income statement program

8/10/2019 Income Statement Program

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AP-13: Audit Program for the

Income Statement

Company Balance Sheet Date

The company has the following general ledger account groupings classified in the followingcaptions in the income statement.

GeneralLedger Number1

AccountDescription Income Statement Component

Audit rogram for the Income Statement

Company !alance Sheet Date

Audit"b#ecti$es

Audit rocedures for Consideration

N%Aerformedby

&or'papInde(

)INANCIAL STAT*+*NT ASS*,TI"NS

*%" *(istence or occurrence. -%A -aluation orallocation.
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C Completeness. %D resentationand disclosure.,%" ,ights and obligations.

ADIT "!/*CTI-*S

A. ,e$enue is for $alid transactions in the ordinary course ofbusiness that are recorded correctly as to account0 amount0 andperiod0 and uncollectible amounts0 returns0 or allowances areade1uately pro$ided for 2assertions *%"0 ,%"0 -%A0 and %D3.

!. ,ecorded re$enue includes billings at the correct amountfor products shipped or ser$ices pro$ided 2assertion C3.

C. Costs of products or ser$ices are $alid0 complete0 andrecorded correctly as to account0 amount0 and period 2assertions*%"0 C0 ,%"0 -%A0 and %D3.

D. *(penses are $alid0 complete0 and recorded correctly as toaccount0 amount0 and period 2assertions *%"0 C0 ,%"0 -%A0 and%D3.

*. ,e$enues0 cost of products or ser$ices0 e(penses0 ande(traordinary0 unusual0 or infre1uent items are properly described

and disclosed in the income statement 2assertion %D3.

ID*NTI)ICATI"N C"D*S

The letters preceding each of the abo$e audit ob#ecti$es0 i.e.0 A0 !0etc.0 ser$e as identification codes. These codes are presented in theleft column labeled 4Audit "b#ecti$es5 when a procedureaccomplishes an ob#ecti$e. If the alpha code appears in a brac'et0e.g.0 6A70 6!70 etc.0 the audit procedure only secondarilyaccomplishes the ob#ecti$e. If an asteris' precedes a procedure0 it isa preliminary step or a follow up step that does not accomplish anob#ecti$e.

!ASIC ADIT ,"C*D,*S

8 9. In1uire of management or re$iew documentation obtainedpre$iously 2see C:;


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client=s re$enue recognition policies and determine that they are inaccordance with GAA. In1uire of management about0 ande$aluate0 changes in re$enue recognition policies and significant0unusual0 and comple( transactions occurring at or near year end.

ractical Considerations>

It is important that the auditor understand the business and howit ma'es money. Discussion with the owner%manager may pro$ideinsight on how management $iews its approach to ma'ing abottom;line profit. The auditor=s understanding normally shouldinclude>

The types of products and ser$ices sold.

&hether the client=s business is seasonal or cyclical.

The client=s and the industry=s mar'eting and sales policies.

&hether the client=s compensation arrangements depend onrecording of re$enue 2for e(ample0 whether sales commissions arebased on in$oiced or collected amounts0 fre1uency for paying salescommissions0 etc.3.

Client policies related to sales returns0 discounts0 e(tension of

credit0 deli$ery0 and payment terms.

&hat personnel are in$ol$ed in processes affecting re$enues2such as order entry0 e(tension of credit0 and shipping3.

The auditor=s understanding of the company=s business related

to re$enue recognition should include understanding how controlso$er re$enue transactions may be o$erridden and what the client=smoti$ation to misstate re$enue may be.

If the client has entered into unusual or comple( sales

transactions 2for e(ample0 bill and hold transactions or otherunusual contractual terms30 the auditor should consider performing

additional procedures.

"ther conditions that may indicate improper re$enue

recognition practices and re1uire special consideration in a smallbusiness engagement include>

Sales recorded for products shipped in ad$ance of the


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scheduled shipping date without the customer=s consent.

In$oicing of products prior to shipment 2for e(ample0 billing

for items still being manufactured3.

Sales recorded for shipments made after year end.

Transactions with related parties.

Shipments made on canceled or duplicate orders.

Shipments made to a warehouse or another location withoutinstructions from the customer.

!arter transactions.

Significant sales or $olume of sales near year end.

Longer;than;e(pected payment terms or installment

recei$ables.

Altered dates on contracts or shipping documents.

nusual $olume of sales to distributors or resellers.

