Revenue Cycle (Ch11 Hurt)

92% of Public Companies’ Revenue Processes at Risk for Compliance Failures and Restatements
New study by RevenueRecognition.com and IDC reveals widespread reliance on spreadsheets, which greatly increases the likelihood of control weakness and accounting errors.

A recent survey of 685 senior financial executives from a broad range of companies, revealed that revenue recognition and reporting activities are not automated within Financial/ERP systems. As a result, 92% of public companies are forced to rely on spreadsheets to fill vital gaps in their revenue reporting processes—despite the fact that spreadsheets are prone to errors, lack audit capabilities, and resist internal controls. This, and other findings, is from a new report by www.RevenueRecognition.com and IDC, “Enterprise Systems and Revenue Recognition: The Missing Link”.

Revenue Spreadsheets: The Compliance Killers
These results should be alarming for corporate finance departments, executives, and investors alike, because: 1. The risks introduced by spreadsheets violate basic compliance principles. 2. Revenue accounting problems are the leading cause of financial restatements. 3. The number of restatements is on the rise.
As a result, compliance managers should be addressing the issue of having spreadsheets in the revenue reporting process. Executives should be extremely cautious about the integrity of the numbers they are attesting to under Sarbanes-Oxley requirements. Investors have to be wary of the risks of restatement which can hurt stock prices.

http://www.alacra.com/acm/2033_sample.pdf

The Functionality Gap
Financials/ERP systems manage operational data flows throughout an enterprise, but they may not automate critical tasks in the revenue recognition and reporting workflow. This causes a break down in the financial reporting infrastructure. As the table below illustrates, it is very common for companies to use spreadsheets for one or more of the key revenue recognition and reporting tasks listed. More than half of all companies are using spreadsheets to create their accounting entries for revenue. Surprisingly, public companies with more than $200 million in revenue are substantially more reliant than the overall sample (61% vs. 52%) on spreadsheets for basic accounting entries.

Table 1
Spreadsheet-based revenue recognition and reporting tasks.
(Multiple responses accepted, n=685)
1. Creating accounting entries 52%
2. Creating revenue recognition schedules for future periods 47%
3. Reporting on future revenue streams 47%
4. Applying revenue allocation rules 43%
5. Performing revenue contribution analysis 42%
6. Redistributing revenue (e.g. SOP 97-2, EITF 00-21) 35%
7. Reviewing sales orders for deferred revenue 27%
8. Do not use spreadsheets for any of these activities 8%
Source: www.RevenueRecognition.com and IDC, 2006

Internal Controls
Respondents were presented with a list of eleven accounting activities and asked to identify for which areas it is most difficult to establish internal controls. As the table below shows, contract management and revenue recognition accounting were the top two most challenging areas for companies with more than $20 million in revenue. No other process rated higher than 10%.
Table 2
In your opinion, for which area is it most difficult to establish internal controls? (Rev=$20M+, n=492)
1. Contract administration and management 34%
2. Revenue recognition accounting 32%
3. Purchasing and payables 8%
4. Billing and accounts receivable 8%
5. Order processing 5%
6. All others combined 13%
Source: www.RevenueRecognition.com and IDC, 2006
Enid man faces embezzlement charges ENID, Okla.

An Enid man faces felony charges after allegedly admitting to taking money from his former employer over a two-year period. Zane Robert Davidson, 24, was charged Friday with a felony count of embezzlement, which carries up to ten years in prison and a $10,000 fine if he is convicted. Davidson allegedly embezzled nearly $35,000 from Rooster in Wine, the restaurant where he had worked since 2002, according to court documents. The restaurants owners reported their suspicions about Davidson to Enid police earlier this week. Davidson subsequently admitted to taking as much as $400 a week from the restaurant over the past two years, according to the affidavit. Two of Rooster in Wines five owners provided detectives with documentation that indicated Davidson took almost $35,000 from the restaurant since November 2002. Davidson confessed to pocketing the proceeds from meals paid with cash during that period, while credit card transactions were logged into the restaurants computer system as required, according to the affidavit. Davidson posted $5,000 bail after being arrested on the embezzlement charge. He is due back in court May 18 for a bond appearance.

