Audit Procedures For Revenues: Everything You Need To Know!

Revenue is the backbone of any business entity because if a business concern is not making revenues, it won’t be able to exist for long. The revenues of any business entity can vary depending on the nature of the business, industry, size of the business, and many other factors. However, the importance of the revenues never undermines regardless of business size or nature.

In products industries, revenues are generated by selling a product. At the same time, the provision of services in the service industry generates revenues for business entities. Therefore, a general notion of sales is also used when referring to revenues.

In the modern accrual system, the revenues can be in the form of cash or account receivables. There can be material misstatements in reporting, revenue recognition, or classification. Besides, the risk of fraud can also not be ignored. Therefore, it is necessary to design internal control procedures and perform regular reviews & audits of accounts related to revenue.

In today’s article, we will discuss all the audit procedures, assertions, risks, and internal control procedures for the audit of revenues for any business entity. So let’s get into it.

What Is a Revenue Audit?

The revenue audit of any business entity can be two-fold, including checking the accuracy and authenticity of the financial statements and revenue recognition in a timely manner according to the prescribed accounting standards. The revenue audit is part of the overall audit performed by the independent auditor. However, a company’s internal auditor can also perform a revenue audit to test the internal control procedures.

Objectives of Revenue Audit

The definition of revenue audit makes it quite obvious what are the objectives of performing the audit on the revenues of a business entity. The primary objective of any kind of audit is to get an independent opinion on the financial statements of any business entity. Whether an auditor is performing a cash or revenue audit, the main objective is to ensure that the statements show a true and fair view of the business.

However, if we further open it up, the objectives behind performing an audit of revenues are as follows:

  • The first objective of a revenue audit is to ensure that the business entity has followed the proper rules for revenue recognition and that revenue has been recognized in a timely manner.
  • Besides, the other primary objectives of revenue audit involve testing the efficiency and efficacy of the internal control procedures.
  • Secondary objectives of revenue audit also include checking the degree of compliance with accounting standards in any business entity.

Internal Control Procedures

Any business entity will conduct an audit to check the compliance of internal controls and regulations they have made for certain matters. Therefore, it will not be wrong to say that the internal control procedures of any business entity work as the first line of defense for financial matters.

Similarly, every business entity will design and implement certain internal control procedures for revenue recording and recognition. Besides, the inherent risk of fraud and abuse against revenues is also a reason why internal controls are necessary.

The general internal control procedures for revenue can be as follows:

  • Proper segregation of duties for recording and recognition of revenues. The personnel involved in cash receipts, revenue recording, general ledger adjustments, etc., should be given responsibility for only similar activities to minimize the chances of error.c
  • Documentary evidence for every transaction should be prepared.
  • Every product should be compared to the approved order before shipping it out(independent inspection).
  • Proper procedures for credit card transactions
  • Personnel using POS terminals should have unique IDs and passwords so that fraud through unauthorized access can be avoided
  • Prenumbered credit notes
  • There should be a consistent recording of products returned by customers. Proper scrutiny should be done whether the returns were made before or after the accounting period ends.
  • No unauthorized personnel should be given access to the information system to edit, change, or delete sales orders, contracts, in-process transactions, etc.

Audit Risks And Deficiencies Associated With Revenue

Whenever an auditor takes on the responsibility to audit financial statements or a specific account, certain risks and deficiencies are associated with it. These risks correlate to the chances of material misstatement and inaccurate recording of transactions in different accounts. Similarly, there are certain audit risks and deficiencies associated with revenue accounts.

Risk of Material Misstatement

The first type of risk that has to be addressed when auditing the revenues of any entity is a risk of material statement. Internal control does not detect or prevent such risks because they are raised when control risk and inherent risks are combined.

Inherent Risks

The inherent risks associated with revenue recording and recognition can be defined as inaccuracy and errors in the revenue figures. The inherent risk will be higher if a business has more complex revenue transactions. Misstatement of the revenue figures due to the complex nature of the business is a prime example of inherent risk.

Control Risk

Control risk, on the other hand, can be characterized as one arising from inefficient internal control procedures. When an internal control procedure is unable to detect and mitigate inherent risk, it leads to control risk. Therefore, the auditors have to ensure that proper control tests should be run before planning the substantive procedures and tests of details for revenue audit.

