CHAPTER 4 3.

Determining whether the goods are available for

Audit of the shipment and prepare them for shipment.
REVENUE and COLLECTION CYCLE
Part 1: Risk Assessment This DOES NOT APPLY to cash transactions or
over-the-counter transactions.

REMEMBER: In the practice of accountancy, we 4. Shipping the goods.

should be professional, perform effectively and 5. Billing the customer.
efficiently, follow standards, and document our work 6. Collecting cash.
adequately and properly. 7. Recognizing the effects of these transactions on
related accounts such as cash, accounts receivable,
Other cycles to be discussed… inventory, and possibly commissions expense.
✓ Expenditure/Acquisition and Payment Cycle
✓ Investing Cycle KEEP IN MIND that this model is applicable to
✓ Financing Cycle MERCHANDISING BUSINESSES especially one
of a wholesaler-retailer-transaction. Thus, it is NOT
APPLICABLE TO ALL revenue cycles.
Accounting records – basis in determining the validity of
the assertions on the financial statement level. Example where the cycle fits:
• The sales transaction between a manufacturer of
Preliminary risk assessment – provides the basis for smartphone (e.g. Samsung and a retail store that
identifying the inherent and control risks sells the smartphone)

Analytical procedures – required by PSA 520, also This model does not fit with the retail to customer revenue
provides valuable trends and relationships in the cycles of Shopee and Lazada.
components of financial statement that might show
unusual increases/decreases indicating possible Puregold, Robinson’s Supermarket, and 2Brothers have
misstatements due to fraud or error. also different cycle model that incorporates the use of
point of sale or POS systems and uses real-time cash
basis payment and inventory processing.

The wholesaler-retailer model incorporates ALL of the

elements of revenue cycle.

1. Customer Order may involve transforming non-

standard forms to the entity’s standard format.
2. Credit Approval for the specific sales transactions,
if applicable, for example, when the transaction is
between a wholesaler and a retailer who has a credit
line with the wholesaler or a credit card transaction The types of transactions and their effect on specific
which requires the approval of the issuer of the card. accounts related to the revenue cycle include:
1. Cash and credit sales
However, such query, checking, and approval DOES 2. Sales discounts, returns and allowances
NOT APPLY to over-the-counter transactions. For 3. Cash receipt sales and collection of trade
example, when paying for grocery items you bought receivables on credit sales
from the shelf and checking out to the cashier’s 4. Provision of allowance for uncollectible accounts
counter. Except of course when you plan to pay with 5. Write-off of uncollectible accounts
your credit card for the grocery items.
MOST SIGNIFICANT ACCOUNTS in the revenue Online sales system generates and order number for the
cycle includes: customer and informs the customer that, that is the
1. Revenue reference number linked to his order. This number both
2. Accounts receivable serves as a purchase order and a sales order number.

Evidence as to the assertion for both accounts (revenue In case the customer wants to follow up later, he can cite
and a/r) will have to be obtained by the auditor for these the purchase order number and the sales representative
accounts. accepting his call will call up the details of the order in the
system.
For many clients, the existence assertion related to the
revenue maybe one of the more relevant assertions. When the PO is received from a BUSINESS ENTITY,
the PO is usually a prenumbered form. The serial
For accounts receivable, the more relevant assertion are number provided by the ordering entity.
usually existence and valuation.
The purchase order provides EVIDENCE that the
Documents Used in the Audit Cycle and Their Audit customer ACTUALLY ORDERED goods.
Significance
PO numbers are recorded on sales invoices so that an
auditor can determine a PO to which an invoice relates.

Sellers generally maintain a file of each customer’s PO.

1. Purchase Order
At various stages of the revenue cycle, documents are
produced as evidence of the task being carried out
throughout the process. These documents DESCRIBE the
resource documents critical to the update of accounting
records in both the general and the subsidiary ledgers as 2. Sales Order
well as of the specific special journals, if any. This document is prepared by the seller AFTER receiving
the purchase order from the customer.
They provide the basis for the amounts recorded in the
financial statements and therefore are PRIMARY The sales order is a prenumbered internal document
EVIDENCE that the auditor will ask from the client when where the seller records the description, quantity, and
performing the substantive audit procedures. related information for goods ordered by the customer.

