Case 15-8 Controlling Revenue

Case 15 8 Controlling Revenue Page 1case 15 8 Controlling Reven

Analyze the revenue process of Always Better Care Company (ABC), focusing on internal control measures within order processing and shipping/invoicing, and how these controls mitigate risks of material misstatements. Compare the relevant controls and procedures under PCAOB standards versus AICPA standards, and propose audit procedures to test control effectiveness and detect potential omissions or errors in recording invoices for shipped goods.

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The evaluation of internal controls over revenue recognition is crucial for auditors to obtain sufficient appropriate audit evidence and to prevent or detect material misstatements. In the case of Always Better Care Company (ABC), an investigation into the controls within the order processing and shipping/invoicing processes reveals the measures implemented to address common risks such as erroneous order entry, unauthorized shipments, or failure to record shipped goods and invoices properly.

Internal Controls in the Order Processing Sub-Process

The order processing sub-process encompasses receiving, validating, and entering customer orders into the system. ABC's controls include multiple checkpoints: customer orders are entered via various channels—fax, mail, email, or phone—and converted into system entries by customer service associates (CSAs). Orders reference an existing customer account; if a non-existing account is identified, a credit review is initiated, and the account is created only after credit approval, reducing the risk of unauthorized transactions.

Mandatory fields such as order type, source, sales organization, account numbers, item quantities, and pricing details are systematically populated, facilitating control over data completeness and accuracy. The system flags nonstandard payment or shipping terms, and exceptions require managerial review, adding a layer of oversight against unconventional or potentially fraudulent transactions. Orders with holds due to credit issues are scrutinized, and only approved orders proceed, safeguarding the company against extending credit improperly.

Furthermore, all sales orders must be reviewed and approved by a customer service manager before shipping, creating a control point that deters unauthorized or erroneous orders from moving forward. Errors identified during review are corrected by CSAs and rerouted for approval, ensuring accuracy and reducing misstatements. These controls collectively contribute to the completeness, accuracy, and authorization of sales orders.

Integrating Controls in Shipping and Invoicing

Following order approval, data transfer from order entry to shipping and invoicing is automated, streamlining operations and minimizing manual entry errors. The shipping process involves shipping personnel verifying outgoing inventory against system records and preparing bills of lading, which are prenumbered to maintain sequence integrity. This prenumbering acts as a control to prevent shipment omissions or duplications.

The shipping personnel manually log shipment details onto a spreadsheet in addition to using prenumbered bills of lading, establishing documentary evidence for shipped goods. The warehouse director’s daily review compares shipment logs to the open invoice report, checking prenumbered bills, sequence, and consistency. Discrepancies prompt investigations, with proper documentation supporting resolutions. This review serves as a control to ensure that shipments are accurately captured and recognized financially.

Invoicing is handled nightly via the Great Plains system, which performs a three-way match to verify that shipped items correspond to purchase orders and bill of lading information before generating invoices. This control minimizes the risk of invoicing errors or unauthorized billing. Additionally, a review process involves assessing nonstandard sales terms and making necessary adjustments to align with U.S. GAAP standards, overseen by the Accounting Manager and the Assistant Controller, enhancing compliance and accuracy.

Differences in Guidance: PCAOB vs. AICPA

Under PCAOB standards, the emphasis is on obtaining a robust understanding of transaction flows, mapping points where misstatements could occur, and evaluating controls that mitigate these risks—using process flow diagrams and narrative descriptions. The PCAOB explicitly requires testing controls' operating effectiveness through procedures such as reperformance, inquiry, and inspection, coupled with detailed assessment of control design and implementation.

In contrast, the AICPA standards focus on obtaining sufficient audit evidence about assertions, emphasizing substantive procedures unless controls are relied upon. When controls are tested, the AICPA permits a more flexible approach—either testing control operating effectiveness or performing substantive procedures directly, depending on the assessed risks and control reliance decisions.

While PCAOB standards demand a more detailed focus on control testing and documents, AICPA standards might allow for a proportionate approach, emphasizing substantive testing if controls are deemed ineffective or if the reliance is limited. Both frameworks aim to ensure that auditors effectively identify and respond to risks of material misstatement, but PCAOB underscores the importance of control testing as a core part.

Audit Procedures for Testing Operating Effectiveness of Controls on Invoice Recording

To address the risk that goods are shipped but no invoice is generated—the control identified in Question 2—the auditor could perform several procedures. First, select a sample of shipments logged in the shipping department and trace each to the corresponding invoice in the system to verify that the shipment was invoiced and recognized in the financial records. Reperformance of the system’s three-way match process, including verifying that the invoice was generated only when matching purchase order, shipment, and receive data, provides assurance regarding control operational effectiveness.

Second, the auditor can examine prenumbered bills of lading and shipping logs to ensure sequence completeness. Comparing shipment logs to invoicing batches and shipments logs helps identify un-invoiced shipments, if any, highlighting possible control failures. The test of control might include inquiry with shipping personnel and review of documented approvals for shipments outside standard procedures.

Under PCAOB standards, this testing might involve detailed procedures—such as direct observation of control operation, inspection of control documentation, and reperformance of control activities over multiple periods—to substantiate that shipping and invoicing are properly linked. Under AICPA standards, the auditor might rely more heavily on substantive tests of details, such as vouching a sample of recorded sales back to shipment documentation and subsequent invoicing, especially if control testing provides limited evidence.

In conclusion, testing a control related to invoice generation after shipment involves confirming that shipping data leads to timely and accurate invoice processing. The extent and nature of audit procedures may vary depending on the standards applied, but the goal remains to provide reasonable assurance that the company’s controls over revenue are effective and that financial reporting is reliable.

Conclusion

Effective internal controls in ABC’s revenue process—such as managerial review of orders, segregation of duties, prenumbered shipping documents, and system-generated reconciliations—substantially mitigate risks related to revenue misstatements. Comparing PCAOB and AICPA approaches reveals differences in emphasis; PCAOB advocates detailed control testing, while AICPA permits more reliance on substantive procedures when controls are weak or not relied upon. Audit procedures tailored to testing controls—such as tracing transportation logs to invoices or verifying sequence completeness—serve to strengthen audit evidence and support accurate financial reporting.

References

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