Inherent risks in the revenue & collection cycle, the acquisition & expenditure cycle, and the production cycle
The production cycle especially payroll has three inherent risks namely, ghost workers, overpaying for production or time, and incorrect accounting. The revenue and collection (R&C) cycle have inherent risk in sales and accounts receivables such as the time of recognizing revenue, the effect of abnormal sales terms, sales with significant returns and shipping of goods reported as sales. In addition, there is an overstatement of net receivables, receivables used as collateral, recording receivables as current when the probability of its collection is very low.
The acquisition and expenditure (A&E) cycle identify a short-range effect on the financial statement due to incorrect recognition of expenditure, which increases net income because expensed items are recorded as assets. Also, it includes non-cancellable purchase agreements and unreported liabilities. These cycles are similar in that they use similar management assertions and common control objectives, and they are mainly concerned with the completeness and validity of recording. They are part of an audit program that guides auditors to identify inherent and control risks and are different because each represents related accounts in the accounting system.
R&C and A&E cycles control
A&E cycle entails dealings that run through bills payment and services and goods purchases activities. These activities embrace elements like authorization of transaction, custody, recording and periodic reconciliation. Source documents include Purchases Journal, Trial balance (inventory Reports and accounts payable), and purchase voucher (purchase order, vendor invoice, receiving report). Control considerations should include segregation of duties, offering detailed control inspection activities and gathering information on control structure through questionnaires for internal control.
Auditors should emphasize obligations and completeness assertions on liabilities accounts like account payable. This is vital because firms are less concerned about liabilities and expenses recording and auditors should not rely on the completeness, rather they should look for the unrecorded liabilities (Ruby.fgcu.edu, 2008).
R&C entails activities that are related to receipts and processing, delivering, billing, collection & depositing cash receipt and bank reconciliation. Source documents include Credit checks, Pending orders and Price List Master Files, Sales journals, and Sales Analysis reports. There should be proper duties segregation, offer detailed error-checking activities and individuals handling cash must have fidelity bond insurance. Auditors must emphasize right and existence assertions for assets and obligations and completeness assertions for liability (Louwers et al, 2007).
A&C extended procedures
A firm must have control activities for input, output and processing in position and functioning to detect, correct and prevent accounting errors. The common control objectives such as completeness, accuracy, accounting, validity, classification, correct period recording, and authorization should be linked to the A&E cycle. Auditor normally performs detailed Control Audit Procedures test to establish if the controls are functioning. The necessary activities to be adopted to produce relevant evidence entail tracing, vouching, scanning, observing and recalculating (Louwers et al, 2007).
When auditing accruals and prepayments, the auditor utilizes audit documentation which indicates opening balances, expenses, payments and closing balances. Reconciling beginning balances with the previous period’s audit documentation, payments on vouching and determining the accuracy of closing balances, the auditor is aware that the amount recorded as expense must be correct (Louwers et al, 2007).
Common errors or frauds
Errors and fraud related to R&C include abnormal entries to sales journal or Receivables Subsidiary Ledger, altered or missing source documents and extreme credit memo or any other amendments to receivables immediately after year-end. For A&E, the firm’s cash disbursements and account payable systems might be utilized by fraudsters to produce false payments through false invoices. Similarly, the production cycle has errors and fraud which include personnel file details to payroll division files and payroll register that does not match. In addition, physical inventories and recorded inventories will not match where the latter is overstated (Louwers et al, 2007).
Testing relevant management assertions in each cycle
In R&C, auditors emphasize rights and existence assertions in finding evidence on assets through the use of audit procedures like recalculation, observation, confirmation, vouching, scanning, verbal inquiry, analytical procedures and scanning (Louwers et al, 2007). And when focusing on liabilities, they emphasize obligations and completeness (Louwers et al, 2007).
While in A&E, the auditor emphasizes obligations and completeness assertions in case of liabilities including accounts payable. But auditor should not rely only on completeness’ management assertion he/she should look for unreported liabilities. Finally, in the production cycle completeness is emphasized in that personnel file, payroll division file and payroll register should match. Validity is also tested in preparation for the payroll register (Louwers et al, 2007).
References
Louwers et al. 2007. Auditing and Assurance Services, 2nd ed., McGraw-Hill/Irwin, New York.
Ruby: Chapter 15–Auditing the Expenditure Cycle. 2008.