In this chapter we described the details of controls over receivables and revenue, the auditors' consideration of these controls, and substantive tests of the receivables and revenue accounts. To summarize:

• The audit of receivables and revenue represents significant audit risk because (a) many incidences of financial statement fraud have involved the overstatement of receivables and revenue, (b) revenue recognition may be based on complex accounting rules, and (c) receivables and revenue are usually subject to valuation using significant accounting estimates. Companies should establish effective high-level controls over the financial reporting of these accounts, including (a) an audit committee to oversee the reliability of reporting of revenue, (b) an internal audit department to monitor compliance with other revenue cycle controls, (c) human resource policies and practices to ensure that competent personnel are involved in determining revenue and receivables estimates, and (d) effective monitoring policies and procedures. In addition, a sound accounting system and effective control activities should be established for the revenue cycle.

• The revenue cycle includes the receiving of orders from customers, the delivery and billing of goods and services, and the recording and collection of accounts receivable. Effective internal control over sales transactions is best achieved by having separate departments responsible for preparing sales orders, approving credit, shipping merchandise, billing customers, maintaining the accounts receivable subsidiary ledger, and authorizing adjustments to sales and accounts receivable.

• The auditors' consideration of internal control over revenue and cash receipts provides them with a basis for assessing control risk for the related financial statement assertions. To assess control risk at less than the maximum for a particular assertion, the auditors must perform tests of the operating effectiveness of the controls. The auditors' assessments of inherent and control risks then are used to determine the nature, timing, and extent of the substantive tests of receivables and revenue.

• The primary objectives for the auditors' substantive tests of receivables and revenue are to (a) substantiate the existence of receivables and the occurrence of revenue transactions, (b) establish the completeness of receivables and revenue, (c) determine that the client has rights to the recorded receivables, (d ) determine that the valuation of receivables and revenue is at an appropriate net realizable value, and (e) establish that the presentation and disclosure of receivables and revenue are appropriate.

• The most time-consuming and critical audit procedures for receivables and revenue are those designed to test the assertions of existence, occurrence, and valuation. Among the procedures designed to achieve these objectives is confirmation of accounts receivable, which is generally required in all audits. Acknowledgment of the debt provides evidence of existence of receivables and occurrence of sales, as well as the gross valuation of the amounts. An important part of obtaining evidence about the proper valuation of accounts receivable is the auditors' evaluation of the adequacy of the allowance for uncollectible accounts. Since this account is a management estimate, it is typically audited by a combination of inquiry of management, analytical procedures, and inspection of various documents.

• Other significant aspects of the audit include evaluation of the appropriateness of the client's methods of revenue recognition, and procedures directed at identifying and evaluating the disclosure of related party transactions and receivables.

Describe the nature of receivables.

Describe the auditors' objectives for the audit of receivables and revenue.

Describe the documents, records, and accounts that compose the revenue (sales) transactions cycle and the fundamental controls over receivables and revenue.

Assess the risks of material misstatement (inherent and control risks) of receivables and revenue.

Design typical tests of controls used by auditors to support the assessed levels of control risk for the financial statement assertions related to receivables and revenue.

Explain how the auditors design substantive audit procedures to address the risks of material misstatement of receivables and revenue.