The first part discussed the principles of revenue recognition under the FRF for SMEs. This part will focus on auditing issues, including some common questions auditors should ask.
For any material financial statement classification, an auditor is responsible for evaluating the appropriateness and reasonableness of relevant financial statement assertions, that is, management's representations resulting from an entity's financial reporting and internal control systems. AU-C 315 in the Clarified Auditing Standards discusses management's financial statement assertions for account balances, transactions and presentation, and disclosures in financial statements. Following are some common questions auditors should ask regarding relevant assertions for revenues:
- Were sales of products or services made to valid customers, do they meet the criteria for valid sales, and did they actually occur in the reporting period? (Existence, occurrence and cutoff)
- Do other revenues represent legitimate income of the entity received or earned in the reporting period? (Existence, occurrence and cutoff)
- Have all revenues of the entity been reflected in the financial statements? (Completeness)
- Are the sales or other revenues valued properly, that is, do they reflect arms-length valuation for products, services, or transactions recorded during the reporting period? (Valuation and accuracy)
- Are the revenues presented in the proper account classifications and are all necessary disclosures included? (Disclosure and presentation)
- Are revenues consistently recorded to reflect GAAP or another comprehensive basis of accounting? (Valuation and accuracy)
- Are only revenues applicable to the reporting period presented in the financial statements? (Existence)
AU-C 500 and AU-C 315 make it clear that auditors must gather sufficient evidence to evaluate relevant assertions for all material financial statement classifications. The auditing standards also make it clear that some assertions, particularly the completeness assertion for revenues, may require procedures other than detailed tests of balances to reduce detection risk to an acceptably low level.
Evaluating the Completeness Assertion
When risk assessment procedures (including systems walk-through procedures), analytical procedures or tests of balances procedures can be performed to efficiently evaluate the completeness assertion, tests of controls may not be necessary for this purpose. Evaluating the completeness of revenues only through tests of balances, however, is difficult at best.
Examples of substantive tests that can be used to evaluate the completeness assertion for revenues include examining contracts with customers to determine all revenues that should be recorded are recorded or using predictive analytical procedures to determine the accuracy of recorded revenues or expenses. An example includes using copy machine meter readings for a copying business to compute copying revenues and copy machine rental expense. In other instances, systems walk-through procedures and/or limited tests of controls may be necessary to properly evaluate the completeness assertion for revenues.
Nature, Extent, and Timing of Tests of Balances Procedures
The nature, extent, and timing of audit procedures designed by the auditor are in direct response to the assessment of the risk of material misstatement in the financial statement classification. The auditor must perform risk assessment procedures to provide a satisfactory basis for the assessment of risks at the financial statement and relevant assertion levels. Risk assessment procedures by themselves do not provide sufficient competent audit evidence on which to base the audit opinion, but combined with other audit procedures (analytical and tests of balances procedures), they provide substantive evidence that can be sufficient to enable an auditor to evaluate relevant financial statement assertions.
Other Resource Materials
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- Small Audits Made Easy and Profitable
- Performing Tests of Balances Auditing Procedures
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