PM550–4 Revenue Recognition

• Discuss the practical issues and challenges when auditing the risk related to revenue recognition.. • Direct engagement teams to develop tailored audit procedures that respond to the r

Audit Excellence 2008

You will be able to:

• Describe the objective and significance of revenue

recognition

• Discuss the practical issues and challenges when auditing the risk related to revenue recognition

• Implement an efficient and effective process on

engagements to identify and pinpoint risks related to revenue recognition

• Outline the documentation appropriate to support the

assessment of the risk of revenue recognition

• Direct engagement teams to develop tailored audit

procedures that respond to the risk of revenue recognition

What we already know

Revenue recognition is a presumed specific risk due to fraud

• We should ordinarily presume that there is a specific risk of material

misstatement due to fraud related to revenue recognition and consider which types of revenue, revenue transactions, or potential errors may give rise to such risk

<Audit Approach Manual G045.02>

Exception - rebutting the presumed risk

• If we have not identified a specific risk of material misstatement due to fraud related to revenue recognition, we should document the reasons supporting our determination

<Audit Approach Manual G045.05>

Why revenue recognition is still topical

Revenue Recognition

Be mindful of deficiencies and plan towards a better audit

Fraud cases

Economic factors

Regulators’ concerns/

Practice review findings

Evolving business

models/practices

ISA

Regulators’ concerns

Key findings from PCAOB:

• Evaluate compliance with GAAP & address complex or

specialized revenue-recognition accounting principles

• Deficiencies in performing audit procedures:

– Inadequate substantive procedures to test the existence,

completeness, and valuation of revenue.

– Examining significant contractual arrangements.

– Performing cutoff procedures.

– Applying confirmation procedures.

Common fraud schemes used for improper revenue recognition

• Side agreements

• Channel stuffing

• Round tripping sales

• Bill and hold transactions

• Fictitious sales to existing or nonexistent customers

• Contract accounting scheme

• Sham related party transactions

• Contract with multiple deliverables

• Consignment sales

Process overview of revenue recognition

WPs in Large Man pack

Step 1: Determine the overall audit strategy

Step 2: Discuss the possibility of fraudulent financial

reporting Step 3: Understand the entity and its environment

Step 6: Pinpoint the presumed specific identified risk

Step 4: Understand the revenue significant flow of

transactions

Step 5: Perform preliminary analytical review

1230

1410

1535

1611

1832/1811 1213

Revenue recognition criteria – IAS 18

No managerial involvement

or control

Reliable measurement

Economic benefits probable

Transfer of risks and rewards

Goods

Revenue recognition criteria – IAS 18

No managerial

involvement

or control

Reliable measurement

Economic benefits probable

Transfer of risks and rewards

Goods

Percentage completion

Reliable measurement

Economic benefits probable

Services

Analyze and disaggregate the revenue account

Type B: Retailing

Type A: Distribution

Type C: Wholesale

Type B: Retailing

Type A: Distribution

Linking the presumed risk with our audit assurance model

Type C: Wholesale

Pinpoint the risk to

specific transactions

Pinpoint the risk to specific transactions

Pinpoint the specific risk at the potential error level

Cutoff Validity

Design the right approach

Process overview of revenue recognition

AS/2 common documentation

in a large pack

Step 1: Determine the overall audit strategy

Step 2: Discuss the possibility of fraudulent financial

reporting Step 3: Understand the entity and its environment

Step 6: Pinpoint the presumed specific identified risk

Step 4: Understand the revenue significant flow of

transactions

Step 5: Perform preliminary analytical review

1230

1410

1535

1611

1832/1811 1213

Example 1

• “Keep it in the Family” is a manufacturing entity which sells all of

its goods to a wholly-owned subsidiary of its parent entity

• Sales are priced on arm’s length basis and in line with the

standard pricing policy of the group.

• Sales are recognized when title passes.

Keep it in the Family

Can we rebut the presumed revenue recognition risk?

Example 2

• “You’re Trumped” is a property investment company

• It owns one leasehold property for rental purpose.

• It has entered into rental agreements with five tenants at a fixed

monthly rental for fixed terms.

• Rental income is recognized on a straight line basis over the lease term.

You’re Trumped

Can we rebut the presumed revenue recognition risk?

Rebuttal of the presumed specific identified risk

It is unusual to be able to rebut the presumption of revenue recognition risk

• Document the reasons of the rebuttal in the text box of “Audit Plan by Account”.

Examples of audit responses dealing with specific risk of revenue recognition

Perform substantive analytical procedures

Confirm with customers

Inquiries of sales and marketing, legal counsel

Attend year-end inventory count

Perform cut-off procedures

Test operating effectiveness of controls

“Pervasive responses”, such as “applying increased

professional skepticism, is generally not appropriate or

sufficient

Other efficiency and effective considerations to

achieve a focused level of substantive assurance

Performing tests of details using a focused level of

substantive assurance for the entire revenue balance is

usually not efficient or effective

May be effective to apply nonrepresentative selections in tests

of details

Perform substantive analytical procedures, with a maximum level of substantive assurance to obtain at:

• Intermediate level (for non-SIR)

• Moderate level (for SIR)

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