Auditing Higher Education Institutions:
Key Considerations for Hong Kong Auditors
Higher education institutions, including colleges and universities, play a pivotal role in shaping the future of society by nurturing the next generation of professionals and leaders. As an auditor in Hong Kong, understanding the complexities of auditing these institutions under the Hong Kong Financial Reporting Standards (HKFRS) is crucial. This blog post will explore the key aspects to consider when auditing higher education institutions and highlight the remarkable capabilities of our Audit Program 3.0, which can dramatically reduce time costs and generate customized illustrative documentation for audit engagements.
Part 1: Revenue Recognition in Higher Education Institutions
Accurate revenue recognition is essential when auditing higher education institutions. Given the unique characteristics of the sector, it’s crucial to comprehend the specific rules and guidelines surrounding revenue recognition for these organizations. Key factors to consider include:
1. Identifying the sources of revenue: Higher education institutions typically derive revenue from various sources, such as tuition fees, government grants, donations, research funding, and auxiliary services. Understand the different sources of revenue and the applicable recognition criteria for each.
2. Timing of revenue recognition: Assess whether revenue is recognized over time or at a specific point in time. For instance, tuition fees are usually recognized over the period of instruction, while government grants may be recognized when certain milestones are met.
3. Deferred revenue: Verify that revenue is deferred when the institution receives payments in advance for services that have not yet been rendered, such as prepaid tuition fees or event ticket sales.
4. Donation and grant accounting: Review the criteria for recognizing donations and grants, particularly when they come with stipulations or conditions. Ensure that revenue is recognized in accordance with HKFRS 15 and HKAS 20.
5. Auxiliary services: Examine the revenue recognition policies for auxiliary services, such as on-campus housing, meal plans, or bookstore sales, and ensure they align with HKFRS requirements.
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 Higher education (colleges and universities) 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 Higher Education Entity (Colleges and Universities) under Hong Kong Financial Reporting Standards (HKFRS)
For a mid-sized higher education entity with an annual revenue of about $90 million, operating under the Hong Kong Financial Reporting Standards (HKFRS), the revenue recognition would follow the requirements of HKFRS 15 “Revenue from Contracts with Customers.” This standard provides guidance on the recognition and measurement of revenue arising from contracts with customers, including students and other parties.
Revenue Recognition Criteria under HKFRS 15
Under HKFRS 15, revenue is recognized when (or as) an entity satisfies a performance obligation by transferring a promised service to a customer. A service is transferred when the customer obtains control of that service. The following five steps are used to apply the core principle of HKFRS 15:
1. Identify the contract(s) with a customer.
2. Identify the performance obligations in the contract.
3. Determine the transaction price.
4. Allocate the transaction price to the performance obligations in the contract.
5. Recognize revenue when (or as) the entity satisfies a performance obligation.
Painstakingly Detailed Explanation of Revenue Recognition for a Higher Education Entity
Step 1: Identify the contract(s) with a customer
A contract is an agreement between the entity and a customer that creates enforceable rights and obligations. In the context of a higher education entity, a contract may be in the form of a student enrollment agreement or a research grant agreement with a third party.
Step 2: Identify the performance obligations in the contract
Performance obligations are the promises to transfer services to a customer. For a higher education entity, the performance obligations typically include providing educational services (e.g., classroom instruction, examinations, and grading) and other services (e.g., research, consulting, and training).
Step 3: Determine the transaction price
The transaction price is the amount of consideration the entity expects to be entitled to in exchange for transferring the services. This may include tuition fees, research grants, and other fees and charges related to the educational services provided by the entity.
Step 4: Allocate the transaction price to the performance obligations in the contract
If a contract has multiple performance obligations, the transaction price is allocated to each performance obligation based on the relative standalone selling prices of the services. For a higher education entity, this allocation may be based on the published tuition fee schedule or other observable pricing information.
Step 5: Recognize revenue when (or as) the entity satisfies a performance obligation
Revenue is recognized when the entity satisfies a performance obligation by transferring control of the service to the customer. This typically occurs over time as the educational services are provided to the students or as the research and other services are completed.
For educational services, the revenue is recognized over the academic period during which the services are provided, typically on a straight-line basis. For research and other services, the revenue is recognized based on the progress towards the completion of the performance obligations, which may be measured using the output method (e.g., milestones achieved) or the input method (e.g., costs incurred).
Documents Supporting Revenue Recognition in Higher Education Entity
The following documents within the business operations specific to this industry would help the accounts team to know when to recognize revenue:
1. Student enrollment agreement: This document indicates the agreed-upon terms, including the educational services to be provided, the tuition fees, and the payment schedule.
2. Course schedule: This document serves as evidence of the educational services provided to the students over the academic period.
3. Tuition fee invoice: This document is issued to the students upon enrollment and indicates the transaction price, less any discounts or scholarships.
