Auditing Financial Advisory Services Companies:
Key Factors for Hong Kong Auditors to Consider
Financial advisory services companies play a crucial role in guiding individuals and businesses towards informed financial decisions. As a Hong Kong auditor, understanding the unique challenges and risks associated with auditing companies in this industry is essential. In this blog post, we will discuss the key points to consider when auditing financial advisory services companies that adopt the Hong Kong Financial Reporting Standards (HKFRS) framework. Additionally, we will introduce our innovative Audit Program 3.0, which can significantly reduce time costs and generate customized illustrative documentation for your audit engagements.
Part 1: Revenue Recognition in Financial Advisory Services
Accurate revenue recognition is vital when auditing financial advisory services companies. HKFRS 15 “Revenue from Contracts with Customers” provides guidance on recognizing revenue. In the financial advisory services industry, revenue recognition may involve various considerations, such as fees for asset management, financial planning, and investment advisory services. Key factors to consider include:
1. Identifying the contract: Ensure a legally enforceable contract exists between the company and its clients, outlining the rights, obligations, and payment terms for all parties involved.
2. Identifying performance obligations: Analyze the services promised to clients and determine if they constitute separate performance obligations. In financial advisory services, this may involve evaluating investment advice, portfolio management, and financial planning services.
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.
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 service to the client. For financial advisory services, this may involve recognizing revenue over time or at a point in time, depending on the nature of the performance obligation and the terms of the contract.
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 Financial advisory services 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 a Mid-Sized Financial Advisory Services Entity under Hong Kong Financial Reporting Standards (HKFRS)
This documentation provides a detailed explanation of how revenue recognition would occur for a typical mid-sized entity engaged in the principal activity of financial advisory services under Hong Kong Financial Reporting Standards (HKFRS). It covers the proper timing of revenue recognition, the application of the five-step model, and the types of documents within the business operations that would help the accounts team know when to recognize revenue.
Overview of Revenue Recognition under HKFRS 15
HKFRS 15 Revenue from Contracts with Customers establishes a comprehensive framework for determining whether, how much, and when revenue is recognized. The standard is based on a five-step model:
1. Identify the contract(s) with a customer.
2. Identify the separate performance obligations in the contract.
3. Determine the transaction price.
4. Allocate the transaction price to the separate performance obligations.
5. Recognize revenue when (or as) the entity satisfies a performance obligation.
Revenue Recognition for Financial Advisory Services
Financial advisory services may include investment advice, financial planning, wealth management, tax consulting, and other related services. Revenue recognition for these services typically depends on the specific terms of the contract with the client and the satisfaction of performance obligations.
Step 1: Identify the Contract(s) with a Customer
Contracts for financial advisory services may be written, oral, or implied by customary business practices. The accounts team should maintain a database of all client contracts, including key terms such as fees, service scope, and performance obligations.
Step 2: Identify the Separate Performance Obligations in the Contract
Performance obligations are promises to provide a distinct good or service to the customer. In a financial advisory services contract, performance obligations may include:
1. Providing an initial financial plan or investment strategy.
2. Ongoing investment advice and portfolio management.
3. Tax planning and preparation services.
4. Regular financial review meetings.
The accounts team should carefully review each contract to identify the separate performance obligations and ensure they are properly documented.
Step 3: Determine the Transaction Price
The transaction price is the amount of consideration the entity expects to receive in exchange for transferring goods or services to the customer. In the case of financial advisory services, the transaction price may include:
1. Fixed fees for specific services, such as an initial financial plan.
2. Ongoing asset-based fees, calculated as a percentage of assets under management.
3. Hourly fees for consulting or tax preparation services.
The accounts team should maintain accurate records of client fee schedules, billing arrangements, and any changes or amendments to the transaction price over time.
Step 4: Allocate the Transaction Price to the Separate Performance Obligations
For contracts with multiple performance obligations, the transaction price should be allocated to each obligation based on the relative standalone selling prices. The standalone selling price is the price at which the entity would sell a promised good or service separately to a customer.
In the case of financial advisory services, standalone selling prices may be determined based on:
1. Market prices for similar services offered by competitors.
2. Cost-plus profit margin approaches, considering the costs of providing the services and a reasonable profit margin.
3. Adjusted market assessment methods, taking into account the entity’s specific value proposition and target market.
The accounts team should carefully allocate the transaction price to each performance obligation and document the basis for their allocations.
Step 5: Recognize Revenue when (or as) the Entity Satisfies a Performance Obligation
Revenue is recognized when (or as) the entity satisfies a performance obligation by transferring a promised good or service to the customer. In the case of financial advisory services, revenue recognition may occur:
1. At a point in time: For performance obligations such as providing an initial financial plan, revenue may be recognized when the plan is delivered to the customer.
2. Over time: For ongoing services such as investment advice or portfolio management, revenue may be recognized over the period during which the services are provided, based on the passage of time or the achievement of specific milestones.
The accounts team should monitor the progress of each performance obligation and recognize revenue accordingly.
Key Documents for Revenue Recognition in Financial Advisory Services
To facilitate accurate revenue recognition, the accounts team should maintain and review the following documents:
1. Client contracts: These documents outline the terms and conditions of the financial advisory services, including fees, service scope, and performance obligations.
