Guide to Audit of Revenue from Operations as per AS 9

The Audit of Revenue from Operations as defined by Accounting Standard (AS) 9 involves the examination and verification of a company's revenue records to ensure the accuracy and completeness of recorded revenue transactions and that they are in compliance with the principles outlined in AS 9, "Revenue Recognition."

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Table of Contents

1. Introduction
2. Audit of Revenue
3. Reporting Requirements
4. Disclosure Requirements as per Schedule III (Division 1) of the Companies Act, 2013 and AS 9 “Revenue Recognition”

1. Introduction

Accounting Standard AS 9 “Revenue Recognition” defines revenue as under:

“Revenue is the gross inflow of cash, receivables or other consideration arising in the course of the ordinary activities of an enterprise from the sale of goods, from the rendering of services, and from the use by others of enterprise resources yielding interest, royalties and dividends. Revenue is measured by the charges made to customers or clients for goods supplied and services rendered to them and by the charges and rewards arising from the use of resources by them. In an agency relationship, the revenue is the amount of commission and not the gross inflow of cash, receivables or other consideration.”

AS 9 deals with the bases for recognition of revenue in the statement of profit and loss of an enterprise. The Standard is concerned with the recognition of revenue arising in the course of the ordinary activities of the enterprise from the sale of goods, the rendering of services, and the use by others of enterprise resources yielding interest, royalties and dividends.

Some key consideration in recognition of revenue in the statement of profit and loss are:

1. The timing of recognition of revenue.
2. The amount of revenue. It is generally determined by agreement between the parties involved in the transaction.
3. Uncertainties regarding the determination of the amount, or its associated costs may influence the timing of revenue.

1.1 Sale of Goods

Revenue from sale of goods is recognized when:

• The seller has transferred the property in the goods to the buyer for a consideration.
• Significant risks and rewards of ownership have been transferred to the buyer.
• The seller retains no effective control of the goods transferred to a degree usually associated with ownership.
• There is no significant uncertainty regarding the amount of consideration that will be derived from sale of goods.

Generally, the transfer of property in goods results in or coincides with the transfer of significant risks and rewards of ownership to the buyer. However, there may be instances where transfer of property in goods does not coincide with the transfer of significant risks and rewards of ownership. In such cases, revenue is recognized upon transfer of significant risks and rewards of ownership to the buyer. Such cases may arise where delivery has been delayed through the fault of either the buyer or the seller and the goods are at the risk of the party at fault as regards any loss which might not have occurred but for such fault.

1.2 Sale of Services

Revenue from service transactions is generally recognized:

• As the service is performed, following either ‘Proportionate Completion Method’ or ‘Completed Service Contract Method’.
• There is no significant uncertainty regarding the amount of consideration that will be derived from rendering of service.

(a) Proportionate completion method: In cases where performance of service consists of the execution of more than one act, revenue is recognized proportionately by reference to the performance of each act.

The revenue recognized under proportionate completion method is to be determined on the basis of contract value, associated costs, number of acts or some other suitable basis. However, for practical purposes, when services are provided by an indeterminate number of acts over a specific period of time, revenue is recognized on a straight-line basis over the specific period unless there is evidence that some other method better represents the pattern of performance.

For example, an annual maintenance contract for an equipment requires the service provider to inspect the equipment and clean the equipment every quarter. In this case, the annual charges received from the customer are recognized as revenue on quarterly basis, that is, 25% of maintenance fees charged is recognized as revenue in each quarter.

(b) Completed service contract method: This method to recognize revenue from rendering services is followed where either the performance consists of the execution of a single act or services are performed in more than a single act, and the services yet to be performed are so significant in relation to the transaction taken as a whole that performance cannot be deemed to have been completed until the execution of those acts. The completed service contract method is relevant to these patterns of performance and accordingly revenue is recognised when the sole or final act takes place, and the service becomes chargeable.

For example, a contract requires the entity to install wooden benches at various parks maintained by the municipal corporation across the city. The contract stipulates that consideration shall be payable only upon installation of all benches across the city and the consideration is a lump sum amount for the entire contract. Completion of services will be acknowledged by the municipal corporation only when all benches have been installed. In this case revenue will be recognized upon completion of the contract, that is, when all benches have been installed across the city.

