Auditing a Revenue Cycle

Auditing a Revenue Cycle

When an auditor from an audit firm in Johor Bahru performs an audit for the revenue cycle, as part of the financial audit, they should examine the inherent risk related to that revenue cycle before conducting tests to identify whether it is free from fraud and error. Its inherent risks are associated with the pressures from the company’s management to misstate its profits as well as cutoff dates for certain types of sales. By performing the tests of controls and the substantive tests, the auditors may give some assurance that the company has recorded its revenue correctly.

Issues

Typically, the issues concerning revenue recognition are caused by refund and return rights, bill and hold transactions, round-trip sales, gross sales, as well as consignment sales. In some cases, the management will misstate the company’s profit to impress the board of directors or to encourage its investors. Otherwise, this can be merely due to human error that one has recorded the revenue at an incorrect timing. Before the auditors start conducting the audit (Also see Introduction to Pre-audit), they should make sure that they have acquired an in-depth understanding of the industry that the company is operating in so that they can examine the audit results better.

Analytical Procedures

This process often includes calculating many different financial ratios (Also see Financial Ratio Analysis) and making comparisons between those ratios and that of the industry’s benchmarks. When auditing the company’s revenue cycle, auditors should assess its gross profit margin as well as how much growth it has gone through in a year. The analytical procedures also require them to analyse to company’s maximum capacity for sales if it has fully utilised its staff and facilities. Also, the auditors should check the account of accounts receivable to make sure that it is not surpassing the company’s sales. If this happens, the company may be facing a credit risk and, in the future, it will probably face some problems in its cash flow.

Tests of Controls

Regardless of the cycle that the internal controls (Also see A Checklist for Ways to Access Internal Controls) are associated with, their main component is always the compliance and adoption to the strong controls and high ethical standards by the management. Tests of controls for a company’s revenue cycle include the separation of tasks for documenting sales orders, shipping and filling out, the proper documentation and authorisation to provide discounts for cash or early payments, and the personnel who are involved in accepting and approving sales credit. Besides, the tests also consist of proper recording for depositing and collecting cash, documenting the receipts, as well as the authorisation of the management to identify that an account is uncollectable, and they should write off the amount to bad debts (Also see What Are Accounts Receivables and Bad Debts?).

Substantive Tests

By performing substantive tests, the auditors can find out misstatements or errors in the documentation or the accounts which are related to the revenue cycle. The tests require the auditors to check the company’s trial balance which the accountant has created when the revenue cycle has ended, confirm the sum of accounts receivable with its debtors, assess the accuracy of the allowance for doubtful accounts by evaluating the company’s history. Also, they need to trace, vouch and perform cutoff tests for all the sales, cash receipts and sales returns. To achieve this, the auditors will assess all the documents about a client besides examining a journal entry. Then, they will either perform their work either forward, that is, from the company’s original sales order to its journal entry, or backwards, which is the other way round.