Revenue testing continues to be scrutinised by the UK’s audit regulator, with the FRC Audit Inspections 2022 identifying that 4 of the 7 firms during the latest round of audit inspections need to improve their revenue testing.
But what can smaller firms learn from these inspection results to ensure high quality audit with their revenue testing?
Everything is clear in hindsight, but several the issues identified are easy to avoid. Not sampling from the whole year, or not testing the completeness of the revenue population, or not testing adjustments to revenue won’t win anyone auditor of the year. Focus on getting the basics from the key findings right, first and foremost.
Whenever revenue recognition is impacted by management judgement its important auditors adequately test and challenge these areas. Where revenue relates to long term contracts the accounting includes many inputs and judgements for auditors to consider. But even simple judgements such as unbilled (or uninvoiced) revenue require due care and attention. Be sure to allocate additional time and effort to testing judgements impacting revenue.
All to often auditors of SMEs focus too heavily on the completeness assertion when testing revenue. I’ve heard many (often confusing) arguments as to why this is, for example that SMEs just want to reduce their tax liability. But there are limited issues raised by the FRC regarding the testing of the completeness assertion, with far more focus given to occurrence, accuracy, and cut-off testing.
It is important audit firms distinguish between the inherent risk of fraud in revenue recognition (where I would still challenge the heavy focus in SME audits on the completeness assertion…) and the normal risk of material misstatement. Don’t focus on testing whether revenue is omitted to the detriment of testing other assertions, in particular the occurrence and accuracy of the revenue which has been recognized.
Substantive analytical procedures are very rarely deployed by the largest firms in general, and particularly to test revenue. And there is a reason why. They are really hard to do well. Criticism is highlighted again in the FRC’s inspections of substantive analytical procedures and their suitability to revenue testing.
Firms have moved away from these techniques in favour of data analytics, where 100% of transactions can be analysed in seconds and focused testing performed over the higher-risk items. Which is far more favourable than the huge sample sizes firms are facing now that many third-party methodology providers have removed their flawed sample-size caps. The benefits of deploying technology to test revenue are clear and all firms should be embracing revenue audit data analytics.
There are some clear takeaways for revenue testing from the FRC’s latest inspection results. It is not just the largest audit firms that should be invested in audit quality, there is always something for all firms to learn and apply. To support improving revenue testing and firm wide procedures across your firm, or on your next audit, download our full guide covering the FRC audit inspection 2022 results. These include our handy quick reference cheat-sheets, which include the 28 revenue testing tips extracted from the FRC’s latest inspections. We’ve included a sample of 8 tips below.
