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CHAPTER 17Audit of the Acquisition

and Payment Cycle: Tests of Controls,

Substantive Tests of Transactions, and Accounts Payable

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- purchases- purchase returns and allowances- purchase discounts- cash in bank- accounts payable- property, plant, and equipment- prepaid expenses- manufacturing, administrative, selling expenses

What accounts are typically involved in What accounts are typically involved in the acquisition and payment cycle?the acquisition and payment cycle?

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- acquisition of goods and services- cash disbursements for those acquisitions

What What classes of transactionsclasses of transactions occur in occur in the acquisition and payment cycle?the acquisition and payment cycle?

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mmm...an expenditure

mmm...a revenue

What is the relationship between the sales and collection cycle and the acquisition and payment cycle?

They are different perspectivesof the same transaction.

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What is the What is the sequence of business sequence of business functionsfunctions that occurs in the acquisition that occurs in the acquisition

and payment cycle?and payment cycle?

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1. An employee recognizes a need for a purchase; com- pletes a requisition and sends it to purchasing.

PURCHASINGDEPARTMENT

Ace CompanyPURCHASE

REQUISITION

The engineeringdept. needs 200yellow #2 pencils. authorized employee

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2. Purchasing shops for the ap- propriate quality at the best price, then prepares a pur- chase order.

PURCHASINGDEPARTMENT

Ace CompanyPURCHASE

ORDERTo: Big Pencil Co.Please ship 200yellow #2 pencilsby 6/2/x0.Price .04/each

purchasing agent

BIGPencil Co.

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3. When goods arrive from the vendor, the receiving dept. inspects, counts, and pre- pares a receiving report.

RECEIVINGDEPARTMENT

Ace CompanyRECEIVING

REPORTReceived onecase (count 200)yellow #2 pencilson 6/1/x0.Condition: OK

receiving employee

BIGPencil Co.

BIGPencil Co.

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4. When the vendor’s invoice arrives, accounts pay- able enters the amount in the acquisitions journal and the a/p master file.

Accounts PayableDEPARTMENT

Big Pencil Co.INVOICE

Thanks for buy-ing 200 yellow

#2 pencils. Please pay

$8 by 6/15/x0.

BIGPencil Co.

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4. When the vendor’s invoice arrives, accounts pay- able enters the amount in the acquisitions journal and the a/p master file.

Accounts PayableDEPARTMENT

acquisitions journaldescription _ $$ _June 1, 19x0Pencils - Big Pencil Co. 8.00

a/p master file vendor _ $$ _June 1, 19x0Big Pencil Co. 8.00 balance 8.00

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5. Before the due date, a check is mailed to the vendor

a/p master file vendor _ $$ _June 1, 19x0Big Pencil Co. 8payment-6/12 8 balance 0

Ace Company

Pace CompanyBig Pencil Co.

Ace Company

BIGPencil Co.

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cash payments journaldescription _ $$ _June 12, 19x0Big Pencil Co. 8.00

Ace Company

Pace CompanyBig Pencil Co.

Ace Company

5. Before the due date, a check is mailed to the ven- dor and the payment is recorded in the cash pay- ments journal

a/p master file vendor _ $$ _June 1, 9x0Big Pencil Co. 8payment-6/12 8 balance 0

BIGPencil Co.

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cash payments journaldescription _ $$ _June 12, 19x0Big Pencil Co 8.00

Ace Company

Pace CompanyBig Pencil Co.

Ace Company

5. Before the due date, a check is mailed to the ven- dor and the payment is recorded in the cash pay- ments journal and the a/p master file.

a/p master file vendor _ $$ _June 1, 19x0Big Pencil Co. 8.00payment-6/12 8.00 balance 0

BIGPencil Co.

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DEBIT MEMO A document indicating a re- duction in the amount owed to a vendor because of re- turned goods or an allow- ance granted.

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VOUCHER A document used by organi- zations to establish a formal means of recording and controlling acquisitions.

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How does an auditor How does an auditor design tests of design tests of controls and controls and

substantive tests of substantive tests of transactions for the transactions for the

acquisitions and acquisitions and payments cycle?payments cycle?

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Understand controls asthey relate to acquisi-tions and payments

As discussedin chapter 9

How does an auditor How does an auditor design tests of design tests of controls and controls and

substantive tests of substantive tests of transactions for the transactions for the

acquisitions and acquisitions and payments cycle?payments cycle?

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Assess the planned con-trol risk related to acqui-

sitions and payments

Understand controls asthey relate to acquisi-tions and payments

How does an auditor How does an auditor design tests of design tests of controls and controls and

substantive tests of substantive tests of transactions for the transactions for the

acquisitions and acquisitions and payments cycle?payments cycle?

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In assessing control In assessing control risk, the auditor risk, the auditor should consider:should consider: Assess the planned con-

trol risk related to acqui-sitions and payments

Understand controls asthey relate to acquisi-tions and payments

??

