Chapter 9:

Auditing the Revenue Cycle

IT Auditing & Assurance, 2e, Hall & Singleton Singleton

IT Auditing & Assurance, 2e, Hall &

MANUAL PROCEDURES
Follow Figure 9-1 Obtaining & recording customers orders
Document = SALES ORDER [Figure 9-2] One copy in Open Order File

Approving credit
One copy of sales order went to credit

dept. Returned authorized copy triggers release of sales order into system
IT Auditing & Assurance, 2e, Hall & Singleton

MANUAL PROCEDURES
Processing shipping orders
4 copies of Sales Order to warehouse; packing slip,

shipping notice, stock release, file copy

Locate and pick goods using Stock Release; package

them with packing slip

Reconcile documents and goods, sign Shipping Notice,

prepare Bill of Lading multiple copies [Figure 9-3]

Transfer custody of goods (packing slip inside) and 2

copies of Bill of Lading to carrier

Record shipment in shipping log Send shipping notice to Billing Dept. File: Stock Release, 1 BOL, File Copy
IT Auditing & Assurance, 2e, Hall & Singleton

LEGACY SYSTEM PROCEDURES

Keypunch batch of shipping notices Edit run program, correct any errors

Field checks Limit tests Range tests Price times quantity extensions

Sort run on batches by AR account number

Legacy systems store records in sequential manner,

usually tape Next process is to post individual shipping notices to appropriate individual AR accounts

AR update & billing run [Figure 9-4]

Updates AR file becomes new AR file Billing would be printing invoices to be mailed Sales journal file or printout Journal voucher for AR [DR] and sales [CR]
IT Auditing & Assurance, 2e, Hall & Singleton

LEGACY SYSTEM PROCEDURES

Re-sort by inventory item {why?}
Same reason; but this process is to update Inventory

Items

Inventory update run [Figure 9-5]

Reduce quantity on hand for items shipped, generate a

new Inventory file Compare On Hand quantity with Reorder Point to identify items needing replenishment; file or printout Journal voucher for Cost of Goods Sold [DR] and Inventory [CR]

Sort journal entries by GL # Run general ledger update Management reports

IT Auditing & Assurance, 2e, Hall & Singleton

BATCH CASH RECEIPTS SYSTEMS WITH DIRECT ACCESS FILES

See Figure 9-6 Discrete events that naturally fit the batch approach Update Procedures Mail Room
Receives checks and Remittance Advices. Separates checks from Remittance Advices Prepares a Remittance List multiple copies Copy of Remittance List and checks go to Cash Receipts Dept. Remittance Advices and copy of Remittance List go to AR Dept. Last copy of Remittance List to Controllers Office
IT Auditing & Assurance, 2e, Hall & Singleton

BATCH CASH RECEIPTS SYSTEMS WITH DIRECT ACCESS FILES

Cash receipts dept.
Reconciles checks and remittance list Prepares deposit slip multiple copies Using terminal/IS, creates a journal voucher of cash received; Cash [DR] and AR [CR] End of day, deposit cash and Deposit slips to the bank File copy of deposit slip

IT Auditing & Assurance, 2e, Hall & Singleton

BATCH CASH RECEIPTS SYSTEMS WITH DIRECT ACCESS FILES

AR Dept.
Reconciles remittance advices and

remittance list
Prepares batch for transactions

based on remittance advice data to update AR subsidiary ledger

Files remittance advices and

remittance list
IT Auditing & Assurance, 2e, Hall & Singleton

BATCH CASH RECEIPTS SYSTEMS WITH DIRECT ACCESS FILES

DP Dept.
Accesses the two files created in cash receipts (journal

voucher) and AR (batch transaction file of CR) Reconciles the files Updates AR-SUB accounts Updates GL (AR, Cash) Creates a cash receipts journal System produces transaction listing that is sent to AR dept. where AR clerk will reconcile against the remittance list of file there More management reports

IT Auditing & Assurance, 2e, Hall & Singleton

REAL-TIME SALES ORDER ENTRY AND CASH RECEIPTS

See Figure 9-7 Sales procedures

Transactions are processed as they occur, separately Credit check is performed online by the system If approved, system checks availability of inventory If available, system: Transmits electronic stock release to warehouse dept Transmits electronic packing slip to shipping dept Updates inventory file records for depletion Records sale in open sales order computer file
IT Auditing & Assurance, 2e, Hall & Singleton

REAL-TIME SALES ORDER ENTRY AND CASH RECEIPTS

Warehouse procedures
Produces hard copy of stock release Clerk picks goods, sends them with a copy of stock

release to shipping dept.