2. Fee schedules and billing arrangements: These documents detail the transaction price, including any fixed fees, asset-based fees, or hourly fees.
3. Service delivery records: These documents track the completion of performance obligations, such as the delivery of financial plans, investment advice, or tax preparation services.
4. Client communication records: Emails, meeting notes, and other correspondence can provide evidence of the entity’s satisfaction of performance obligations and the timing of revenue recognition.
By understanding the proper timing of revenue recognition, applying the five-step model of HKFRS 15, and maintaining accurate documentation, the accounts team can ensure that a mid-sized financial advisory services entity with about $90 million annual revenue recognizes revenue in compliance 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 critical when auditing financial advisory services 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 contracts, 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 client contracts and service agreements.
5. Monitoring and review of estimates: Examine the company’s process for reviewing and updating estimates used in the revenue recognition process, such as the standalone selling price and the expected duration of client contracts.
Understanding the intricacies of revenue recognition and internal controls in financial advisory services 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 Financial advisory services industry when applying HKFRS as follows. This documentation would typically be included in section C5.1 of the APM:
“Audit Documentation of Internal Controls for Revenue Recognition, Sales Receipts, and Sales Posting
Hypothetical Audit Client: FinTech Services Company
Financial Reporting Framework: Hong Kong Financial Reporting Standards (HKFRS)
Compliance with: HKSA 230 Audit Documentation, HKSA 315 Understanding the Entity and its Environment, and Assessing the Risks of Material Misstatement
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1. Internal Controls for Revenue Recognition
Control Activity 1.1: Revenue Recognition Policy Review and Approval
Type of Control: Preventative
Position Responsible: Director
Frequency: Annually
Walkthrough:
1. Director reviews the revenue recognition policy in accordance with HKFRS.
2. Director ensures that the policy is compliant with the current financial reporting standards and reflects the company’s principal activities.
3. Director approves the updated policy and communicates it to the Accounts Manager.
Control Activity 1.2: Review and Authorization of Sales Contracts
Type of Control: Preventative
Position Responsible: Accounts Manager
Frequency: Upon contract signing
Walkthrough:
1. Accounts Manager reviews each sales contract to ensure compliance with the company’s revenue recognition policy.
2. Accounts Manager verifies that the contract terms are clear, enforceable, and in line with the company’s pricing policies.
3. Accounts Manager authorizes the sales contract and communicates the contract details to the Accounts Clerk for recording in the accounting system.
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2. Internal Controls for Sales Receipts
Control Activity 2.1: Segregation of Duties for Sales Receipts and Deposits
Type of Control: Preventative
Positions Responsible: Accounts Clerk (for sales receipts), Operations Manager (for bank deposits)
Frequency: Ongoing
Walkthrough:
1. Accounts Clerk prepares sales receipts and records them in the accounting system.
2. Accounts Clerk verifies the receipt details, including customer information and payment amounts, against the authorized sales contract.
3. Operations Manager reviews the recorded sales receipts and prepares bank deposits.
4. Operations Manager deposits funds into the company’s bank account and retains the deposit slip for reconciliation purposes.
Control Activity 2.2: Bank Reconciliation
Type of Control: Detective
Position Responsible: Accounts Manager
Frequency: Monthly
Walkthrough:
1. Accounts Manager obtains bank statements and deposit slips from the Operations Manager.
2. Accounts Manager reconciles the bank statements with the sales receipts recorded in the accounting system.
3. Accounts Manager investigates any discrepancies and resolves them with the Operations Manager.
4. Accounts Manager prepares a bank reconciliation report and files it for future reference.
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3. Internal Controls for Sales Posting
Control Activity 3.1: Review and Approval of Sales Posting
Type of Control: Preventative
Position Responsible: Accounts Manager
Frequency: Ongoing
Walkthrough:
1. Accounts Clerk records sales transactions in the accounting system based on the authorized sales contracts and sales receipts.
2. Accounts Manager reviews the sales postings for accuracy, completeness, and compliance with the revenue recognition policy.
3. Accounts Manager approves the sales postings and ensures they are correctly recorded in the general ledger.
Control Activity 3.2: Periodic Review of Aged Receivables
Type of Control: Detective
Position Responsible: Accounts Manager
Frequency: Monthly
Walkthrough:
1. Accounts Manager generates an aged receivables report from the accounting system.
2. Accounts Manager reviews the report to identify overdue customer balances and assess the adequacy of the allowance for doubtful accounts.
3. Accounts Manager follows up with customers for overdue payments and, if necessary, adjusts the allowance for doubtful accounts.
4. Accounts Manager files the aged receivables report for future reference.
These internal control activities provide a comprehensive understanding of the revenue recognition, sales receipts, and sales posting processes of this hypothetical FinTech Services Company. The detailed walkthroughs should enable another auditor with no prior experience with this audit client to fully understand the client’s internal controls.”
Leveraging Audit Program 3.0 for Enhanced Efficiency
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In conclusion, understanding revenue recognition and internal controls is crucial when auditing financial advisory services 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.