AUDITING THE REVENUE CYCLE Audit procedures associated with the revenue cycle is the main point in this report. Basically, it is divided into three sections. First, it begins with a review of alternative technologies used in both legacy and modern system. The focus is on the key operational task performed under each technological environment. The second section discusses the revenue cycle audit objectives, controls and test of controls that an auditor would perform to gather evidence needed to limit the scope, timing and extent of substantive tests. The last section describes revenue cycle substantive tests in relation to audit objectives.
OVERVIEW OF REVENUE CYCLE TECHNOLOGIES Technology and automation are integral to successful financial leaders’ strategy to offset rising expenses and improve operating income. The most efficient revenue cycle will use “best practice” processes enabled by highly optimized technology. By using this combination of process and technology, organizations may realize efficiencies driven by improved workflows; reduced manual intervention; and more relevant, reliable, and timely decision-support information. This section examines alternative information technologies used in the revenue cycle.
The first of these is a sales order system that employs batch processing and uses sequential files for storing accounting records. This is an example of an early legacy type system. This approach characterizes the era of data ownership in which files were designed exclusively for the use of a single user. Second is a cash receipt system that employs batch processing and uses direct access files. This configuration is found in both modern systems and late-era legacy systems. The direct access file approach offers operational advantages over sequential file processing and permits limited data sharing.
The final system is a modern real-time sales order entry and cash receipts system that uses database technology. Modern systems design embraces reengineering to radically reshape business processes and workflow. This process involves replacing traditional procedures with procedures that are innovative and sometimes very different from those that previously existed. Information Technologies Used in the Revenue Cycle I. Batch processing system using sequential files Batch processing using sequential files involves two procedures: ? Manual procedures ? Automated procedures
Batch processing system using sequential files – Manual procedures In this basic system, order taking, credit checking, warehousing and shipping are performed manually. The following discussion outlines the key features of the system. 1. Obtaining and recording the customers’ order The sales process begins in the sales department with the receipt of a customer order indicating the type and quantity of merchandise being requested. The primary objective of this step is to ensure that the relevant data about the transaction are transcribed into a standard format that can be processed by the selling entity’s system.
The document prepared in this procedure is the sales order. The process begin as the sales order captures vital information such as the name and address of the customer; the customer’s account number; the name, number and description of the item sold; the quantities and unit prices of each item sold; and other financial information such as taxes, discounts and freight charges. In manual systems, multiple copies of sales order are produced to serve different purposes. After preparing the sales order, the sales clerk files one copy of it in the customer open order file for future reference.
Since the process is done manually, filling the order and getting the product to the customer may take days or even weeks. 2. Approving Credit The next step in the revenue cycle is transaction authorization, which involves verifying the customers’ creditworthiness. The circumstances of the sale will determine the nature of the credit check. In our system, the credit authorization copy of the sales order is sent to the credit department for approval. The returned approval triggers the release of the other sales order copies simultaneously to various departments.
The credit copy is filed in the customer open order file until the transaction is complete. 3. Processing Shipping Orders The final step is the processing of shipping orders. The sales department sends the stock release copy of the sale order to the warehouse. After picking the stock, the clerk initials the stock release copy to indicate that the order is complete and accurate. The clerk then adjusts the stock records to reflect the reduction in inventory. Updating the inventory accounting records is an automated procedure that will be discussed later. Batch processing system using sequential files – Automated procedures
This is an automated operation. The computer system described here is an example of a legacy system that employs the sequential file structure for its accounting records. Both tapes and disks can be used as the physical storage medium for such system. However the use of tapes has declined considerably in recent years. Most organizations that still use sequential files store them on disks that are permanently connected it the computer system and require no human intervention. The following are the main points of batch processing system using sequential files – Automated procedures: 1. Keypunch/Data Entry
The process begins with the arrival of batches of shipping notices from the shipping department. These documents are copies of the sales orders that contain accurate information about the number of units shipped and information about the carrier. The data processing clerk converts the shipping notices to magnetic media to produce a transaction file of sales orders. Typically this process is continual. Batch control totals are calculated for each batch on the file. 2. Edit run The edit program is the first run in the batch process. This program validates transactions by testing each record for the existence of clerical or logical errors.
Later, these are corrected by an authorized person and resubmitted for processing with the next day’s business. The edit program recalculates the batch control totals to reflect changes due to the removal of error records. The clean transaction file is then passed to the next run in the process. 3. Sort Run The sort run physically arranges the sales order transaction file sequentially by account number, which is one of its secondary keys. To process a sequential transaction file, it must be placed in the same sequence as the master file that it is updating. 4. AR Update and Billing Run
This procedure creates a new AR_SUB master file that incorporates all the changes to the customer accounts that are affected by transaction records. The original AR-SUB master file remains complete and unchanged by the process. The creation of new and separate master file is a characteristic of sequential file processing. 5. Sort and Inventory Update Runs The sort program sorts the sales order file on the other secondary key- Inventory Number. The inventory update program reduces the quantity-on-hand field in the affected inventory records by the quantity sold field in each sales order record.
