaid balances to the accounts receivable control account is a common reconciliation. This should be performed by personnel who have no responsibility over authorization, custody or recording of transactions. An aged trial balance is usually used for this reconciliation. Text goes through examples of Custody/Recording and periodic reconciliation for cash receipts and balances as well Audit evidence Same or similar from computerized to noncomputer environments: Bank statements/reconciliations Invoices Shipping docs Packing slips Customer PO s Pending order master file Credit check files Price list master file Sales journal CAATS Some examples of CAAT s on high volume sales: Analyses of customers or geographic regions assessed as high risk; Look for unusually large entries (fraud or error) Look for round numbers, repeat numbers or amounts just below a control figure that repeat more often than typical Number sequence on invoices agree to GL 5

6 Other procedures Sales analyses Aged accounts receivable trial balance this is the summary of the sub ledger used by the credit dept to follow up overdue and delinquent accounts if GL balance is higher than the sub-ledger, the company is going to be out of luck as they cannot collect an amount that is not related to a specific customer. Cash receipts journal Segregation of duties As always, a good control is to have segregation of duties; this holds true for the revenue cycle. Examples: Credit authorization should be different dept than sales Custody of cash receipts should not also have access to A/R records Recording sales/cash receipt different than recording A/R Authorization of non-cash credit to A/R separate from cash custody Custody and recording of cash separate from reconciliation Functional Responsibilities these are the different duties related to each accounting cycle. The above are examples of functional responsibilities. The FR should always be appropriately segregated when possible. 8.3 Revenue and collection cycle Tests of controls Explain the control objectives and test of controls procedures for the revenue and collection cycle. (Level 1) Control risk assessment determines nature, timing and extent of substantive procedures If auditor is relying on controls, risk assessed at below maximum and carries out tests of controls Good controls low control risk: Smaller sample sizes, earlier timing for substantive tests. Poor controls high control risk: Larger samples, more work at year end. 6

7 Control tests Identify general control objectives Develop detailed test of controls procedures that will satisfy general control objectives Evaluate results of the tests and finalize control risk assessment for each assertion in the revenue and collection cycle Revenue and collection cycle General control objectives: Recorded sales are valid and documented Valid sales transactions are recorded and none omitted Sales are authorized according to company policy Sales invoices are accurately prepared Sales transactions are properly classified Sales transaction accounting is proper Sales transactions are recorded in the proper period Examples of control tests For more detailed listing see Exhibit 11-4 in text page 445 Sales select sample of shipping docs, scan for missing numbers, trace to related sales invoice Scan sales invoices for missing numbers Vouch prices to approved price lists Trace posting to GL and proper customer account Cash Vouch to deposit slip and remittance list Trace to bank statement A/R trace sales invoices to A/R posting Vouch debit entries to sales invoices or credit entries to cash receipts 7

8 Remember directions of vouching and tracing If you can think of a paper invoice as a sales voucher then hopefully you can remember that the goal of vouching is to start at the computer and head towards the sales voucher. If results of control tests are favourable control risk is assessed as low and substantive procedures can be limited in cost saving ways.(smaller sample sizes, etc) If tests reveal control weaknesses substantive procedures will need to be designed to reduce DR 8.4 Cash balances Identify the relevant significant assertions and knowledge of the entity s business for the audit of cash balances, and describe the analytical and substantive procedures that support these assertions. (Level 1) Knowledge of entity used to identify areas of cash: Petty cash or other cash on premises All banks used and extent of accounts at each bank Names of signing authorities Analysis cash balance from one period to another; determines consistency with A/R and reasonableness with fluctuations Fluctuations can be a clue to cash misappropriation 8

9 Substantive procedures Most important assertions are existence, ownership and completeness Existence count cash on hand Bank confirmations Review subsequent month to identify large deposits prior to year end that are withdrawn immediately after Review bank reconciliations agree them to bank statements, confirmation and GL Ownership typically supported by possession (ie cash on hand, bank accounts in name of client) just have to watch out for cash restrictions Valuation only an issue if foreign currency held determine x-rate at year end. Disclosure presentation and disclosure should be in accordance with the Handbook restrictions must be disclosed in the notes. 8.5 Accounts receivable Explain the relevant knowledge of the entity s business for the audit of accounts receivable, and describe the analytical procedures used to audit accounts receivable. (Level 1) 9