1.3 Revenue arising from the use by others of enterprise resources

This includes interest, royalties and dividends. Revenue should be recognised only when no significant uncertainty as to measurability or collectability exists. These revenues are recognised on the following bases:

1. Interest: on a time proportion basis taking into account the amount outstanding and the rate applicable.
2. Royalties: on an accrual basis in accordance with the terms of the relevant agreement.
3. Dividends from investments in shares: when the owner’s right to receive payment is established.

1.4 Uncertainties in Revenue Recognition

AS 9 provides guidance on the effect of uncertainties on recognition of revenue.

• Recognition principles of AS 9 requires the following prerequisites to revenue recognition:

1. 1. revenue is measurable; and
   2. at the time of sale or the rendering of the service it would not be unreasonable to expect ultimate collection.

• There may be situations where it is not possible to assess the ultimate collection with reasonable certainty at the time of raising any claim (such as insurance claim or price escalation claim). In this regard AS 9 requires that:

1. 1. Revenue recognition is postponed to the extent of uncertainty involved.
   2. In such cases, it may be appropriate to recognise revenue only when it is reasonably certain that the ultimate collection will be made.
   3. Where there is no uncertainty as to ultimate collection, revenue is recognised at the time of sale or rendering of service even if the customer makes payment in instalments.

• AS 9 requires that when consideration receivable for the sale of goods, the rendering of services or from the use by others of enterprise resources is not determinable within reasonable limits, the recognition of revenue is postponed.
• When recognition of revenue is postponed due to the effect of uncertainties, it is considered as revenue of the period in which it is properly recognised, that is, when no uncertainties exist. (For example, revenue in respect of an insurance claim was not recognised at the time of filing claim during the year ended 31st March 2021 as there were uncertainties regarding collection. During the year ended 31st March 2022, the uncertainties ceased to exist as the insurance surveyor approved the claim amount. In this regard, revenue to the extent of claim approved will be recorded in the financial year ending on 31st March 2022.

It is possible that uncertainty relating to collectability arises subsequent to the time of sale or the rendering of the service (for example, the customer has become insolvent). In such cases, AS 9 states that it is more appropriate to make a separate provision to reflect the uncertainty rather than to adjust the amount of revenue originally recorded. For instance the entity may record a suitable provision for doubtful trade receivables.

Accounting Standard AS 9 has provided several illustration on recognition of revenue considering various situations such as:

• “Bill and Hold” sales
• Delivery subject to conditions
• On approval sales
• Guaranteed sales
• Consignment sales
• Principal-agent relationship

2. Audit of Revenue

In carrying out the audit of revenue, the objective of the auditor is to validate the following assertions:

• Existence: That recorded revenue represents goods shipped/services rendered during the period and that there is no overstatement of revenue. (For example, in respect of sale of goods, risks and rewards have been transferred.).
• Completeness: All sales made during the period have been recorded and that there is no understatement of revenue. (For example, there are no instances where sale has been completed, such that the risks and rewards have been transferred but the same has not been recognized.).
• Accuracy: All revenue transactions have been recorded correctly.
• Presentation & Disclosure: Required disclosures as per Schedule III and applicable accounting standards (AS 9) have been appropriately made.

2.1 Potential Risks of Material Misstatements in Revenue

It is common for promoters and senior management to attempt to accelerate the recognition of revenue in order to show better financial performance than is really the case. This is because, a business is often judged by the amount of revenue that it reports. If a business reports steep increases in revenue, then it is likely that investors/potential investors will be willing to pay more for its shares, thus increasing the organization’s value. On the contrary, a decline in revenue will typically lower the entity’s valuation. It is for these reasons that the senior management is quite sensitive to changes in reported revenue levels, and, therefore, are more likely to use grey areas of the revenue recognition regulations to boost revenue numbers.

It is important to note that Standard on Auditing SA 240

“The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial Statements” issued by the Institute of Chartered Accountants of India states: “When identifying and assessing the risks of material misstatement due to fraud, the auditor shall, based on a presumption that there are risks of fraud in revenue recognition, evaluate which types of revenue, revenue transactions or assertions give rise to such risks”. (Paragraph 26 of SA 240).

Some of the potential misstatements in revenue recognition are:

• Manipulation of sales:

1. 1. To achieve a set target such as revenue forecast given to shareholders.
   2. To achieve a target where commissions and bonuses are linked to targeted sales. (For example, this may be achieved by ‘channel stuffing’).

