Audit of the Acquisition and Payment Cycle Chapter

Audit of the Acquisition and Payment Cycle Chapter 18 © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 18 - 1

Learning Objective 1 Identify the accounts and the classes of transactions in the acquisition and payment cycle. © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 18 - 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 © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 18 - 3

Accounts in the Acquisition and Payment Cycle Cash in Bank Accounts Payable Cash Acquisitions disbursements of goods and services Purchase Returns Purchase and Allowances returns and allowances Purchase Discounts Purchase discounts Raw Material Purchases Property, Plant, and Equipment Prepaid Expenses © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 18 - 4

Accounts in the Acquisition and Payment Cycle Accounts Payable Acquisitions of goods and services Manufacturing Expense Control Subsidiary accounts Repair and maint. Taxes Supplies Freight in Utilities Selling Expense Administrative Control Expense Control Subsidiary accounts Accounts Commissions Supplies Travel expense Officers’ Delivery expense travel Repairs Legal fees Advertising Auditing fees Taxes © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 18 - 5

Learning Objective 2 Describe the business functions and the related documents and records in the acquisition and payment cycle. © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 18 - 6

Classes of Transactions and Accounts Inventory Property, plant, and equipment Prepaid expenses Leasehold improvements Accounts payable Manufacturing expenses Selling and administrative expenses © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 18 - 7

Classes of Transactions and Accounts Cash in bank (from cash disbursements) Accounts payable Purchase discounts © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 18 - 8

Business Functions in the Cycle Processing Purchase Orders Receiving Goods and Services Recognizing the Liability Processing and Recording Cash Disbursements © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 18 - 9

Related Documents and Reports Processing Purchase Orders Purchase requisition Purchase order Receiving Goods and Services Receiving report © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 18 - 10

Related Documents and Reports Recognizing the Liability Acquisitions transaction file Acquisitions journal or listing Vendor’s invoice Debit memo Voucher A/P master file A/P trial balance Vendor’s statement © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 18 - 11

Related Documents and Reports Processing and Recording Cash Disbursements Check Cash disbursements transaction file Cash disbursements journal or listing © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 18 - 12

Learning Objective 3 Describe how e-commerce affects the acquisition of goods and services. © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 18 - 13

How E-Commerce Affects the Acquisition and Payment Cycle Electronic data interchange (EDI) is the electronic exchange of information between companies and their suppliers and consumers. Suppliers Customers EDI Purchase orders Customer orders © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 18 - 14

How E-Commerce Affects the Acquisition and Payment Cycle Information about products is available over the Internet. Some companies use extranets which link the intranets of two or more companies. Other companies use businessto-business auctions hosted on the Internet to negotiate purchases. © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 18 - 15

Learning Objective 4 Understand internal control and design and perform tests of controls and substantive tests of transactions for the acquisition and payment cycle. © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 18 - 16

Methodology for Designing Tests of Balances – Accounts Receivable Understand internal control – acquisitions and cash disbursements. Assess planned control risk – acquisitions and cash disbursements. Evaluate cost-benefit of testing controls. © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 18 - 17

Methodology for Designing Tests of Balances – Accounts Receivable Design tests of controls Audit procedures and substantive tests of transactions for Sample size acquisitions and cash disbursements to meet Items to select transaction-related Timing audit objectives. © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 18 - 18

Understand Internal Control The auditor gains an understanding of internal control for the acquisition and payment cycle by studying the client’s flowcharts, preparing internal control questionnaires, and performing walk-through tests for acquisitions and cash disbursements. © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 18 - 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 © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 18 - 20

Evaluate Cost-Benefit of Testing Controls The auditor identifies the key internal controls and weaknesses and assesses control risk. The auditor decides whether substantive tests will be reduced sufficiently to justify the cost of performing tests of controls. © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 18 - 21

Controls and Substantive Tests of Transactions for Acquisitions Recorded acquisitions are for goods and services received, consistent with the best interests of the client (existence). Existing acquisitions are recorded (completeness). Acquisitions are accurately recorded (accuracy). Acquisitions are correctly classified (classification). © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 18 - 22

Controls and Substantive Tests of Transactions for Cash Disbursements The assumption underlying these controls and audit procedures is separate cash disbursements and acquisitions journals. The acquisitions and cash disbursements tests are typically performed concurrently. © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 18 - 23

Learning Objective 5 Describe the methodology for designing tests of details of balances for accounts payable using the audit risk model. © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 18 - 24

Methodology for Designing Tests of Details of Balances for A/P Phase I Set tolerable misstatement and assess inherent risk. Identify client risks affecting accounts payable. © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 18 - 25

Methodology for Designing Tests of Details of Balances for A/P Phases I and II Assess control risk and design and perform tests of controls and substantive tests of transactions. © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 18 - 26

Methodology for Designing Tests of Details of Balances for A/P Phase III Design and perform analytical procedures. Design and perform tests of details of accounts payable balance. © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 18 - 27

Learning Objective 6 Design and perform analytical procedures for accounts payable. © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 18 - 28

Analytical Procedures for the Acquisition and Payment Cycle Analytical Procedure Possible Misstatement Compare acquisition- Misstatement of related expense accounts payable balances with prior years. and expenses Review list of accounts Classification payable for unusual, misstatement for nonvender, and interest- nontrade liabilities bearing payables. © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 18 - 29

Analytical Procedures for the Acquisition and Payment Cycle Analytical Procedure Possible Misstatement Compare individual Unrecorded or accounts payable with nonexistent accounts, previous years. or misstatements Calculate ratios such as Unrecorded or purchases divided by nonexistent accounts, accounts payable, and or misstatements accounts payable divided by current liabilities. © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 18 - 30

Learning Objective 7 Design and perform tests of details of balances for accounts payable, including out-of-period liability tests. © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 18 - 31

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. © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 18 - 32

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. © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 18 - 33

Cutoff Tests ü Relationship of cutoff to physical observation of inventory ü Inventory in transit © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 18 - 34

Learning Objective 8 Distinguish the reliability of vendors’ invoices, vendors’ statements, and confirmations of accounts payable as audit evidence. © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 18 - 35

Reliability of Evidence Distinction between vendors’ invoices and vendors’ statements Difference between vendors’ statements and confirmations © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 18 - 36

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. © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 18 - 37

Types of Audit Tests for the Acquisition and Payment Cycle Cash in Bank Accounts Payable Acquisition Expenses Payments Expenses Audited by TOC, STOT, and AP Ending balance Audited by AP and TDP Audited by AP TOC + STOT + AP + TDP = Sufficient competent evidence per GAAS © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 18 - 38

Types of Audit Tests for the Acquisition and Payment Cycle Accounts Payable Acquisition of assets Acquisition Assets Audited by TOC, STOT, and AP Ending balance Audited by AP and TDP TOC + STOT + AP + TDP = Sufficient competent evidence per GAAS © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 18 - 39

End of Chapter 18 © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 18 - 40