Sales recorded based on letters of intent or purchase orders.

Shipments to freight companies pending return to the seller

because the customer has canceled or re1uires modifications priorto deli$ery.

Shipments of only a portion of the product when the portionnot deli$ered is a significant part of the product.

A change in the company=s re$enue recognition policy.

The e(istence of side agreements.

The additional procedures section of this audit program


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includes common procedures for auditing re$enue recognition insmall businesses.

Information obtained from discussions regarding the business

and economic effects on the business of current situations can alsobe helpful as the auditor e$aluates the reasonableness of re$enuesand e(penses and e(planations of differences.

The auditor should determine at the start of the audit any ma#or

changes that ha$e been made in the production and sales areas thatwould affect the normal relationships. )or e(ample0 significantchanges in employee benefits might affect salaries and employeecompensation and ha$e an effect on the procedures the auditor willperform for the payroll area.

The AICA Audit Guide0 Auditing ,e$enue in Certain

Industries0 pro$ides general accounting and auditing guidancerelated to re$enue recognition as well as specific guidance onauditing re$enue transactions in the computer software and high;technology manufacturing industries. The Audit Guide can beordered by calling 2???3 @@@;@@@ or online at www.cpa2bi.com.

A0 ! B. erform an analytical test of sales by obtaining for thewor'papers a schedule summariing sales by ma#or product lineand geographic location for the year compared to prior year

amounts0 budgets0 or other e(pectations. Analye this schedule andcritically e$aluate and document e(planations for significantdifferences that are unusual in amount or nature.


Analytical tests in$ol$e comparisons of recorded amounts tothe auditor=s e(pectations. *(amples of sources of information forthe auditor to consider in de$eloping such e(pectations mayinclude>

rior year financial information.

!udgets or amounts e(trapolated from interim figures.

,elationships of financial amounts within the period.

Industry statistics0 such as gross margins.

,elationships of financial amounts to nonfinancial data.
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If desired0 this schedule can be combined with the scheduledescribed in basic procedure


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readily determinable from the wor' performed30 2B3 the results ofthe comparison between the e(pectation and recorded amounts0 and2


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*(planations should be e$aluated in the light of audit e$idenceobtained in other related audit areas.

Comparison of such information can also be made to industry

statistics in some cases.

"ther tests of cost of sales can be a$oided or reduced if the

significant differences identified on this analysis are ade1uatelye(plained and corroborated.

Step


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b. Determine that the amounts tested are properly classified

and recorded in the correct general ledger account.

c. Document the items tested.


C:;@a04lanning &or'sheet To Determine *(tent ofSubstanti$e Tests05 may be used to determine the e(tent of detailtesting needed.

This procedure is done for legal fees to identify legal counsel

engaged by the company. The legal counsel used for litigationshould be identified for purposes of obtaining lawyers= letters. 2SeeChapter 9H.3 Space should be pro$ided on the schedule to e(plain

the ser$ices described in each bill e(amined.

This procedure is done for consulting fees to identify anypayments related to en$ironmental remediation liabilities. A;9pro$ides specific in1uiries for identifying an increased ris' forliabilities of this sort.

!asic procedure Hb is essential in industries that ha$e

accounting methods especially sensiti$e to proper classification ofe(pense amounts0 e.g.0 construction contracting0 or where e(penses

are presented in great detail in the income statement. In some cases0applying this procedure may in$ol$e audit sampling. Section HEe(plains an efficient sampling approach for tests of classificationsof transactions0 and C:;@cpresents a 4Sampling &or'sheet forTesting Account Coding and Classifications.5 See also theadditional procedures section of this audit program.

A common form of fraudulent financial reporting in smallbusinesses is to charge fi(ed asset additions to repairs andmaintenance or some other e(pense account to reduce incometa(es. If the auditor has identified ris' factors that indicate

management may be inclined to understate income for ta( reasonsthrough inappropriate means0 consideration should be gi$en totesting material repair and maintenance transactions to determine ifamounts should be capitalied as fi(ed assets.

See additional procedures for e(panded testing of e(penses if

the auditor decides to modify his or her procedures in response to
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e(planations.

The e(planations should be consistent with changes noted and

tested in balance sheet areas.

