Auditing Revenue – Risks, Assertions, and Procedures

Overview:

Audit tends to be a process spread across numerous different aspects that need to be inculcated by the auditors in order to ensure that they are able to gain the required evidence. This involves testing various different assertions on a number of different grounds in order to get reasonable assurance on a number of grounds. In this regard, audit planning tends to play a very important role, primarily because of the fact that it helps auditors prioritize over which part of audit they should carry out first, and which should be conducted at a later stage.

Auditing for revenue holds substantial value when it comes to auditing revenue, predominantly because of the reason that it tends to be the most crucial part that impacts the overall financials of the company. Therefore, auditing of revenue from the perspective of the company holds tantamount value, because it needs to be tested across a variety of assertions.

Risks:

Revenue Audit is often considered to be a high-risk process in the company, because of the fact that the inherent risk is mostly high when it comes to revenue. This is primarily because of the fact that there are several different complex transactions that are included in the revenue recognition process. Therefore, the main aim of the auditor is to reduce the risk associated with a material misstatement that might occur as a result of material misstatement in the financial statements.

Risk of Material Misstatement is defined as the risk that the line items that are mentioned in the financial statement have a higher variation in comparison to their actual figures. In this regard, it is important to consider the fact that the risk existing in revenue audit pertains to the revenue figure being materially misstated to an extent that internal controls are unable to detect that particular risk. Further explanation of the risks associated with Revenue Audit is provided below:

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Inherent Risk

Inherent Risk in the process of revenue audit pertains to the exposure of revenue figures towards misstatement. In this case, the level of inherent risk is also contingent on the nature of the business, as well as the complexity of the transaction involved. An example of inherent risk in revenue would be recording scrap materials sold as general revenue of the company.

Control Risk

As far as the Control Risk of revenue is concerned, it mainly results from the failure of the internal controls to detect the inherent risk. In this regard, revenue might be in a position to severely misstate the financial position of the company. Therefore, control risk tends to play a very important role when it comes to revenue.

Therefore, the main role of the auditor when it comes to auditing revenue is to ensure that the assessment is undertaken in order to plan the subsequent part of the audit process in a clear manner. Followed by the assessment, they are supposed to draw audit procedures based on the assertions they need to test for when it comes to revenue.

Assertions:

The audit assertions that are used when testing for revenue are as follows:

  • Occurrence: This assertion mainly tests if the revenue that has been declared by the company is actually existent on the financial statement or not. This is a verification that the sale process has actually occurred.
  • Completeness: All revenues that are declared on the financial statement should be complete in terms of their classification. For example, they should be mentioned in full, in addition to any disclaimers that follow the relevant sale.
  • Accuracy: Revenues that are declared on the financial statements should be accurately measured, in the sense that there should be no material misstatement in rounding off or any other relevant errors that might tweak the final result of the financial statements for the end-user.
  • Cut-off: The revenues that are declared for the particular year, should belong to that specific time frame only. Therefore, revenues for any previous year or the following year should not be included as revenue of the current year.
  • Classification: Revenue should be classified properly, and it is only supposed to include amounts that are earned (or received) as a result of the day-to-day operations of the business. Any sale of fixed asset, or any other financial incoming should not be classified as revenue for the company. In the same manner, the organization is also supposed to draw a line between earned, and unearned revenue.
  • Presentation: The presentation of revenue should abide by the accounting norms and principles. Sufficient and complete disclosure should be made with revenue, in order to state any disclaimers that users of the financial statements should be aware of.
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Procedures:

Audit Procedures for testing revenue include both, Test of Controls, as well as Substantive Tests. Both of them are given in detail below:

Audit Procedure for revenues

Test of Controls:

In the case of auditing revenue, Internal Controls play a very important role. This implies that in the case where internal controls are effectively present, it is assumed that the control risk is low. In other words, it means that the internal controls are effective in preventing, detecting, or correcting material misstatements that occur in the revenue account.

Therefore, the audit procedures involve testing these controls to obtain sufficient audit evidence in order to support the given assessment. However, these tests are only performed in the case where the auditor wants to rely on the internal controls in order to reduce the inherent risk of material misstatement. In the case where the auditor does not want to rely on any internal controls, then audit procedures would solely rely on substantive tests. In this regard, the test of controls includes the following:

  • Inquiring the client’s staff in relation to the internal controls processes
  • Observing the actual implementation of the internal control processes
  • Inspection of the supporting documents in order to ensure that proper controls have been established
  • Re-performing the controls that have been performed by the client’s staff

Furthermore, there are other few details that need to be included when it comes to auditing revenue. They include the following:

  • Authorization: It needs to be seen if there is an authorization process pertaining to sales confirmation or order dispatches.
  • Segregation of Duties: The presence of segregation of duties is imperative in order to ensure that there is no conflict of interest involved that might give room to any fraud.
  • Completeness of Revenue: Completeness of Revenue is obtained by verifying the sequencing presented in the financial statements.
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Substantive Audit Procedures for Revenue

Substantive Audit Procedures for Revenue include the following components:

Further details of these are given below:

1) Substantive Analytical Procedures

Substantive Analytical Procedures for Revenue mainly include inspection and observation by the auditors in order to inspect the changes in trends that have occurred in the previous years. For example, there is a need to ensure that there are no inconsistencies in the sales figures over the course of time.

The actual occurrence of revenue should ideally be aligned with the actual figures. In the case where this does not happen, it gets important to follow this up with relevant tests for details. However, even if proper concrete evidence is obtained from substantive analytical procedures, the test of details is still required.

2) Test of Details for Revenue:

In order to test details for revenue, audit procedures are designed around assertions. Example and description of test of details are given in the table below:

Audit AssertionExample of Audit Procedure
OccurrenceSelecting a sample to check for records of sales revenue, followed by vouching, and tracing those sales invoices with respective sales entries.
CompletenessSelecting a sample of bills, tracing these selected bills, and scanning the sequential number of sales invoices in the sales journal.
AccuracySelecting a sample of sale invoices, and further verification of sales invoices with supporting documents in order to make sure that they are properly recorded in the financial statements.
Cut-OffSelecting a sample of invoices (at random) from the year-end, and checking if they have been correctly classified.