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Revenue Recognition

(SFAC No. 5) requires that before revenue is recognized it must be realized and earned.
SECs SAB No. 101 requires the following criteria for revenue recognition:


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 assured.

Revenue cycle transactions include all the processes ranging from the sale to shipping a product, billing the customer, and collecting cash

Overview Of The Revenue Process

order from a customer

exchange of goods or services for a promise to pay

the payment of cash

Overview of the Revenue Cycle (Sales made on Account)

Receive customer purchase order

Check inventory stock status

Obtain credit approval

Prepare shipping and packing documents

Ship and verify shipment of goods

Prepare the invoice

Send monthly statements to customers

Receive payment

Auditors Objectives in Auditing Receivables and Revenue

Consider inherent risks of material misstatement, including fraud risks. Consider internal control over receivables and revenue. Substantiate the existence of receivables and the occurrence of revenue transactions. Establish the completeness of receivables and revenue transactions.

Determine that the client has rights to recorded receivables. Establish the clerical accuracy of records and supporting schedules of receivables and revenue.

Determine the valuation of receivables and revenue is at appropriate net realizable values.
Determine that the presentation and disclosure of receivables and revenue are adequate

Separation of receivables into appropriate categories Adequate reporting of any receivables pledged as collateral Disclosure of related party sales and receivables.

Functions In The Revenue Process


entry (sales) Credit authorization Warehousing (maintaining inventory) Shipping Billing Cash receipts Accounts receivable General ledger

Revenue Cycle Documents


purchase order Sales order Bill of lading (shipping document) Invoice Control listing Credit memo

Some Improper Revenue Recognition Schemes

Recognize revenue on fictitious shipments

Hidden side letters that give customers unlimited right to return product
Record consignment sales as final sales Accelerated recognition of sales occurring after yearend Ship unfinished goods



goods before date agreed to by customer fictitious invoices

Create Ship Ship

goods never ordered

more goods than ordered

shipments to company's warehouse as shipments of replacement goods as new


sales sales


Revenue Cycle Controls

Segregation of duties 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 and review of account codings

Potential Misstatements of Revenue

Recording unearned revenue Ethical environment created by top management Effective billing process (tied to shipping function) Effective controls for testing invoices, computer reconciliations

Early (late) recognition of revenue Ethical environment created by top management Effective cutoff procedures in shipping department

Potential Misstatements of Revenue

Recording revenues with significant uncertainties

Ethical environment created by top management

Recording revenues when significant services still must be performed

Ethical environment created by top management

Overestimation of the amount of revenue earned

Ethical environment created by top management

Substantive Tests

Substantive Tests

Audit Objectives

Obtain aged listing of receivables Clerical accuracy and reconcile to General Ledger Obtain analyses of Notes Receivables and related interest Inspect notes on hand and confirm those not on hand Existence, occurrence, and rights

Confirm receivables with debtors Existence, occurrence, and rights Valuation

Substantive Tests
Review the year-end cutoff of sales transactions

Audit Objectives
Existence, occurrence, and rights Completeness

Perform analytical procedures Review significant year-end sales contracts

Verify interest earned on notes receivable

Existence, occurrence, and rights Completeness Valuation

Existence, occurrence, and rights Completeness

Substantive Tests

Audit Objectives

Valuation Evaluate the propriety of clients accounting for transactions. Evaluate accounting estimates related to revenues. Determine the adequacy of allowance for uncollectible accounts. Ascertain the existence of pledged receivables. Investigate receivables from related parties. Evaluate financial statement presentation and disclosure. Presentation and disclosure