The FIRST DOCUMENT produced by the revenue cycle The seller is actually just copying the details of the
is the purchase order. It represents a request for purchase order to the sales order.
merchandise by a customer. It is received by the company
(seller) through various means. This task is especially true when the purchase order is
received in hard copy from business entities that ordered
Orders may be made by: in BULK for retail.
• Telephone
• Printed form that the customer fills out In case the order was received online where the inventory
description is from the seller’s database, that purchase
As an additional control, an order confirmation is also order also serves as the sales order. The approved sales
added by online sellers to ensure that the customer is order becomes the AUTHORIZATION for stock release
really the person who is buying and that the customer is and shipment.
sure that he wants it to be delivered to the address s/he
specified.
The sales order CONTAINS the seller’s understanding
on the sales terms.

A seller should account for the numerical sequence to help

ensure that the shipments are made for sales order and that
all sales are build.

When it is generated by the seller’s information system,

the program or system that generates the sequential
number SHOULD BE DOCUMENTED especially when
an algorithm is used to auto-generate the numbers.

4. Sales Invoice
This document is the output of the BILLING
PROCEDURE and is sent out to customers as a demand
of payment of goods shipped.

It contains the PO reference so that the customer will be

able to check his own records and reconcile with the
amount owed to the seller.

It is a prenumbered document indicating the description

and quantity of goods sold or shipped, the price including
freight if it is shouldered by the buyer, insurance, terms,
3. Shipping Docs/Bill of Lading and other relevant data.
This document is produced when the goods are SHIPPED
by either the seller itself or a third-party courier. Sales invoice further indicates credit terms, shipping
terms, and price charged for the merchandise.
When a third-party courier is involved the bill of lading
document is ISSUED by the COURIER to the SHIPPER Seller should account for the numerical sequence to help
to acknowledge receipt of the cargo for shipment. ensure that all sales are recorded.

BOTH the internal shipping documents and the bill of When sales invoice is generated by the seller’s
lading contain the description of the goods, the quantity information system, the program or software that
shipped, and other relevant data. generates the sequential numbers SHOULD BE
DOCUMENTED especially when an algorithm is used to
The SIGNATURE of the courier or the customer on the auto-generate the numbers.
shipping document provides externally generated
evidence that goods have been shipped.

Seller should account for the numerical sequence to help

ensure that all shipments are recorded as sales.

When shipping documents are generated by the seller’s

information system, the program that generates the
sequential numbers SHOULD BE DOCUMENTED
especially when an algorithm is used to auto-generate the
numbers.

5. Credit Memo
The after sales processes includes transactions that
happen after the goods have been shipped to the customer.
It includes sales return which triggers a REDUCTION in Remittance advices facilitate the recording of cash
the accounts receivable balance of the customer as receipts.
evidenced by a credit memo.
If the customer does not return a remittance advice, the
The returns may be triggered by defective goods or goods employee opening the mail usually prepares one.
returned due to some other valid reasons.
A remittance advice usually indicates the date, amount of
The form often takes a general form as a sales invoice, but payment, and the invoices paid.
it effects a reduction rather than an increase in accounts
receivable. Sellers generally file remittance advice by customer then
by dates.
It may also refer to a purchase order or sales invoice to
which the returned goods relate.

A credit memo provides EVIDENCE that a seller has

reduced the amount previously billed to a customer.

Seller should account for the numerical sequence to help

ensure that all credit memos are recorded.

When credit memos are generated by the seller’s

information system, the program or software that
generates the sequential numbers SHOULD BE
DOCUMENTED especially when an algorithm is used to
auto-generate the numbers. 7. Uncollectible Account Authorization Form
Also known as “Accounts Receivable Write Off
Authorization Form”

Is a pre-numbered document used INTERNALLY in

the accounts receivable write off process indicating
authority to write an accounts receivable off has
uncollectible.

The form is usually initiated by the department handling

the accounts receivable subsidiary ledger and aging the
accounts receivable of each customer.