A new inventory master file is created in the process. In addition, the program compares values of the quantity-on-hand and the reorder point fields to identify inventory items that need to be replenished. 6. General Ledger Update Run Under the sequential file approach, the general ledger master file is not updated after each batch of transactions. To do so would result in the recreation of the entire general ledger every time a batch of transactions is processed. Firms using sequential files typically employ separate end-of-day procedures to update the general ledger accounts.
Batch processing system using sequential files will generate a number of management reports. This may include sales summaries, inventory status reports, transaction listings, journal voucher listings and budget and performance reports. II. Batch Cash Receipts System with Direct Access Files Cash receipts procedures are natural batch systems. They are not continuously occurring throughout the day because they are basically discrete events. Checks and remittance advices arrive from the postal service in batches. Same as deposit of cash receipts in bank which usually happens as a single event at the end of the business day.
Technology employed in this receipt system uses direct access files and batch processing which then is used to automate traditional procedures. The following discussion outlines the main points of this system: 1. Mailroom The mailroom separates the checks and remittance advices and prepares a remittance list. These checks and a copy of remittance list are sent to the cash receipts department. 2. Cash Receipts Department The cash receipts clerk reconciles the checks and the remittance list and prepares the deposit slips. The remittance list and one copy of deposit slip are then filed.
At the end of the day, the clerk deposits the cash in the bank. 3. Accounts Receivable Department The accounts receivable clerk receives and reconciles the remittance advices and remittance list. Via terminal, the clerk creates the cash receipts transaction file based on the individual remittance advices. The clerk then files the remittance advices and remittance list. 4. Data Processing Department At the end of the day, the batch program reconciles the journal voucher with the transaction file of cash receipts and updates the AR-SUB and the general ledger control accounts.
This process employs the direct access method described earlier. Finally, the system produces a transaction listing that the accounts receivable clerk will reconcile against the remittance list. III. Real-Time Sales Order Entry and Cash Receipts This system provides real-time input and output with batch updating of only some of the master files. It replaces manual procedures and physically documents with interactive computer terminals just like a reengineered sales order system. The main points of the system are the following: 1. Order Entry Procedure Sales Procedures
Under real-time processing, sales clerks receiving orders from customers process each transaction separately as it is received. Using a computer terminal connected to an edit/inquiry program, the clerk performs the following task in real time mode: 1. Perform a credit check online by accessing the customer credit file 2. If credit is approved, the clerk then accesses the inventory master file and checks the availability of the inventory. 3. The system automatically transmits an electronic stock release record to the warehouse and a shipping notice to the shipping department, and records the sale in the open sales order file.
Warehouse Procedure The warehouse clerk’s terminal immediately produces a hard copy printout of the electronically transmitted stock release document. The clerk then picks the goods and sends them along with a copy o the stock release document to the shipping department. Shipping and Billing The shipping clerk reconciles the goods, the stock release document, and the hard copy packing slip produced on the terminal. The clerk then selects the carrier and prepares the goods for shipment. From a terminal, the clerk transmits a shipping notice containing invoice, date, and carrier information to create a shipping log of the event.
The transaction record is removed from the open sales order file and added to the sales invoice file. Finally, drawing from data in the customer file, the system automatically prepares the customer’s bill. 2. Cash Receipts Procedure In this system, each invoice is billed and paid individually. Cash from customers may be received and processed as just described or may be sent directly to a bank lock-box. In either case, the remittance advices are sent to the accounts receivable function, where the clerk enters them into the system via a terminal.
Each remittance record is assigned a unique remittance number and is added to the remittance file. Placing the remittance number and the current date in the respective fields then closes the corresponding open invoice record. Features of Real-Time processing This system is a departure from traditional accounting. A central feature of the system is the use of an events database. Traditional accounting records may not exist per se. In theory such system does not even need a general ledger because sales, sales returns, accounts receivable-control and cost of goods sold can all be derived from the invoices in the events database.
Most organizations, however, prefer to maintain a separate general ledger file for efficiency and as a cross check of processing accuracy. The four advantages which make this approach attractive option for many organizations are the following: 1. Real-time processing greatly shortens the cash cycle of the firm. 2. Real-time processing can give a firm a competitive advantage in the market-place. 3. Manual procedures tend to produce clerical errors, such as incorrect account numbers, invalid inventory numbers and price-quantity extension miscalculations. 4.
Real-time processing reduces the amount of paper documents in a system. REVENUE CYCLE AUDIT OBJECTIVES, CONTROLS AND TEST OF CONTROLS Input controls Input controls are designed to ensure that the transactions are valid, accurate, and complete. Control techniques vary considerably between batch and real time systems. The following input controls relate to revenue cycle operations: Credit Authorization Procedure The purpose of the credit check is to establish the creditworthiness of the customer. Only customer transactions that meet the organization’s credit standards are valid and should be processed further.