Shipping procedures
Reconciles goods, stock release, packing slip from

system. Online, IS prepares Bill of Lading for shipment, and shipping notice for DP Dept. Select carrier and prepare goods for shipment, along with packing slip and Bill of Lading Stock release form is filed
IT Auditing & Assurance, 2e, Hall & Singleton

REAL-TIME SALES ORDER ENTRY AND CASH RECEIPTS

Billing procedures

Record sales invoice and shipment in IS Print invoice to be sent to customer Update shipping log and sale invoice files Delete shipment from open sales order file

Cash receipts procedures

Keypunch cash receipts using the remittance advice

into IS,matching it with the specific record in the sales invoice file Keypunch any credit memos using similar process Generate a remittance file of posted transactions
IT Auditing & Assurance, 2e, Hall & Singleton

FEATURES OF REAL-TIME PROCESSING

Events Database

Traditional accounting does not have to exist in per se (in traditional form) General Ledger can be derived at any time from a compilation from the events database

Advantages
Greatly shortens the cash cycle of the firm Can give a firm a competitive advantage (e.g., managing inventory better) Real-time editing permits the identification of many kinds of errors as they occur, greatly reducing the efficiency and effectiveness of business processes Reduces the amount of paper documents Electronic audit trails are possible in real-time computer-based systems
IT Auditing & Assurance, 2e, Hall & Singleton

MANAGEMENT ASSERTIONS AND REVENUE CYCLE AUDIT OBJECTIVES

Existence / Occurrence

VERIFY AR balance represents amounts actually owed as of Balance Sheet date Establish sales represents goods shipped and/or services rendered during period of financials Determine all amounts owed organization are included in AR VERIFY shipped goods, services rendered, and/or returns and allowances for period are included in financials

Completeness

Accuracy
VERIFY revenue transactions are accurately computed, based on correct prices and quantities Ensure AR subsidiary ledger, sales invoice file, remittance file are mathematically correct .. And agree with GL accounts

Rights & Obligations

Determine organization has legal right to AR VERIFY accounts sold or factored have been removed from AR Determine AR balance stated in net realizable value Establish allocation for uncollectible accounts is appropriate VERIFY AR and revenues for period are properly described and classified
IT Auditing & Assurance, 2e, Hall & Singleton

Valuation or Allocation Presentation and Disclosure

INPUT CONTROLS
Purpose
Ensure creditworthiness of customers Control techniques vary considerably between batch systems and

real-time systems Credit authorization procedures

Credit worthiness of customer Batch and manual systems use credit dept. Real-time systems use programmed decision rules

Testing credit procedures

Verify effective procedures exist Verify information is adequately communicated Verify effectiveness of programmed decision rules (test data, ITF) Verify that authority for making credit decisions is limited to authorized credit personnel/procedures Perform Substantive Tests of Detail Review credit policy periodically and revise as necessary
IT Auditing & Assurance, 2e, Hall & Singleton

INPUT CONTROLS
Data Validation Controls
To detect transcription errors in data as it is processed
Batch: after shipment of goods
Error logs Error correction computer processes Transaction resubmission procedures

Missing data checks presence of blank fields Numeric-Alphabetic data checks correct form of data Limit checks value does not exceed max for the field Range checks data is within upper and lower limits Validity checks compare actual values against known acceptable values Check digit identify keystroke errors by testing internal validity

Real-Time: Errors handled as they occur

Testing Data Validation Controls

Verify controls exist and are functioning effectively Validation of program logic can be difficult
If Controls over system development and maintenance are NOT weak, testing data editing/programming logic more efficient than substantive tests of details (test data, ITF) Some assurance can be gained through the testing of error lists and error logs (detected errors only)
IT Auditing & Assurance, 2e, Hall & Singleton

