Question

Explain why it is important to understand the accounting and reporting requirements for an area that an auditor will be assigned to audit – use sales and collections as an example. Briefly explain FASB’s revenue recognition standard.

2. Explain the basic processes involved in generating and document revenue transactions; and in collecting for revenue transactions. You can use an example to help you explain the process. As part of your explanation, also state which documents are used to detail the revenue and collections transactions in these processes.

3. Describe the steps auditors use to test controls. Within each testing step, describe the key issues and concepts. Give an example or examples to help you explain these steps.

Answer 1

The main objective of the work performed by the auditor in an audit engagement is that of obtaining reasonable assurance as to whether the financial statements, as a whole, are free from material misstatement, so that the auditor is able to express an opinion on the financial statements and report accordingly in the auditor’s report.

To obtain reasonable assurance about the financial statements, which is a high but not absolute level of assurance, the auditor needs to design and perform audit procedures to obtain sufficient appropriate audit evidence to be able to draw reasonable conclusions on which to base the auditor’s opinion.

The sales and collections cycle in a business refers to the set of processes that begin when a customer purchases goods or services and ends when the company receives complete payment for the purchase. As part of the year-end audit of a company's financial statements, external accountants test sales transactions and the internal controls over those transactions to ensure that the company is not materially misstating its revenues or accounts receivable.

FASB-Revenue is one of the most important measures used by investors in assessing a company’s performance and prospects. However, previous revenue recognition guidance differs in Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS)—and many believe both standards were in need of improvement.

On May 28, 2014, the FASB and the International Accounting Standards Board (IASB) issued (press release) converged guidance on recognizing revenue in contracts with customers. The new guidance is a major achievement in the Boards’ joint efforts to improve this important area of financial reporting.

Presently, GAAP has complex, detailed, and disparate revenue recognition requirements for specific transactions and industries including, for example, software and real estate. As a result, different industries use different accounting for economically similar transactions.

The objective of the new guidance is to establish principles to report useful information to users of financial statements about the nature, amount, timing, and uncertainty of revenue from contracts with customers.

2--Records the received revenue when payment is remitted by the debtor. The billed receivable is liquidated and the cash collection recorded. When revenue is received before it is earned, it is recorded on the cash receipt document as deferred revenue.

Non-Sufficient Funds (NF)

If a cash receipt document has been processed for a customer's check, and the check is returned for insufficient funds, a Non-Sufficient Funds (NF) document is processed. This document is used only when the check references a Receivable document. The Non-Sufficient Funds (NF) document reverses out the payment to the referenced receivables, and optionally applies a non-sufficient funds check charge.

Receivable (RE)

Enters revenue that is earned and billable into the system. Earned revenue is recognized, a billed receivable recorded, and an invoice is sent to the debtor.

Receivable Credit Memo (RM)

Credits a customer's account. For example, a Receivable Credit Memo (RM) is entered when a customer receives the incorrect quantity of goods or if the customer overpays.

Journal Voucher Master (JVM)

Reclassifies deferred revenue as earned. Journal voucher documents are discussed in detail in See Journal Vouchers.

Journal Voucher Correction (JVC)

The Journal Voucher Correction (JVC) document is used to correct previously posted expenditure or revenue transactions. The Journal Voucher Correction (JVC) document is a generalized document that records accounting corrections that cannot or should not be made.

3---(a)A test of controls is an audit procedure to test the effectiveness of a control used by a client entity to prevent or detect material misstatements. Depending on the results of this test, auditors may choose to rely upon a client's system of controls as part of their auditing activities.

Points to be noted:--

Reperformance. Auditors may initiate a new transaction, to see which controls are used by the client and the effectiveness of those controls.

Observation. Auditors may observe a business process in action, and in particular the control elements of the process.

Inspection. Auditors may examine business documents for approval signatures, stamps, or review check marks, which indicate that controls have been performed.

(b)--EXAMPLE---

• IF the warehouse is always locked (an internal control) it is less likely that the inventory will be stolen.

• This can be tested by periodically checking the warehouse door.

• If the control works there will need to be less substantive testing directed at existence of inventory.