Recent audit quality results suggest deterioration in the quality of audits reviewed by QAD, with revenue highlighted as a common area of weakness across audits requiring improvement or significant improvement. Howard Freeman, an audit partner at Shorts, talks through some of the common pitfalls.
Shorts is a seven-partner firm employing around 120 staff in offices across Sheffield and Chesterfield. Freeman joined the firm 20 years ago this year, having trained at Coopers & Lybrand in Sheffield. “I work across an SME client portfolio. A lot of our clients are family businesses, there are quite a few charities, and some have international aspects but we don't have any listed clients,” Freeman explains.
Because revenue is deemed to be high risk from a fraud point of view, it’s an area that should definitely be on the auditor’s radar, Freemans says. At the same time, the growing complexity of business makes it all the more important for auditors to consider different revenue streams separately, Freeman says. “It's vitally important in the planning stages of an audit to understand the revenue streams and focus your work to appropriately.”
“For example, I've got a visitor attraction client generating income from ticket sales, from the cafe and the restaurant, they also run events and have sponsorship, generate revenue from parking and have a shop.”
And yet, auditors will generally focus their attentions on the balance sheet, and revenue can often play second fiddle, Freeman explains. “I imagine aspects of the P&L account and revenue might often be left to more junior members of the audit team. So, there's an inherent danger, if you're not careful that revenue is not focused on as much as it should be right from the start.”
Focusing your audit testing on the biggest area of revenue alone is a flawed approach, Freeman warns. “It's important at the planning stage of the audit to properly consider all the different revenue streams. And if they're using different systems and present different risks, you need to identify those early and document that thought process too.”
A holistic approach to audit that takes broader factors into consideration rather than looking at revenue in isolation, will stand you in good stead, Freeman says.
Understanding the accounting policy and sales terms is essential to determining whether the point of revenue recognition is appropriate and can also impact on areas of the balance sheet like debtors and creditors, Freeman explains. You might have a sales stream where you get paid up front, so you need to defer that income because you haven't earned it yet. “You don't just audit sales in isolation, you audit sales alongside deferred income or money that's owed.”
Completeness of income is a common potential risk identified at the audit assertion level for a private company. Testing a sample of transactions only tells part of the story. How would you pick up if a sales transaction was missed off the list? Again, it's important to understand the system - from how orders are received and recorded through to fulfilment - to be able to audit the revenue correctly.
Some audit files start at the wrong place, Freeman warns. “If it's a company that sells goods, your first point of evidence would be a goods dispatch note or a sales order note - something that shows your goods have left the factory. But where is the invoice that supports that transaction? It's important to understand the system so that you can go to the earliest piece of evidence in that system to see the sales coming in and make sure the revenue is recorded.
This is where less experienced members of staff need to be guided through the process, Freeman says. “If you've got to pick 30 or 40 items, they might not think to go back to that dispatch note or sales order, so it's making sure you plan your work properly and explain to your junior team members exactly what they need to do but also why they’re doing that test because they're much more likely to spot when something not right.”
Training and mentoring is key. Factor in proper time for more senior staff to coach their juniors and be available for them to ask questions. “I say to all members of the team, if you don't understand ask questions, and if you get an explanation and still don't understand ask your question, again, because somebody hasn't explained it well enough.”
The introduction of ISQM 1 has helped to galvanise more rigorous and regular training, Freeman says. In Shorts’ case, that translates to the setting up of more formalised training and technical documentation processes.
With something like ISQM 1, there's a temptation to approach it as a box-ticking exercise, but we saw it as an opportunity to streamline processes and improve the quality of our audits.
Led by the firm’s practice director and an audit senior manager, the ISQM 1 project has resulted in the creation of training and technical committees that meet on a regular basis. Alongside regular training, all of the firm’s processes are properly documented, and the firm has developed a library of constantly-updated materials including audit manuals, a handbook and checklists that are made available to everyone in the firm.
“All our audit team members find it helpful knowing where that resource is, and that it's up-to-date. The big firms have dedicated technical departments, whereas we don't have that so it's even more important for the smaller firms to have an organised system like that.”
Meanwhile, new auditing standards ISA 315 requires firms to assess the risks of material misstatement in the accounts. “The standard says you've got to spend more time at the planning stage of an audit, thinking about where the risks of material misstatement are, and how you're going to tackle them. We're spending more time on planning as a result.”
“It's making us sit down as a team and spend more time looking through the areas of risk, including revenue and think about how we’re going to audit them. The standard requires that all members of the team – including partners and juniors - have to be involved in that discussion. It means we all know what we're doing long before we go out to do the actual work. That's been a major positive from the audit quality side.”
With changes to the accounting rules for revenue under FRS 102 on the horizon, audit firms would do well to plan ahead for those changes, Freeman urges. “We're starting to have that included in our training courses. It's a good opportunity not only to consider how the accounting rules are changing, but also whether we need to review our approach to auditing revenue under the new rules.”
ISQM 1 - Maintaining momentum
Hear from member firms and QAD as they reflect on implementing ISQM and discuss survey results, and share your own challenges and experiences with your peers.