In batch systems with manual credit authorization procedures, the credit department is responsible for implementing the firm’s credit policies. Testing Credit Procedures Failure to apply credit policy correctly and consistently has implications for the adequacy of the organization’s allowance for uncollectible accounts. The following tests provide evidence pertaining to the valuation/allocation audit objectives and to a lesser extent, the accuracy objective. The auditor needs, therefore, 1. to determine that effective procedures exist to establish appropriate credit limits; 2. ommunicate this information adequately to the credit policy decision makers; 3. review credit policy periodically and revise it as necessary; and 4. monitor adherence to current credit policy. The auditor can verify the correctness of programmed decision rules by using either: ? Test Data ? Integrated Test Facility This testing is easily accomplished by creating several dummy customer accounts with various lines of credit and then processing test transactions that will exceed some of the credit limit. The auditor can then analyze the rejected transactions to determine if the computer application correctly applied the credit policy.
The integrity of reference data is an important element in testing credit policy controls. A correctly functioning computer application cannot successfully apply credit policy if customer credit limits are excessively high or can be changed by unauthorized personnel. Substantive Tests traditionally follow test of controls because the results of test of controls because the results of test of controls are used to determine the nature, timing, and extent of the substantive tests. In this case, however, substantive tests may be the most efficient way to verify if credit policy is being properly applied.
Data Validation Controls In the batch system, data validation occurs only after the goods have been shipped. Extensive error logs, error correction, and transaction resubmission procedures characterize such systems. General Types of Validation Tests that are relevant to the revenue cycle includes: ? Missing Data Checks ? Numeric-Alphabetic Data Checks ? Limit Checks ? Range Checks ? Validity Checks ? Check Digit Testing Validation Controls Data entry errors that slip through edit programs undetected can cause recorded accounts receivable and revenue amounts to be materially misstated.
The audit procedures described provide evidence about the accuracy assertion. The central audit issue is whether the validation programs in the data editing system are functioning correctly and have continued to function as intended throughout the period. Testing the logic of a validation program, however, represents a significant undertaking. The auditor may decide to rely on the quality of other controls to provide the assurance needed to reduce substantive testing. Batch Controls Batch Controls are used to manage high volumes of transaction data through a system.
The objective of batch control is to reconcile output produced by the system with the input originally entered into the system. While initiated at the data input stage, batch control continues through all phases of data processing. An important element of batch control is the batch transmittal sheet which captures relevant information about the batch, such as the following: ? A unique batch number ? A batch date ? A transaction code ? The number of records ? The number of records in the batch ? The total dollar value of a financial field ? The total of a unique nonfinancial field Testing Batch Controls
The failure of batch controls to function properly can result in records being lost or processed multiple times. Test of batch of controls provide the auditor with evidence relating to the management assertions of completeness and accuracy. Process Controls Process Controls include computerized procedures for file updating and restricting access to data. Depending on the level of computer technology in place, process controls may also include physical manual tasks. File Update Controls These controls ensure that each run in the system processes the batch correctly and completely. After each major operation in the process, key ields such as invoice amount and record counts are accumulated and compared to the corresponding values stored in the control record. A discrepancy may indicate that a record was lost in processing, a record in the batch went unprocessed, or a record was processed more than once. Transaction Code Controls The actual tasks performed by the application are determined by a transaction code assigned to each record. Errors in transaction codes, or in the program logic that interprets them, can cause incorrect processing of transactions and may result in materially misstated sales and accounts receivable balances.
Sequence Check Controls In systems that use sequential master files, the order of the transaction records in the batch is critical to correct and complete processing. As the batch moves through the process, it must be re-sorted in the order of the master file used in each run. Testing File Update Controls The failure of file update controls to function properly can result in records going unprocessed, being processed incorrectly, or being posted to the wrong customer’s account. Tests of file update controls provide the auditor with evidence relating to the assertions of existence, completeness and accuracy.
Testing run-to-run controls is a logical extension of these procedures and needs no further explanations. Test of transaction codes and sequence checks can be performed using ITF or the tests-data approach. The auditor should create test data that contain records with incorrect transaction codes and records that are out of sequence in the batch and verify that each was handled correctly. Implicit in this test is verifying the mathematical correctness of the computer operation. The efficient use of logic-testing CAATTs like ITF requires careful planning.