10 Knowledge of entity Management s attitudes (aggressive toward sales targets?) Types of products and/or services likelihood product returned for repair under warranty Types of customers, number and account size Economic factors affecting both company and customers Credit policies too liberal could make collectability an issue (i.e. substantive tests for existence/occurrence and valuation) Analytical procedures Focus on sales and comparisons to A/R: Increase in sales does not match the percentage increase in A/R possible collection issues, overly lenient credit controls Increase in gross profit can indicate overstated sales should query management for any reasonable explanation for changes in gross profit Analyze aged summary of receivables does it agree to GL; compare to prior year any significant changes?; any long outstanding amounts that should be set up in allowance for doubtful accounts 8.6 Accounts receivable Substantive procedures Identify the most significant assertions with respect to accounts receivable, and describe the substantive procedures used to support these assertions. (Level 1) 10

11 Existence and ownership importance Some of the troubles in the financial world are related to overstating assets and revenues and understating expenses. For the revenue and collection cycle, then, it is important to examine the existence and ownership assertions. Overstatement is easier to find since there will be amounts recorded that shouldn t be as opposed to amounts that should be but aren t (completeness). For example sales recorded too early results in overstated A/R and sales. Auditor is also concerned with valuation and collectability. Has management been consistent with regard to estimates of allowance for doubtful accounts. Overstated A/R helps the liquidity ratios Completeness not as important for A/R as it is more likely that management will overstate A/R not understate it. Existence Established through review of sales transactions and supporting documentation Review of sales and cash receipts journal A/R balance confirmations 11

12 Substantive procedures Select sample of A/R and vouch to the supporting documentation such as sales invoices, shipping documents, packing slips, etc. Vouch A/R to cash receipts These can also be dual purpose tests where the samples were testing the controls of proper support documentation. Always want to look at sales and cash receipt cut-off analyze source documents close to the year end both before and after. Have goods been shipped prior to year end, etc. Send confirmations Valuation Concerned with collectability Proper estimates must be made by management for doubtful accounts Obtain confirmations Review aged summary are customer receivables accurate in amount and period (i.e. 30 days, 60 days, etc) Review actual cash receipts after year end. Very good evidence that the A/R was correct when the company collects that amount. Review factors used by management to estimate ADA Credit and collection policies are they being adhered to? Past collection history Economic factors on client and client s customers Is provision for warranty and sales returns necessary 12

13 Ownership and Disclosure Ownership really just looking for evidence that receivables have not been pledged i.e. review loan and other credit arrangements for security and pledges of A/R. Disclosure ensure proper presentation and disclosure in accordance with the Handbook. Main disclosure issue is that A/R is disclosed at net realizable value A/R checklist C Accounts receivable Confirmations Explain the nature and types of confirmations in the context of accounts receivable and their reliability as evidence. (Level 1) Procedures Accounts receivable confirmations Can be either positive or negative or both Positive requires a response better evidence if the receivable is left blank for customer to fill in from their accounting records. Negative requires response only if the amount is incorrect. Not as reliable (per CAS 505 and logic) since it is the lack of response that indicates evidence that nothing is wrong however the lack of response could be because of other reasons even if balance is wrong (customer didn t get the letter, chose to ignore it, etc) 13

14 Confirmations for A/R would not be used in a situation where RMM for A/R has been assessed as low or where the quality of evidence gained by using confirmations is deemed low. Some of the issues with confirmations: Can provide evidence supporting value but not collectability No response Auditors must control the confirmations to prevent unauthorized persons from filling in the confirmation Auditor makes assumptions about person signing confirmation that are hard to prove without further audit work (module notes 8.7) Generally considered strong evidence but it is possible that a suspicious balance can be confirmed and yet be incorrect. 8.8 Acquisition and expenditure cycle The basics Identify the main activities and accounts, the sources of evidence, and the functional responsibilities in the acquisition and expenditure cycle, and explain how these responsibilities should be segregated. (Level 1) 14

15 Main activities and accounts Transactions relating to purchase of goods or services and the subsequent disbursement of funds to pay for goods or services Control risk assessment governs nature, timing and extent of substantive procedures. Main balance sheet accounts: Cash Inventory Property, plant & equipment A/P Also included are various expense accounts from the I/S Activities in the cycle Purchase requisition Authorization to purchase Issue purchase order Receive goods and/or services Receive vendor invoice Approve invoice accuracy Record A/P Authorize payment Issue cheque Segregation Functional responsibilities should be segregated Authorization Custody Recording Reconciliation 15

