Audit Verification of Revenue: Aligning with Ind AS 115 for Accurate Reporting

In the world of financial audits, ensuring the accuracy of a company's reported revenue is one of the most vital tasks. Revenue, being one of the largest figures on a financial statement, requires careful scrutiny. In India, Ind AS 115 provides the necessary framework for recognizing revenue, based on a set of principles that aim to standardize and improve how companies record their earnings. This standard, Revenue from Contracts with Customers, helps ensure that the revenue a company reports is consistent, transparent, and in line with the actual value provided to customers.

For auditors, verifying revenue involves looking at the entire lifecycle of a transaction-from its inception to the final recording in financial statements. But how do these principles correlate with the process of verifying revenue in real-world scenarios? Let's delve into this in detail, and I'll also share some examples that demonstrate how this all comes together in practice.

What Is Ind AS 115?

Ind AS 115 lays out a set of rules for companies to follow when recognizing revenue from customer contracts. Essentially, the standard is designed to ensure that revenue is recorded when control of goods or services passes to the customer, rather than when risks and rewards transfer. This approach gives a clearer picture of the value being provided to customers and improves consistency across industries.

Here's a look at the key elements of Ind AS 115

1. Identify the Contract with the Customer: A contract has to be an agreement between the company and its customer, establishing clear rights and obligations. For the contract to qualify, it should be enforceable, and there must be a clear understanding of the goods or services to be delivered.
2. Identify Performance Obligations: The contract often has multiple promises to deliver different goods or services. These are termed performance obligations. Revenue is recognized when each of these obligations is fulfilled.
3. Determine the Transaction Price: The transaction price is the total consideration the company expects to receive in return for fulfilling its obligations. This can include discounts, bonuses, or penalties, and needs to be accounted for appropriately.
4. Allocate the Transaction Price: When a contract includes more than one performance obligation, the price must be divided among them based on the standalone selling prices of the goods or services.
5. Recognize Revenue when the Obligation is Fulfilled: This principle is critical-revenue is only recognized when control of the product or service has been transferred to the customer. This can happen either over time or at a specific point, depending on the nature of the contract.

How Does Audit Verification Work?

In an audit, verifying revenue involves a thorough process to ensure that what's recorded in the books is true, accurate, and consistent with the company's policies. The auditor checks if the company's revenue recognition practices comply with Ind AS 115, verifying that all steps of the process- identifying contracts, performance obligations, pricing, and revenue recognition-are handled correctly.

Here's how auditors typically approach this

1. Understanding the Company's Revenue Streams: First, auditors need to understand the company's revenue streams-how they earn income, the types of contracts involved, and the methods used for recognizing revenue. This is a foundational step because it helps auditors assess whether Ind AS 115 has been correctly applied.

   • For example, in a telecom company, auditors would look into how they handle revenue from subscriptions, prepaid plans, or bundled offers, ensuring each service is recognized separately if required.

2. Testing Internal Controls: Internal controls are essential for ensuring that revenue is recorded accurately and that no errors or fraud take place. The auditor will check the company's internal processes, including how sales transactions are approved and how billing systems work.

   • For instance, in a construction company, progress billing and milestones for project completion must be reviewed to ensure that revenue is recognized as per the actual work completed.

3. Assessing Contract Terms: Auditors must thoroughly review the contracts to ensure they align with Ind AS 115. This means verifying that performance obligations are identified correctly and ensuring that revenue is recorded when these obligations are satisfied.

   • In software contracts, for example, auditors will check how revenue is recognized for licenses, upgrades, or maintenance services, ensuring that the terms align with the standard.

4. Cut-off Testing: Revenue cut-off testing ensures that transactions are recorded in the correct accounting period. This is especially important around year-end, where revenue must be recognized at the right time.

   • For example, in a retail setting, auditors would confirm that sales made just before the year-end are properly recorded, and returns or exchanges after the year-end are not prematurely reflected in the current period.

5. Reviewing Variable Considerations: Often, the price that a company receives can change, depending on performance clauses in contracts (such as discounts, rebates, or bonuses). Auditors ensure that these adjustments are properly estimated and recognized.

   • In industries like manufacturing, where there may be performance bonuses or penalties based on delivery schedules, the auditor verifies that the revenue recognized accounts for these variables.

6. Verification of Revenue Recognition: The auditor will review actual transactions to confirm that revenue is recognized in line with Ind AS 115. This involves checking the documentation for contracts, shipping records, and customer acceptance.

   • For instance, in a project-based business, auditors will assess whether revenue is recognized over time or at a point in time based on the nature of the contract.

7. Substantive Testing: Auditors use substantive testing to validate a sample of transactions. This is done by reviewing customer contracts, invoices, and the underlying evidence to confirm that the revenue reported is accurate.

   • An example could be a monthly subscription service-auditors will verify that the company recognizes revenue over time, as the service is rendered, and not all at once when payment is received.

8. Ensuring Proper Disclosure: Ind AS 115 requires detailed disclosures to explain how revenue recognition policies have been applied. Auditors check that these disclosures are clear and in line with regulatory requirements, especially in the first year of adopting the standard.

   • An IT company, for instance, would disclose how it recognizes revenue for software licenses, consulting services, and annual maintenance contracts.

Linking Audit Verification to Ind AS 115

Audit verification and Ind AS 115 are interdependent. The standard provides a clear structure for recognizing revenue, and the auditor's job is to ensure that the company adheres to these guidelines.

• Performance Obligations: The auditor verifies that performance obligations are clearly identified, and revenue is recognized when the obligations are fulfilled.
• Transaction Price: The auditor checks that the correct transaction price is determined, including adjustments for any variable consideration.
• Revenue Timing: The auditor ensures that revenue is recognized only when control is transferred, which could happen either over time or at a specific point in time.
• Disclosure: Auditors verify that all necessary disclosures are made about revenue recognition methods and the impact of applying Ind AS 115.

Real-Life Example: A Construction Project

Consider a construction company engaged in long-term projects. Under Ind AS 115, revenue from these projects should be recognized over time, based on the percentage of completion. In this case:

• The auditor will verify whether the work done on-site aligns with the percentage of completion method for revenue recognition.
• They will review contracts to ensure that performance obligations (like completion of a certain section of a building) are clearly stated.
• The auditor will ensure that the transaction price (contract value) includes only enforceable amounts, adjusting for any penalties or bonuses based on progress.

Summary

Verifying revenue through an audit is about ensuring that everything is properly recorded according to the standards set by Ind AS 115. The standard itself guides when and how revenue should be recognized, while the auditor ensures that these principles are correctly applied in practice. By focusing on the right processes and controls, auditors can confirm that revenue figures are reliable, consistent, and accurately reflect the business's activities. Real-world examples from various sectors, including construction and software, illustrate the practical application of these principles and the role of auditors in making sure companies comply with them.