Auditing the Revenue Cycle

BATCH PROCESSING USING SEQUENTIAL FILE – MANUAL PROCEDURE

Taking the customer order

• The customer order is not in a standard format and may or may not be a
physical document transcribe it into a formal sales order
• Orders may arrive by/from:
• Mail
• Telephone
• Website
• A field representative
• The sales order (paper or electronic) indicates:
• The customer’s name, address, and account number
• Description of the items sold
• The quantities and unit prices of each item sold

Check credit
• The customer’s creditworthiness needs to be established. The circumstances of the sale
will determine the nature and degree of the credit check
• The credit authorization copy of the sales order is sent to the credit department for
approval
Processing Shipping Orders
- The sales department sends the stock release (also called the picking ticket) copy of the sales order to
the warehouse.
- The clerk initials the stock release copy to indicate that the is complete and accurate . One copy of
the stock release travels with the goods the shipping department, and the other warehouse to
provide record of the transaction.

BATCH PROCESSING USING SEQUENTIAL FILE – AUTOMATED PROCEDURE

Key punch/Data Entry – Process begins with the arrival of batches of these shipping notices from the
shipping department. These documents are copies of the sales orders that contain accurate information
about the number of units shipped and informations about the carrier.
Edit Run – This program validates transactions by testing each record for the existence of clerical or
logical errors.
Sort Run – Physically arranges the sale order transaction file sequentially by account no. which is one of
its secondary keys.
AR Update and Billing Run – AR update program posts to AR by sequentially matching the account no.
Key in each sales order record in the AR-SUB master file.
Sort and Inventory Update Runs - The inventory update program reduces the quantity on hand field in
the effected inventory records by the Quantity sold field.
General ledger Update Run – Under the sequential file approach the general ledger master file is not
update after each batch of transactions.
- At the end of the General ledger system accesses the journal voucher file. This file contains journal
vouchers are sorted by general ledger account no. And posted to general ledger in a single run and a new
general ledger is created.

Batch Cash Receipts System with Direct Access Files

The cash receipts system uses direct access files and batch processing is used to automate traditional
procedures.
These are the following main points of the system.
Mailroom – separates the checks and remittance advices and prepares a remittance list.
Cash Receipts Department – cash receipt clerk reconciles the checks and the remittance list and
prepares the deposit slips.
Accounts Receivable (AR) Department - AR clerk receives and reconciles the remittance advises and
remittance list.
Data Processing Department – batch program reconciles the journal voucher with the transaction file
of cash receipts, and updates the AR-SUB and the general ledger control accounts (AR-Control and
Cash).

REAL TIME SALES ORDER ENTRY AND CASH RECEIPTS

Order Entry Procedure

 Sales order procedure – sales clerks receives orders from customers. Process each transaction
separately as it is received. Using a terminal connected to an edit/inquiry program.
 Warehouse procedure – warehouse clerk immediately produces a hardcopy print out of the
electronically transmitted stock release document.
  Shipping and billing – the shipping clerk reconciles the goods, the stock release document, and
the hard copy packing slip produced or terminal, then the clerk selects carrier to ship the goods.
 Cash Receipts Procedure – in an open invoice file system, each invoice is billed and paid
individually. Payment from customer may be processed as just described or may be sent directly
to the bank lock box. In either case the remittance advices are sent to AR Dept. Where the clerk
enters them into the system via terminal.
FEATURE OF REAL-TIME PROCESSING
Four advantages make the approach attractive option for many organizations:
1. Real time processing greatly shortens the cash cycle of the firm.
2. Real time processing can give a firm a competitive advantage in market place.
3. Manual procedure tend to produced clerical errors, such as incorrect account numbers, and price
quantity.
4. Real time processing reduces the amount of paper document in a system.

End of the day procedure

DR CR

Cash XXXX
Cash over short XXXX
Accounts receivable/ XXXX
credit card
Cost of goods sold XXXX
Sales XXXX
Inventory XXXX

Input Controls – are designed to ensure that transactions are valid and complete.

 Credit Authorization Procedures – established the credit worthiness of the customer.

 Testing Credit Procedures – Failure to apply credit policy correctly and consistently has
implications for the adequacy of the organizations allowance for uncollectible accounts. The
following test provide evidence pertaining to the valuation/allocation and accuracy objectives:
- Auditor can verify the correctness of programmed decision rules by using either the test data or
integrated test facility (ITF)
- Auditor needs to verify that the authority for making line-of-credit changes is limited to authorized
credit department personnel.
  Data Validation Controls – input validation controls are intended to detect transcription errors in
the transaction data before they are processed
Examples that are relevant to the revenue cycle:
1. Missing data checks 4. Range checks
2. Numeric – Alphabetical data checks 5. Validity checks
3. Field checks 6. Check digit

 Testing Validation Controls – The auditor may decide to rely on the quality if other controls to
provide assurance needed to reduce substantive testing.

Example: After reviewing systems development and maintain controls, the auditor may determine
that the controls over original program design and testing and subsequent changes to programs are
effective.
- If control over systems development and maintainance are weak, the auditor may decide that
testing the data editing controls would be more efficient than performing extensive substantive
test of details.

