Chapter 7 Notes: Auditing and Assurance Services

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Chapter 7
Overall Audit Approach for the Revenue and Collection Cycle
* Audit risk- the risk that auditors will issue and unqualified opinion on financial statements that contain a material misstatement * Inherent risk and control risk
* 3 step approach for audit risk model
* Set audit risk at desired levels
* Assess risk of material misstatement
* Determine detection risk based on the level of audit risk and risk of material misstatement * The components of the audit risk model are assessed on an assertion-by-assertion basis * This assessment recognizes that certain assertions assume an increased level of importance and are of more interest to auditors than others * Existence assertions is important in the audit or A/R and the occurrence is important for sales * If the audit team estimates that control risk is below maximum they need to perform test of controls to confirm that the control activities are operating effectively and that the auditors initial strategy is sound LO1: Inherent Risk in the Revenue and Collection Cycle

Revenue Recognition
Revenue Recognition- recording revenues in the entities
* To be recognized revenues must be realized or realizable or earned * Revenue earning activities involve delivering or producing goods, rendering services, or performing other activities that constitute its ongoing major or central operations, and revenues are considered to have been earned when the entity has substantially accomplished what it must do to be entitled to the benefits represented by the revenues * All criteria must be met for revenue to be realizes, realizable, or earned: * Persuasive evidence of an arrangement exists

* Delivery has occurred or services have been rendered
* The seller’s price to the buyer is fixed or determinable * Collectability is reasonably ensured
Collectability of A/R
In most companies, a portion of accounts receivable will not be paid. GAAP requires clients to provide and estimation of uncollectable amounts and provide and allowance for it. Estimation of allowance for doubtful accounts can be subjective and difficult for the client and the auditor. A reason for difficulty can be changing economic conditions. Customer Returns and Allowances

Sometime customers have the right to return unused or unsold merchandise. An appropriate evaluation of revenue can be performed when these agreements are in the purchase contract and disclosed to the auditor. Clients may enter into informal right of return agreements with customers unknown to the auditors. Liabilities for known return, warranties, and other potential obligations are often very difficult to estimate. Companies with new products or technologies have an even higher inherent risk in these areas. LO2: Revenue and Collection Cycle: Typical Activities

Basic activities in the revenue and collection cycle are
1. Receiving and processing customer orders
2. Delivering goods and services to customers
3. Billing customers and accounting for A/R
4. Collecting and depositing cash received from customers

Entity Level Control

It is important that auditors consider the entity-level controls in all processes and procedures. In the revenue process, management should have a process for continually reviewing revenue and comparing it to the budgets and forecasts. Management should constantly scrutinize total write-offs of A/R, merchandise returns, and the timeliness of collections. Physical control over inventory and warehouses must include entity level control such as id badges and restricting access to facilities.

Receiving and Processing Customer Orders, Including Credit Granting * Customers can initiate sales by mailing P/O’s, call or fax , emails, websites or go to the phycial locations. * It is important that credit sales are authorized to ensure that the customer will be able to pay for the good or services * Access to master file for additions, deletions,...
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