Table of Contents
What is a Revenue Audit?
A revenue audit is a process in which tax authorities check a company’s records to verify the accuracy of its reported revenues. It includes reviewing income statements, balance sheets, cash flow statements, accounts receivable ledgers, and other financial documents against the company’s tax returns.
Revenue is generally one of the largest accounts on financial statements—the main purpose of a revenue audit is to monitor and ensure tax compliance with national and international accounting standards (including ASC 606 and IFRS 15), spot signs of tax evasion, and collect additional tax, interest, or penalties where needed.
Revenue audits often require a significant amount of work on the part of both the tax authority and company. The process may involve extensive record-keeping, data analysis, and other measures to ensure compliance.
Companies should take steps to proactively prepare for a revenue audit by maintaining accurate records and staying abreast of changes in applicable tax laws. Ideally, they should have a designated team of staff and external advisors to assist in the audit process, so they can respond quickly to requests from the taxing authority.
- Auditing revenue recognition
- Revenue testing
The Importance of Revenue Audits
Although revenue audits aren’t something a business looks forward to, they serve an important purpose in verifying a company’s tax compliance.
A successful audit can help protect businesses from paying fines and penalties and ensure they are paying the right amount of taxes.
Auditing revenue also provides companies with the opportunity to understand how their revenue is being reported and understand their overall profitability.
Audits by Tax Authorities
Audits by tax authorities are carried out differently in different parts of the world. In the United States, for example, the Internal Revenue Service (IRS) is responsible for conducting revenue audits.
The IRS employs a team of auditors who review business records and financial documents to verify all taxes are accurately reported and paid. They may also take additional steps based on their findings, such as issuing fines or levying criminal charges.
In other countries, different organizations may be responsible for conducting revenue audits. For example, in the United Kingdom, HM Revenue & Customs is responsible for conducting revenue-related audits.
From a tax authority standpoint, there are a few things that would trigger an audit:
- Digital asset transactions (e.g., Bitcoin payments, blockchain-based transactions)
- Significant discrepancies in state and federal financial statements
- Large increases or decreases in revenue from year to year
- Failure to disclose or correctly report income sources
- Overuse of certain deductions or credits
- Foreign financial assets and revenue streams
- Cash-based businesses
- Claiming a hobby as a business to deduct everyday expenses
No matter where a company is based, it’s important to stay up to date with applicable tax laws and regulations, keep detailed books, and account for all revenue generation that takes place within the business.
Internal audits take place as a preventive measure—that is, to ensure business operations are conducted in accordance with applicable laws and regulations, as well as any internal policies or procedures.
Internal audits generally fall into two categories: financial statement audits and operational audits.
Financial audits involve detailed reviews of company finances and records concerning income, expenses, profits, losses, assets, liabilities, etc.
Operational audits focus on the performance and effectiveness of company functions, such as human resources or marketing.
Internal audits are typically conducted by an auditor who is either an employee of the company, a third-party contractor, or an accountancy firm. The results of these reviews can help identify problems, inefficiencies, or compliance issues before they become more serious.
The Revenue Audit Process
The three components of the revenue audit process are understanding how a company generates revenue, audit procedures, and testing procedures.
Understanding Revenue Growth
Discrepancies with revenue recognition usually stem from one of the following areas:
- Consignment sales
- Round-trip sales
- Refunds and returns
- Bill and hold transactions
- Professional services delivery
- Complex contracts (or contract terms)
Sometimes, company leadership might misstate revenue figures to seem more attractive to investors. Other times, incorrect revenue recognition is due to human error.
Before an auditor carries through with revenue audit procedures, they need to understand the company’s revenue and receipts cycle. They will likely review the following records:
- Billing documents
- Bank statements
- Payment receipts
- Sales contracts or agreements
Auditing Procedures for Revenue
Auditing revenue is a multi-step process that can be carried out in-person or via mail. It typically involves:
- Document collection – collecting financial documents, such as income statements and tax returns, to review for accuracy and completeness.
- Verification – confirming information provided in the documents against other sources of information, such as bank records or customer data.
- Investigation – conducting an in-depth investigation of discrepancies or issues identified during the verification process.
- Determination – determining whether any discrepancies are due to negligence, a fraudulent return, or other causes.
- Final report – providing a final report and recommendations for correcting any errors found during the audit process.
Testing Procedures: Substantive and Controls
Auditors use two types of tests to assess a company’s revenue operations.
