As auditors, we perform the audit of revenue by testing various audit assertions, including occurrence, completeness, accuracy, and cut-off. Among these assertions, the occurrence may be the most important assertion as material misstatement of revenue usually because of overstatement rather than understatement.
This is due to the company usually want to show higher revenue than it actually is, especially when it has the incentive to overstate the revenue. Likewise, the most common inherent risk related to the revenue is the misstatement that could occur due to the management’s incentive or pressure to receive a certain level of sales or to obtain a certain level of bottom-line profit.
Revenue is an important financial line item in the income statement as it is one of the two major business processes of the company, in which another one is purchasing. Because of this, revenue is usually the material item in the financial statement.
In the audit of revenue, the inherent risk is usually high when the client has to deal with many complex sales transactions in its business, e.g. those sales transactions that make it difficult to determine when the sales has taken place and complete. In this case, we usually focus our attention more on revenue recognition where the material misstatement can easily occur either due to error or fraud.
Audit Assertions for Revenue
The audit assertions for revenue are included in the table below:
|Audit assertions for revenue|
|Occurrence||Revenues that have been recorded actually occurred and are related to the client.|
|Completeness||All revenues that should have been recorded have actually been recorded.|
|Accuracy||All revenue transactions have been recorded correctly.|
|Cut-off||All revenues have been recorded in the correct accounting period.|
|Classification||All revenue transactions have been properly classified in accordance with applicable accounting standards.|
|Presentation||Sufficient and proper disclosure related to sale revenues have been made.|
In the audit of revenue, the occurrence assertion may be one of the most relevant audit assertions here. This is especially true if the client has incentives to overstate revenues.
Risk of Material Misstatement in Audit of Revenue
Risk of material misstatement is the risk that the material misstatement can occur on financial statements and the internal controls can’t prevent or detect it. It is the combination of inherent risk and control risk.
In the audit of revenue, the risk of material misstatement is the risk that revenue contains material misstatement but the internal control cannot prevent or detect such misstatement.
Inherent risk of revenue risk is its susceptibility to misstatement. The level of inherent risk usually depends on the nature and complexity of the business. Usually, the more complex the revenue transaction is, the higher the inherent risk it faces.
Control risk for revenue is the risk that the client’s internal control fails to prevent or detect the material misstatement that occurs in the revenue account. The client’s internal control may fail to prevent or detect the material misstatement due to two circumstances.
First, it may be due to there is no proper internal control in the first place. Second, it may be due to the control procedures are not properly executed by related personnel as they are intended.
As auditors, we have responsibly to perform an assessment of the risk of material misstatement in the planning stage of the audit. This includes the assessment of the risk of material misstatement for revenue.
This is so that we can design appropriate audit procedures to respond to the risk that we have identified and assessed. Audit procedures may include both test of controls and substantive tests.
Test of Controls in Audit of Revenue
In the audit of revenue, we may assess the control risk as low in case that we believe that the internal controls are effective in preventing, detecting or correcting the material misstatements that can occur in the revenue account.
In this case, we need to perform test of control to obtain sufficient audit evidence to support our assessment. However, we only perform tests of controls if we intend to rely on the client’s internal controls to reduce the risk of material misstatement.
As a result, if the client’s internal controls prove to be strong and effective after the test, we can reduce some of our tests of details. On the other hand, we may need to increase the sample size of the detail tests if the result of the control test shows otherwise.
Test of controls procedures may include:
- Inquire the client’s staff related to the internal controls processes
- Observe the clients’ staff performing the controls
- Inspect the supporting documents to ensure that the controls have been properly performed
- Re-perform the controls that have been performed by clients’ staff
It is useful to notice that the inquiry procedure is usually performed together with other procedures, such as inspecting the supporting documents or observing the client’s staff performing the controls, in order to ensure that the explanation given by the client’s staff or management is true.
Test of control example in the audit of revenue:
- We test the control of authorization of the sales recording by obtaining supporting documents to verify whether the sales order and dispatching document have been approved before sales are recorded.
- We test the control of segregation of duties by verifying whether the persons who take order and person who records sales and the person who receives payment are different personnel.
- We test the completeness of revenues by verifying the numerical sequences of invoices.
Substantive Audit Procedures for Revenue
Substantive Analytical Procedures for Revenue
Like the audit of other financial statements line items, we perform substantive analytical procedures on revenue before performing the test of details.
We usually perform substantive analytical procedures by looking at the trends from the previous months or years and the relationship between sale revenue and other independent items such as cost of sales, selling expenses and the growth of sales in the sectors.
If the client’s record is significantly different from our expectation after looking at the trends or the relationship of other items, we will need to follow up with sufficient appropriate tests of details. On the other hand, if our expectation is not significantly different from what the client has recorded, we might be able to reduce tests of details.
It is useful to note that in the audit of revenue, it is unlikely that the audit evidence obtained from substantive analytical procedures alone will be sufficient; hence the test of details will usually be required, more or less.
Test of Details for Revenue
In the audit of revenue, test of details usually focuses on the occurrence of revenue, completeness of revenue transactions, the accuracy of the revenue record and the cut-off of the accounting period.
Occurrence tests whether the revenue transactions that have been recorded in the client’s accounts actually exist. Under the accrual basis of accounting, all revenues should be recognized and recorded when they occurred regardless of whether the payment have been received or not. In most cases, it happens when the goods are delivered.
Example: the test of occurrence assertion
- Select a sample of recorded sale revenue transactions
- Vouch the selected transactions to sale invoice to ensure transactions recorded are based on sale invoices
- Trace sale invoice to customer order and bill of lading to ensure sales have actually happened and goods have been shipped to customers
- Scan sale journal for duplicate journal entries
In the audit of revenue, completeness tests whether all revenues that actually happened have been recorded in the accounts. The completeness assertion here is the opposite of the occurrence assertion above. While occurrence tests the revenues that had been recorded to ensure they actually exist, the completeness tests the revenues that occurred to ensure they have been recorded.
Example: the test of completeness assertion
- Select a sample of bills of lading
- Trace the selected bills of lading to sales invoice and sales journal to ensure they have been recorded as sales revenue
- Scan the sequential number of sales invoices in the sales journal; ensure that the missing numbers are not unrecorded sales and have an appropriate explanation for.
Accuracy tests to see whether the revenue transactions recorded are free from error. We usually review to see whether the sale invoices prepared are mathematically corrected and there is no misstated amount recorded.
Example: the test of accuracy assertion
- Select a sample of sale invoices
- Verify the selected sale invoices with supporting documents to makes sure they are accurately prepared
- Trace sale invoices to sale journal and accounting record to make sure they are recorded in the correct amount
Cut-off tests whether the revenue transactions are recorded in the correct accounting period. Sale revenues may be recognized in the wrong accounting period due to the complicated process of the sale order, shipment and sale invoice or the client may intend to move accounting transactions from one year to another in order to increase the bottom line.
Example: the test of cut-off assertion
- Select a sample of sales invoices around the year-end
- Inspect the dates on the invoices and compare them with the dates of dispatch of goods and trace to the dates recorded in the sale journal and accounting record to ensure the correct accounting period entries.
- Select a sample of return documents (for sale returns) around the year-end and trace to the related credit entries