Accounts Receivable, Notes Receivable and Revenue

1. Accounts Receivable, Notes Receivableand Revenue

2. Revenue Cycle--Documents • Customer purchase order • Sales order • Bill of lading • Sales invoice • Control listing ( remittances) • Credit memo • Sales Returns • Bad Debt Write-off

3. Categories of Internal ControlsRevenue Cycle (Sales & A/R) • Controlling customers’ orders • Credit approval • Issuing merchandise • Shipping • Billing • Adjustments to sales and receivables

4. Common Revenue Cycle Internal Controls • Segregation of duties--sales and collections • Matching of sales invoices and shipping documents • Clerical accuracy checks on invoices • Credit approval for sales transactions • Mailing of monthly statements • Reconciliation of bank accounts • Use of control listing of cash receipts • Use of budgets and analysis of variances • Control over shipping and billing documents • Use of authorized credit memoranda • Use of chart of accounts & review of account codings

5. Most Likely Misstatements-Sales, A/R • Recording unearned revenue & receivables. • Premature/Delayed recognition of revenue & A/R. (e.g., Bill & Hold Schemes – Mattel, Regina) • Recording revenues when significant uncertainties. exist (including side agreements) • Recording revenues when significant services still must be performed. • Overestimation of revenue earned. • Recording fictitious sales & receivables (ZZZZ Best). • Non-recording of sales returns (Regina). • Round Tripping (Sales & Purchase of Same Items).

6. Objectives for the Substantive Tests of Receivables and Sales • Substantiate Existence of receivables & occurrence of sales/revenue transactions • Establish the Completeness of receivables and sales/revenue transactions • Determine that client has Rights to recorded receivables • Establish clerical accuracy of records/supporting schedules • Determine that Valuation of receivables and appropriate recognition of revenue transactions • Determine that Presentation and disclosure of receivables and sales/revenue are adequate

7. Substantive TestsReceivables and Sales • Obtain aged listing of receivables and reconcile to ledgers. • Obtain analyses of notes and related interest.

8. Substantive TestsReceivables and Sales • Obtain aged listing of receivables and reconcile to ledgers. • Obtain analyses of notes and related interest. • Inspect notes on hand/confirm those held by others.

9. Substantive TestsReceivables and Sales • Obtain aged listing of receivables and reconcile to ledgers. • Obtain analyses of notes and related interest. • Inspect notes on hand/confirm those held by others. • Confirm receivables with debtors.

10. Confirmation of Receivables Receivables should be confirmed, unless: • Accounts receivable are immaterial, • The use of confirmations would be ineffective, or • The auditors’ combined assessment of inherent and control risk is low, and audit risk can be reduced to acceptablylow level with other substantive tests.

11. Confirmation of Receivables • IF management, without a valid reason, refuses to allow confirmations or if alternative procedures would be inadequate or insufficient audit evidence, auditor should communicate this refusal to those charged with governance and consider the impact on the audit and audit opinion. • Oral confirmation alone is NOT considered a confirmation, but could be part of alternative procedures.

12. Sending Receivable Confirmations • Select Accounts to Confirm. • Select Type of Confirmation (Later Slide): • Positive - Asks For A Response Whether They Agree With The Client’s Balance or Not. • Negative - Asks For A Response Only If They Disagree With The Client’s Balance. • Draft Request for Client to Sign. • Request asks for Response Directly to Auditor.(With Self Addressed Stamped Envelope)

13. Sending Receivable Confirmations(con’t) • Auditor Should Mail to Ensure They Are Sent. • Primary Reliability Risks: • Response Might Not Be from Proper Source. • Respondent Might Not Be Authorized to Respond. • Integrity of Transmission Might Have Been Compromised. (Especially for fax, e-mail and electronic (web-based) • Consider Confirming by Telephone for Mailed, E-mail or Fax Responses, or Use Digital Signatures, Encryption, or WebTrust Attestation or VeriSign Certification for web-based responses.

14. Positive or Negative Form? If confirmations are the sole audit evidence at the assertion level (e.g., existence) for certain accounts, then the negative form can only be used if ALLof the following are true: • Combined Assessed Level of IR & CR is Low with internal controls tested for the assertion. • There is a large number of small, homogeneous account balances, • A very low exception rate is expected, and • Recipients are unlikely to disregard the confirmation.

15. Nonresponses No Response to Positive Confirmation Requests • Send 2nd, 3rd Request • Call Customer • Offer to Provide Additional Detail (Such as Amounts by Invoice for Customers Using a Voucher Accounts Payable System) • Perform Alternative Procedures • Subsequently Paid: Review Detail Support. • Not Paid: Review Support for Original Entry and for Existence of Customer.

16. Clearing Confirmation Exceptions • Must Gather Evidence to Determine Whether Customer or Client is Correct. • Customers Frequently do not Look at Cutoff Date so Could be Mere Timing Problem - But Could also be Lapping. • Sometimes Exceptions Show Tip of an Iceberg: • Consignments Recorded as Sales • Advance Payments not Considered • Significant Right to Return Goods • FOB Destination Sales • Bill and Hold Schemes

17. Confirmation ReliabilityResults of Field Test Overall Response 69% Long Past Due Response 35% Overall Error Detection Rate 47% Large Overstatement Detection Rate 53% Large Understatement Detection Rate 42% Small Overstatement Detection Rate 47% Small Understatement Detection Rate 47%

18. Confirmation ReliabilityResults of Field Test-Conclusions • Too much reliance has traditionally been placed in confirmation reliability. • Although possibly sound evidence for existence, is of somewhat lesser reliability for valuation and completeness. • SAS 67 identified weaknesses, but still virtually requires accounts receivable confirmations unless certain conditions exist.