By determining in advance the input and process controls to be tested, a single unit procedure can be devised that performs all tests in one operation. Access Controls Access controls prevent and detect unauthorized and illegal access to the firm’s assets. Inventories and cash are the physical assets of the revenue cycle. Traditional techniques used to limit access to these assets include the following: ? Using warehouse security, such as fences, alarms, and guards ? Depositing cash daily in the bank ? Using a safe or night deposit box for cash Locking cash drawers and safes in the cash receipts department Testing Access Controls Access control is at the heart of accounting information integrity. In the absence of controls, invoices can be deleted, added, or falsified. Individual account balances, can be erased, or the entire accounts receivable file can be destroyed. Evidence gathered about the effectiveness of access controls tests the management assertions of existence, completeness, accuracy, valuation and allocation, rights and obligations and presentation and disclosure. Segregation of Duties
Proper segregation of duties ensures that no single individual or department processes a transaction in its entirety. The number of employee in the organization and the volume of transactions being processed will influence how tasks are divided. In general, the following rules apply: 1. Transaction authorization should be separate from transaction processing. 2. Asset custody should be separate from the recordkeeping tasks. 3. The organization should be so structured that the perpetration of a fraud requires collusion between two or more individuals. Supervision can also provide control in the systems that are properly segregated.
Independent Verification has the purpose to review the work performed by others at key junctures in the process to identify and correct errors. In testing physical controls, inadequate segregation of duties and the lack of effective supervision and independent verification can result in fraud and material errors. The exposure issues are similar to the access control issues. Inappropriate access privileges are often associated with incompatible duties. Similarly, the purpose of collusion is to achieve unauthorized access to assets as well as the information needed to conceal the crime.
In the absence of supervision and independent verification activities, errors and fraud may go undetected. Evidence gathered from reviewing job descriptions and organizational charts, and by observing physical processes, could be used to tests all of the management assertions. Output Controls Output controls are designed to ensure that information is not lost, misdirected, or corrupted and that system processes function as intended. It can be designed to identify potential problems. Reconciling the general ledger is an output control that can detect certain types of transaction processing errors.
Another important element of output control is the maintenance of an audit trail. Examples of Audit Trail Output Controls: 1. Accounts Receivable Change Report This is a summary that shows the overall change to accounts receivable from sales orders and cash receipts. 2. Transaction Logs It serves as a permanent record of a valid transactions and not all the transaction file will always be successfully processed. 3. Transaction Listings These listing should go to the appropriate users to facilitate reconciliation with input. 4. Log of Automatic Transactions
To maintain an audit trail of the activities, all internally generated transactions must be placed in a transaction log, and a listing of the transactions should be sent to the appropriate manager. 5. Unique Transaction Identifiers Each transaction processed by the system must be uniquely identified with a transaction number. 6. Error Listing A list of all error records should go to the appropriate user to support error correction and resubmission. Testing Output Controls The absence of adequate output controls has adverse implications for operational efficiency and financial reporting.
Evidence gathered through tests of output controls relates to the completeness and accuracy assertions. SUBSTANTIVE TESTS OF REVENUE CYCLE ACCOUNTS The strategy used in determining the nature, timing, and extent of substantive tests derives from the auditor’s assessment of inherent risk, unmitigated control risk, materiality considerations, and the need to conduct the audit in an efficient manner. Revenue Cycle Risks and Audit Concerns In general, the auditor’s concerns in the revenue cycle pertain to the potential for overstatement of revenues and accounts receivable rather than their understatement.
Overstatement of accounts can result from material errors in the processing of normal transactions that occur throughout the year. In addition, the auditor should focus attention on large and unusual transactions at or near period-end. Specific issues that give rise to these concerns include these following: ? Recognizing revenues from sales transactions that did not occur; ? Recognizing sales revenues before they are realized; ? Failing to recognize period-end cutoff points, thus allowing reported sales revenues for the current period to be inflated by post-period transactions; ?
Underestimating the allowance for doubtful accounts, thus overstating the realizable value of accounts receivable; ? Shipping unsolicited products to customers in one period that are returned in a subsequent period; and ? Billing sales to the customer that are held by the seller. In resolving these concerns, the auditor will seek evidence by performing a combination of tests of internal controls and substantive tests. Tests of controls include testing both general controls and application controls specifically related to revenue cycle procedures.
An auditor may use an integrated test facility (ITF) to test the accuracy of sales transaction postings to the accounts receivable file. Although positive results from such a test may enable the auditor to reduce the degree of substantive testing needed to gain assurance about the mathematical accuracy of account processing, they offer no assurance about the collectibility of those accounts receivable. Similarly, ITF can be used to test the credit-limit logic of the edit program to provide assurance that the organization’s credit policy is being properly implemented.
However, this test provides no evidence that proper cutoff procedures were followed in calculating the total value of accounts receivable. In addition to tests of controls, the auditor must perform substantive tests to achieve audit objectives. The quality of internal controls bears on the nature and extent of substantive tests determined by the auditor to be necessary. Understanding Data The following tests involve accessing and extracting data from accounting files for analysis. The auditor needs to understand the systems and controls that produced the data, as well as the physical characteristics of the files that contain them. First, the auditor must verify that he or she is working with the correct version of the file to be analyzed. To do so, the auditor must understand the file backup procedures and, whenever possible, work with the original files. ? Second, ACL can read most sequential files and relational database tables directly but esoteric and/or complex file structures may require “flattening” before they can be analyzed. This process may involve additional procedures and special programs to produce a copy of the original file in a format that ACL can accept.