Davidson had been one of the top candidates to fill a number of openings at the Enid Police Department before the embezzlement allegations came to light this week.
Capt. Bryan O’Rourke said Davidson voluntarily removed himself from the departments hiring list after detectives contacted him during their investigation of the embezzlement allegations. O’Rourke said Davidson passed through the department’s mandatory background test before he was placed on the hiring list earlier this month. Before discovering Davidson's embezzlement, his former employer gave Davidson a positive recommendation during that process, O’Rourke said.
Audit: Worker Took Pike Place Money
By Linda Keene Seattle Times Staff Reporter
The Washington State Auditor's Office has concluded that Millie Padua, a longtime and popular Pike Place Market employee, was responsible for misappropriating at least $174,000 over a three-year period. The special audit released today said the former day stall assistant/Market master took the money from 1996 to 1998.
Discrepancies discovered
The state auditors found discrepancies between amounts of money that had been collected from day-stall tenants and amounts deposited in the Market's bank for day-stall rentals. In 1996, the difference was $64,688; in 1997, $54,816; and in 1998, $54,371. The discrepancies went unnoticed because there were no procedures for double-checking the deposits. One person, Padua, was responsible for submitting the receipts and keeping records on them, according to the audit. "No other individual reviewed or monitored this documentation," it said. Market officials said new procedures, with checks and balances, had been implemented. "We've got a pretty tight system now, and hopefully that type of thing will never happen again," said Mike Caldwell, interim director of the Market. "
REVENUE CYCLE

1) Identify major activities
2) Find risks in narrative
3) Find documents in narrative

Waren Sports Supply is a distributor of sporting goods to colleges and universities in the Midwest. Kramer, Adams and Ford are Waren’s three employees.

The sales process starts when the customer calls Waren to place an order. They receive the customer purchase order, if need be, Kramer checks the customer’s credit and initials approval on customer purchase order. Waren requires most of its customers to prepay for goods ordered. For these cash sales, the customer sends a check with its purchase order. A picking ticket is created and sent to the warehouse for the goods that the customer ordered.

In the warehouse, clerks receive the customer purchase order and picking ticket. They proceed to pick the items from inventory to fill the order. The customer purchase order and two copies of the bill of lading are used to prepare a pre-numbered sales invoice. The current price list is consulted, Adams reviews the invoice, and the customer order is shipped.

Included in the merchandise shipped to the customer, is a sales invoice and a bill of lading. Separately, another sales invoice is mailed to the customer to bill them for what they owe for the merchandise they recently received.

When the check is received with the customer purchase order, it is restrictively endorsed. The CPO is sent to the shipping department, assuming a cash order. The check is entered into the cash receipts prelist. The cash receipts prelist is used to populate the cash receipts journal and the accounts receivable subsidiary ledger, the cash receipts prelist is then filed numerically. The check is sent to Kramer, who prepares a bank deposit slip for each day’s receipts, and deposits them at the end of the day. Ford receives validated deposit receipt, verifies that deposit receipt and prelist agree with cash receipts journal. She initials journal. Documents filed and pulled monthly for bank reconciliation process.

