Auditing Apparel and Fashion Retail Companies:
Key Considerations for Hong Kong Auditors
The apparel and fashion retail industry is dynamic and ever-changing, making it an exciting area for auditors to explore. In this blog post, we will discuss important aspects to consider when auditing apparel and fashion retail companies that adopt the Hong Kong Financial Reporting Standards (HKFRS) framework. Additionally, we will introduce our innovative Audit Program 3.0, which can help CPA firms significantly reduce time costs by generating customized illustrative documentation for audit engagements.
Part 1: Revenue Recognition in Apparel and Fashion Retail Companies
Accurate revenue recognition is critical when auditing companies in the apparel and fashion retail industry. HKFRS 15 “Revenue from Contracts with Customers” provides guidance on recognizing revenue. In this sector, revenue recognition typically involves sales of goods, returns, discounts, and loyalty programs. Key factors to consider include:
1. Identifying the contract: Ensure a legally enforceable contract exists between the company and its customers, outlining the rights, obligations, and payment terms for all parties involved.
2. Identifying performance obligations: Analyze the goods or services promised to customers and ascertain if they constitute separate performance obligations. In apparel and fashion retail, this usually involves evaluating the sale of individual products.
3. Determining the transaction price: Examine the contract to identify the total amount the company expects to receive in exchange for satisfying its performance obligations. Consider any discounts, rebates, or loyalty programs that may affect the transaction price.
4. Allocating the transaction price: Allocate the transaction price to each performance obligation based on the relative standalone selling price.
5. Recognizing revenue: Recognize revenue when the company satisfies a performance obligation by transferring control of a good to the customer. For apparel and fashion retail companies, this typically occurs at the point of sale.
Illustrative Example 1: Application of HKFRS 15 - Revenue Recognition
For example, Audit Program 3.0 would include the following audit documentation on the Revenue Recognition in the Apparel and fashion retail industry when applying HKFRS as follows. This documentation would typically be included in the Engagement Planning Meeting Minutes in Section C of the APM:
“Revenue Recognition for Apparel and Fashion Retail under Hong Kong Financial Reporting Standards (HKFRS)
A mid-sized apparel and fashion retail company with approximately $90 million in annual revenue that adopts Hong Kong Financial Reporting Standards (HKFRS) would recognize revenue in accordance with HKFRS 15 “Revenue from Contracts with Customers.” This standard provides guidance on the recognition and measurement of revenue arising from contracts with customers.
Five-Step Model for Revenue Recognition
HKFRS 15 outlines a five-step model for recognizing revenue from contracts with customers:
1. Identify the contract with a customer: A contract is formed when there is an agreement between the company and the customer, both parties have approved the agreement, the company has committed to providing goods or services, and the payment terms are identifiable.
2. Identify the performance obligations in the contract: A performance obligation is a promise to transfer goods or services to the customer. For an apparel and fashion retail company, this typically involves the sale of clothing and accessories.
3. Determine the transaction price: This is the amount of consideration the company expects to receive in exchange for transferring the goods or services to the customer.
4. Allocate the transaction price to the performance obligations in the contract: The transaction price is allocated to each performance obligation based on the relative standalone selling prices of the goods or services being provided.
5. Recognize revenue when (or as) the company satisfies a performance obligation: Revenue is recognized when the company transfers control of the goods or services to the customer, which typically occurs at the point of sale in a retail environment.
Determining the Point of Revenue Recognition
For an apparel and fashion retail company, revenue is generally recognized at the point of sale when the following conditions are met:
1. Transfer of control: Control of the goods (e.g., clothing and accessories) is transferred to the customer when they take possession of the items, either in-store or upon delivery for online sales.
2. Collectability: The customer has committed to paying for the goods, either by paying in cash, using a credit/debit card, or through other payment methods such as mobile wallets.
3. Identification of the transaction price: The transaction price is determined by the retail price of the items sold, including any discounts, promotions, or sales taxes applicable at the time of sale.
Calculation of Revenue
Revenue is calculated as follows:
Revenue = Quantity Sold × Selling Price per Unit
Where:
– Quantity Sold is the number of items sold to the customer.
– Selling Price per Unit is the retail price of each item, including any discounts or promotions applied to the sale.
Supporting Documentation for Revenue Recognition
To ensure accurate and timely revenue recognition, the accounting team in an apparel and fashion retail company should maintain appropriate supporting documentation, such as:
– Sales receipts: These document the details of the sale, including the date, items sold, quantity, selling price, and any discounts or promotions applied.
– Cash register reports: These are generated by the point-of-sale system and provide a summary of all transactions processed during a given period, including the total sales revenue, number of items sold, and any discounts or promotions applied.
– Sales returns and allowances records: These records track any returns or allowances provided to customers for damaged or unsatisfactory products and are used to adjust the revenue recognized for those sales.
– Online sales records: These records track sales made through the company’s online store, including the date, items sold, quantity, selling price, and any discounts or promotions applied. The records also track the shipment and delivery of the goods to the customer.
By following the guidance provided by HKFRS 15 and maintaining appropriate documentation, a mid-sized apparel and fashion retail company with approximately $90 million in annual revenue can accurately recognize revenue in accordance with Hong Kong Financial Reporting Standards.
