How To Develop A Strategic Auditing Plan For Revenue Recognition

How To Develop A Strategic Auditing Plan For Revenue Recognition

Revenue recognition is a complicated, five-step process, and some enterprises believe that it can be ignored because it does not impact their financial statements. The financial statements of those who take the shortcut will never conform with GAAP. It is vital to show the work. It is impossible to know its impact on your financials if you don’t take every contract through the prescribed five steps. Many of those who follow the instructions gain insight and control over their contracts.

For those enterprises who flatly refuse to go through the five-step process, it might be wise to meet with all their stakeholders. They should consider their long-term goals and consider switching to a non-GAAP framework like AICPA’s Financial Reporting Framework for SMEs.

Skepticism and Empathy

The new standards and the pandemic make the auditing task a lot harder. Businesses are struggling, and auditors will be more skeptical but hopefully very empathetic, which is not easy and requires strong people skills.

Read and Understand Contracts

The first two steps in the five-step revenue recognition process require identifying the contract with the customer and its performance engagements. Familiarity with these contracts will make it a lot easier for the auditors to make sense of things. For example, many clients mistake purchase orders for deals, while a master supply agreement governs the purchase orders. It is vital to understand the complete agreement entirely before it is possible to understand management’s decisions about revenue recognition.

The Company, The Processes, and The Controls

The auditors will have to comprehend the client, the business model, and the industry before they can grasp revenue recognition. A mere visit to the finance department won’t do. The auditors should visit every department involved in contract negotiations and order fulfillment before understanding all the critical processes.

This will allow for the development of insights that might differ significantly from the accounting department’s views.

Transfer Of Control

It is vital to analyze when control is transferred. Some producers for short-term manufacturing clients recognize revenue when they ship a product to their customers. Think very carefully about the transfer of control, for example, if a finished product is waiting in your warehouse before the client is ready to tale delivery.

Percentage Of Completion Basis

To recognize revenue on a percentage-of-completion basis, enterprises must gather information and documentation on their projects’ status.

Typically, accounting systems are not set up to do that. In such an event, you have to get special reports on all ongoing projects and work in progress at the end of each period.

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Separate Or Distinct From Customer’s Perspective

Although some contracts contain separate performance obligations, it might be moot if you agreed only to deliver one project, good, or service to the client. It is vital to have a robust conception of the promised good or service. Exactly what was sold to the customer?

Nothing can be distinct if everything goes together to comprise the final good or service.

Variable Prices

It might be complicated to determine and allocate a transaction price if you use variable pricing based on purchase quantity or discounting. It might be necessary to consider sales returns and allowances in the determination of the transaction price.

Management Estimates

Auditing management estimates is a tough call. One way to approach it is by looking back at the assumptions on which the calculations were based: were they biased in any way? Be prepared for pandemic-related judgment questions from your auditors.

The revenue recognition standard is principle-based. It relies on judgments and estimates, and the same would be a lot harder to evaluate because of the pandemic. For example, rights and options will be a lot harder to enforce when customers are economically weak due to the pandemic.

You will be dealing with concessions and changes in the number of goods or services to be delivered. Minimum purchase commitments will change, and the probability of collection will be questioned and affected. As a result, significant financing components will become a lot more common.

The accounting rules for the above did not change, but auditors will be looking out for it to verify that the accounting had been performed correctly.

COVID-19

Revenue recognition will be significantly affected by COVID-19, and it will be added to your audit of revenue recognition. One recommendation is to make your disclosures overtly client-specific.

A vital feature of the revenue recognition standard is that the disclosures must provide financial statement users with comprehensive revenue recognition information.

Disclosures will vary significantly between industries and between private companies and public companies. Your auditors must have a real comprehension of which disclosures are appropriate for your enterprise.

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Developing A Strategic Auditing Plan

Communication

A successful audit is all about open lines of communication. Lorin Venable says she spends half of her time communicating with role players including DOD leaders, militarys service personnel, and Congress. We need to determine their expectations and add it to our strategic plan detailing our approach to military equipment inventories, payroll reconciliation, and other issues. Venable’s communication strategy includes:

  • A planning Phase
  • An internal Control Assessment
  • A testing Phase

Communication has to be continuous until the end of the process.

Flexibility

A good and sound plan is essential, but a strategic audit plan should not be set in stone. It must be well-thought-out and always in agreement with your client, no matter how large or small the enterprise might be. It should remain flexible enough to allow for disruptions like COVID-19, which limited DOD onsite audits.

AICPA Guidance, for example, provides guidance on flexibility and tools that are available. Once your strategic plan outlines what you will look at and how you will do an audit, you can move forward and adapt to change when required.

Human Resources

It is vital to examine the human resources required to implement your strategic plan. An appropriate allocation of human resources is non-negotiable. Build strategies to shift resources to support teams that need extra help without hindering other teams.

At the DOD Venable creates teams of up to thirty auditors who allocate their work across 32 financial statement and system audits.

Technology Requirements

Carefully consider your technology needs. At the DOD, the teams typically visit hundreds of military sites, but due to the pandemic, they had to do more than 1,000 virtual walkthroughs, which shifted audit protocols.

Because we had a plan, it was easy to switch gears when we had to rely on technology, Venable said. We turned to AICPA Guidance to shoot video for inventory counts, although the remote locations hampered transmissions, and confidentiality was considered.

Continuous Monitoring

Your audit plan has to be monitored all year¾auditing is a never-ending process that starts all over again in January. As we follow the current year’s program, we continuously revisit our plan to learn and improve our strategy next year, Venable explained. We monitor the federal government’s rules and guidelines and the DOD and standard accounting and auditing guidelines and updates.

Meet with your teams and leaders monthly to review strategies that worked, identify those that did not work, and discuss future goals. You have to learn from problems and build on successes every year to create more robust plans.

Readers should note that this article is only intended to convey general information on these issues and that FAS CPA & Consultants (FAS) in no way intends for the contents of this article to be construed as accounting, business, financial, investment, legal, tax, or other professional advice or services. This article cannot serve as a substitute for such professional services or advice. Any decision or action that may affect the reader’s business should not rely solely on the contents of this article, but should rather be consulted on with a qualified professional adviser. FAS shall not be responsible for any loss sustained by any person who relies on this presentation. This article is subject to change at any time and for any reason.

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