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On 5 October 2017, the Public Company Accounting Oversight Board (PCAOB) published its practice alert, Matters Related to Auditing Revenue from Contracts with Customers. The practice alert provides the considerations to assist the auditor in identifying the underlying risk associated with the implementation of the standard, evaluation of the sufficiency of management’s transition disclosure, auditing the underlying transition adjustment and gain an understanding of management’s processes and internal controls over the processes used to implement the practice alert.

Key considerations:

The PCAOB emphasized the importance of the new revenue standard as revenue is typically one of the largest accounts in the financial statements, a significant driver of operating results and important metric for users of the financial statements. The matters covered in the practice alert are:

  1. Auditing management’s transition adjustment and underlying disclosures in the notes to the financial statements – The practice alert says that auditors need to assess and identify the potential risk of material misstatement and consider the sufficiency of the underlying disclosures to the financial statements. The objective of the auditor’s review of interim financial information should include the auditor basis for communicating whether they are aware of any material modifications as a result of the new revenue standard. Review procedures should include inquiring of the company, to include operational and accounting personnel, regarding the status of the implementation and the identification of any effects of the new standard.
  2. Considering internal control over financial reporting – The practice alert emphasizes that the auditor must obtain an understanding of the process that management applied to determine the impact from implementing the new revenue standard to include identifying the flow of transactions and evaluating the design and test the operating effectiveness of the internal controls.
  3. Identifying and assessing fraud risks – The practice alert discusses that an auditor should presume that there is a risk of material misstatement relating to improper revenue recognition as it relates to the implementation of the new revenue standard to include the identification of transition adjustments, if any. A potential risk resulting from the new revenue standard includes management intentionally misstating earnings to meet the expectations of the users of the financial statements which may occur if the transitions adjustments are significant to the company’s financial performance.
  4. Evaluating whether revenue is recognized in conformity with the applicable financial reporting framework – The auditor must have extensive knowledge of the company’s process, to include evaluating the underlying contracts as it relates to the goods and/or services provided by the company and understanding the assumptions and reasonableness of the estimates that management applies to record revenue as a result of the new revenue standard.
  5. Evaluating information system and manual controls. – The auditor should obtain an understanding of the information system relevant to financial reporting, including, among other things, (a) the related business processes; (b) the related accounting records and supporting information used to initiate, authorize, process, and record transactions; and (c) how the information system captures events and conditions, other than transactions, that are significant to the financial statements.

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