Revenue recognition is an accounting concept that dictates how a company records sales transactions. Companies cannot recognize revenue until it is earned and realizable. Revenue is earned when making sales of goods or services. Realizable indicates the company expects to receive cash relating to previous sales. External audits review a company’s accounting procedures relating to revenue recognition. Audits ensure a company is properly recording information according to national accounting standards.
External revenue recognition audits review the company’s general ledger to determine how it records sales. Information relating to goods or services sold, date of delivery and payment method are a few important parts of a revenue recognition audit. Auditors may select a sample of transactions to review these specific details. The company’s accounting manual or revenue recognition policies and procedures may also be included during the audit. Auditors will ensure revenue information in the general ledger matches actual sales invoices.
Financial statement reviews are an important part of a revenue recognition audit since the statements contain information relating to a company’s financial information. Companies may attempt to boost their sales figure on the income statement by including information from previous or subsequent accounting periods. Auditors will review the income statement against the company’s general ledger to determine if any variations exist. A review of previous accounting periods can also indicate the revenue trends of a company. Auditors pay close attention to revenue recognition on financial statements since external business stakeholders rely on this information.
Accounts receivable contains information regarding outstanding accounts sales. Companies often extend credit to customers and allow them to purchase goods on account. The accounts receivable sub-ledger contains the unpaid balances from customers. Auditors will review this information to ensure the amount of cash outstanding matches the original sales invoice. Companies can manipulate accounts receivable information by including false account balances to improve their balance sheet. Auditors will ensure each outstanding account balance is legitimate and that the company has a reasonable expectation for collecting the outstanding balance.
Companies may use accruals or deferrals when recording revenue. Accruals and deferrals allow companies to adjust accounting information for timing differences. Accrued revenue is recognizable sales even though cash is not received. Deferred revenue occurs after cash is received for a sale. Auditors pay close attention to accruals and deferrals to ensure they represent actual transactions and not falsified information.