Last updated on Jul 21, 2024

What are the best audit procedures to improve revenue recognition accuracy?

Revenue recognition is a critical aspect of corporate finance, as it affects how a company reports its income, expenses, and cash flows. However, revenue recognition can also be subject to errors, fraud, or manipulation, especially when there are complex contracts, multiple performance obligations, or deferred revenue. Therefore, auditors need to apply effective procedures to verify the accuracy and completeness of revenue recognition in accordance with the applicable accounting standards and policies. In this article, we will discuss some of the best audit procedures to improve revenue recognition accuracy and reduce the risk of material misstatement.

1 Analyze revenue trends and ratios

One of the first steps in auditing revenue recognition is to analyze the revenue trends and ratios of the company and compare them with the industry benchmarks, prior periods, and expectations. This can help identify any unusual or significant fluctuations, variances, or inconsistencies that may indicate errors or fraud in revenue recognition. For example, auditors can examine the revenue growth rate, the gross margin, the days sales outstanding, the revenue per customer, the percentage of completion, and the deferred revenue balance. Any deviations from the norm or the budget should be investigated and explained by the management.

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Syed Ali Jawed Akhtar

Strategic Planning | Financial Management | Risk Management | Audit | Digital Transformation | Sustainability | Data Analytics | Investigations & Inquiries
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Before analysis, the first step should be to understand the Company's revenue recognition policies. To do this, to review the policies documented in the financial statements and accounting manuals, and then evaluate whether the policies comply with accounting standards (eg., IFRS 15) and industry-specific regulations. The next step is to assess the effectiveness of internal controls related to revenue recognition, including segregation of duties and authorization procedures, and to test the design and operating effectiveness of internal controls through walkthroughs and testing. Once a thorough understanding has been obtained, then the remaining trend analysis and financial assessment can be conducted in a targeted manner.

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FCA ASA Pratik Arora

Finance Controller & Accomplished Finance Leader | 13+ Years in Audit, Advisory, FP&A, Taxation & Compliance | Proven Expertise in Cost Optimization & Process Automation Across Multiple Sectors
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the first step is to understand the revenue model adopted by the company and the kind of contracts the company enters. trend comes after you have evaluated how revenue is recognised. identification of deliverables assocaited to each contract would benefit in accessing the correct revenue to be recognised

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Jack T.

Internal Auditor at Infanta Credit & Development Cooperative
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Revenue recognition risk refers to the possibility that the company has recognized revenue inappropriately or prematurely, which can significantly affect its profitability and solvency. Revenue must be recognized when it has been earned and realized, and must be supported by sufficient and appropriate documentation.

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2 Review contracts and invoices

Another important procedure is to review the contracts and invoices that form the basis of revenue recognition. Auditors need to understand the terms and conditions of the contracts, such as the delivery dates, the payment terms, the performance obligations, the warranties, and the discounts. They also need to check the accuracy and validity of the invoices, such as the dates, the amounts, the customers, and the products or services. Auditors should select a sample of contracts and invoices and trace them to the accounting records and the financial statements. They should also look for any evidence of side agreements, modifications, or cancellations that may affect revenue recognition.

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FCA ASA Pratik Arora

Finance Controller & Accomplished Finance Leader | 13+ Years in Audit, Advisory, FP&A, Taxation & Compliance | Proven Expertise in Cost Optimization & Process Automation Across Multiple Sectors
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review of contract gives clarity on the instances when the revenue could be generated or recognised. it is principally depending on the contract - the deliverables. Invoicing is conversion of recognised revenue to accounts receivables. revenue os recognised once the work is completed or task is performed which we also call unbilled reveune.

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Jack T.

Internal Auditor at Infanta Credit & Development Cooperative
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What are the best audit procedures to improve revenue recognition accuracy? Analyze revenue trends and ratios. Review contracts and invoices. Test revenue cut-off. Perform analytical procedures. Be the first to add your personal experience. Confirm revenue with third parties. Here's what else to consider.

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3 Test revenue cut-off

A crucial procedure to ensure revenue recognition accuracy is to test the revenue cut-off at the end of the reporting period. Auditors need to verify that the revenue is recognized in the correct period according to the revenue recognition criteria, such as the transfer of control, the satisfaction of performance obligations, and the collectability of payment. Auditors should examine the shipping documents, the delivery receipts, the customer acceptance forms, and the bank statements to confirm the timing and occurrence of revenue transactions. They should also look for any revenue transactions that are recorded before or after the cut-off date and adjust them accordingly.

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FCA ASA Pratik Arora

Finance Controller & Accomplished Finance Leader | 13+ Years in Audit, Advisory, FP&A, Taxation & Compliance | Proven Expertise in Cost Optimization & Process Automation Across Multiple Sectors
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at a each cut-off's we have to ensure and check the extent of revenue we can recognise in form of unbilled which principally depends on the % work is performed. this is dependent on the management and the auditor cant do much about it since the completion is accessed technically which auditor cant comment upon

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4 Perform analytical procedures

Another useful procedure is to perform analytical procedures on the revenue accounts and balances. Analytical procedures involve comparing, calculating, and evaluating financial and non-financial data to identify any significant or unusual relationships or trends. For example, auditors can compare the revenue by product line, by customer segment, by geographical region, or by sales channel. They can also calculate the revenue recognition percentage, the revenue turnover rate, the revenue per unit, or the revenue per employee. They can then evaluate the results and investigate any deviations or anomalies that may indicate errors or fraud in revenue recognition.

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5 Confirm revenue with third parties

A final procedure to enhance revenue recognition accuracy is to confirm revenue with third parties, such as customers, suppliers, or intermediaries. Confirmations are a form of external evidence that can corroborate the existence, accuracy, and completeness of revenue transactions and balances. Auditors can send confirmation requests to a sample of third parties and ask them to confirm the details of the revenue transactions, such as the dates, the amounts, the products or services, and the payment status. Auditors should also follow up on any non-responses, discrepancies, or exceptions and resolve them with the management.

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FCA ASA Pratik Arora

Finance Controller & Accomplished Finance Leader | 13+ Years in Audit, Advisory, FP&A, Taxation & Compliance | Proven Expertise in Cost Optimization & Process Automation Across Multiple Sectors
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reconciliaton of account statement , obtaining direct confirmation helps to get an external confirmation on the accuracy of revenue. point to note here is that only the invoiced revenue can be confirmed by third party.

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6 Here’s what else to consider

This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?

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What are the best audit procedures to improve revenue recognition accuracy?

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1 Analyze revenue trends and ratios

2 Review contracts and invoices

3 Test revenue cut-off

4 Perform analytical procedures

5 Confirm revenue with third parties

6 Here’s what else to consider

Corporate Finance

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