Chapter 10

Prepared by Richard J. Campbell

Copyright 2011, Wiley and Sons

Auditing Revenue Processes: Sales,Billing, and Collection in the

Health-Care Provider and RetailingIndustries

Learning Objectives

Chapter 10-1

1. Understand the revenue-producing, billing, and collection activities of the health-care provider and retail industries.

2. Recognize the importance of revenue recognition as it relates to the audit and the potential for fraud.

3. Learn the business processes, transactions, documents, controls, and accounts associated with the sales and collection cycle.

4. Describe the relationships of management assertions, company controls, tests of controls, dual purpose tests, substantive analytical procedures and tests of details of balances for the sales and collections cycles.

Learning Objectives

5. Explain audit procedures for various management assertions of the revenue cycle.

6. Explain the use of confirmations including their purposes, use, responses, and value to the audit.

7. Learn how to audit cash accounts.

Chapter 10 -2

OVERVIEW

Learning Objective #1Chapter 10 -3

Virtually all businesses have a revenue and collection function that is fundamental to the primary productive activity of a company. As a result, the revenue cycle interacts with and depends on other cycles.

Typical transaction activities for sales, billing, and cash receipts are as follows. Sales for cash and for accounts receivable Cash receipts Sales returns and allowances Writing off uncollectible accounts receivable Estimating bad debt expense

HEALTH-CARE PROVIDERS

Chapter 10 -4 Learning Objective #1

Health-care providers sell a service. Health-care providers in the United States

are often paid by third-party payers in addition to or instead of the patient who receives the service.

Accounting controls for billing are especially important because, under a fee-for-service plan, the insurance company typically pays the health-care provider based on a contract rate for a particular medical treatment or diagnosis.

An alternative to a fee-for-service plan is a capitation agreement.

RETAILING

Chapter 10 -5 Learning Objective #1

A retail entity’s primary business activity is selling finished goods inventory to a customer for cash or on credit.

The simplest retail transaction is one for cash, in which the customer exchanges cash for goods at the point of sale.

Credit Card Sale

Chapter 10 -6 Learning Objective #1

EXHIBIT 10-1

Sale on Trade Credit with Shipping

Learning Objective #1Chapter 10-7

EXHIBIT 10-2

Revenue Recognition

Chapter 10 -8 Learning Objective #2

Revenue recognition is important because decisions about whether and when to recognize revenue have played a major role in numerous accounting frauds.

Improper revenue recognition is a problem that has been seen many times in financial statements. For public companies the primary concern is that revenue may be overstated.

Sales

Chapter 10 -9 Learning Objective #2

One of the first concerns regarding the revenue cycle is that all recorded sales entries are the result of real transactions that meet the criteria for revenue recognition.

Alternatively, it is important that no sales transactions go unrecorded.

Accurate posting of accounts receivable subsidiary ledgers is important.

Documents and Processes

Chapter 10 -10 Learning Objective #3

Some businesses use the term customer order to refer to any order document provided by the customer, and the seller may create a new document called a sales order.

The result of this formal credit-granting process is documented using some type of credit approval form.

Documents associated with the shipping process may be called shipping documents or bills of lading.

The document used by a company when it bills a customer directly for a credit sale is called an invoice.

Shipping Document

Learning Objective #3Chapter 10 - 11

Learning Objective #3Chapter 10-12

INVOICE

Monthly Statement

Learning Objective #3Chapter 10-13

Remittance Advice

Learning Objective #3Chapter 10-14

Aged Accounts Receivable Trial Balance

Learning Objective #3Chapter 10-15

Business Activities and Related Documents

Learning Objective #3Chapter 10-16

EXHIBIT 10-3

Scannable Bar Code

Learning Objective #3Chapter 10-17

Medical Record

Learning Objective #3Chapter 10-18

Potential Misstatements and Controls

Learning Objective #3Chapter 10-19

Documentation plays a major role in internal controls.

The credit approval or insurance verification process must be completed and documented.

Authorization for the credit sale should come from a source that is independent of the person completing the sale.

Approved customer orders, sales orders, pick tickets, or similar documents authorize the release of goods from storage or warehousing.

Potential Misstatements and Controls

Learning Objective #3Chapter 10-20

Controls are needed to ensure that goods are shipped on a timely basis and bills are sent out for all goods that are shipped

When cash is received, the goal is to create an immediate record of its receipt and place it in safekeeping.

When checks are received in the mail, they should immediately be restrictively endorsed and a daily remittance list should be prepared concurrently.

Potential Misstatements and Controls

Learning Objective #3Chapter 10-21

Good segregation of duties requires separating the following activities:

1. Receiving the cash and making the deposit

2. Updating the accounts receivable records

3. Reconciling the initial cash records with the daily deposit ticket

MANAGEMENT ASSERTIONS IN AN INTEGRATED AUDIT

Financial Statement Assertions and Audit Evidence-Gathering Activities

EXHIBIT 10-4

Chapter 10-22 Learning Objective #4

AUDIT TESTS AND PROCEDURES

Learning Objective #5Chapter 10-23

Tests of controls provide evidence about whether an ICFR is operating as designed and whether the control is being performed by someone with appropriate authority and qualifications.

Some tests of controls are performed simultaneously with tests of details of balances that provide audit evidence on the amount and disclosure of the account balance.

When a test addresses both a control function and the amount or disclosure, it is called a dual purpose test.

AUDIT TESTS AND PROCEDURES

Learning Objective #5Chapter 10-24

Tests of controls may be performed at an interim date.

