2500 Plaza 5 25th fl Jersey City NJ 07311 phone 732-516-1648 fax 732-516-9778
Copyright © Daniel Cullinane CPA.
As part of a financial audit, the auditor must assess the inherent risk associated with the revenue cycle and perform tests to determine it is relatively free of error or fraud. The inherent risk for this cycle is related to the cutoff dates for particular types of sales and the pressures from management to misstate revenues. By conducting so-called substantive tests and tests of controls, the auditor can provide some assurance that the revenues of the company are recorded accurately.
Revenue recognition issues usually stem from consignment sales, round-trip sales, refund and return rights, gross sales and bill and hold transactions. Sometimes management feels pressure to misstate revenues to encourage investors or impress upper-level management or the board of directors. Other times it is simply a case of human error and recording the revenue at the wrong time. Before performing the audit, the auditor should develop an understanding of both the entity and industry in which the organization operates so he can better assess the outcome of the auditing procedures.
Analytical procedures often include running various financial ratios and comparing them to industry benchmarks. For the revenue cycle, the auditor examines the gross profit margin and the amount of growth that the company has experienced in one year. As part of the analytical procedures, he should analyze the organization's maximum capacity for sales if its facility and employees were fully utilized. He must also examine the accounts receivable account to ensure it is not outgrowing sales. If it is, this could indicate that the company is a credit risk and may have cash flow problems in the future.
Tests of Controls
The main component for the internal controls of an organization, no matter which cycle they are pertinent to, is management's adoption and adherence to high ethical standards and strong controls. Tests of controls for the revenue cycle include who accepts and approves credit sales; the separation of duties for filling out, shipping, and recording sales orders; appropriate documentation for collecting and depositing cash and recording the receipts; the appropriate authority and documentation to grant discounts for early or cash payments and sales returns; and management authorization to determine that an account is uncollectible and should be written off to bad debts.
Performance of substantive tests will help to find any errors or misstatements within the accounts or documentation associated with the revenue cycle. These tests include checking the trial balance that the accountant creates at the end of the cycle, confirming receivable amounts with the company or person who owes money and evaluating the accuracy of the allowance for uncollectible accounts by reviewing the history of the entity. They also include vouching, tracing and performing cutoff tests for all sales, sales returns and cash receipts. To do this, the auditor examines all documentation related to a customer and also examines a journal entry; she then either works forward from the initial sales order to the journal entry or backward from journal entry to initial sales order to determine accuracy.
REVENUE CYCLE AUDIT PROCEDURES
Daniel Cullinane CPA
25 Plaza 5 25th fl Jersey City NJ phone 732-516-1648 fax 732-516-9778