INPUT CONTROLS
Batch controls
Manage high volumes of similar transactions Purpose: Reconcile output produced by system with the original

input Controls continue through all computer (data) processes Batch transmittal sheet:
Unique batch number Batch date Transaction code Record count Batch control total (amount) Hast totals (e.g., account numbers)

Testing data validation controls

Failures of batch controls indicates data errors Involves reviewing transmittal records of batches processed and

reconcile them to the batch control log (batch transmittal sheet) Examine out-of-balance conditions and other errors to determine cause of error Review and reconcile transaction listings, error logs, etc.
IT Auditing & Assurance, 2e, Hall & Singleton

PROCESS CONTROLS
Computerized procedures for file updating Restricting access to data Techniques:
File update controls -- Run-to-run batch control data to monitor

data processing steps Transaction code controls to process different transactions using different programming logic (e.g., transaction types) Sequence check controls sequential files, proper sorting of transaction files required Testing file update controls results in errors Testing data that contains errors (incorrect transaction codes, out of sequence) Can be performed in ITF or test data CAATTs requires careful planning Single audit procedure can be devised that performs all tests in one operation.
IT Auditing & Assurance, 2e, Hall & Singleton

ACCESS CONTROLS
Prevent and detect unauthorized and illegal access to firms systems and/or assets

Warehouse security Depositing cash daily Use safe deposit box, night box, lock cash drawers and safes Accounting records
Removal of an account from books Unauthorized shipments of goods using blank sales orders Removal of cash, covered by adjustments to cash account Theft of products/inventory, covered by adjustments to inventory or cash accounts

Testing access controls heart of accounting information integrity

Absence thereof allows manipulation of invoices (i.e., fraud) Access controls are system-wide and application-specific Access controls are dependent on effective controls in O/S, networks, and databases
IT Auditing & Assurance, 2e, Hall & Singleton

PHYSICAL CONTROLS
Segregation of duties
Rule 1: Transaction authorization separate from

transaction processing Rule 2: Asset custody separate from record-keeping tasks Rule 3: Organization structured such that fraud requires collusion between two or more people

Supervision
Necessary for employees who perform incompatible

functions Compensates for inherent exposure from incompatible functions Can be supplement when duties are properly segregated Prevention vs. detection of fraud and crime is objective: supervision can be effective preventive control
IT Auditing & Assurance, 2e, Hall & Singleton

PHYSICAL CONTROLS
Independent verification
Review the work of others at critical points in business processes Purpose: Identify errors or possible fraud Examples:
Shipping dept. verifies goods sent from warehouse dept. are correct in type and quantity Billing dept. reconciles shipping notice with sales notice to ensure customers billed correctly

Testing physical controls

Review organizational structure for incompatible tasks Tasks normally segregated in manual systems get consolidated in

DP systems. Duties of design, maintenance, and operations for computers need to be separated Programmers should not be responsible for subsequent program changes.
IT Auditing & Assurance, 2e, Hall & Singleton

OUTPUT CONTROLS
PURPOSE: Information is not lost, misdirected, or corrupted; that the system output processes function properly Controls are designed to identify potential problems
Reconciling GL to subsidiary ledgers Maintenance of the audit trail that is the primary way to trace the source of detected errors
Details of transactions processed at intermediate points AR change report Transaction logs: permanent record of valid transactions Transaction listings successfully posted transactions Log of automatic transactions Unique transaction identifiers Error listings

Testing output controls

Reviewing summary reports for accuracy, completeness,timeliness, and relevance for decisions Trace sample transactions through audit trails; including transaction listings, error logs, and logs of resubmitted records ACL is very helpful in this process
IT Auditing & Assurance, 2e, Hall & Singleton

