Term
| Why are Revenue accounts so important? |
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Definition
1. Sales transaction are always material and critical to a co's f.s. - you need sales and revenues for financial health of co.
2. According to SEC, a majority of f.s. manipulations and audit failures involve overstated revenues (fictitious sales or premature recognition) |
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Term
| The Cycle Approach takes advantage of what? |
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Definition
| The fact that transactions generally affect related accts on both the B/S and I/S. Accounts are interrelated. EX/ sales>cash/ar....Bad debt exp>allow. doubtful accts. |
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Term
| How debits and credits protect themselves |
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Definition
| Double-entry accounting provides a natural control against overstated revenues. You have to credit something if u debit cash... usually A/R because A/R is harder to audit than cash. |
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Term
| Revenue Recognitions under SEC SAB 101 |
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Definition
| Companies cannot recognize revenue until the end customer has taken title and assumed substantially all risks and rewards of ownership without further obligation by the seller - no revenue recognition otherwise. |
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Term
| Ways revenue can be overstated: |
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Definition
1. Record Revenue (maybe not even collect cash), but do not deliver finished (or any) goods or services. You don't provide what was promised.
2. Offer irrevocable rights of return and then understate the corresponding allowances - make side agreements that auditors won't see.
3. Understate other obligations (rebates)
4. Moves sales at the beg. of year 2 to the end of year 1.
5. Sell at huge gains to related parts (enron)
6. Channel Stuffing - boost sales by giving incentives to by at the end of a period.
7. SEC v. Nabors and McCracken |
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Term
| Is understating Revenue important too? |
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Definition
| Yes, while it is not the focus of as much attention, they should also consider controls to ensure that all legitimate revenues have been recorded. Reveneue that is not recorded in one period can be saved for future periods to smooth earning. Also, if revenue is TOO high in one period, the mkt might think they should perform that good every time. |
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Term
| Fraud in Revenue Recognition |
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Definition
| SAS 99 - consideration of fraud in a financial statement audit. Discuss fraud probability and procedures and audit accordingly. Ausitor should presume a risk of material misstatement due to fraud related to revenue recognition. |
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Term
| Red Flags that signal the potential for fraud in the F.S. |
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Definition
1. External risk indicators - competition, new regulation
2. Internal Red Flags - Poor IC controls
3. Unusual financial results - number crunching |
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Term
| How auditors should deal with red flags? |
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Definition
1. Examine external and internal pressures that could lead to fraud
2. Examine the f.s. to determine if account balances seem off. |
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Term
| Taking financial statement analysis - |
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Definition
| the same ratio and trend analyses and similar tools that are useful to investors are also useful to auditors for investigations unusual revenue relationships. (compare across time and industry averages) |
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Term
| Are legitimate receivables collectible receivables? |
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Definition
| Not necessarily, have to go beyond just confirmation letters. Have to perform your own analysis to see if it is collectible. |
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Term
| What is the best guide for where allowance for doubtful accounts are? |
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Definition
| Collection history - you can see if the percentage of total receivables shrinking or increasing over time. |
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Term
| How to check collectibility issues... |
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Definition
look at collection history
consider collateral backing the co can fall back on
be aware of any economic circustances affecting major customers. |
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Term
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Definition
| A classic form of embezzlement in which an employee steals cash received from customer 1, then applies cash received from customer 2 to customer 1's account, then from customer 3 to customer 2, and so forth. (asset misappropriation) |
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Term
| How is Lapping controlled? |
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Definition
| Through segregation of duties, having all employees take some vacation... |
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Term
| Is confirmation a credible source of evidence? |
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Definition
| Yes, becomes it comes from an external party - doesn't not collectibility though |
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Term
| Who should send confirmations? |
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Definition
| Auditors and they should be received directly to the auditors as well |
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Term
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Definition
| request a reply even if the confirmed balance is correct. The auditor must follow up on non-replies or apply alternate procedures - ex/ check to see if customer payed the receivable, seek response |
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Term
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Definition
| request a reply only if the confirmed balance is incorrect. |
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Term
| How do you decided whether to send a positive or negative confirmation? |
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Definition
| Take into account the magnitude and risk associated with the receivables portfolio. Positive - significant customers, negative - sample of smaller customers |
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Term
| SEC - Nabors v. McCracken |
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Definition
| The most overstated account is the inventory account. Its hard to value inventory, its scattered all over the world.. They realized this so they went to purchasing account to overstate inventory. |
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