|Waren Company sub |Risks (WCGW) |Control Activities (compare manual and automated) |Documents |
|processes in Revenue | | | |
|Cycle | | | |
| |a.Wrong Info |a. send sales acknowledgement |Cust PO |
|Sales Order |b.Cust bad credit |repeat order to cust |Sales order |
| |c.Exceed credit limit |b.check credit rpt | |
| |d.Lose order |c.check outstanding balance | |
| | |d. automated system | |
| | |write sales order | |
| | |sequential numbered orders | |
|Ship goods |a.Pick wrong goods |a.independent check– match packing list with sales |Packing list |
| |b.Miss delivery date |order or Cust PO |Pick ticket (could be copy of|
| |c.Ship to wrong address |b.file sales orders by delivery date or number, |sales order) |
| |d.goods damaged in transit |check file every week |Bill of lading |
| |e.forget to ship |c.match packing slip to sales order | |
| | |d.insurance | |
| | |e.check Sales Order file weekly | |
|Billing |a.forget to bill |a.copies of ship docs to billing dept |Shipping docs above |
| |b.bill wrong amount (wrong price |a.copy of cust PO to billing – filed temporarily and|Cust po |
| |or wrong qty) |file is checked weekly |Invoice |
| |c.bill for goods not shipped |b.Second person checks invoice |Monthly statement |
| |d.send bill to wrong |Peachtree – price is set in inventory – automatic | |
| |customer/wrong address |(have mgr verify price list) | |
| |e.duplicate bill |Match to ship docs (not cust PO) | |
| | |c. match to ship docs | |
| | |c.send statement | |
| | |d.match invoice to Cust PO | |
| | |d.verify billing vs. ship address | |
| | |e.monthly statement | |
| | |e.only bill from ship docs – then when billing is | |
| | |complete – staple together and file | |
|Cash receipt |a.Steal cash |a.locked cash drawers |Cust check |
| |b.apply pymt to wrong invoice |a.lockbox (PO Box –retrieved by bank) |Prelist |
| |c.apply to wrong G/L (automated |a.one person open mail and restrictively endorse and|Deposit slip |
| |system) |creates prelist, another posts, another takes to |Monthly statement |
| |d.forget to apply discount |bank. Match prelist, CR journal and deposit slip | |
| | |a.monthly statements | |
| | |a.person who does not have custody of cash – | |
| | |authorizes write-offs | |
| | |b.monthly statement | |
| | |c.bank reconciliation | |
| | |d.monthly statement | |
| | |d.automated system | |
|(other – “exception” |a. forget to ship backorder when |a.backorder triggers PO – copy to purchasing. Purch | |
|processes) |goods are in stock |keeps BO file, Shipping also has BO file. When goods| |
|Backorder |b.write-off bad debt to cover |are rec’d compare rec rpt to back order file. | |
|Write-off bad debt |theft of cash |b.authorized by someone who does not have access to | |
|Sales |c.post an allowance not deserved |cash | |
|returns/allowances | |c.manager authorization | |

COSO Framework within the Revenue Cycle

Control Environment- the tone at the top of the organization. Without clear, demonstrated commitment of upper management and opinion leaders in the organization, internal control will not be taken seriously elsewhere in the hierarchy.

Accurate sales projections – if managers rewarded for meeting budget – might underestimate sales projections
Commission structure that creates incentives for sales people to act in best interest of company

Risk Assessment-using a taxonomy, business experience, research, and dialogue to identify the risks associated with operations.

Revenue has inherent risk – may overstate revenue to manipulate earnings

Control Activities- the actual internal controls implemented on the basis of the risk assessment.

See table above

Information and Communication- • For an internal control system to function effectively, its purpose, methods, and results must be communicated throughout the organization. Employees at all levels should understand the risk exposures they face and the controls employed to mitigate those exposures.
Inform employees about controls and also WHY they have to implement controls

• Information must be accurate, valid, classified correctly, and in the proper accounting period.

Misclassified to wrong GL
Posted to wrong period

Monitoring- SOX mandates internal control monitoring and personal certification by the CEO and CFO of the organization. Companies’ objectives and business processes change over time, so the monitoring function in an important part of the maintaining good internal control.

Compare budgeted sales to actual sales
Internal audit test control activities
Alaska Airlines Revenue Cycle

How does Alaska Airlines earn revenue?

How is that revenue paid for?

Is any of this revenue unearned when they receive payment?
List the steps in the sales process for Alaska Airlines
Identify risks and mitigating controls. (one copy from each group will be turned in)

|Sales process steps |Risks |Controls |
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