Substantive procedures are designed to identify errors, fraud, or areas of potential noncompliance. An auditor might review a sample of customer invoices and compare them against bank documents, sales orders, and other records. Substantive testing also involves analytical procedures, such as running financial ratios and comparing them to industry benchmarks (although these are more of a guide than a definitive measure).
If the audit findings from substantive tests reveal misstatements, further testing will be required. That’s why it’s important to conduct substantive tests internally—doing so eliminates potential risks of material misstatements.
Controls testing procedures examine a company’s internal processes for revenue recognition, bookkeeping, and billing. An auditor might review a business’s practices to ensure that all customer invoices are correctly recorded or assess the completeness of its accounts receivable records.
These types of audits give auditors a comprehensive understanding of a business. The auditors may review invoices and expenses, confirm inventory counts at year-end, assess the effectiveness of specific controls, and perform additional evaluations. If a company shows strong internal controls and proper documentation during controls tests, auditors won’t spend as much time on substantive testing.
How Businesses Prepare for an Audit
Businesses need to take steps in advance of a revenue audit to ensure they don’t have to deal with audit issues. They need to develop and implement a strategy for collecting the necessary documents, ensure all books and records are accurate and up-to-date, and train staff on revenue recognition procedures.
Records Needed for a Revenue Audit
Auditors request company records are requested on a case-by-case basis—certain records may be required for certain types of audits. Generally, auditors will request the following documents:
- Income statements and balance sheets
- Tax returns (state and federal)
- Bank statements
- Purchase orders (e.g., accounts payable and receipts)
- Sales contracts and their terms
- Depreciation schedule and sales invoice for acquisitions during the reporting period
- Reseller permits
- Documentation for all tax exemptions, deductions, and write-offs
Missteps to Avoid in Revenue Audits
Auditors will look for evidence of fraud, negligence, or non-compliance during each audit. Although it is unlikely they will miss anything, it is important to remember that they may be looking for discrepancies and errors in areas you may not have expected.
To avoid any missteps, ensure that all financial documents are accurate and up-to-date, all tax returns are filed on time, and staff members understand proper revenue recognition procedures.
Here are a few common missteps companies should be aware of:
- Risk assessment. Effective audit engagements rely on the auditor’s risk assessment procedures. Auditors sometimes overlook the company’s processes and controls related to the revenue lifecycle. To identify material misstatement risks, auditors must understand the client’s contract terms and procedures implemented to meet ASC 606 requirements.
- Substantive testing. Auditors typically test insufficiently when companies require guesswork in their revenue recognition process (such as with long-term contracts with no set value). They must continuously test their estimates and evaluate each event, test management’s accounting estimates and assumptions, assess control effectiveness, and develop a point estimate or range.
- Documentation. Auditors must adhere to AU-C Section 230, Audit Documentation, which requires documentation so clear an unrelated third-party auditor could understand the procedures, results, and conclusions of the audit. They should consider the materiality of the client’s estimated revenue from contracts in relation to financial statements. If significant, auditors must include abstracts or copies of each contract in their audit documentation as per AU-C Section 230, paragraph .10.
Benefits of Revenue Recognition Software in Auditing
Revenue recognition automation software is a valuable tool for businesses and auditors alike. They can quickly review all contracts and related transactions, recognize revenue per applicable accounting standards, and ensure compliance throughout the entire audit review.
Many of these systems provide features such as:
- Contract analysis
- Transaction tracking
- Billing history monitoring
- Automated reporting
- Customer segmentation
- Financial visibility across multiple locations/divisions
- Real-time alerts
Most importantly, it keeps all relevant data and records in one place, ensuring accurate audit findings that won’t take hours to sift through.
Organizations using revenue recognition software also have better insights into their bookkeeping processes, which helps them maintain compliance and avoid costly mistakes before an audit reveals them.
People Also Ask
How are accounts selected for a revenue audit?
The vast majority of businesses file their tax returns without any further action. Certain criteria that could trigger a company’s selection for an audit include:
Random selection and computer screening
Reporting a higher-than-average income
Submitting an unusually large number of extra deductions
Working with a lot of independent contractors vs. employees
Claiming continuous business losses on a Schedule C
Large volumes of cash or cryptocurrency transactions
What is revenue testing?
Revenue testing is a procedure auditors carry out during a revenue audit. It involves testing the accuracy of reported revenue and associated disclosures by examining evidence such as contracts or sales invoices. Auditors can also analyze the internal controls in place to identify any weaknesses that may have resulted in material misstatements. The goal is to detect any errors, omissions, or non-compliance with applicable accounting standards.