• Recording fictitious sales. (For example, recognition of revenue on shipments that never occurred).
• Revenues might be incorrectly recorded either due to the complexity of sales terms or recognised despite non-fulfilment of conditions Some possible instances are:

1. 1. Delivery subject to conditions, for example, goods have been sold subject to installation and/or inspection.
   2. Sales on approval
   3. Consignment Sales
   4. Principal-Agency relationship, that is sale is recognised even though the supposed buyer is in effect an agent.

• Revenue from services is recognised upfront instead of being recorded as services are rendered. (For example, while admission fees/registration fees from students may be recognised upfront, tuition fees should be recognised as revenue over the period of instruction).
• The company might fail to derecognize the sales return resulting in the overstatement of sales as well as account receivables. (For example, there are significant sales returns subsequent to the period-end).
• Early recognition of sales that occurred after end of period.
• Sales are recorded though there are hidden side letters giving customers an irrevocable right to return the product.

Note: The above is not a comprehensive list of all possible risks of material misstatement. This is only a list of most common risks. The auditor should evaluate the potential risks of material misstatement based on the facts and circumstances of the entity being audited.

2.2 Audit Procedures: Revenue

• The auditor should obtain an understanding of :
  1. Nature of products sold and services rendered by the entity. The auditor should ensure that the objective clause of entity’s Memorandum of Association includes these business activities.
  2. Sales process, for example, whether direct sales or through dealers, distributors, agents, consignment agents, etc.
  3. Entity’s accounting policy for recognition of revenue.
  4. Entity’s policies relating to pricing, credit/payment terms and acceptance of sales return.

• The auditor should ensure that an appropriate and consistent revenue recognition policy is applied. The auditor should also ensure that the accounting policy for revenue recognition is in line with generally accepted accounting principles (Accounting Standard 9). [For example, policy to recognise dividend income on the basis of past trend or newspaper reports citing accrual basis of accounting is not in line with generally accepted accounting principles].
• The auditor should consider accounting for long term contracts, warranty contracts, significant orders spread over the year end, inventory dispatched but not invoiced, and sales invoiced but not delivered.
• The auditor should ensure that where a sale includes a deferred element (for example, a maintenance or support service), a portion of revenue is deferred where appropriate, for instance accounting for unearned revenue.
• For a sample of recorded sales, the auditor should verify sales order, invoice and goods despatch/delivery note. The auditor should verify that the sales are recorded as per price list.
• The auditor should also cross-check dispatch notes with sales invoices to ensure that all goods despatched have been invoiced.
• The auditor should enquire about unusual delays between the despatch of goods and invoicing.
• In case of ‘bill and hold’ sales, the auditor should ensure that the recognition criteria of AS 9 has been met before sales are recognised.
• In respect of goods sent on approval, the auditor should ensure that the revenue is recognised when the recognition criteria of AS 9 has been met. This generally happens when:

1. 1. The goods have been formally accepted by the buyer, or
   2. The buyer has done an act adopting the transaction, or
   3. The time period for rejection has elapsed or where no time has been fixed, a reasonable time has elapsed.

• In case of sales to intermediate parties such as dealers/distributors, the auditor should ensure that:

1. 1. Revenue is not recognised until the significant risks and rewards of ownership have passed.
   2. Where the intermediate party is in substance an agent, revenue should not be recognised until the related goods have been sold to the customer.

• In the case of consignment sales the auditor should verify the following:

1. 1. Consignment sales agreement
   2. Whether consignment sales summary is being received regularly (normally the same should be received every month)
   3. Whether sales are recorded as per sales summary received from consignment agent
   4. Expenses have been recorded as per terms of the agreement

• The auditor should verify the following:

1. 1. Whether there is a formal documented policy for discounts
   2. Whether discounts have been properly authorised
   3. Authorisation for changes in prices
   4. Alterations to system for prices/discounts (such as billing software)

• In cases where there are significant cash sales, such as a retail industry, the auditor should verify the process of reconciling sales with cash collections. (This reconciliation should ideally be done on a daily basis). The auditor should also ensure on a sample basis that the cash is deposited with bank on the next working day.

• In case of export sales, the auditor should ensure that sales are recorded using exchange rates in accordance with AS 11.
• In case of sales to related parties, the auditor should compare the rates offered to related parties with those with third parties to ensure that the transactions are at arm’s length.
• Sales Returns:

1. 1. The auditor should verify the entity’s policy for sales returns
   2. While vouching the sales return, the auditor should verify the inward return note along with the inspection report. The auditor also needs to ensure that credit note is issued with the correct value.