This is NOT a sales process form but included here

6. Remittance Advice because it affects the accounts receivable valuation.
It is a document that is more of an output of the payment
collection process than the sales process. The UAA form provided evidence that an account
receivable is uncollectible.
However, its relevance is that it also produces the
accounts receivable balance. Sellers should account for the numerical sequence to help
ensure that all write offs are authorized and recorded.
Also, using remittance advice is not popular anymore
especially now that various online payment options are When uncollectible accounts authorization forms are
already available over the internet. generated by the seller’s information system, the program
or software that generates the sequential numbers
It is attached by the payer to the check payment for an SHOULD BE DOCUMENTED especially when an
invoice. The document may also be a turn-around algorithm is used to auto-generate the numbers.
documents, one that is sent by the seller, usually as a part
of:
• the invoice with a “Tear here” line before it
• a check, one that is created by the payor
• a statement identifying the invoices being paid
 The Accounting Records in the Revenue and
Accounting Cycle

The conceptual framework of accounting considers

accounting records as FUNDAMENTAL to the fair
presentation of financial statements REQUIRED by the
IFRS with which the PFRS is currently fully converged.

Thus, as the intermediary record serving as a link to the

financial statement balances and supporting documents,
accounting records PROVIDE a vital evidence and at
the same time, a tool to verifying the propriety of
8. Monthly Statement of Account management’s assertions.
Is prepared by the seller to remind the buyer of any unpaid
invoices and to inform the buyer of the unpaid balance
with the seller, which is the balance of the buyer’s account
in the accounts receivable subsidiary ledger.

It indicates the:
• beginning balance
• amount and date of each sale during the period
including the invoice number
• payments received during the period
• credit memos issued
• ending balance due

This document also enables the buyer to reconcile any 1. Sales Journal
unrecorded payments paid to the seller as an outstanding It is a journal for recording ALL sales transactions.
item.
Detailed sales journal includes:
The statement of account doubles as the current invoice • each sales transaction indicating the sales invoice
for some service companies such as utility and and details of the invoice such as gross sales
telecommunications companies (Meralco, Globe, Smart, discounts
Maynilad, MWSS). • identifications for various classification of sales,
sales location, or division
When that is the case, it usually includes the details of the • other details may be used for the generation of
current transactions when there is only ONE summary sales report by revenue centers
transaction for the month.
When sales journals are in electronic format kept by the
If the statement is inaccurate, many customers would seller’s information system, the program should be
contact the seller. However, most disputes are usually the designed so that the auditor can TRACE the source
payments made by the customer which has not yet been document from the sales journal archive file.
recorded by the seller and does not reflect in the monthly
statements sent to the buyer/customer. There must also be a feature to accumulate the DAILY
transactions into an archive file for feature references.
When statement of accounts is generated by the seller’s
information system, the program or software that
generates the sequential numbers SHOULD BE
DOCUMENTED especially when an algorithm is used to
auto-generate the numbers.
2. Sales Returns and Allowances Journal 4. General Journal
This is a journal updated by the after sales process. This is a journal in which ALL TRANSACTIONS for
which special journals are not designed.
It is SIMILAR to the sales journal EXCEPT the seller uses
it to record returns of merchandise or adjustments to the Sales and collection cycles transaction frequently
invoice amount. recorded in the general journal include entries to:
• estimate uncollectible accounts expense
This journal is NOT NECESSARY when returns and • write-off accounts identified as uncollectible
allowances are recorded using the sales journal.
When the general journal is in electronic format kept by
When sales returns and allowances are in electronic the seller’s information system, the program should be
format kept by the seller’s information system, the designed so that the auditor can TRACE the source
program should be designed so that the auditor can document, the journal voucher to the supporting
TRACE the source document from the file. document from the file.

There must also be a feature to accumulate the DAILY There must also be a feature to accumulate the DAILY
transactions into an archive file for feature references. transactions into an archive file for feature references.

3. Cash Receipts Journal 5. A/R Master File/ Subsidiary Ledger

This is a journal updated by the accounts receivable A file recording the individual sales, cash receipts, sales
collection process when recording cash receipts from returns and allowances for EACH customer and
customer collection, cash sales, and other cash receipts. maintaining customer account balances.