Part 2: Understanding the Design and Implementation of Internal Controls within the Revenue Recognition Business Process
Evaluating the design and implementation of internal controls related to revenue recognition is essential when auditing apparel and fashion retail companies. Key areas to assess include:
1. Segregation of duties: Assess whether there is an appropriate division of responsibilities among employees involved in the revenue recognition process to minimize the risk of errors or fraud.
2. Authorization and approval: Verify that sales transactions, pricing changes, and discounts are authorized and approved by the appropriate personnel.
3. Revenue recognition policies and procedures: Review the company’s policies and procedures for recognizing revenue to ensure they comply with HKFRS 15 requirements.
4. Periodic review and reconciliation: Confirm that revenue transactions are periodically reviewed and reconciled to supporting documentation, such as sales invoices and contracts.
5. Monitoring and review of returns, discounts, and loyalty programs: Examine the company’s process for reviewing and updating estimates related to sales returns, discounts, and loyalty programs, which may affect revenue recognition.
Understanding the nuances of revenue recognition and internal controls in apparel and fashion retail companies can help auditors provide valuable insights and support to their clients.
Illustrative Example 2: System Notes on Internal Controls in Revenue Business Process
For example, Audit Program 3.0 would include the following illustrative audit documentation when understanding the internal controls in the revenue business process of a client operating in the Apparel and fashion retail industry when applying HKFRS as follows. This documentation would typically be included in section C5.1 of the APM:
“Control Activity 1: Segregation of Duties
Control Type: Preventive
Person Responsible: Director and Operations Manager
Frequency: Ongoing
Description:
1. The Director and Operations Manager ensure that responsibilities related to revenue recognition, sales receipts, and sales posting are segregated among the Accounts Manager, Accounts Clerk, and store personnel.
2. The Accounts Manager is responsible for overseeing the overall revenue recognition process, reconciling sales data, and reviewing sales returns and allowances.
3. The Accounts Clerk is responsible for recording sales transactions in the accounting system, verifying sales receipts and cash register reports, and maintaining sales documentation.
4. Store personnel handle sales transactions, process payments, and issue sales receipts to customers.
Control Activity 2: Approval of Sales Discounts and Promotions
Control Type: Preventive
Person Responsible: Director and Operations Manager
Frequency: As needed
Description:
1. The Director and Operations Manager review and approve any sales discounts or promotions before they are implemented in the stores.
2. Approved discounts and promotions are communicated to the Accounts Manager and store personnel.
Control Activity 3: Sales Receipts Issuance and Review
Control Type: Detective
Person Responsible: Accounts Clerk
Frequency: Daily
Description:
1. Store personnel issue sales receipts for each transaction, including the date, items sold, quantity, selling price, and any discounts or promotions applied.
2. At the end of each day, the Accounts Clerk reviews sales receipts and cash register reports to verify the accuracy of sales transactions and to ensure all sales have been recorded correctly.
Control Activity 4: Reconciliation of Sales Data
Control Type: Detective
Person Responsible: Accounts Manager
Frequency: Weekly
Description:
1. The Accounts Manager reconciles sales data from cash register reports, online sales records, and sales returns and allowances records with the accounting system.
2. Any discrepancies or unusual transactions are investigated and resolved by the Accounts Manager.
Control Activity 5: Review of Sales Returns and Allowances
Control Type: Detective
Person Responsible: Accounts Manager
Frequency: Weekly
Description:
1. The Accounts Manager reviews sales returns and allowances records to ensure they are properly documented and accounted for in the financial statements.
2. The Accounts Manager investigates any unusual trends or patterns in sales returns and allowances and resolves any issues identified.
Control Activity 6: Authorization of Online Sales
Control Type: Preventive
Person Responsible: Operations Manager
Frequency: Ongoing
Description:
1. Online sales are processed through a secure e-commerce platform that requires customers to provide valid payment information before completing a transaction.
2. The Operations Manager periodically reviews the security of the e-commerce platform to ensure the risk of fraud is minimized.
Control Activity 7: Periodic Review of Internal Controls
Control Type: Monitoring
Person Responsible: Director
Frequency: Annually
Description:
1. The Director conducts an annual review of the company’s internal controls over revenue recognition, sales receipts, and sales posting to assess their effectiveness in preventing, detecting, and correcting misstatements.
2. The Director makes recommendations for improvements to internal controls, as necessary, and ensures they are implemented in a timely manner.
By implementing and maintaining these internal controls, the apparel and fashion retail company can effectively prevent, detect, and correct misstatements in its financial statements related to revenue recognition, sales receipts, and sales posting.“
Leveraging Audit Program 3.0 for Enhanced Efficiency
Now, let’s discuss the transformative capabilities of Audit Program 3.0. This powerful software automates the generation of customized audit programs, risk identification and assessments, and internal control documentation. By selecting the client’s industry and financial reporting framework, Audit Program 3.0 creates tailored working papers that save time and effort while ensuring compliance with AFRC standards.
In conclusion, understanding revenue recognition and internal controls is crucial when auditing apparel and fashion retail companies adopting HKFRS. By leveraging the power of Audit Program 3.0, Hong Kong auditors can streamline their work, enhance efficiency, and elevate audit quality to new heights. Experience the transformative impact of Audit Program 3.0 on your practice and watch your client relationships thrive.