7593 Considerations when performing revenue CAATs

Jun-2019

OAG Guidance

A revenue CAAT involves the analysis of electronic data to provide evidence over revenue journal entries or transactions. Properly designed and executed, a revenue CAAT may reduce the extent of substantive testing required on expected revenue transactions and help us to focus our tests of details on unexpected (generally higher risk) transactions.

OAG Guidance

A revenue CAAT will not be the most effective approach for every entity, however it will likely be more effective in circumstances where:

• The accounting for revenue and accounts receivable is straight forward, and complex revenue transactions are rare (e.g., no multiple performance obligation contracts or performance obligations satisfied over time). Complex revenue transactions and/or journal entries would be considered and tested separately, as appropriate.

• Revenue is predominantly settled in a straight forward manner (e.g., through receipt of cash) and predominantly follows an expected transaction and/or journal entry flow.

• We have a thorough understanding of the revenue process and related internal controls are operating effectively.

• We plan to obtain moderate or high substantive evidence over cash and accounts receivable.

• There is limited history of audit adjustments, no specific risks of fraud have been identified in addition to the presumed risk of fraud in revenue recognition, and appropriate procedures have been performed to address the presumed risk.

• Electronic data can be easily retrieved from the entity.

OAG Guidance

We may use CAATs to automate audit procedures we use to obtain evidence over revenue (for additional guidance and factors to consider, refer to OAG Audit 7592). For example, a revenue CAAT may involve the analysis of electronic data and enable us to match revenue transactions to accounts receivable and cash at the sales ledger level, or analyze journal entries related to revenue and accounts receivable at the general ledger level, and profile the risk of revenue transactions / journal entries within the revenue and receivables process. By analyzing revenue transactions / journal entries and identifying those which are not settled in the normal expected transaction flow (i.e. settled in cash or remaining in accounts receivable), we can reduce (but not eliminate) the need to perform further substantive tests of details of matched/expected transactions / journal entries and focus our tests of details on the higher risk unmatched / unexpected transactions / journal entries. Evidence obtained from such procedures would be based on the principle that, in many businesses, revenue is transacted via accounts receivable and settled in cash, which is matched to the revenue recorded via an allocation of this cash to the underlying transaction in accounts receivable. Therefore, by using a revenue CAAT to determine that revenue is settled in cash, we may obtain some but not all necessary evidence over accuracy and occurrence of matched / expected revenue transactions / journals. Additional substantive audit procedures would be necessary to support the accuracy and occurrence assertions as part of an overall approach to revenue, such as verifying that cash received relates to valid revenue transactions. Where transactions / journal entries do not follow the normal expected transaction flow, they would need to be separately investigated and tested.

The audit evidence obtained from a revenue CAAT will vary depending on the nature of the CAAT. Additionally, the level of procedures performed on the revenue transactions will vary depending on the nature of the CAAT. The simple act of matching transactions or analyzing journal entry data cannot provide sufficient audit evidence that:

• The performance obligation under revenue contracts with customers has been satisfied.

• Individual transactions have been recorded at the correct amount.

• The cash received relates to amounts recorded for a particular revenue stream, and has been recorded against the correct invoice / customer account.

• Contract assets or contract liabilities (including variable consideration balances such as discounts), rebates and other customer arrangements have been appropriately accounted for.

This is why substantive audit procedures to support the accuracy and occurrence of revenue transactions are still necessary for expected transactions / journal entries when a revenue CAAT is used. In order to obtain sufficient appropriate audit evidence, we consider the nature of additional audit procedures required and interpret the outputs of the revenue CAAT using professional judgment.

In addition, a revenue CAAT may not address all elements of the relevant financial statement assertions. We determine what additional audit evidence is needed to address audit risks impacting revenue which are not addressed by the revenue CAAT (e.g. discounts, price concessions, trade promotions).

As noted previously, in order to make effective use of a revenue CAAT we need to obtain a moderate or high level of substantive evidence over cash, e.g. by performing testing of bank reconciliations and bank confirmations at a moderate or high level of evidence. We also perform specific testing to determine that cash received represents a bonafide customer remittance and that the remittance was applied to the appropriate customer account including tracing the revenue transactions to cash.

When we use revenue CAATs to obtain evidence over accuracy and occurrence of revenue we would also need to obtain a moderate or high level of substantive evidence over accounts receivable. We generally obtain this evidence by performing third party confirmations and/or subsequent receipts (liquidation) testing at a moderate or high level of evidence.

OAG Guidance

Using accept-reject testing would normally not be appropriate when obtaining evidence over monetary balances. However we may be able to apply accept-reject testing to obtain evidence over occurrence, accuracy and completeness for revenue transactions /  journal entries that pass through the revenue CAAT logic as expected, and are settled in cash when the following pre-conditions are met:

• Controls over revenue need to be tested for operating effectiveness at a moderate or high level of assurance.
• Moderate or high substantive evidence needs to be obtained over accounts receivable.
• Moderate or high substantive evidence needs to be obtained over cash.

The desired level of evidence for the accept-reject test is set based on the assessed risk of material misstatement and planned extent of controls testing. The accept-reject test needs to be designed to validate the underlying data within the entity’s system with respect to each of the following:

• Identifying the contract(s) with a customer
• Identifying the performance obligation in the contract (if multiple performance obligations are identified consider whether use of a revenue CAAT is likely to be effective)
• Determining the transaction price
• Allocating the transaction price to the performance obligation in the contract (typically straightforward for revenue contracts where use of a revenue CAAT may be effective (i.e., a single performance obligation))
• Recognizing revenue as the entity satisfies the performance obligation

We would not use accept-reject testing even when we use a revenue CAAT if:

• Revenue streams include multiple performance obligations, or
• Revenue is not directly transacted via accounts receivable and settled in cash (e.g., satisfaction of performance obligations over time).

Consider how CAATs may be used in conjunction with other audit procedures in order to obtain sufficient appropriate audit evidence over revenue transactions.