&hen an analytical procedure is used as the principalsubstanti$e test of a significant financial statement assertion0 SASNo. EF0 Analytical rocedures0 as amended by SAS No. F0 AuditDocumentation0 re1uires the auditor to document 293 thee(pectation and the factors considered in its de$elopment 2unlessreadily determinable from the wor' performed30 2B3 the results ofthe comparison between the e(pectation and recorded amounts0 and2


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be necessary.Section HEe(plains an efficient sampling approach.See also the additional procedures section of this audit program.

The auditor may find it necessary to test a few indi$idual

compensation amounts to supporting documents to obtainsatisfaction about the $alidity of the data used.

&hen an analytical procedure is used as the principal

substanti$e test of a significant financial statement assertion0 SASNo. EF0 Analytical rocedures0 as amended by SAS No. F0 AuditDocumentation0 re1uires the auditor to document 293 thee(pectation and the factors considered in its de$elopment 2unlessreadily determinable from the wor' performed30 2B3 the results ofthe comparison between the e(pectation and recorded amounts0 and

2


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8 ?. Consider the need to apply one or more additionalprocedures. The decision to apply additional procedures should bebased on a consideration of whether information obtained ormisstatements detected by performing substanti$e tests or from

other sources during the audit alter your #udgment about the need toobtain a further understanding of control acti$ities0 the assessedle$el of ris' of material misstatements 2whether caused by error orfraud30 and on an e$aluation of whether the basic procedures ha$ebeen sufficient to achie$e the audit ob#ecti$es. Attach auditprogram sheets to document additional procedures.


Certain common additional procedures relating to thefollowing topics are illustrated following this program>

Completeness of sales.

,e$enue recognition.

Sales cutoff.

!ill and hold transactions.

Sales returns.

Cash disbursements.

Additional procedures in response to fraud ris' assessment

related to accounts payable and cash disbursements.

ayroll transactions.

Additional procedures in response to fraud ris' assessment

related to payroll e(pense.

ractitioners may refer to C=s Guide to )raud In$estigations

for more e(tensi$e fraud detection procedures if it is suspected thatthe financial statements are materially misstated due to fraud.

8 . Consider whether procedures performed are ade1uate torespond to identified fraud ris' factors. If fraud ris' factors or otherconditions are identified that re1uire an additional audit response0consider those ris' factors or conditions and the auditor=s responsein connection with the performance of Step 99 A;9b.
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ractical Consideration>

Specific responses to identified fraud ris' factors are addressedin indi$idual audit programs. In connection with e$aluation andother completion procedures in A;9b0the auditor considers the

need to perform additional procedures based on the results ofprocedures performed in the indi$idual audit programs and thecumulati$e 'nowledge gained from performing those procedures.

8 9. Consider whether the results of audit procedures indicatereportable conditions in internal control and0 if so0 add to the memoof points for the communication of reportable conditions. 2Seesection 9EHfor e(amples of reportable conditions0 and see C:;9?for a wor'sheet that can be used to document the points as they areencountered during the audit.3

C"NCLSI"N

&e ha$e performed procedures sufficient to achie$e the auditob#ecti$es for the income statement0 and the results of theseprocedures are ade1uately documented in the accompanyingwor'papers. 2If you are unable to conclude on any ob#ecti$e0prepare a memo documenting your reason.3

Additional Audit Procedure! for the Income

Statement

Instructions> Additional procedures will occasionally be necessary on some smallbusiness engagements. The following listing0 although not all;inclusi$e0 representscommon additional procedures and their related ob#ecti$es.

Completeness of Sales
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! erform a test of sales completeness by applying the followingprocedures>

a. Select a sample of original shipping documents. Document

the items selected.

b. Trace the information on the documents to the related salesin$oices. Determine that details are appropriately reflected on thein$oice.

c. Determine that the total amount of sales reported on thein$oice is properly computed and appro$ed.

d. Trace the amounts on sales in$oices to proper recording inthe sales #ournal or general ledger0 as appropriate.

e. Determine that proper accounting treatment has beenapplied to these sales transactions.


The test is designed to test the completeness of salestransactions.

See section HEfor a discussion of an efficient sampling

approach for this type of test.

The auditor should not pro$ide detailed documentation

regarding the tracing of the in$oice amount to the general ledger ifcomplicated tie;ins are necessary to determine that amounts areproperly recorded. This documentation is unnecessary andinefficient.

,e$enue ,ecognition

A a. If the company had sales for which the earnings processwas not complete0 consider whether re$enue was appropriatelydeferred.