When cash receipts journal is in electronic format kept by The master file is the BASIS for preparing the a/r trial
the seller’s information system, the program should be balance, which is the amount owed by each customer at
designed so that the auditor can TRACE the source a point in time.
document from the file.
When the accounts receivable master and subsidiary files
There must also be a feature to accumulate the DAILY is in electronic format kept by the seller’s information
transactions into an archive file for feature references. system, the program should be designed so that the auditor
can TRACE the source document from the file.
There is NO NEED for a feature to accumulate the
DAILY transactions into an archive file since the other
journals’ supporting entries to the a/r master and
subsidiary file must have the historical data.

Risk Assessment Procedures

REMEMBER that in Phase I, the auditor obtains

information about the client, its business, its internal
control, and many details about the financial policies
including accounting methods and the estimates.
Identifying Inherent Risks in the Revenue Account
As part of the risk assessment process, the auditor As regards to revenue, the timing of revenue recognition
performs analytical procedures on the financial is of IMPORTANCE in the revenue cycle.
statements. These information provide the basis for
assessing the risk of material misstatements or RMM that The simple principle of recognizing revenue when it is
partly may be caused by inherent and business risks. REALIZED seems quite simple in principle.

HOWEVER, in practice, it is DIFFICULT TO APPLY

because of reasons such as the complexity of the sales
transaction which makes determining when a sale has
actually taken place, difficult. Especially when certain
peculiar conditions and contingent situations are part of
the sales team.

To be able to properly identify and assess inherent

risks related to revenues, the auditor MUST
understand the following:
• The client’s core business. How does the business
earn revenue?
1. Inherent Risks • The operational details of the revenue process
At the financial statement level, may stem from the nature including the nature of non-standard obligations
of the client’s business and its operations. • The unusual items and when did the title pass to
the customer in these transactions
2. Fraud Risks • The customer’s right to return the product and the
May be ASSESSED through the understanding of the returns history
client’s internal control, analysts in the walk-throughs • The contracts that combine sales and lease
conducted in the client in the Phase I – Planning Stage. • The client’s treatment with sales transaction
made with recourse that have an
Fraud risks may also be assessed when doing the abnormal/unpredictable amount of returns
preliminary analytical procedures.
The PRIMARY inherent risk associated with accounts
receivable is that the net amount is not collectible.
Whether because the recorded receivables do not
represent genuine claim, genuine sales, or provision of
allowance for uncollectible accounts has been estimated.

Such risks AFFECT the financial statement assertions of

existence and valuation.

Additionally, when the entity SELLS receivables, the risk

of ownership claim may also exist.
Other risks affecting receivables arise from the
following conditions:
• Receivables are PLEDGED as collateral against
specific loans with restricted use, which must be
included in the disclosures
• Receivables are INCORRECTLY CLASSIFIED
as current when the likelihood of collection
during the next year is low
• Collection of a receivable is contingent on
specific events that cannot be estimated
• Payment is not required until purchasers sells the
product to customers
• Orders are accepted from customers with poor Appendix 2 of PSA 240 lists some risk factors that maybe
credit uncovered by the auditor.

These are categorized into three (3):

