Question

List below 3 specific substantive tests for the revenue cycle:

1.

2.

3.

Answer 1

Three specific substantive tests for revenue cycle is as below

(1) Analytical Procedures :-

Analytical procedures often include running various financial ratios and comparing them to industry benchmarks. For the revenue cycle, the auditor examines the gross profit margin and the amount of growth that the company has experienced in one year. As part of the analytical procedures, he should analyze the organization's maximum capacity for sales if its facility and employees were fully utilized. He must also examine the accounts receivable account to ensure it is not outgrowing sales. If it is, this could indicate that the company is a credit risk and may have cash flow problems in the future

Performing planning Analytical Procedures

• Step 1: Identify Suitable Analytical Procedures
• Step 2: Evaluate Reliability of Data Used to Develop Expectations
• Step 3: Develop Expectations
• Step 4 and Step 5: Define and Identify Significant Unexpected Differences
• Step 6 and Step 7: Investigate Significant Unexpected Differences and Ensure Proper Documentation.

(2) Tests of Controls :-

The main component for the internal controls of an organization, no matter which cycle they are pertinent to, is management's adoption and adherence to high ethical standards and strong controls. Tests of controls for the revenue cycle include who accepts and approves credit sales; the separation of duties for filling out, shipping, and recording sales orders; appropriate documentation for collecting and depositing cash and recording the receipts; the appropriate authority and documentation to grant discounts for early or cash payments and sales returns; and management authorization to determine that an account is uncollectible and should be written off to bad debts.

Performing planning for test of controls

• The auditor will select both entity-wide and transaction controls for testing.
• Typical tests of transaction controls include
  • inquiry of personnel performing the control
  • observation of the control being performed
  • inspection of documentation confirming that the control has been performed reperformance of the control by the individual testing the control

(3) Sustantive Tests :-

Performance of substantive tests will help to find any errors or misstatements within the accounts or documentation associated with the revenue cycle. These tests include checking the trial balance that the accountant creates at the end of the cycle, confirming receivable amounts with the company or person who owes money and evaluating the accuracy of the allowance for uncollectible accounts by reviewing the history of the entity. They also include vouching, tracing and performing cutoff tests for all sales, sales returns and cash receipts. To do this, the auditor examines all documentation related to a customer and also examines a journal entry; she then either works forward from the initial sales order to the journal entry or backward from journal entry to initial sales order to determine accuracy.

Revenue - Substantive Tests of Details

• Primarily involve inspection of relevant client documentation
• Focused on existence and valuation assertions
• GAS can be used to:
  • Look for gaps in recorded sales invoice numbers
  • Verify that missing numbers are appropriate and do not represent unrecorded sales
  • Provide evidence on both existence and completion assertions