Generally0 the earnings process is not complete unless all of the
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following criteria are met>

e$idence of the final understanding between the parties to thee(change transaction e(ists0

deli$ery has occurred or ser$ices ha$e been performed0

the sales price is fi(ed or determinable0 and

collectibility is reasonably assured.

Some situations when the earnings process would not be

considered complete include sale and deli$ery of a piece ofmachinery that has not been installed when installation is theseller=s responsibility sale of a piece of machinery that as part ofthe original contract re1uires customiation sale but not deli$ery of

goods sold )"! recei$ing point or sale of goods sub#ect tocustomer cancellation or termination clauses.

b. If the auditor0 based on his or her understanding of theclient=s business or consideration of fraud ris' factors0 decides tomodify procedures related to re$enue recognition0 considerconfirming additional information with customers in con#unctionwith accounts recei$able confirmation procedures 2seeA;

*(amples of information to confirm include rele$ant contract

terms such as acceptance criteria0 deli$ery and payment terms0 theabsence of future or continuing client obligations0 the right to returnproduct0 guaranteed resale amounts0 and cancellation and refundpro$isions. The auditor should also consider confirming that theclient and customer do not ha$e any side agreements in addition tostated contract terms.

ractitioners may refer to C=s Guide to )raud In$estigationsfor more e(tensi$e fraud detection procedures if it is suspected thatthe financial statements are materially misstated due to fraud.

See also the additional procedures related to bill and hold

transactions.

Sales Cutoff
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A If the auditor0 based on his or her understanding of the client=sbusiness or consideration of fraud ris' factors0 decides to performadditional procedures related to sales cutoff0 perform the followingprocedures>

a. Analye the ratio of sales in the last month or wee' of theperiod to total sales for the period.

b. Compare re$enues recorded daily for the periods shortlybefore and after year end for unusual fluctuations.

c. Compare sales credits for returns subse1uent to year endwith monthly sales credits during the year to determine if there isan unusual increase that may indicate contingent sales or specialconcessions to customers.

d. Compare monthly cash receipts during the year to cashreceipts subse1uent to year end to determine if receipts subse1uentto year end are unusually low compared to the collection historyduring the months under audit.

e. -ouch large or unusual sales made at year end to originalsource documents.


These procedures are generally designed to detect ano$erstatement of re$enue.

The following factors may influence the scope of sales cutoff

testing>

Large 1uantities of in$entory awaiting shipment noted by theauditor during the physical in$entory obser$ation.

Significant 1uantities of in;transit in$entory at year end.

nusual increase in sales the last few days of the yearfollowed by an unusual decrease in sales subse1uent to year end.

Numerous shipping locations.

Transactions in which re$enue is recognied before titlepasses to the buyer.


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!ill and Jold Transactions

A If the company is holding in$entory that has been billed tocustomers0 perform the following procedures>

a. Determine that the transaction meets the following criteria>

293 ,is's of ownership ha$e passed to the buyer.

2B3 The customer has a fi(ed commitment to purchase thegoods.

2


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The client=s past e(perience with bill and hold transactions2for e(ample0 whether the client has a history of re$ersing bill andhold transactions in subse1uent periods3.

&hether the customer has an e(pected ris' of loss in the e$entof a decline in the in$entory=s mar'et $alue.

&hether the client=s custodial ris's are insurable and insured.

&hether the related recei$able from the customer should be

discounted in accordance with A! "pinion No. B9.

&hether e(tended procedures are necessary to ensure thatthere are no e(ceptions to the customer=s commitment to accept andpay for the in$entory 2i.e.0 the business reasons for the bill and hold

transaction ha$e not resulted in a contingency to the customer=scommitment3.

Sales ,eturns

A If the entity sells a product and a right of return e(ists eithercontractually or from e(isting practice0 determine whether re$enuehas been recognied in accordance with S)AS No. H?and theallowance for future returns is reasonable.

Cash Disbursements

C0 D Determine whether the company records e(pense amounts using a$oucher system or as they are actually paid. !ased on the methodused by the company0 select a sample of $ouchers or cash

disbursements incurred during the year charged to e(pensecategories. Document the items selected and perform the followingprocedures>

a. Compare the amount0 payee or $endor0 date0 anddescription to the $endor=s in$oice and canceled chec's0 ifappropriate.
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b. Determine that the transaction was properly authoried.

c. Determine that the e(pense is an appropriate transaction forthe company.

d. Trace the e(pense amount to determine that it was properlyclassified in the general ledger.

e. Summarie e(ceptions and determine the results of theo$erall test.


