Audit of Acquisition and Payment Cycle: Accounts and Transactions Identified

Audit of the Acquisition and Payment Cycle: Tests of Controls, Substantive Tests of Transactions, and Accounts Payable. Chapter 19 ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 19 - 1 Learning Objective 1 Identify the accounts and the classes of transactions in the acquisition and payment cycle. ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 19 - 2 Transactions in the Acquisition and Payment Cycle 1. Acquisitions of goods and services 2. Cash disbursements 3. Purchase returns and allowances and purchase discounts 2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 19 - 3 Accounts in the Acquisition and Payment Cycle Cash in Bank Accounts Payable Cash Acquisitions disbursements of goods and services Purchase returns and allowances Purchase discounts Raw Material Purchases Purchase Returns and Allowances Property, Plant and Equipment Purchase Discounts Prepaid Expenses ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 19 - 4 Accounts in the Acquisition and Payment Cycle Manufacturing Expense Control Account Subsidiary accounts Repair and maintenance Taxes, Supplies Freight in, Utilities

Accounts Payable Acquisitions of goods and services Selling Expense Control Account Subsidiary accounts Commissions Travel, delivery expenses Repairs, Advertising Administrative Expense Control Account Subsidiary accounts Supplies, Officers’ travel Legal fees Auditing fees, Taxes ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 19 - 5 Learning Objective 2 Describe the business functions and the related documents and records in the acquisition and payment cycle. ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 9 - 6 Classes of Transactions and Accounts Acquisitions: ? ? ? ? Inventory Property, plant, and equipment Prepaid expenses Leasehold improvements ? Accounts ? payable Manufacturing expenses ? Selling and administrative expenses 19 - 7 ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder Classes of Transactions and Accounts Cash disbursements: ? Cash in bank (from cash disbursements) payable Purchase discounts ? Accounts ? ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 19 - 8 Business Functions in the Cycle Processing purchase orders ? Receiving goods and services ? Recognizing the liability ? Processing and recording cash disbursements ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 19 - 9 Related Documents and Reports Processing purchase orders: ? Purchase requisition ? Purchase order Receiving goods and services: ? Receiving report ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 19 - 10 Related Documents and Reports Recognizing the liability: ? Vendor’s invoice ? Debit memo ? Voucher ? Acquisitions transaction file 2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 19 - 11 Related Documents and Reports Recognizing the liability: ? Acquisitions journal or listing ? Accounts payable master file ? Accounts payable trial balance ? Vendor’s statement ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 19 - 12 Related Documents and Reports Processing and recording cash disbursements: ? Check ? Cash disbursements transaction file ? Cash disbursements journal or listing ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 19 - 13 Learning Objective 3

Describe how e-commerce affects the acquisition of goods and service. ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 19 - 14 How E-Commerce Affects the Acquisition and Payment Cycle Internet-based technologies allow for electronic linkages between suppliers and customers. Information about products is available over the Internet. ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 19 - 15 How E-Commerce Affects the Acquisition and Payment Cycle Some companies use extranets which allow companies to communicate and conduct business in a secure setting.

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Other companies use business-to-business auctions hosted on the Internet to negotiate purchases. ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 19 - 16 Learning Objective 4 Understand internal control, and design and perform tests of controls and substantive tests of transactions for the acquisition and payment cycle. ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 19 - 17 Methodology for Designing Controls and Substantive Tests Understand internal control – acquisitions and cash disbursements Assess planned control risk – acquisitions and cash disbursements

Determine extent of testing controls Design tests of controls and Audit procedures substantive tests of transactions Sample size for acquisitions and cash Items to select disbursements to meet Timing transaction-related audit objectives ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 19 - 18 Understand Internal Control ? Study the client’s flowcharts ? Review internal control questionnaires ? Perform walk-through tests ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 19 - 19 Assess Planned Control Risk ? Authorization of purchases Separation of asset custody from other functions ? Timely recording and independent review of transactions ? Authorization of payments ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 19 - 20 Determine Extent of Testing of Controls ? The auditor identifies the key internal controls and weaknesses and assesses control risk ? The auditor performs tests of controls to obtain evidence that controls are operating effectively ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 19 - 21 Controls and Substantive Tests of Transactions for Acquisitions ?