Deficiencies In Revenue Recording and Recognition

  • Intentional overstatement of the revenues and account receivables by the company
  • The relevant personnel does not follow the revenue recognition principles and assertions properly.
  • There is no proper cutoff which leads to overstatement or understatement of revenues for the business entity
  • The revenue collections are embezzled or theft by the company’s employees
  • Proper segregation of duties is not followed, leading to one person performing many tasks
  • An incompetent person with insufficient knowledge is handling the allowances and revenues
  • The cash drawer is in access to many people
  • No independent and surprise audits of revenue accounts

Assertions of Revenue Audit

An audit assertion is the statement of the management about the accuracy and correctness of the figures posted in the financial statements. The auditors have to obtain the evidence to verify the audit assertions for any account of the financial statements.

The common audit assertions for the revenue account are as follows:

Existence

The existence or occurrence assertion means that the auditor should check whether the revenues recorded in the books actually occurred or are fictitious figures.

Completeness

When performing a revenue audit, the assertion of completeness implies that the auditor should ensure the revenues’ balances in the income statement and general ledger includes all the transactions that occurred during the accounting period.

CutOff

The auditor should check that the revenues earned in an accounting period were recorded and recognized in the same period.

Accuracy

The auditor should also assess the arithmetical accuracy of the revenue transactions

Classification And Presentation

This assertion for revenue audit implies that the auditor needs to verify the proper disclosure related to revenues in the financial statement. Besides, it is also to ensure that the revenue transactions that occurred in an accounting period are recorded according to the accounting standards prescribed.

Audit Procedures

Based on the audit risks and assertions, here are the general audit procedures an auditor will undergo when inspecting the revenue accounts of an entity:

Tests Of Control

The control risk for any audit is considered important but is often believed to be lower in the case of the revenues. However, the detection and correction of material misstatement will only be possible if comprehensive tests of controls are conducted for revenue audit. The auditor will perform the following tests of controls:

Walkthrough Test

Walkthrough tests are the most descriptive and useful inquiry tools when performing the audit. The walkthrough test of revenue might include inquiries from the staff of the business entity to know their knowledge about internal control procedures. The walkthrough test can include inquiries about

the segregation of duties(who does what), the knowledge of billing personnel about the software company is using, etc. Other questions might relate to recognition and cutoff practices for revenues. It is indeed a very effective test to know about the efficiency of internal controls.

Documentary Evidence

The auditor might deem it necessary to collect the supporting documents as evidence to know if the company’s internal controls are properly followed and performed.

Observation On Site

One test of control to check revenue control procedures is the on-site observation of the employees recording and recognizing the revenue transactions. 

Substantive Procedures

Based on the results of the test of controls, the auditor will plan the substantive procedures to further dig into the audit. The substantive procedures will include both analytical and detailed tests. Here are the substantive procedures the auditor for all revenue assertions that auditor might perform:

Occurrence

To check the occurrence and existence of revenue transactions, the auditor will examine the policy of the client regarding pricing, credit, revenue cycle, and sales returns. The auditor will select a sample of the revenue transactions recorded in the financial statements and track them to the sales reports. The next step is to get the documentary evidence of sales being recorded in the company’s financial statements.

Completeness

To check the completeness of the revenues, the auditor might perform the following procedures:

  • Take a sample of sale transactions and track them to documentary evidence.
  • Sales revenue analysis to identify any unusual transaction or event
  • Sale price authorization inspection to detect any fraudulent transaction or practice from the employees.
  • Verification that IFRS 15 revenue recognition criteria are met for recording transactions
  • Verifying the numerical sequence of invoices with the recording sequence of financial statements
  • Analytical procedures to compare monthly revenues and yearly revenues

Accuracy

  • The auditor can audit the accuracy of revenue transactions by running journal entry tests to highlight duplicate entries.
  • Recalculating discounts, if any, to check the appropriation of the calculations
  • Recalculating tax on revenues to test arithmetical accuracy

Cut Off

  • Cutoff tests to make sure that the revenues earned in a certain accounting period is recognized in the same period
  • Select a few invoices from the beginning and end of the year to review if proper cutoff procedures are followed for recognition. 
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