The test is not normally essential and may be omitted ifade1uate e$idence is obtained from e(amination of indi$iduale(pense amounts and 'ey accounts combined with analytical

procedures. It may be necessary for some small business clients0e.g.0 a contractor or manufacturer where bids or prices are based oncosts of production 2i.e.0 to test $aluation30 or where e(penses arepresented in great detail in the income statement 2i.e.0 to testclassification3. If the auditor0 based on his or her consideration offraud ris' factors0 concludes that procedures should be modifiedrelated to accounts payable disbursements0 the auditor shouldconsider performing the ne(t additional procedure listed in thisprogram instead of this procedure.

C:;@a0 4lanning &or'sheet To Determine *(tent of

Substanti$e Tests05 can be used to determine the e(tent of detailtesting needed.

If audit sampling is deemed necessary0 refer to section HEfora discussion of an efficient sampling approach to this type of test.

The auditor should not e(amine the nature of discounts paid

and similar items of minimal importance simply because they areassociated with the disbursement or e(pense $oucher. The 'eyelements related to the transaction should be tested only forpropriety and proper accounting treatment.

Additional rocedures in ,esponse to )raud ,is' Assessment,elated to Accounts ayable and Cash Disbursements
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C0 D If the auditor0 based on his or her consideration of fraud ris'factors0 decides to modify procedures related to accounts payable ordisbursements0 the following procedures should be considered>

a. ,e$iew the $endor list for any unusual patterns0 such asnames that may be similar but not identical to names of appro$ed$endors and $endors that ha$e multiple addresses. ,e$iew $endorfiles for unusual items0 such as $endor in$oices that appeardifferent from the norm0 consecuti$e $endor in$oice numbers0preprinted and not customied forms0 different deli$ery addresses0different telephone numbers0 and other unusual patterns.

b. *(amine disbursement records for payments of thefollowing types>

293 ayments charged to e(pense accounts in which it issuspected that fraudulent payments are being hidden.

2B3 ayments for ser$ices that do not re1uire deli$ery ofgoods or significant documentation to obtain payment 2fore(ample0 payment of sales commissions0 consulting fees0 repair andmaintenance0 etc.3.

2

293 The identity of the endorsees. Compare to the payee0 date0and amount and re$iew the signature.

2B3 Discrepancies between related documents0 such as the


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amount or name on the chec' differing from the in$oice ordiscrepancies between documents0 the chec's0 and the cashdisbursements #ournal.

2

ractitioners may refer to C=s Guide to )raud In$estigations

for more e(tensi$e fraud detection procedures if it is suspected thefinancial statements are materially misstated due to fraud.

articular attention should be paid to disbursements occurring

near year end. The cle$er fraud perpetrator will concentrate his orher misappropriation at the end of the year to minimie the amountof time the theft remains on the boo's.

ayroll Transactions

D Select a sample of payroll transactions during the year. Documentthe items selected and perform the following procedures>

a. Trace the gross pay to proper authoriation.

b. ,ecalculate the gross pay if it is determined on an hourlybasis.

c. Trace the hours used to compute gross pay to time cards ortimesheets0 as appropriate.

d. Determine that the gross pay amount is appropriate andproperly classified in the general ledger.

ractical Consideration>

This procedure is often inefficient and should be a$oided


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unless effecti$e analytical procedures cannot be designed. If it mustbe performed0 seesection HEfor an e(planation of an efficientsampling approach.

Additional rocedures in ,esponse to )raud ,is' Assessment,elated to ayroll *(pense

D a. If the auditor0 based on his or her consideration of fraudris' factors0 decides to modify procedures related to payrolle(pense0 the e(tent of the preceding procedures may be e(panded.In addition0 the following procedures may also be performed>

293 "btain a list of current and former employees frompersonnel files and compare to the payroll list suspected ofincluding fictitious employees. Note any discrepancies.

2B3 Loo' for employees who ha$e no ta( withholding forms0insurance elections0 or other employee benefit elections ordeduction forms.

2


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b. If the auditor0 based on his or her consideration of fraud

ris' factors0 decides to modify procedures related to payrolle(pense0 the payroll register and payroll chec' register may bere$iewed for>

293 Duplicate names or addresses.

2B3 Names of former employees.

2

income statement program

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