Revenue Accounts and Management Assertions

Once the auditor has a solid understanding of the company’s revenue and collection cycle, the auditor can identify (a) significant accounts and (b) relevant assertions.

The auditor should first identify the significant accounts. An account is significant if there is a reasonable chance it could contain a material misstatement.

The auditor can use the audit risk model to identify significant accounts, as follows:
• Set audit risk at a level (e.g., low) with which the auditor is comfortable
• Assess the risk of material misstatement (both inherent risk and control risk)
• Set detection risk at the appropriate level for the account

Certain accounts will be at a higher risk of material misstatement, so the auditor needs to focus the most attention on those accounts (thereby decreasing detection risk for those accounts).

Note that there is always presumed to be a fraud risk for revenue recognition, so sales revenue will be a significant account.

Accounts receivable will almost always will be a significant account, with limited exceptions (e.g., a company has a small, immaterial accounts receivable balance).

After identifying the significant accounts (sales revenue and accounts receivable), the auditor should identify the relevant assertions. An assertion is relevant if there is a reasonable chance it could contain a misstatement that leads to the financial statements being materially misstated.

Certain assertions are more important than others. For example, occurrence is important for sales revenue whereas existence is important for accounts receivable. While the completeness assertion should also be tested for sales and receivables (the company might have neglected to record a sale), it is less critical than occurrence (for sales) and existence (for receivables) because management usually has an incentive to overstate (rather than understate) sales.

Below is a list of assertions that management is making about revenue transactions, along with potential misstatements.

Occurrence: Revenue recorded when goods haven’t yet been shipped or services haven’t yet been rendered; alternatively, revenue recorded for sales to fictitious customers.

Completeness: Goods shipped or services rendered, but revenue not recorded.

Authorization: Goods shipped at unauthorized prices, on unauthorized terms, or to customers who are a poor credit risk.

Accuracy: Revenue recorded for the wrong dollar amount.

Cutoff: Revenue recorded in the wrong accounting period.

Classification: Revenue not properly classified.

Below is a list of assertions that management is making about accounts receivable balances, along with potential misstatements.

Existence: Some (or all) of the accounts receivable don’t actually exist.

Rights and obligations: The company doesn’t hold or control the rights to the accounts receivable (e.g., it sold the accounts receivable to a factor).

Completeness: Not all of the accounts receivable were recorded.

Valuation: Accounts receivable weren’t recorded at the right amounts and/or the uncollectible portion hasn’t been correctly estimated.

Classification: Accounts receivable haven’t been recorded in the correct accounts.

0:00 Introduction
0:16 Identify significant accounts
1:08 Identify the relevant assertions
1:40 List of assertions about revenue transactions
3:01 List of assertions about accounts receivable balances
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[labcdel]

Amazing content, thanks for all the amazing accounting, finance, and audit videos. Keep it up, your videos have taught me so much, over traditional college lectures.

[eisenhoward]

Been auditing for 6 months and this is the first time I am sort of understanding what I'm doing everyday 😅. Thanks!

[anelekawandy]

You sir are doing the Lord's work, thank you so much

[lolatatasja]

Thank you! This finally made it click!!

[NeyTorres]

How do you access if something is "material" or inmaterial? Is this based on statistics of the size of the account vs the rest of the balance sheet/income statement?

[pineappleognam]

please make these audit available in free pdf's just like FAR and Managerial. Thank you so much!