Auditing Key Business Processes: Revenue, Purchasing, Inventory, and Cash
Chapter 10: Auditing the Revenue Process
Five-Step Approach to Revenue Recognition
- Identify the contract(s) with customers.
- Identify performance obligations.
- Determine transaction price.
- Allocate transaction price to performance obligations.
- Recognize revenue when obligations are satisfied.
Fraud Risks
Side agreements, channel stuffing, related party transactions, bill and hold sales.
Types of Transactions
Sales transactions, cash receipts, sales returns.
Key Documents
- Customer sales order, shipping document, sales invoice,
- Credit Approval Form, Open Order Report, Sales Journal,
- (Bill returned to Customer) Customer Statement, Accounts Receivable subsidiary ledger,
- Aged Trial Balance of Accounts Receivable, Remittance Advice, Cash Receipts Journal,
- Credit Memorandum, Write off Authorization (By Treasurer)
Major Functions
- Order entry, credit authorization, shipping, billing, cash receipts.
- Accounts Receivable, General Ledger
Inherent Factors Affecting Revenue
- Industry Factors
- Complexity of Revenue Recognition
- Difficulty of Auditing Transactions and Account Balance
- Misstatements Detected in prior Audits
Documentation of Auditor’s Understanding of Revenue Process
Procedure Manuals, Narrative descriptions, IC Questionnaire, Flowcharts
To Set Control Risk
The auditor must test controls. Tests: Inquiry of Client personnel, Inspection of documents, Observation of operation of control, Walkthroughs, Reperformance of Control.
Level of control risk – either quantitative or qualitative terms such as low, medium or high
Assertions
Occurrence, Completeness, Authorization, Accuracy, Cutoff, Classification, Presentation
The auditor’s testing of control for revenue processing impacts the detection risk and therefore the level of substantive procedures impacted by the controls.
Substantive analytical procedures are used to examine plausible relationships among revenue-related accounts. Tests of details focus on transactions, account balances or disclosures.
Tests of details concentrate on the ending balance for accounts receivable and related accounts as well as related disclosures.
Aggregate misstatement > Tolerable Misstatement = Account not fairly presented otherwise Account fairly presented.
Chapter 11: Auditing the Purchasing Process
Expense & Liability Recognition
Expenses for goods, services, or activities. Liabilities for future sacrifices or obligations.
Purchasing Process Overview
Purchase requisition → Purchase order → Receiving report and liability recorded → Vendor payment.
Types of Transactions
Purchase, cash disbursement, purchase return. (In all of these 3 Various asset and expense accounts are common)
Documents and Records
- purchase requisition, Purchase order, receiving report,
- vendor invoice, voucher, voucher register/ purchase journal,
- accounts payable subsidiary ledger, vendor statement,
- Check/EFT, cash disbursements journal.
Major Functions
- Requisitioning, purchasing, receiving,
- invoice processing, disbursements, accounts payable.
Generally, the purchasing process is not difficult to audit and does not present contentious accounting issues.
However, the auditor’s experience in past audits must be considered when assessing inherent risk
Chapter 13: Auditing the Inventory Management Process
Documents and Records
- Production schedule, materials requisition, inventory master file,
- product data Information, cost accumulation report, Inventory status report,
- Shipping order
Major Functions
- Inventory management, raw materials stores, manufacturing,
- finished goods stores, cost accounting, general ledger
Inherent Risk Assessment
- Industry competition, technology changes,
- high-value items theft, related-party transactions.
Auditing Inventory
Observing physical inventory, testing transactions, valuation, and allocation.
Possible causes of book-to-physical differences:
- Inventory cutoff errors
- Pilferage or theft
Examples of Disclosure Items:
- Cost method (FIFO, LIFO, retail method)
- Components of inventory
- Consigned inventory
- LIFO liquidations
- Disclosure of unusual losses from write-downs or losses on long-term purchase commitments
- Warranty obligations
Chapter 16
“Cash” reported in the financial statements represents currency on hand and cash on deposit in bank accounts, including certificates of deposit, time deposits, and savings accounts.
“Cash equivalents” are frequently combined with cash for presentation in the financial statements.
Short-term, highly liquid investments that are readily convertible to cash or so near their maturity that there is little risk of change in their value.
Examples: Treasury bills and money market funds
##Because of the residual nature of the cash account,
the auditor’s use of substantive analytical procedures for auditing cash is typically limited to:Comparison with prior years cash balances & Comparison with budgeted amounts
To Audit Cash – Auditor should get copy of bank reconciliation, Cutoff Bank Statement, Standard Bank Confirmation
Fraud Related Audit Procedures: Extended Bank Reconciliation procedures, Proof of Cash, Tests for Kiting
Auditing Petty Cash – Usually not material, Potential for defalcation, Seldom perform substantive tests, Document controls
Key Points to Remember
- Importance of control environment and understanding internal controls.
- Identifying and assessing fraud risks in each process.
- Documentation and evidence collection through documents, records, and observations.
General Auditing Tips
- Always consider inherent and control risks.
- Understand the business and industry-specific factors.
- Proper documentation and detailed workpapers are crucial.