If the client organization’s systems personnel perform the flattening process, the auditor must verify that the correct version of the original file was used and that all relevant records from the original were transferred to the copy for analysis. Customer file The customer file contains address and credit information about customers. The credit limit value is used to validate sales transactions. If the sum of the customer’s outstanding account balance and the amount of current sales transaction exceeds the pre-established credit limit, then the transaction is rejected. Sales Invoice File
This file, along with the Line Item file, captures sales transactions data for the period. The sales invoice file contains summary data for each invoice. When an order is shipped to a customer, a record is added to the file. Summing invoice amount for all records in the file yields total sales for the period. When cash receipts are received, they are matched to the open invoice record, which is then closed by placing the current date in the Closed Date field. Also, the Remittance Number, which is the primary key of the cash receipt record, is added to the invoice record as a cross reference.
The accounts receivable balance for a particular customer is calculated by summing the Invoice Amount fields for all of the customer’s open invoices. Total accounts receivable for financial reporting purposes are the sum of all the open invoice records in the file. Line Item File The line item file contains a record of every product sold. Since a single transaction can involve one or more products, each record in the sales invoice file is associated with one or more records in this file. This file contains two primary keys- invoice number and item number. Both keys are needed to uniquely define each record in the file.
They also provide links to related records in the sales invoice and inventory files. The line item file is needed for operational tasks such as billing, customer service, marketing, and auditing. This data also provide audit evidence needed to corroborate the accuracy of price times quantity calculations that are summarized in the sales invoices. Inventory File The inventory file contains quantity, price, supplier, and warehouse location data for each item of inventory. Shipping Log File The shipping log is a record of all sales orders shipped to customers.
The primary key of the file is the bill of lading (BOL) number. The data in this file are useful for verifying that all sales reflected in the sales invoice file were shipped in the period under review. As an efficiency tool, these data can also be used to determine if customer orders are being shipped in a timely manner. File Preparation Procedures As a preliminary step in using ACL, each file is needs to be defined in terms of its physical location and its structure. Through a series of easy-to-use pop-up menus, the auditor specifies the name of the file and where it resides on the mainframe or PC.
ACL then prompts the auditor to define the file’s structure in terms of the length of each field and the data type contained in each field. When the file definition is completed, it is saved under a unique name assigned by the auditor. All future file access is accomplished by simply selecting the file definition from an ACL menu. ACL automatically locates the file and presents it on screen, where the auditor can review and manipulate its contents. ACL’s verify command analyzes the data fields in the selected file to ensure hat their contents are consistent with the field type in the file definition. Any validity errors detected by ACL need to be traced to their source and resolved. The auditor may also find batch control totals to be an effective means of verifying data integrity. Testing the Accuracy and Completeness Assertions Auditors often precede substantive tests of details with an analytical review of account balances. In the case of the revenue cycle, an analytical review will provide the auditor with an overall perspective for trends in sales, cash receipts, sales returns, and accounts receivable.
Ratio analysis may be used to compare total sales to cost of goods sold, sales to accounts receivable, and allowance for doubtful accounts to accounts receivable. Significant variations in account balances over time, or unusual ratios, may signify financial statement misrepresentations. However, analytical procedures can provide assurance that transactions and accounts are reasonably stated and complete and may thus permit the auditor to reduce substantive tests of details on these accounts. Review Sales Invoices for Unusual Trends and Exceptions
A useful audit procedure for identifying potential audit risks involves scanning data files for unusual transactions and account balances. The auditor can use ACL’s stratify feature to identify anomalies. The stratify function groups data into predetermined intervals and counts the numbers of records that fall into each interval. The auditor can use other ACL features to seek answers to questions raised by the preceding analysis. ACL provides a filter capability that can be used to select or ignore specific records from an entire file.
Using this feature, the auditor can select from the sales invoice file only those records with negative invoice amounts. The resulting view of the file is much smaller and provides the auditor with the details needed to investigate these anomalies. Review Sales Invoice and Shipping Log Files for Missing and Duplicate Items Searching for missing and/or duplicate transactions is another important test that helps the auditor corroborate or refute the completeness and accuracy assertions. Duplicate and missing transactions in the revenue cycle may be evidence of over- or understated sales and accounts receivable.
Duplicate sales invoice records may indicate a computer program error that materially overstates sales and accounts receivable. On one hand, a missing sales invoice may point to an unrecorded sale that was shipped but not billed, thus understating these accounts. On the other hand, it may indicate nothing more than an invoice that was issued and voided because of a clerical error. ACL is capable of testing a designated field for out-of-sequence records, gaps in sequence numbers, and duplicates for the entire file. Using this feature, the auditor can scan the invoice number field of all records in the sales invoice file.
A duplicate record may indicate that the same product was shipped to the customer twice. If it is presumed that the customer was billed only once, then the organization has forfeited the revenue from the second shipment. Missing invoices may denote that some customer orders are not shipped at all. An example of how a single test procedure can support more than one audit objective. Invoices missing from the shipping log provide evidence that tests the valuation/ allocation assertion. The auditor seeks assurance that sales revenue is recognized only when appropriate criteria are met.