SUBSTANTIVE TESTS OF REVENUE CYCLE ACCOUNTS

PURPOSE: Determine the nature, timing, and extent of substantive tests using auditors assessment of inherent risk, unmitigated control risk, materiality considerations, and efficiency of the audit. Concern: Overstatement or understatement of revenues? Focus on large and unusual transactions, especially near period-end Recognizing revenues from sales that did not occur Recognizing revenues BEFORE they are realized Failing to recognize cutoff points Underestimating allowance for doubtful accounts Shipping unsolicited products to customers, subsequently returned Billings customers for products held by seller Tests of controls and substantive tests Credit limit logic may be effective but cut-off of AR may be error Substantive testing of AR may give assurance about accuracy of total AR but does not offer assurance about collectibility
IT Auditing & Assurance, 2e, Hall & Singleton

SUBSTANTIVE TESTS OF REVENUE CYCLE ACCOUNTS

Understanding data
VERIFY data used in CAATTs (e.g., ACL) is accurate VERIFY adequate setup of files from originals

(e.g., ACL and Profilecommand) Relationships and data from [see Figure 9-10]:
Customer file Sales Invoice file Line item file Inventory file Shipping log file

File preparation procedures

IT Auditing & Assurance, 2e, Hall & Singleton

SUBSTANTIVE TESTS OF REVENUE CYCLE ACCOUNTS

Accuracy/completeness assertion
Analytical review of account balances
Overall perspective for trends in sales, cash receipts, sales returns, and AR Provides first-level assurance that amounts are reasonably stated and reasonably complete If so, may reduce the extent of substantive testing

Review sales invoices for unusual trends and

exceptions
Scanning data files using CAAT (e.g., ACL and stratify and possibly filters - see Figure 9-11)
Reveals all errors or raises questions?
IT Auditing & Assurance, 2e, Hall & Singleton

SUBSTANTIVE TESTS OF REVENUE CYCLE ACCOUNTS

Accuracy/completeness assertion
Review sales invoice and shipping log files
Missing and duplicate transactions [see Table 9-2] Questions/survey: Are procedures in place to document and approve voided invoices? How are gaps in sales invoice numbers communicated to management? What physical controls exist over access to sales invoice source documents? If applicable, are batch totals used to control batch transactions during each processing step? Are transaction listings reconciled and reviewed by management?

Review line item and inventory files for pricing accuracy

ACL allows auditor to compare prices on invoices with inventory using JOIN [see example on page 413] Testing unmatched records (complement)
IT Auditing & Assurance, 2e, Hall & Singleton

SUBSTANTIVE TESTS OF REVENUE CYCLE ACCOUNTS Existence assertion

Confirmation of AR SAS #67
Not required if:
AR is immaterial Assessed Control Risk is low Confirmation process will be ineffective

CAATTs to use for this function?

Steps: Select accounts to confirm Consolidate invoices (not AR subsidiary) using CLASSIFY (filter) and SUMMARIZE (amount) [see Tables 9-3 and 9-4] Why? JOIN the CUSTOMER file with the new consolidated invoice file

Prepare confirmation requests [see Figure 9-12]

Positive and Negative Confirmations (ACL, EXPORT)

Evaluating and controlling responses

Retain custody of the confirmation letters until mailed The letters should be addressed to the auditor, not client org. The replies should be mailed to the auditor, not client org. Discrepancies should be investigated. Non responses to POSITIVE confirmation should be investigated
IT Auditing & Assurance, 2e, Hall & Singleton

SUBSTANTIVE TESTS OF REVENUE CYCLE ACCOUNTS

Valuation/allocation assertion
Corroborate or refute AR is stated at reasonable Net

Realizable Value
AGING AR
ACL, AGE [see Table 9-7]

Is allowance for doubtful accounts reasonable compared to prior years and based on composition of AR portfolio
Confirmation process will be ineffective

Review past-due balances

Conference with credit manager to determine collectibility Determine if methods used to estimate allowance for doubtful accounts is adequate, not the collectibility of each account Determine if overall allowance is, therefore, reasonable

IT Auditing & Assurance, 2e, Hall & Singleton

Chapter 9:
Auditing the Revenue Cycle

IT Auditing & Assurance, 2e, Hall & Singleton Singleton

IT Auditing & Assurance, 2e, Hall &