 Batch controls – used to managed high volume of transaction data through a system.
Objective: Reconcile output produced by the system with original input.
Transmittal sheet is the Important elements of batch control which captures relevant informations about
the batch, such as:
1. Unique batch number
2. Batch data
3. Transaction code (indicating the type of transaction such as sales order or cash receipt)
4. The number of records in the batch
5. The total amount value of financial field
6. The total of a unique non-financial field.

These provides assurance that:

1. All sales invoices and cash receipts records that are entered into the
system were processed.
2. No invoices or cash receipts were processed more than once.
3. All invoices and cash receipts entered into the system are accounted for
as either successfully processed .
4. Or rejected because of errors.
Testing Batch controls – The failure of batch controls to function properly can result in records
being lost or processed multiple times. Test of batch controls provide the auditor with evidence
relating to the management assertion of completeness and accuracy.

o Process Controls – include computerized procedure for file updating and restricting access to
data.
o File Update Controls – These controls ensure that each run in the system processed the batch
correctly and completely.
Testing File Update Controls – failure of file update controls to function properly can result in
records going unprocessed, being processed incorrectly or being posted to the wrong
customer’s account.
 o Access Controls – prevented detect unauthorized and illegal access to the firms assets.
Traditional techniques used to limit access to these asset include the following:
 Using warehouse security such as fences, alarms and guards
 Depositing cash daily in the bank.
 Using safe or right deposit box for cash
 Locking cash drawers and safes in the cash receipts department.
The following are examples of risk specific to revenue cycle.
1. An individual with access to the AR subsidiary ledger could remove his or her
account(someone else)from books
2. Access to blank sales orders may enable an unauthorized individual to trigger the
shipment of the product.
3. An individual with both cash and accounting records could remove cash from the
firm and cover the act by adjusting the cash account
4. An individual with access to physical inventory records could steal products and
adjust the record to cover the theft.
Testing Access Controls – “Access control is at the heart of accounting information”.
Without controls invoices can be deleted, added or falsified. Account balances can be
erased or even the entire file can be destroyed.

o Physical Controls
Segregation of duties – proper segregation of duties ensures that no single individual or department
process a transaction in its entirety.
3 rules apply:
Rule 1- Transaction authorization should be separate from transaction processing.
Rule 2- Asset custody should be separated from the record keeping task.
Rule 3- The organization should be structured that the perpetration of fraud requires collusion
between two or more individuals.
Supervision – it is important that entity has a strong supervisory control to prevent anomalies within
entity.
Independent verification – The purpose of independent verification is to review the work
performed by others at a key junctures in the process to identify and correct errors.
The following are two examples in the revenue cycle:
1. The shipment department verifies that the goods sent from the warehouse
are correct department in type and quantity to present discrepancies.
2. The billing department reconciles the shipping notice with the sales
invoice to ensure that customers billed only for the items and quantities
were actually shipped.
Testing physical Controls – Inadequate segregation of duties and the lack of effective supervision
and independent verification can result in fraud and material errors.

Output Controls – are designed to ensure that information is not lost, misleaded or corrupted and the
system process function as intended. Reconciling the general ledger is an output control that can detect
certain types of transaction processing errors.
 Output control can be designed to identify potential problem.
Another important element of output control is the maintainance of an audit trail.
The following are examples of audit trail output controls:
• Accounts Receivable Charge Report – Summary report that shows the overall change
accounts receivable from sales order and cash receipts.
• Transaction Logs – All successful transaction processed by the system should be
recorded on a transaction log, which serves as a journal.
Two purpose of transaction logs:
1st Original transaction file produced at the data input is usually temporary file.
2nd Not all the records in the temporary transaction file will always be successfully processed.
• Transaction listings – List of all successful transaction (Hard copy).

• Log of Automatic Transactions – To maintain an audit trail of these activities. All internally
generated transactions must be placed in a transaction log, and a listing of these transaction
should be sent to the appropriate manager.
• Unique Transaction Identifiers – All transaction in the system must be uniquely identified with
their transaction codes. This control is the only practical means of tracing a particular transactions
through a database of thousands or even million of records.
• Error of listing – A listing of all error records should go to the appropriate user to support error
correction or resubmission.
• Testing Output Control – involves reviewing summary reports for accuracy, completeness,
timeliness and accuracy to the decisions that intended to support
- Auditor should trace sample transactions through audit trail reports,
including transaction listings, error logs of resubmitted records.

Substantive Test of Revenue Cycle Accounts

Revenue Cycle Risk and Audit concern – The auditors concern in the revenue cycle is the potential of
overstatement of revenues rather that their understatement.
Overstatement can result from material errors in the processing of normal transactions throughout the
year.
Specific issues that give rise to these concerns:
 Recognizing revenues from sales transactions that didn’t occur.
 Recognizing sales revenues before they realized
 Failing to recognize period-end cut off points, thus allowing reported sales revenues for the
current period to be inflated by post-period transaction.
 Underestimating the allowance for doubtful accounts, thus overstating the realizable value of AR.
 Shipping unsolicited products to customer in one period that returned in a subsequent period.
 Billing sales to the customer that are held by the seller.
The auditor seek evidence by performing a combination of test of internal control and substantive test.
Test of control both general controls and application controls specifically related to revenue cycle
procedures.
ITF(Integrated test facility) – test the accuracy of sales transaction posting to the AR file.
- to test credit limit logic of the edit, program to provide assurance that
organization’s credit policy is properly implemented.
 Perform substantive test to achieve audit objective.