4. Student payment: This serves as evidence that the student has accepted the educational services and has paid the agreed-upon transaction price.
5. Research grant agreement: This document indicates the agreed-upon terms, including the research services to be provided, the grant amount, and the payment schedule.
6. Progress reports: These documents serve as evidence of the progress towards the completion of the research and other services, which may be used to measure the revenue recognized based on the output method or the input method.
By following the guidance provided by HKFRS 15, the accounts team of a mid-sized higher education entity can accurately recognize revenue in their financial statements. This ensures that the entity’s financial statements present a true and fair view of its financial performance and position.”
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 vital when auditing higher education institutions. 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 institution’s policies and procedures for recognizing revenue to ensure they comply with HKFRS requirements.
4. Periodic review and reconciliation: Confirm that revenue transactions are periodically reviewed and reconciled to supporting documentation, such as enrollment records, grant agreements, or donor correspondence.
5. Monitoring and review: Examine the institution’s process for tracking and updating revenue-related estimates, such as deferred revenue or grant milestones, to ensure accurate recognition.
Understanding the intricacies of revenue recognition and internal controls in higher education institutions 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 Higher education (colleges and universities) industry when applying HKFRS as follows. This documentation would typically be included in section C5.1 of the APM:
“Control 1: Segregation of Duties in Revenue Recognition Process
Type of Control: Preventive
Frequency: Ongoing
1. The Accounts Manager is responsible for overseeing the revenue recognition process and ensuring that revenue is recognized accurately and consistently, and in compliance with HKFRS 15.
2. The Accounts Clerk is responsible for generating invoices, recording revenue transactions, and maintaining accounts receivable records.
3. The Director and Operations Manager are responsible for reviewing and approving the revenue recognition policies and procedures, as well as monitoring their effectiveness.
Control 2: Authorization and Approval of Revenue Transactions
Type of Control: Preventive
Frequency: Ongoing
1. The Accounts Clerk generates the tuition fee invoices for each enrolled student based on the approved fee schedule and any applicable discounts or scholarships.
2. The Accounts Manager reviews and approves the invoices before they are issued to the students.
3. The Accounts Clerk records the revenue transaction in the accounting system upon receipt of payment from the student.
4. The Accounts Manager reviews and approves the revenue transactions recorded by the Accounts Clerk, ensuring that they are consistent with the approved invoices and comply with HKFRS 15.
Control 3: Reconciliation of Accounts Receivable and Revenue
Type of Control: Detective
Frequency: Monthly
1. The Accounts Clerk prepares a detailed reconciliation of the accounts receivable and revenue balances at the end of each month.
2. The Accounts Manager reviews the reconciliation, investigates any discrepancies, and ensures that appropriate adjustments are made to the accounting records.
3. The Director and Operations Manager review the completed reconciliation and discuss any significant issues with the Accounts Manager.
Control 4: Review and Approval of Research Grants and Contracts
Type of Control: Preventive
Frequency: Ongoing
1. The Operations Manager is responsible for overseeing the administration of research grants and contracts and ensuring that the entity complies with the terms and conditions of the agreements.
2. The Accounts Manager collaborates with the Operations Manager to ensure accurate revenue recognition for research grants and contracts, following the requirements of HKFRS 15.
3. The Director reviews and approves the research grant agreements and contracts before they are executed, ensuring that they are in line with the entity’s strategic objectives and financial capabilities.
Control 5: Monitoring of Progress towards Completion of Performance Obligations
Type of Control: Detective
Frequency: Ongoing
1. The Operations Manager monitors the progress towards the completion of performance obligations for research grants and contracts, using either the output method (e.g., milestones achieved) or the input method (e.g., costs incurred).
2. The Accounts Manager reviews the progress reports prepared by the Operations Manager and ensures that the revenue recognition is updated accordingly in the accounting records.
3. The Director and Operations Manager meet regularly to discuss the progress of ongoing research projects and address any issues that may impact the revenue recognition.
Control 6: Periodic Review of Revenue Recognition Policies and Procedures
Type of Control: Preventive
Frequency: Annually
1. The Director, Operations Manager, and Accounts Manager conduct an annual review of the revenue recognition policies and procedures to ensure that they remain up-to-date and in compliance with HKFRS 15.
2. Any revisions to the policies and procedures are documented, approved, and communicated to the Accounts Clerk and other relevant personnel.
3. The Director and Operations Manager monitor the effectiveness of the revised policies and procedures and make further adjustments as needed.
By implementing these internal controls, the entity can effectively prevent, detect, and correct misstatements in its financial statements, ensuring that they present a true and fair view of its financial performance and position. This documentation is in compliance with Hong Kong Standards on Auditing (HKSA) 230 Audit Documentation and HKSA 315 Understanding the Entity and its Environment and Assessing the Risks of Material Misstatement.”
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 higher education institutions 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.