Substantive procedures on account balances and disclosures may be sufficient for coming to conclusions for the financial statement audit.

The auditor must keep in mind the evidence needed for both aspects of the integrated audit when planning and conducting tests of controls.

Examples of Tests of Controls for Sales

Learning Objective #5Chapter 10-25

EXHIBIT 10-5

Examples of Tests of Controls for Sales

Learning Objective #5Chapter 10-26

EXHIBIT 10-5

Examples of Tests of Controls for Sales

Learning Objective #5Chapter 10-27

EXHIBIT 10-5

Examples of Tests of Controls for Sales

Learning Objective #5Chapter 10-28

EXHIBIT 10-5

Examples of Tests of Controls for Sales

Learning Objective #5Chapter 10-29

EXHIBIT 10-5

Tests of Controls for Cash Receipts

Learning Objective #5Chapter 10-32

EXHIBIT 10-6

Tests of Controls for Cash Receipts

Learning Objective #5Chapter 10-31

EXHIBIT 10-6

Tests of Controls for Cash Receipts

Learning Objective #5Chapter 10-32

EXHIBIT 10-6

Tests of Controls for Cash Receipts

Learning Objective #5Chapter 10-33

EXHIBIT 10-6

Tests of Controls for Cash Receipts

Learning Objective #5Chapter 10-34

EXHIBIT 10-6

SUBSTANTIVE PROCEDURES: DUAL PURPOSE TESTS, ANALYTICAL PROCEDURES,AND TESTS OF DETAILS OF BALANCES

Learning Objective #5Chapter 10-35

The three categories of substantive procedures are discussed in the remainder of the chapter: dual purpose tests, substantive analytical procedures, and tests of details of balances.

When a single audit procedure contributes audit evidence about both controls and account balances, it is called a dual purpose test.

Sometimes, dual purpose tests for sales may be the only detailed procedures the auditor performs that include examining the dollar amounts recorded for individual sales transactions and comparing them to the specific supporting documents.

Examples of Dual Purpose Tests for Sales Activities and Related Accounts

Learning Objective #5Chapter 10-36

EXHIBIT 10-7

Examples of Dual Purpose Tests for Sales Activities and Related Accounts

Learning Objective #5Chapter 10-37

EXHIBIT 10-7

Examples of Dual Purpose Tests for Sales Activities and Related Accounts

Learning Objective #5Chapter 10-38

EXHIBIT 10-7

Examples of Dual Purpose Tests for Cash Receipts Activities andRelated Accounts

Learning Objective #5Chapter 10-39

EXHIBIT 10-8

Examples of Dual Purpose Tests for Cash Receipts Activities andRelated Accounts

Learning Objective #5Chapter 10-40

EXHIBIT 10-8

Substantive Analytical Procedures

Learning Objective #5Chapter 10-41

A fundamental substantive audit procedure, sometimes called fluctuation analysis, compares a current account balance with that same account’s balance in the prior year or with its budgeted amount.

EXHIBIT 10-9

Examples of Substantive Analytical Procedures for Sales, Cash Receipts, andRelated Accounts

Learning Objective #5Chapter 10-42

EXHIBIT 10-10

External Confirmations

Learning Objective #5Chapter 10-43

External confirmation is “the process of obtaining and evaluating direct communication from a third party in response to a request for information about a particular item affecting financial statement assertions.”

The confirmation process involves the following:

1. Selecting the items to confirm

2. Designing the confirmation

3. Communicating directly with the third party from whom the confirmation information is requested

4. Receiving the response

5. Evaluating the information provided via the confirmation

An Example of a Positive Accounts Receivable Confirmation

Learning Objective #6Chapter 10-44

An Example of a Negative Accounts Receivable Confirmation

Learning Objective #6Chapter 10-45

Bank Confirmations

Learning Objective #7Chapter 10-46

Tests of Details of Balances Sales andCollections Cycle

Learning Objective #7Chapter 10-47

EXHIBIT 10-11

Tests of Details of Balances Sales andCollections Cycle

Learning Objective #7Chapter 10-48

EXHIBIT 10-11

Tests of Details of Balances Sales andCollections Cycle

Learning Objective #7Chapter 10-49

EXHIBIT 10-11

Tests of Details of Balances, Cash inthe Bank

Learning Objective #7Chapter 10-50

EXHIBIT 10-12

Tests of Details of Balances, Cash inthe Bank

Learning Objective #7Chapter 10-51

EXHIBIT 10-12

Tests of Details of Balances, Cash inthe Bank

Learning Objective #7Chapter 10-52

EXHIBIT 10-12

Review Question

Chapter 10-53

A company has a limited number of employees.When one person is absent due to illness, thecash receipts process has insufficient segregationof duties. The company vice president, who isboth competent and otherwise independent ofthe cash receipts function, reconciles the cashaccounts on a monthly basis. Which of the followingcontrols is the type provided by the vicepresident’s activity?(a) Management (c) Compensating(b) Preventive (d) Overriding

Review Question

Chapter 10-54

A retail entity sells its products in a traditionalstore environment and over the Internet viaonline transactions. How is this situation bestdescribed?(a) These two types of sales represent two majorclasses of transactions.(b) Management’s financial statement assertionsdiffer for the two types of sales.(c) Because of the different processes none of thesame ICFR procedures will be effective for bothtypes of transactions.

Review Question

Chapter 10-55

For which assertion does a confirmation of an account receivable provide the most evidence?(a) Existence(b) Valuation(c) Completeness(d) Presentation and disclosure

Copyright

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