Auditing Revenue Recognition in a Pandemic

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The COVID-19 pandemic has thrown many curveballs at the accounting industry, one of which is how to properly perform revenue recognition tests in accordance with the latest authoritative guidance while also adjusting testing for the pandemic environment.  FASB (Financial Accounting Standards Board) issued Accounting Standards Update (ASU) No. 2020-05, Topic 606 - Revenue from Contracts with Customers, which eliminated the transaction-specific and industry-specific revenue recognition methods and introduced a principles-based method for determining revenue recognition.  Many auditors will be seeing the implementation of this major update for the first time this year.  The implementation of the update as well as the adjustment of revenue cycle processes and procedures to handle the pandemic has presented challenges for many companies and audit teams must be aware of these challenges when designing testing procedures.  

 

Tip Number One: Gain an understanding of the company’s revenue cycle process and procedures and its controls over revenue recognition

Before financial statement testing and internal control testing can be performed it is imperative that the audit team spend some time gaining an understanding of how a company is implementing the revenue recognition update as well as how it has adjusted revenue processes and procedures to account for the COVID-19 pandemic.  The audit team will likely need to venture outside of the accounting and finance department to talk to those handling contracts and fulfilling sales.  

 

Tip Number Two: Maintain a high level of skepticism     

Maintaining a high level of professional skepticism is always expected of an auditor, however, the challenges of implementing a complicated accounting update while operating in a pandemic could cause a company to try to find shortcuts to complete the proper steps in revenue recognition.  Auditors will need to scrutinize the company’s method for applying the revenue recognition update, especially as to how the company is handling it while operating in the pandemic environment.  

 

Tip Number Three: Verify the Completion of the Five-Step Revenue Recognition Process    

The revenue recognition update details five actions that a company should follow to ensure that revenue on its financial statement is recognized in accordance with Generally Accepted Accounting Principles (GAAP). 

These five steps are:

  1. Identify the contract with the customer

  2. Identify the performance obligations in the contract

  3. Determine the transaction price

  4. Allocate the transaction price

  5. Recognize revenue when or as the company satisfies the performance obligation. 

Thoroughly completing the steps can be tedious when a company does not believe that there will be a change in revenue recognition methods used or an effect on its financial statements.  But the performance of the actions is the best way to ensure that the financial statements are in accordance with GAAP.

 

Tip Number Four: Be Aware of Increased Judgement-Based Decisions by Clients

The pandemic will make it more challenging to evaluate judgments and estimates made by clients because many companies’ revenue sources have been affected by COVID-19.  This principles-based accounting method for revenue recognition uses judgments and estimates, especially at its implementation.  Evaluating these judgments and estimates during the pandemic is especially challenging.  Clients are dealing with increases and decreases in the number of deliveries of goods and services, fluctuations in the probability of collecting amounts due, minimum purchase commitment changes,  and financing component changes.  Auditors must account for these pandemic-related judgments and estimates when performing revenue recognition testwork.      

 

Tip Number Five: Practice Patience and Empathy

The pandemic has created challenging work environments, which means that auditors may find themselves waiting on information for testwork.  Keep in mind that the employees trying to collect data for testwork are likely working from home, with different work hours, with internet connectivity challenges, and sometimes with children under oot.  Everyone is facing difficult situations!  Prepare ahead of time to be ready to face delays and complications.