19. Shortcomings Found by Peer Reviews • Incorrectly excluded confirmations from tests. • Incorrectly chose negative form as easier to deal with. • Did not project results of the sample - bought into client’s “isolated” problem/error argument. • Did not document how reliability of oral and fax confirmations tested. • Did not apply alternative techniques to nonresponding positive confirmations.

20. Substantive TestsReceivables and Sales • Obtain aged listing of receivables and reconcile to ledgers. • Obtain analyses of notes and related interest. • Inspect notes on hand and confirm those held by others. • Confirm receivables with debtors. • Review the cutoff of sales transactions & large yearend sales contracts & estimates.

21. Substantive TestsReceivables and Sales • Obtain aged listing of receivables and reconcile to ledgers. • Obtain analyses of notes and related interest. • Inspect notes on hand and confirm those held by others. • Confirm receivables with debtors. • Review the cutoff of sales transactions & large yearend sales contracts & estimates. • Perform analytical procedures. • Verify interest earned.

22. Substantive TestsReceivables and Sales • Obtain aged listing of receivables and reconcile to ledgers. • Obtain analyses of notes and related interest. • Inspect notes on hand and confirm those held by others. • Confirm receivables with debtors • Review the cutoff of sales transactions & large yearend sales contracts & estimates. • Perform analytical procedures. • Verify interest earned. • Evaluate proper accounting for sales transactions and the business purpose of very significant or unusual transaction.

23. Criteria for Recognition of Revenue • Persuasive evidence of an arrangement exists between seller & buyer. • Delivery has occurred or services have been rendered. • The seller’s price to the buyer is fixed or determinable. • Collectibility is reasonably assured. • Returns (non-defect) can be reasonably estimated if significant. Source: SEC Staff Accounting Bulletin No. 104 & FAS 48

24. Revenue Recognition Testing Time of Shipment: • Shipping Records Support Recorded Sales? • Controls Exist for When to Record Sales? • Consistent With FOB Terms? (Shipping Point or Destination) • Indication of Bill & Hold Scheme from Confirmations, Sales Invoices/Documents? Time of Delivery/Acceptance: • Documentation of Delivery/Acceptance? Controls? • Evidence from Customer? Confirm?

25. Revenue Recognition Testing con’t Percentage of Completion: • Test Controls Over Integrity of Job Cost Records. • Test Reliability of Actual Costs by Job/Contract, including WIP, to Source Documents. Are There Large Cost Transfers at Quarter/Year End? • Evaluate Reasonableness and Currency of Estimates to Complete. Consistent with Reports to Customer?

26. Revenue Recognition Testing con’t Services Separately Priced: • Relative (Standalone) Selling Price, if available • Total Value Deferred Based on Agreement? • Does Amortization Match Expense Past Incurrence? Services Not Separately Priced: • Relative (Standalone) Selling Price, if available • Reasonableness/Logic of Total Sales Breakout Between Earned & Deferred Portions? (An Accounting Estimate – 3 ways to evaluate.) • Compare Cost History Ratio to Sales Ratio for Earned & Deferred Portions. • Compare to Documentation (Agreement) of When Services are to be Performed.

27. Substantive TestsReceivables and Sales • Obtain aged listing of receivables and reconcile to ledgers. • Obtain analyses of notes and related interest. • Inspect notes on hand and confirm those held by others. • Confirm receivables with debtors. • Review the cutoff of sales transactions & large yearend sales contracts & estimates. • Perform analytical procedures. • Verify interest earned. • Evaluate proper accounting for sales transactions and the business purpose of very significant or unusual transaction. • Evaluate adequacy of allowance for doubtful accounts.

28. Allowance for Doubtful Accounts-Primary Factors to Consider- • Investigate confirmation exceptions with indication of amounts in dispute. • Investigate credit ratings for large accounts receivable at year-end. • After year-end, discuss with the client's credit manager the current status of doubtful and over due accounts. • Consider trends in aging and client’s primary customer industry’s economic conditions. • History of write-offs - but beware.

29. Substantive TestsReceivables and Sales • Obtain aged listing of receivables and reconcile to ledgers. • Obtain analyses of notes and related interest. • Inspect notes on hand and confirm those held by others. • Confirm receivables with debtors. • Review the cutoff of sales transactions & large yearend sales contracts & estimates. • Perform analytical procedures. • Verify interest earned. • Evaluate proper accounting for sales transactions and the business purpose of very significant or unusual transaction. • Evaluate the adequacy of the allowance for doubtful accounts. • Investigate existence of pledged receivables.

30. Substantive TestsReceivables and Sales • Obtain aged listing of receivables and reconcile to ledgers. • Obtain analyses of notes and related interest. • Inspect notes on hand and confirm those held by others. • Confirm receivables with debtors. • Review the cutoff of sales transactions & large yearend sales contracts & estimates. • Perform analytical procedures. • Verify interest earned. • Evaluate proper accounting for sales transactions and the business purpose of very significant or unusual transaction. • Evaluate the adequacy of the allowance for doubtful accounts. • Investigate existence of pledged receivables. • Investigate receivables/sales with related parties

31. Substantive TestsReceivables and Sales • Obtain aged listing of receivables and reconcile to ledgers. • Obtain analyses of notes and related interest. • Inspect notes on hand and confirm those held by others. • Confirm receivables with debtors. • Review the cutoff of sales transactions & large yearend sales contracts & estimates. • Perform analytical procedures. • Verify interest earned. • Evaluate proper accounting for sales transactions and the business purpose of very significant or unusual transaction. • Evaluate the adequacy of the allowance for doubtful accounts. • Investigate existence of pledged receivables. • Investigate receivables with related parties. • Evaluate F.S. presentation and disclosure