Auditing the Revenue Cycle Ch 14

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Chapter 14

Auditing the Revenue Cycle

|Learning Check |

14-1. a.The revenue cycle includes the activities involved in the exchange of goods and services with customers and the realization of the revenue in cash.

b.The classes of transactions in this cycle for a merchandising company are sales, sales adjustments, and cash receipts. The primary accounts affected by these transactions are sales, accounts receivable, cost of sales, inventory, cash, sales discounts, sales returns and allowances, bad debts expense, and allowance for uncollectible accounts

14-2. a.Specific audit objectives for the revenue cycle are derived from the five categories of management's financial statement assertions.

b.Specific audit objectives for credit sales transactions include the following: • Recorded sales transactions represent goods shipped during the period (existence or occurrence). • All sales transactions that occurred during the period have been recorded (completeness). • The entity has the rights to receivables resulting from recorded credit sales transactions (rights and obligations). • All sales transactions are correctly journalized, summarized, and posted (valuation or allocation). • The details of sales transactions support their presentation in the financial statements including their classification and related disclosures (presentation and disclosure).

14-3.It may be appropriate to allocate a proportionately larger share of tolerable misstatement to accounts receivable because of high risk of misstatements in this account and the high costs of applying certain procedures used in auditing receivables (such as sending and processing confirmation requests). This simply means that the auditor chooses to allow relatively more of the total tolerable misstatement (financial statement materiality) remain undetected in accounts receivable where they are more costly to detect than misstatements in some other accounts. Nevertheless, tolerable misstatement must still be sensitive to the amount of misstatement that might influence the decisions of financial statement users.

14-4.Factors that might motivate management to deliberately misstate revenue cycle assertions include: • Pressures to overstate revenues in order to report achieving announced revenue or profitability targets or industry norms that were not achieved in reality owing to such factors as global, national, or regional economic conditions, the impact of technological developments on the entity's competitiveness, or poor management. • Pressures to overstate cash and gross receivables or understate the allowance for doubtful accounts in order to report a higher level of working capital in the face of liquidity problems or going concern doubts.

Factors that might contribute to unintentional misstatements in revenue cycle assertions include: • The volume of sales, cash receipts, and sales adjustments transactions is often high, resulting in numerous opportunities for errors to occur. • The timing and amount of revenue to be recognized may be contentious owing to factors such as ambiguous accounting standards, the need to make estimates, the complexity of the calculations involved, and purchasers' rights of return.

14-5. a.Following are example analytical procedures that the auditor might use to estimate total revenue for a household appliance manufacturer and for an airline.

|Industry |Possible Analytical Procedures | |Household Appliance Mfg. |Use past ratio of net sales to capacity with adjustments for capacity | | |changes. | | |Use a...
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