Chapter 7 Notes: Auditing and Assurance Services
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
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