• Incentives/Pressures.
Risk arise from incentives/pressures when:
o there is EXCESSIVE pressure on
management or operating personal to meet
financial targets established by those charged
with governance including sales or
profitability incentive goals
o financial stability or profitability is
THREATENED by economic industry or
entity operating conditions such as, or as
indicated by high degree of competition or
Identifying Fraud Risks market situation accompanied by declining
While in PSA 240, the auditor’s responsibilities relating margins.
to fraud reiterates that the PRIMARY responsibility for • Opportunities.
PREVENTING AND DETECTING fraud rests with Risk factors arise from opportunities when:
management and those charged with governance, it o monitoring of management is not effective as
ALSO states in par. 16 when performing risk assessment a result of domination of management by a
procedures and related activities to obtain an single person or small group in a non-owner
understanding of the entity and its environment including managed business without compensating
the entity’s internal control, the auditor SHALL perform controls
the procedures in par. 17-24 to obtain information for o internal control components are deficient, as
used in identifying the risks of material misstatements due a result of high rates of employee turn-over
to fraud. or employment of accounting internal audit
or information technology staff that are not
Par. 24 further REQUIRES the auditor to “evaluate effective
whether the information obtained from the other risk • Attitude/Rationalization.
assessment procedures and related activities performed Risk factors arise from attitude/realization when:
indicates that one or more fraud risk factors are present.” o management failings to correct known
material weaknesses or internal control on a
Par. 26 adds that in GENERAL, auditor SHALL timely basis
PRESUME that there is a risk of fraud in revenue o the owner manager makes no distinction
recognition and evaluate which type of revenue, revenue between personal and business transactions
transactions, or assertions give rise to such risk. o there is a known history of violations of
security’s laws or other laws and regulations
or claims against the entity
o senior management or those charged with
governance alleging fraud or violations of
laws and regulations
Identifying Fraud Risks in Revenue Identifying Control Risks in Revenue
Material misstatements due to fraud in the financial Control risk is defined as the risk that could occur in an
reporting relating to revenue recognition often result from assertion about the class of transactions, account balance,
an: or disclosure and that could be MATERIAL either
• OVERSTATEMENT of revenues through individually or when aggregated with other misstatements
premature revenue recognition or recording WILL NOT BE PREVENTED or detected or corrected on
fictitious revenues a timely basis by the entity’s internal control.
• UNDERSTATEMENT of revenues through
improper shifting revenues to a later period It may be likened to a FIREWALL that protects the
organization’s data and IP infrastructure from exposure to
Other revenue fraud schemes are: attacks from hackers and other attempts at accessing the
• Recognition of revenue on shipment that never important detail within the organization’s network.
occurred
• Hidden side letters, agreements containing If the firewall is well-designed, it will prevent the attacks
contract terms that are not part of the formal from accomplishing their malicious goals.
contract, giving customers an irrevocable right to
return the product Inherent risks and fraud risks are COMPARED to
• Recording consignment sales as final sales those attacks.
• Early recognition of sales that occurred after the
end of the fiscal period Firewalls to the internal control, protects the integrity of
the assertions in the financial statements.
• Shipment of unfinished product
• Shipment of product before customers wanted or
Holes or gaps in the firewall REPRESENTS control
agreed to delivery
risks.
• Creation of fictitious invoices
• Shipment of more product than the customer
ordered The BIGGER the hole, the HIGHER the control risks.
• Recording shipments to the company’s own
warehouse as sales
• Shipping goods that had been returned and When an attack HITS an area that has no holes, meaning
recording the shipment as a sale of new goods there is an effective control, the attack will be
before issuing credit for the returned sale neutralized.
• Incorrect aging of accounts receivable and not
recording write-downs of potentially However, when a risk hits a hole in the wall, that risk goes
uncollectible amounts through and damages the INTEGRITY of the financial
• Recording purchase orders as complete sales data.
• Lapping which is a technique used to cover up
embezzlement of cash
After the inherent and fraud risk that may contribute to Understanding of the internal control including the
the risk of material misstatement in the revenue and control environment or entity level control may be
accounts receivable accounts, the auditor needs to obtained through:
UNDERSTAND the controls that the clients have a. Review of client’s documentation, including
designed and implemented to ADDRESS those risks. the Risk Control Matrix which is illustrated
in the next slide
Understanding the client’s internal control will help the b. Walkthroughs of the business processes
auditor PINPOINT where the holes in the firewall are related to financial reporting including the
and how big these holes are. systems that support the business processes
c. Inquiry (by itself, is not sufficient for
The type of the inherent risk and the impact that it understanding the internal control, THUS it is
makes if it occurs and the size of the control risk done in combination with other methods,
DICTATES if the risk is significant or insignificant. usually during the walkthrough of the
business processes
If SIGNIFICANT, then the auditor has a risk of material d. Observation
misstatement at hand.
The methods are MOST EFFECTIVELY DONE in
PSA 315 par. 3 and 12. It is the auditor’s responsibility this order.
to obtain an understanding of the entity’s internal control
as a BASIS in designing and implementing RESPONSES
to the assessed risk of material misstatement.