Recorded acquisitions are for goods and services received (occurrence) ? Existing acquisitions are recorded (completeness) ? Acquisitions are accurately recorded (accuracy) ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 19 - 22 Controls and Substantive Tests of Transactions for Acquisitions ? Acquisitions are correctly included in the master files (posting and summarization) ? Acquisitions are correctly classified (classification) ? Acquisitions are recorded on the correct dates (timing) ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 19 - 23

Attributes Sampling Because of the importance of tests of controls and substantive tests of transactions for acquisitions and cash disbursements, the use of attributes sampling is common in this audit area. ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 19 - 24 Important Differences ? Larger number of transactions ? Significant judgment ? Wide range of dollar amount ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 19 - 25 Learning Objective 5 Describe the methodology for designing tests of details of balances for accounts payable using the audit risk model. 2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 19 - 26 Methodology for Designing Tests of Balances for Accounts Payable Identify client business risks affecting accounts payable Phase I Set tolerable misstatement and assess inherent risk Phase I for accounts payable Assess control risk for the acquisition and payment cycle Phase I 19 - 27 ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder Methodology for Designing Tests of Balances for Accounts Payable Design and perform tests of controls and substantive tests Phase II of transactions for the acquisition and payment cycle 2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 19 - 28 Methodology for Designing Tests of Balances for Accounts Payable Design and perform analytical procedures Phase III for accounts payable balance Design tests of Audit procedures details of accounts Sample size payable balance to satisfy balanceItems to select related audit Timing objectives ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder Phase III 19 - 29 Learning Objective 6 Design and perform analytical procedures for accounts payable. ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 9 - 30 Analytical Procedures for the Acquisition and Payment Cycle Analytical procedure Compare acquisition-related expense account balances with prior years. Possible misstatement Misstatement of accounts payable and expenses Review list of accounts payable Classification misstatement for nontrade liabilities for unusual, nonvendor, and interest-bearing payables ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 19 - 31 Analytical Procedures for the Acquisition and Payment Cycle Analytical procedure Compare individual accounts payable with previous years

Possible misstatement Unrecorded or nonexistent accounts, or misstatements Calculate ratios, such as Unrecorded or nonexistent purchases divided by accounts accounts, or misstatements payable, and accounts payable divided by current liabilities ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 19 - 32 Learning Objective 7 Design and perform tests of details of balances for accounts payable, including out-of-period liability tests. ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 19 - 33 Out-of-Period Liability Tests Examine underlying documentation for subsequent cash disbursements ? Examine underlying documentation for bills not paid several weeks after the year-end ? Trace receiving reports issued before year-end to related vendors’ invoices ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 19 - 34 Out-of-Period Liability Tests ? Trace vendors’ statements that show a balance due to the accounts payable trial balance ? Send confirmations to vendors with which the client does business ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 19 - 35

Cutoff Tests ? Relationship of cutoff to physical observation of inventory ? Inventory in transit ? ? FOB destination FOB origin ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 19 - 36 Learning Objective 8 Distinguish the reliability of vendors’ invoices, vendors’ statements, and confirmations of accounts payable as audit evidence. ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 19 - 37 Reliability of Evidence ? Distinction between vendors’ invoices and vendors’ statements ? Difference between vendors’ statements and confirmations 2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 19 - 38 Sample Size Sample sizes for accounts payable tests vary considerably, depending on many factors. Statistical sampling is less commonly used for the audit of accounts payable than for accounts receivable. ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 19 - 39 Types of Audit Tests for the Acquisition and Payment Cycle Cash in Bank Payments Audited by TOC, STOT, and AP Accounts Payable Acquisition Expenses Expenses Audited by TOC, STOT, and AP Ending balance Audited by AP and TDB Ending balance

Audited by AP TOC + STOT + AP + TDB = Sufficient appropriate evidence per GAAS ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 19 - 40 Types of Audit Tests for the Acquisition and Payment Cycle Accounts Payable Acquisition Assets Acquisition of assets Audited by TOC, STOT, and AP Ending balance Audited by AP and TDB TOC + STOT + AP + TDB = Sufficient appropriate evidence per GAAS ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 19 - 41 End of Chapter 19 ©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 19 - 42

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