Auditors are under fresh orders from their regulator to pay closer attention to the audit of revenue recognition.
After auditors have already gotten an earful from the Public Company Accounting Oversight Board over the audit of internal control over financial reporting, now a new PCAOB practice alert tells auditors where the board’s inspectors most frequently find deficiencies in the audit of revenue recognition. In addition to internal control, revenue recognition is another common trouble spot in PCAOB inspection reports, which consistently identify audit deficiencies across all major firms.
"Revenue is one of the largest accounts in the financial statements and an important driver of a company's operating results," said PCAOB Chairman James Doty in a statement. "Given the significant risks involved when auditing revenue, auditors should take note of the matters discussed in this practice alert in planning and performing audit procedures over revenue." The PCAOB notes in the alert that misstatement of revenue is a common ploy in many financial reporting fraud cases. A 2010 COSO study of 10 years worth of accounting and enforcement actions by the Securities and Exchange Commission found 61 percent of the 347 cases involved gaming or fabricating revenue, the most common method used to improve the appearance of financial statements.
The alert addresses the testing of revenue recognition as a result of contractual arrangements, the evaluation of the presentation of gross versus net revenue, the testing around whether revenue was recognized in the proper period, the evaluation of whether the financial statements include required revenue disclosures, and the risk of fraud associated with revenue. The alert also covers testing and evaluating controls over revenue, applying audit sampling procedures to test revenue, performing substantive analytical procedures to test revenue, and testing revenue across multiple locations.
Chief Auditor Martin Baumann said in statement that engagement partners and senior engagement team members need to focus on those areas throughout the audit, and engagement quality reviewers need to keep those issues top of mind when reviewing audit work. "Audit firms should also revisit their audit methodologies and their implementation of those methodologies to assure that auditing standards are appropriately followed in the area of auditing revenue,” he said. “In addition, they also should consider whether additional training of their auditing personnel or other steps are needed to assure that PCAOB standards are followed.”
The alert acknowledges that the Financial Accounting Standards Board recently adopted a comprehensive new accounting standard that changes the way many companies will recognize revenue. “The Board's staff believes that the auditing matters discussed in this practice alert are likely to continue to have relevance to auditing revenue under the new accounting standard,” the alert notes.