In most organizations, this means that sales are recognized only when the products are shipped. The auditor should review the shipping log for the following period to determine if the missing invoice numbers are recorded there. If so, this would indicate that the merchandise was shipped after the cutoff period. It may be necessary to adjust the sales and accounts receivable balances accordingly. Review Line Item and Inventory Files for Sales Price Accuracy Evidence from testing the product prices charged to customers supports the audit objective of accuracy. Sometimes sales are given limited authority to negotiate prices with customers.
Significant discrepancies between the suggested retail price and the price actually charged, however, may indicate incompetence, clerical errors, or sales personnel exceeding their authority. Auditors would verify pricing accuracy by comparing sales prices on the invoices with the published price list. But because of the physical effort involved with this approach, it could be done only on a sample basis. Therefore, out of thousands of sales records, perhaps only one or two hundred would be tested. ACL allows the auditor to compare the prices charged on every invoice in the file for the period under review.
Testing for Unmatched Records There are two possible causes for unmatched records: ? First, the value of the item number field in the line item record is incorrect and does not match an inventory record. Since the operational assumption is that the inventory master file is correct, then any line item records in the unmatched file are errors. The presence or absence of such errors is evidence that refutes or corroborates the accuracy assertions. ? Second, the inventory file. The presence of inventory records in the unmatched file means that there were no corresponding records in the line item file.
This result is not an error; it means that these products did not sell during the period. After adjusting for any seasonal influences on sales, such evidence may refute the valuation assertion. The auditor may require that the inventory be written down to reflect its market value. Testing the Existence Assertion One of the most widely performed tests of existence is the confirmation of accounts receivable. This test involves direct written contact between the auditors and the client’s customers to confirm account balances and transactions. Statement on Auditing Standards No. 7, the Confirmation Process, states that auditors should request confirmations of accounts receivable except in the following three situations: 1. accounts receivable are immaterial; 2. based on a review of internal controls, the auditor has assessed control risk to be low; or 3. the confirmation process will be ineffective. Because of the way some organizations account for their liabilities, they may be unable to respond to requests for confirmation. Government agencies and large industrial organizations often use an open-invoice system for liabilities.
Under this approach, invoices are recorded individually rather than being summarized or grouped by creditor. In this environment, no accounts payable subsidiary ledger exists. Each invoice is paid as it comes due. For financial reporting purposes, total accounts payable is calculated simply by summing the open invoices. Determining the liability due to a particular creditor, which may consist of multiple invoices, is not such a simple task. The auditor should not assume that an organization using this approach would invest the time needed to respond to the confirmation request.
Under such circumstances, the confirmation process would be ineffective. Selecting Accounts to Confirm Selecting accounts receivable for confirmation involves processing data that are contained in both the customer and the sales invoice files. Each customer record is associated with one or more sales invoice records. The sales invoice file provides the financial information needed for the confirmation requests, and the customer mailing information is contained in the customer file. Obtaining a set of accounts for confirmation requires three steps: 1. CONSOLIDATE INVOICES.
ACL’s classify command allows the auditor to set a filter to select only the open sales invoices and to summarize the invoice amount field for each record based on the customer number. The summarized records are then passed to a new file called classified invoices. 2. JOIN THE FILES. The join feature allows the auditor to select only relevant fields from each of the input files when creating the new file. 3. SELECT A SAMPLE OF ACCOUNTS. To assist the auditor in this task, ACL’s sample feature offers two basic sampling methods: random or record sampling and monetary unit sampling.
The choice of methods will depend on the auditor’s strategy and the composition of the accounts receivable file. If the account balances are fairly evenly distributed, the auditor may want an unbiased sample and will thus choose the random sample approach. Under this method, each record, regardless of the size of the accounts receivable balance, has an equal chance of being included in the sample. If, on the other hand, the file is heavily skewed with large customer account balances, the auditor may select MUS, which will produce a sample biased toward the larger dollar amounts.
ACL’s size command helps the auditor calculate sample size and sampling intervals based on the auditor’s desired confidence level, the size of the population being sampled, and the assessed materiality threshold. Preparing Confirmation Requests The confirmation requests contain the information captured in the AR-Sample file. The requests, which usually take the form of letters, are drafted and administered by the auditor, but are written in the client entity’s name. In a positive confirmation letter, recipients are asked to respond whether their records agree or disagree with the amount stated.
These are particularly useful when the auditor suspects that a large number of accounts may be in dispute. They are also used when confirming unusual or large balances or when a large proportion of total accounts receivable arise from a small number of significant customers. A problem with positive confirmation is poor response rate. Customers that do not dispute the amount shown in the confirmation letter may not respond. The auditor cannot assume, however, that lack of response means agreement. To obtain highest response rate possible, second and even third requests may need to be sent to nonrespondents.