Understanding Data

- It involve accessing and extracting data from accounting files for analysis. To do this, the auditor needs
to understand the systems and controls that produced the data, as well as the physical characteristics of
the files.
- First, the auditor must verify that he or she is working with the correct version of the file to be
analyzed. To do so the auditor must understand the file backup procedures and, whenever possible, work
with the original files.
- Second, ACL can read most sequential files and relational database database tables directly, but
esoteric and/or complex file structures may require “flattening” before they can be analyzed.
- If the client organization’s systems personnel perform the flattening process, the auditor must
verify that the correct version (format that ACL can accept) of the original file was used and all relevant
records from the original were transferred to the copy for analysis.

 Customer file – contains address and credit information about customer.

 Sales Invoice File and Cash Receipts File – captures sales transaction data for the period.
 Line Item File – contains a record of every product sold.
 Inventory File –contains quantity price, supplier, and warehouse location data for each item of
inventory.
 Shipping Log File – This is the record of all sales orders shipped to customer.
 File Preparation Procedures – provide evidence that may either corroborate or refutes audit
objectives. Most of the test described in the ff. involved using ACL to accessed extract data from
the file.

Testing the accuracy and completeness Assertion

Review Sales Invoice for Unusual Trends and Exceptions

 Involves scanning data files for unusual transactions and account balances.
 Auditor can use ACL’s Stratify feature to identify anomalies in the system.

Review Sales Invoice and Shipping logs

Files for missing and Duplicate Items

 Duplicate and missing transactions in the revenue cycle may be the evidence of over or
understated sales and accounts receivable .
 Duplicated sales invoice records may indicate a computer program error that materially overstates
sales and accounts receivable.
 Missing sales invoice may point to an unrecorded sales that was stopped but not billed.
ACL is capable of testing a field for out-of-sequence records, gaps in sequence numbers and duplicate
values for entire file. Auditor can scan the Invoice Number field of all the records in the Sales Invoice
File.

Tests Shipping Log file

 Auditor would test the Invoice Number field for gaps and duplicate records.
 Duplicate record may indicate that the same product was shipped to the customer twice.
 Missing invoices may denote that some customers orders are not shipped at all.

Testing Unmatched Records

 Auditor can produce a new file of only unmatched records.

Two(2) causes for unmatched records

First, the value of the Item Number field in the line item record is incorrect and does not match an
Inventory record.

Second, the presence if inventory records in the unmatched file means that there were no corresponding
records in the line item file. This result is not an error, it means that these products did not sell during the
period.

Testing the Existence Assertion

 Confirmation of accounts receivable

 Involved direct written contract between the auditors and the client’s customer to confirm account
balances and transactions.

The confirmation process involves three stages: Selecting the accounts to confirm, preparing confirmation
request, and evaluating the responses.
 Selecting Accounts to Confirm – involves processing data that are contained in both the
customer and the Sales Invoice File.

Obtaining a set of accounts for confirmation requires three steps: Consolidate invoices by
customers, join the data from the two files, and select a sample of accounts from the joined
file.

Consolidate Invoices – First step is to consolidate all the open invoices for each customer.

Join the Files – Next step in Confirmation process is to join the classified Invoices and Customer
file to produce another new file called Accounts Receivable.

Select a Sample of Accounts – Random Sampling and Monetary unit Sampling(MUS).

Preparing Confirmation Request -Involves preparing confirmation request that contain the information
captured in AR Sample File.

 Negative Confirmation If they disagree with the amount shown in the letter.
 Positive Confirmation whether their records agree or disagree with the amount stated.

Evaluating and Controlling Response

 Evidence provided through confirmations is less reliable when contact between the auditor
and the debtor is disrupted by client interventions.

The auditor should take all reasonable steps to ensure the following procedures are observed:
 The auditor should retained custody of the confirmation letters until they are
mailed.
 The confirmation letters, together with self-addressed to the auditors rather
than the client organization.
 The confirmation request should be mailed by the auditor. If client mailroom
personnel participate in the process they should be adequately supervised.

When responses are returned to the auditor, discrepancies in the amount should be investigated.
Non response to positive confirmation also need to be investigate.

Testing the Valuation

 Auditors objective regarding proper valuation and allocation is to corroborate or refute that
accounts receivable are stated at net realizable value.

Aging Accounts Receivable – is a report that list of unpaid customers invoices and unused credit memos
by data ranges.

As accounts age, the probability that they will ultimately be collected is decreased.

A key issue for auditors to resolve therefore, is whether the allowance calculated by the client is
consistent with the composition of their organization’s AR Portfolio and with the prior years and in
addition auditor needs to determine that the allowance is consistent with current economic conditions.