16 Evidence Management reports generated for control purposes can also be used for audit evidence Exhibit 12-2 on page 493 of text 16

17 8.9 Acquisition and expenditure cycle Tests of controls Explain the control objectives and test of controls procedures for the acquisition and expenditure cycle. (Level 1) General controls Key duties should have segregation and use adequate supporting documentation. Module notes summarizes the main duties in the Acquisition and expenditure cycle as follows: Processing purchase orders: Purchasing department should not be responsible for authorizing the acquisition of goods or for the receiving of goods. All purchase orders should be sequentially pre-numbered. Receiving goods and services: Storeroom personnel should be independent of the receiving department and accounting. Pre-numbered receiving reports should be used. Recording the liability (accounts payable): Accounts payable department should be separate from purchasing, receiving, and reconciling functions. A pre-numbered voucher system should be used. Accounts payable personnel should not have access to cash. Processing and recording cash disbursements: Cheque signer(s) should be separate from accounts payable. Cheques should be pre-numbered. Supporting documents should be cancelled on payment. The person signing the cheques should not authorize or process underlying documentation but should check the documentation. A cash disbursements journal should be used. Reconciliations: The person performing the reconciliation should not be recording, have access to, or authorize purchases or payments. 17

18 General control objectives Exhibit 12-3 page 498 IMPORTANT Recorded purchases are valid and documented Valid purchase transactions are recorded and none omitted Purchases are authorized according to company policy Purchase orders are accurate Purchase transactions are properly classified Purchase transaction accounting is complete and proper Purchase transactions are recorded in proper period Test of control procedures Organization should have detailed control procedures in place Auditor designs tests for controls if control risk assessed at less than maximum Identify population select sample Control procedures Vouching Tracing Observing Scanning Recalculating Control risk assessment Final assessment based on results of test of controls Assess CR at maximum and move on to substantive testing if controls not adequate If CR assessed as low rely on controls and perform minimal substantive testing for efficiency 18

19 8.10 Accounts payable and accrued liabilities Knowledge of the business Explain the knowledge of the entity s business that is relevant to the audit of accounts payable and accrued liabilities. (Level 1) Knowledge of business Like A/R must gain knowledge of management motivation Motivated to maintain high profits could signal understated expenses/payables Auditor must consider deferred or unearned revenue and contingent liabilities Completeness assertion important assertion for A/P use investigative techniques to try to determine if there are unrecorded payables see page for extensive list of procedures Other areas Vendors familiarity with vendors gives good clues as to whether there may be some missing payables compare to prior year or prior periods throughout audit year. Expansion plans usually indicate increase in liabilities (i.e. holdbacks on construction) Salaries and wages appropriate accruals? Sales and sales returns/warranty need to know structure in order to determine deferred/unearned revenue and liabilities for returns or warranty 19

20 Analysis Typically used to direct attention of further audit procedures: Compare payables/purchase ratios to prior years or industry standards Compare aged payables summary to prior years for significant differences 8.11 Accounts payable and accrued liabilities Substantive procedures Identify the most significant assertions with respect to accounts payable and accrued liabilities, and describe the substantive procedures used to support these assertions. (Level 1) Assertions Completeness understated payables Valuation accruals subject to management estimates Existence opposite of completeness in that management may want to overstate expenses/liabilities to minimize net income and as a result income taxes. 20

21 Substantive procedures Completeness again look at page Examples: Review supplier invoices and receiving report for goods received before year end Vouch cash disbursements after year end Review government statements from month following year end (GST, source deduction, PST) Compare prior year accrued expenses to current year Substantive procedures Valuation: Determine adequacy of methods used to estimate significant accruals (i.e. wages, interest expense) Payables and accruals relating to foreign currency transactions are appropriately converted Substantive procedures Existence: Investigating large accrual entries close to year end Testing proper cut-off review shortly before and after year end for transactions Confirmations on sample of large A/P Review A/P for related party payables Management is going to deliberately understate results of operations only after it is at or close to year end so that actual results are known. 21

22 Presentation and disclosure Made in accordance with relevant Handbook recommendations Biggest issue is making sure to classify current and long-term liabilities appropriately. Getting close to the end Start thinking about areas that may be unclear or that need extra attention during review class. Don t forget your quiz this week. Look forward to assignment 3 due at end of Module 9. me if you have questions mike@thorntonandco.com Utilize all your resources Have a good week 22