Negative confirmations request the recipients to respond only if they disagree with the amount shown in the letter. This technique is used primarily when accounts receivable consist of a large number of low-value balances and the control risk of misstatement is considered to be low. The sample size for this type of test typically large and may include the entire population. Evidence from nonreturned negative confirmations selected from a large population provides indirect evidence to support the auditor’s expectation that accounts receivable are not materially misstated. Since the egative confirmations approach does not prove that the intended recipients actually received and reviewed the confirmation letters, evidence of individual misstatements provided by returned responses cannot be projected to the entire population. In other words, responses to negative confirmations cannot be used as a basis for determining the total dollar amount of the misstatement in the account. Such evidence can be used, however, to reinforce the auditor’s prior expectation that the account balance may be materially misstated and that additional testing of details is needed to determine the nature and amount of misstatement.
ACL’s export features can greatly facilitate the physical task of inserting the relevant financial data for each customer into the individual letters. Using this option, the auditor can produce a text version of the AR-Sample file that can be integrated with the confirmation letter text using mail/merge feature of a word processing package such as Microsoft Word or WordPerfect. This facility greatly reduces the clerical effort traditionally associated with confirmation activities. Evaluating and Controlling Responses
Evidence provided through confirmations is less reliable when contact between the auditor and the debtor is disrupted by client intervention. The auditor should take all reasonable steps to ensure the following procedures are observed: ? The auditor should retain custody of the confirmation letters until they are mailed; ? The confirmation letters, together with the self-addressed stamped envelopes, should be addressed to the auditor, rather than the client organization; and ? The confirmation request should be mailed by the auditor. If client mailroom personnel participate in the process, they should be adequately supervised.
Nonresponses to positive confirmation also need to be investigated. SAS 67 requires auditors to use alternative procedures to resolve this issue. A commonly used procedure is to review the following period’s closed invoices to determine if the accounts were actually paid. Testing the Valuation/Allocation Assertion The auditor’s objective regarding proper valuation and allocation is to corroborate or refute that accounts receivable are stated at net realizable value. This objective rests on the reasonableness of the allowance for doubtful accounts, which is derived from aged accounts receivable balances.
To achieve this objective, the auditor needs to review the accounts receivable aging process to determine that the allowance for doubtful accounts is adequate. . APPENDIX A. Batch Processing with Sequential Files B. Sales Order C. Bill of Lading D. Batch Processing with Sequential Files E. Real Time Sales Order Entry and Cash Receipts F. File Structure for the Revenue Cycle G. Relationship between Management Assertions and Revenue Cycle Audit Objectives H. Confirmation Letter FIGURE 9-1. Batch Processing with Sequential Files SALES CREDITDATA PROCESSING WAREHOUSE SHIPPING
FIGURE 9-2. Sales Order CHARGE SALE INVOICE MONTEREY PENINSULA CO-OPINVOICE NUMBER_______ 527 River Road Chicago, IL 60612 (312) 555-0407 SOLD TO FIRM NAME______________________________INVOICE DATE__________ ATTENTION OF___________________________PREPARED BY__________ ADDRESS_______________________________CREDIT TERMS_________ CITY____________________________________ STATE_______ZIP________________________ CUSTOMER PURCHASE ORDER NUMBER________________________________SHIPMENT DATE________ DATE___________________________________SHIPPED VIA___________ SIGNED BY______________________________BOL NO. _______________ QUANTITY ORDERED |PRODUCT NUMBER |DESCRIPTION |QUANTITY SHIPPED |UNIT PRICE |TOTAL | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |TOTAL SALE | | | | |CUSTOMER ACCT. NO. | | | |VERIFICATION | FIGURE 9-3. Bill of Lading UNIFORM STRAIGHT BILL OF LADING-Domestic Monterey Peninsula Co-opDocument No. __________ 527 River Road Chicago, IL 60612 (312) 555-0407Shipper No. __________________________ Carrier No. ___________________________ Date________________________________ TO: Consignee________________________________________ Street____________________________________________ City/State Zip Code______________________________ (Name of Carrier) ____________________________________________________________ _________________________ Route: Vehicle____________ |No.
Shipping units |Kind of packaging, description of articles, special marks and |Weight |Rate |Charges | | |exceptions | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | TOTAL CHARGES $ | | | |The agreed or declared value of the property is herby |IF WITHOUT RECOURSE: |specifically stated by the shipper to be not exceeding: |The carrier shall not make delivery of this shipment | |$____________per___________________ |without payment of freight | | |_____________________________ | | |(Signature of Consignor) | | | | |FREIGHT CHARGES |Signature below signifies that the goods described above | |Check appropriate box: |are in apparent good order, except as noted.
