Auditing Revenue and Expenses
One of the most crucial areas in auditing is the evaluation of a company’s revenue and expenses, which directly affect the bottom line and overall financial health. These elements are frequently tested in the Auditing and Attestation (AUD) section of the U.S. CPA exam. When focusing on auditing revenue and expenses, several key audit procedures come into play: Cut-off testing, Expense Analysis, and Variance Analysis. Mastering these procedures is invaluable for CPA candidates and audit professionals alike.
Sales Cut-off Testing
Sales Cut-off Testing is an audit procedure aimed at verifying that revenue is recognized in the correct accounting period. The purpose is to validate the “cut-off” assertion, ensuring that sales are recorded in the financial statements at the appropriate time. The test typically involves reviewing shipping and sales documents to confirm the timing of revenue recognition. It’s especially relevant in audits and appears in the CPA exam as both multiple-choice questions and task-based simulations.
Example: Imagine you’re auditing a car dealership that reports a massive spike in revenue at the end of the fiscal year. By examining shipping documents, sales invoices, and the general ledger, you discover that several sales were recorded in December but the cars were actually shipped in January of the next year. This is a cut-off error, and those sales should be recorded in the subsequent accounting period to comply with proper revenue recognition principles.
Expense Analysis
Expense Analysis involves the scrutiny of expenses recorded in the income statement. The objective is to assess whether expenses are correctly classified, allocated, and recorded, serving the “accuracy” and “classification” assertions. This process may include analyzing transactions, tracing them back to source documents, and confirming that they have been appropriately authorized and recorded.
Example: During the audit of a software company, you notice that office supply expenses have doubled compared to the previous year. By sampling invoices and payment records, you find that the company incorrectly classified software licensing fees as office supplies. This misclassification should be corrected to ensure that financial statements are accurately representing the nature of expenses.
Variance Analysis
Variance Analysis is a useful tool for auditors to assess the “completeness” and “valuation” assertions related to revenue and expenses. It involves comparing current financial figures to historical data or budgets to identify any significant variances that may require further investigation. Variance Analysis is a critical concept for CPA candidates to understand because it serves as a foundational analytical procedure in auditing.
Example: You’re auditing a restaurant and notice that food costs as a percentage of revenue have substantially decreased compared to the prior year. Upon further inquiry, you learn that the restaurant switched to a less costly food supplier but failed to adjust its standard cost rates. This variance needs to be investigated to ensure that the food costs are accurate and that the reduction in expenses is legitimate.