Risks of Material Misstatement of Revenues

What is Revenue?

Revenues that the entity recognizes in the income statement during the year are income that the entity sells the goods or services to its customers. These revenues are recognized when the control is passed from the entity to its customers.

It is recognized either when the customer pays immediately or sold on credit which means the goods or services are sold but the payments will be collected later.

In general, revenue is one of the key performance indicators that not only the entity itself want to archive, but the board of director as well as the management of the entity want to accomplish.

That is the main reason why revenues are generally set as the high risks of material misstatement when it comes to auditing due to its nature and amount that recognizes in the income statement.

In this article, we will discuss about the risks of material misstatements related to the revenues.

Inherent Risk:

Inherent risks are the risks that not related to the control, but it is highly related to the nature of the account itself, the level of judgment involve in the management, and the complexity of accounts and transactions.

The inherent risk of the revenues is normally considered as high due the revenues have many criteria with significant judgments are involve by the management of the entity.

Here are the examples of inherent risk relate to the revenues that auditor should pay attention during the audit:

  • Management manipulates the figure to achieve the target set by the board. For example, the is the budget sales set by the board or shareholder and at the end of the year, the actual sales are almost reaching the budget. Management might try to manipulate the sales so that the budget will be achieved and management could entitle to receive the bonus that might agree with upfront with the board or shareholders.
  • Risk of recognizing the revenues that do not occur during the period. These might happen at the middle management where a fake sales account is mad at the end of the year and sales are canceled after the year so that their performance is meet.
  • Due to the complexity of sales terms, revenues might be incorrectly recognized for those goods that are in transit or consign at the customers’ store.
  • The company might fail to derecognize the sales return and result in the overstatement of sales as well as account receivables.
  • Due to the complexity of sales term and a large amount of sales transactions, revenues might be incorrectly sales in a different period that its be recognize. For example, the revenues are recognizing in December 2020 for those transactions that occurred in January 2021.
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Therefore, there is a significant risks of material misstatement for the revenues recognition that link to inherent risks of the revenues.

Fraud Risk:

It is obvious or default that fraud risk relate to the revenues are always high. It is due to its nature. The fraud could be committed by entity staffs or at the top management level.

And the form of fraud could be in the form of misappropriation of assets and fraud over financial reporting. For example, the fake sales transactions are creating by sales team by creating the fake customers accounts. Those account will them write off dur to the customers are unable to contact.

However, this kind off fraud might be detected by management by setting up a strong internal control.

Fraud over financial reporting, in the other hand, are very difficult to detect and auditor might need to pay a very great attention since the detect risk are high considering the fraud might be committed by management or even at the board level.

Therefore, there is a significant risks of material misstatements for the revenues related to fraud.

Control Risk:

The risk of material misstatement of the revenue due to control might be occurred but depending on the control of each entity that the auditor auditing.

Auditor normally need to obtain an understanding on the internal control that entity setting to see if there is any loophole could lead to risks of material misstatements on the revenues.

Auditor need to assess the implementation of control whether the key control that help to present error or fraud are effectively and efficiently implement by the company.

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If the control is effectively and efficiently implemented, then the risk of material misstatements might be low. And if the control is not strong and the implementation is not effective and efficient, then the risk of material misstatement is high and the auditor should prepare the procedures to address those risks.