Shipper | |[ ] Freight prepaid |hereby certifies that he is familiar with all the bill of | |[ ] Collect |lading terms and agrees with them. | |[ ] Bill to shipper | | |SHIPPER Monterey Peninsula Co-op |CARRIER | |PER |PER DATE | (This bill of lading is to signed by the shipper and agent of the carrier issuing the name. ) CONSIGNEE FIGURE 9-4. Batch Processing with Sequential Files ____ MAILROOM ___ CASH RECEIPTS_______________ACCOUNTS RECEIVABLE ____ DATA PROCESSING CONTROLLER OFFICE_______ FIGURE 9-5. Real Time Sales Order Entry and Cash Receipts _____ CUSTOMER SALES DEPARTMENT____________DATA PROCESSING DEPARTMENT____ _______WAREHOUSE________SHIPPING DEPARTMENT_____ FIGURE 9-6. File Structure for the Revenue Cycle PK |Customer | Customer |Street |City |State |Zip |Credit | |Number |Name |Address | | |Code |Limit | Customer File PK SK Invoice | Customer |Invoice |Sales |Due |Closed |Remittance | |Number |Name |Amount |Date |Date |Date |Number | Sales Invoice File PK |Invoice |Item |Sales |Quantity |Extended | |Number |Number |Price | |Price | Line Item File SK PK |Item |Description |Warehouse |Quantity on | |Number | |Location |Hand | PK SK Management Assertions Revenue Cycle Audit Objectives | | | | | | | | | TABLE 1. Relationship between Management Assertions and Revenue Cycle Audit Objectives FIGURE 9-7. Confirmation Letter CLIENT LETTERHEAD (CLIENT NAME AND ADDRESS) (Name and Address of Client’s Customer) To Whom It May Concern: In accordance with the request from our external auditors, we ask that you confirm your outstanding account balance with our organization. Our records indicate that your account balances as of (end-of-period date) amounted to ($ amount).
If your records agree with this balance, please indicate by signing in the space provided below and return this letter directly to our auditor’s using the enclosed envelope. Your prompt compliance with this request is greatly appreciated. If the amount indicated is not in agreement with your records, inform the auditors directly using the enclosed envelope. In your response, please show the amount owed according to your records and include full details of the discrepancy. Sincerely, (Name of the Entity) The amount stated above is correct: (Customer Name) ———————– Customer Customer order Receive customer order and prepare sales order File A Customer copy Credit copy Stock release
Packing slip Shipping notice File copy Customer order Credit copy Check credit Credit copy Key strokes Sales order file Edit Edited file Errors Sort program Sorted SO file AR update and billing program Sales orders Sort run Sorted SO file Old AR files New AR files Sales journal Journal voucher Old GL file New GL file Sorted journal vouchers Sorted journal vouchers General ledger update Management reports Customer’s invoice Customer Management Shipping notice Master file update program Sort sales order file by customer account number Old inventory file New inventory file End of day BATCH process File copy Shipping notice Packing slip Stock release
Reconcile documents and goods, sign shipping notice, and prepare BOL Shipping notice Stock release Pick goods and send to shipping Stock release A File copy Stock release BOL File BOL BOL Packing slip Carrier Shipping Log File Inventory File Carrier BOL BOL Stock release Packing slip Terminal Reconcile goods with packing slip and prepare bill of lading Packing slip Terminal Stock release Terminal Accounts Receivable Terminal Remittance advice Credit memo Inventory file Record sales invoice and shipment Sales invoices Existence or OccurrenceVerify that the accounts receivable balance represents amounts actually owed to the organization at the Balance Sheet Date.
CompletenessDetermine that all amounts owed to the organization at the balance sheet date are reflected in accounts receivable. Verify that all sales for shipped goods, all services rendered, and all returns and allowances for the period are reflected in the financial statements. AccuracyVerify that revenue transactions are accurately computed and based on current prices and correct quantities. Ensure that the accounts receivable subsidiary ledger, the Sales Invoice file, and the Remittance file are mathematically correct and agree with general ledger accounts. Rights and ObligationsDetermine that the organization has a legal right to recorded accounts receivable.
Customer accounts that have been sold or factored have been removed from the accounts receivable balance. Valuation and AllocationDetermine that accounts receivable balance states its net realizable value. Establish that the allocation for uncollectible accounts is appropriate. Presentation and DisclosureVerify accounts receivable and revenues reported for the period are properly described and classified in the financial statements. Transaction listing of AR update Cash rec journal Gen Ledger accounts Accounts receivable Master file update program Journal vouchers Cash Rec Trans file Date entry program B A File Bank File Transaction listing of AR update Review Remittance advice Remittance list B Terminal
Update AR ledger Remittance advice Remittance list A Terminal Record cash receipt Deposit slip Deposit slip Deposit slip Remittance list Check Remittance list Check Remittance advice Check Remittance list Remittance list Remittance list Remittance advice Check Customer Inventory file Record sales invoice and shipment Customer file Open sales orders Check, credit and update inventory Inventory file Customer file Customer invoice Terminal Customer order Clerk reconciles deposit slip from bank and cash receipts remittance list Reconciles checks with the RA and prepares remittance list Deposit slip Bank Remittance list Management Management reports