• The auditor should review reconciliation of revenue as per statement of profit and loss with GST Returns filed by the entity.
• Cut-off: The objective of performing cut-off procedures is to ensure that revenues are recognised in the correct accounting period by verifying:

1. 1. That goods delivered have been invoiced
   2. That goods invoiced but not delivered have not been included in closing stocks
   3. That all goods rejected (sales returns) have been removed from sales
   4. The auditor should select sample of invoices, inspect the invoice date and trace the date with goods dispatch note and trace the date to the sales record to ensure the correct accounting period.
   5. The auditor should select subsequent credit notes or invoices cancelled after the year end to check if such credit notes and cancellations should be adjusted in year under audit.
   6. The auditor should select few invoices at the year-end as well as at the beginning of the subsequent year and verify if the revenues are properly recognized in the correct period.
   7. The auditor should review sales returns subsequent to the year-end and ensure that necessary adjustments are recorded (example, in case of channel -stuffing,)

• Considering the availability of data on government portals, the auditor can use external data to obtain a high level of assurance. Some of the procedures that the auditor can perform in respect of revenue are:

E-Way Bill

Electronic Way Bill (e-Way Bill) is a compliance mechanism wherein by way of a digital interface the person causing the movement of goods uploads the relevant information prior to the commencement of movement of goods and generates e-way bill on the GST portal.

The auditor can reconcile the revenue booked as per the records vis-à-vis the e-way bill register in order to test the revenue cut-off testing.

The auditor will need the following data sets:

1. 1. 1. E-way bill register (External evidence – from Government authorised site)
      2. Sales register with delivery dates (Internal evidence – books of account)

These can be used to map the delivery dates in sales register with the dates in the e-way bill register and identify instances wherein the sales are not booked in the correct period.

This test will provide assurance on both ‘Completeness’ and ‘Existence’ Assertions in case of revenue.

e-BRC and Bulk e-BRC details:

An Electronic Bank Realisation Certificate (e-BRC) is a vital digital certificate for export businesses. A bank issues the e-BRC to confirm that the buyer made payment to the exporter against the export of services or goods. A Portal has been released by DGFT for e-BRC services. It provides single point of access to all information, help and access to e-BRC services. The auditor will require the following data

• IEC (Internal data)
• Sales Register (Internal data)
• e-BRC details (External data)

Bank Realisation details in relation to export sales is available through this particular portal. Through e-BRC portal one can view 200 latest records directly (for the selected time period) and can also request for full year’s data i.e., e-BRC bulk data request with the help of client’s Digital Signature and auditor can receive the data directly on his/her email. Once auditor receives the data, auditor can reconcile the full year’s export revenue from the Revenue register for the transactions already realised. Auditor can also check compliance with FEMA regulations.

3. Reporting Requirements

The relevant clause related to revenue on which auditor is required to report under Companies (Auditor’s Report) Order, 2020 is:

Clause (3)(viii): Whether any transactions not recorded in the books of account have been surrendered or disclosed as income during the year in the tax assessments under the Income-tax Act, 1961, if so, whether the previously unrecorded income has been properly recorded in the books of account during the year.

4. Disclosure Requirements as per Schedule III (Division 1) of the Companies Act, 2013 and AS 9 “Revenue Recognition”

Schedule III

Disclosure requirements for Revenue have been described in Paragraph 2(A) of General Instructions of Schedule III for preparation of statement of profit and loss. Additional disclosures are required as per paragraph 5(ix).

Revenue

(A) In respect of a company other than a finance company revenue from operations shall disclose separately in the notes revenue from

(a) sale of products;

(b) sale of services;

(ba) Grants or donations received (relevant in case of Section 8 companies only)

(c) other operating revenues

Less:

(d) Excise duty.

Paragraph 9.1.6 of the Guidance Note on Schedule III (Division 1) clarifies that

“On the introduction of Goods & Services Tax from 1 July 2017 onwards, the collection of GST by an entity would not be an inflow on the entity’s own account but it shall be made on behalf of the government authorities. Accordingly, the revenue should be presented net of GST collected.”

(B) In respect of a finance company, revenue from operations shall include revenue from

(a) Interest; and

(b) Other financial services

Revenue under each of the above heads shall be disclosed separately by way of Notes to Accounts to the extent applicable.