EVALUATING the design of a control involves

considering whether the control, individually or in
combination with other controls, is capable of
EFFECTIVELY preventing or detecting and correcting
material misstatements.

IMPLEMENTATION of a control means that the

control exists and that the entity is using it.
The risks in the first column are the RISKS
There is little point in assessing the implementation of all IDENTIFIED while performing the methods of
compliance to a control that is NOT effective. And so, the understanding the internal control.
DESIGN of a control is CONSIDERED FIRST.
Then, the auditor ASSIGNS A VALUE indicating the
An IMPROPERLY DESIGNED control may represent a
likelihood of such a risk occurring, namely:
material weakness in the entity’s internal control. 1 – Highly unlikely to happen
2 – May possibly happen
3 – Probably happens

Another parameter, the IMPACT is also assigned a value

indicating the severity of the effect of the risk if they
occur.
Namely: trends that might indicate matters that have audit
1 – Low impact implications.
2 – Moderate impact
3 – High impact Auditors DO NOT look at JUST the numbers when
performing analytical procedures.
Likelihood and impact assessed may be partly
determined from the DESIGN of the business process. Unusual or unexpected relationships that are identified
MAY ASSIST the auditor in identifying risks of material
Then the CONTROLS TO THE RISK is also identified. misstatement especially risks of material misstatements
This may be one or more direct or indirect controls to a due to fraud.
risk that could:
• prevent the risk from happening
• detect the occurrence of the risk when it is not
prevented
• correct the effect of the risk in the financial data

The design’s score is on a scale of 0-2 which are

equivalent to:
0 – Ineffective
1 – Effective
2 – Highly effective

The multiplier is anything that makes the control more

effective OTHER THAN the designs. POSSIBLE EXPECTED RELATIONSHIPS which
suggest that NOTHING IS OUT OF THE
In the given example, number of controls is used as a ORDINARY in the revenue cycle include the
multiplier for simplicity. following:
• There is no unusual year-end sales activity
Then, the design and multiplier are MULTIPLIED to • Accounts receivable growth is consistent with
arrive at the control effect which will reduce the revenue
significance of the assessed risk. • Revenue growth, receivables growth and gross
margin are consistent with the activity in the
The risk assessed is then reduced by the control effect to industry
arrive at the assessed risk of material misstatement. • There is no unusual concentration of sales made
to customers (in comparison with the previous
Other means of determining the RMM may be devised year)
and used as part of the audit working papers. • The accounts receivable turnover is not
significantly different from the prior year
• The ratio of the allowance of doubtful accounts to
total receivables or to credit sales is similar to the
prior year.

Any DEVIATIONS from these expectations should be

a RED FLAG to the auditor, indicating that there
could be RMM due to fraud.

For example, the following relationship may SUGGEST

a risk of fraud:
• Revenue is increasing even though there is a
strong competition and a major competitor has
PSA 315 par. 6 REQUIRES the auditor to perform introduced a new product
preliminary analytical procedures as one of the • Revenue increases are not consistent with the
procedures DURING the risk assessment phase. industry or the economy
• Gross margin is higher than average or there is an
Analytical procedures may help IDENTIFY existence of unexpected change in gross margins
unusual transactions or events and amounts, ratios, and
 • Large increases in revenue occur near the end of
the quarte of the year
• Revenue has grown and net income has increased
but there is negative cash flow from operations.

Trend analysis of account balances and ratios are

preliminary analytical procedures that are routinely used
in the revenue cycle accounts.

Example of ratios that auditors might consider for

revenue cycle accounts are as follows:
• Gross margin analysis
• Turnover of receivables (ratio of credit to average
net receivable) or the number of day’s sales in
accounts receivable
• Average receivables balance per customer
• Receivables as a percentage of current assets
• Aging of receivables
• Allowance for uncollectible accounts as a
percentage of accounts receivable
• Bad debt expense as a percentage of net credit
sales
• Sales in the last month (or quarter) to total assets
• Sales discounts to credit sales
• Returns and allowances as a percentage of sales