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In assessing control In assessing control risk, the auditor risk, the auditor should consider:should consider:

- adequate separation of duties- proper authorization- adequate documents and records- use of prenumbered documents- internal verification procedures

Assess the planned con-trol risk related to acqui-

sitions and payments

Understand controls asthey relate to acquisi-tions and payments

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Evaluate cost-benefit of test-

ing controls

Assess the planned con-trol risk related to acqui-

sitions and payments

Understand controls asthey relate to acquisi-tions and payments

How does an auditor How does an auditor design tests of design tests of controls and controls and

substantive tests of substantive tests of transactions for the transactions for the

acquisitions and acquisitions and payments cycle?payments cycle?

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Will substantivetests be reduced

sufficiently to justify the cost ofperforming tests

of controls?

Assess the planned con-trol risk related to acqui-

sitions and payments

Understand controls asthey relate to acquisi-tions and payments

Evaluate cost-benefit of test-

ing controls

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Evaluate cost-benefit of test-

ing controls

Design tests of controls and substantive tests of transactions related to

acquisitions & payments

Assess the planned con-trol risk related to acqui-

sitions and payments

Understand controls asthey relate to acquisi-tions and payments

How does an auditor How does an auditor design tests of design tests of controls and controls and

substantive tests of substantive tests of transactions for the transactions for the

acquisitions and acquisitions and payments cycle?payments cycle?

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Evaluate cost-benefit of test-

ing controls

Design tests of controls and substantive tests of transactions related to

acquisitions & payments

Are recorded ac-quisitions for

goods and serv-ices received?

Assess the planned con-trol risk related to acqui-

sitions and payments

In designing audit In designing audit tests for acquisi-tests for acquisi-

tions and pay- tions and pay- ments, the auditor ments, the auditor should consider:should consider:

Understand controls asthey relate to acquisi-tions and payments

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Evaluate cost-benefit of test-

ing controls

Design tests of controls and substantive tests of transactions related to

acquisitions & payments

Assess the planned con-trol risk related to acqui-

sitions and payments

In designing audit In designing audit tests for acquisi-tests for acquisi-

tions and pay- tions and pay- ments, the auditor ments, the auditor should consider:should consider:

Are recorded ac-

quisitions consist-ent with the bestinterests of the

company?

Understand controls asthey relate to acquisi-tions and payments

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Evaluate cost-benefit of test-

ing controls

Design tests of controls and substantive tests of transactions related to

acquisitions & payments

Are allacquisitionsrecorded?

Assess the planned con-trol risk related to acqui-

sitions and payments

In designing audit In designing audit tests for acquisi-tests for acquisi-

tions and pay- tions and pay- ments, the auditor ments, the auditor should consider:should consider:

Understand controls asthey relate to acquisi-tions and payments

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Evaluate cost-benefit of test-

ing controls

Design tests of controls and substantive tests of transactions related to

acquisitions & payments

Assess the planned con-trol risk related to acqui-

sitions and payments

In designing audit In designing audit tests for acquisi-tests for acquisi-

tions and pay- tions and pay- ments, the auditor ments, the auditor should consider:should consider:

Areacquisitionsaccuratelyrecorded?

Understand controls asthey relate to acquisi-tions and payments

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Evaluate cost-benefit of test-

ing controls

Design tests of controls and substantive tests of transactions related to

acquisitions & payments

In designing audit In designing audit tests for acquisi-tests for acquisi-

tions and pay- tions and pay- ments, the auditor ments, the auditor should consider:should consider:

Assess the planned con-trol risk related to acqui-

sitions and payments

Areacquisitions

correctlyclassified?

Understand controls asthey relate to acquisi-tions and payments

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What is the primary audit objective What is the primary audit objective with regard to with regard to payablespayables??

completeness

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liability

What What audit proceduresaudit procedures will address will address the the completeness of payablescompleteness of payables??

- inquire of management regarding completeness of payables- perform analytical procedures on payables- perform a search for unrecorded liabilities

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Search for Unrecorded LiabilitiesSearch for Unrecorded Liabilities- examine the unpaid vendors’ invoice file after the balance sheet date. Examine those invoices and trace them to related receiving reports. Determine whether the transactions are recorded in the appropriate period.

January

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Search for Unrecorded LiabilitiesSearch for Unrecorded Liabilities- examine vendors’ invoices/statements that were recorded in the last few days of the year and the first few days of the subsequent year. Trace these invoices to the related receiving reports. Determine whether the transaction are recorded in the appropriate period.

December January

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Search for Unrecorded LiabilitiesSearch for Unrecorded Liabilities

- examine cash disbursements for several days subsequent to year-end to determine if the related liability was recorded at year- end. Trace these cash disbursements to receiving reports.

January

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Search for Unrecorded LiabilitiesSearch for Unrecorded Liabilities

December January

- examine receiving reports for several days before and after year-end and trace to vendors’ invoices. Determine when title passed, and trace to the a/p master file.

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Search for Unrecorded LiabilitiesSearch for Unrecorded Liabilities- consider: unpaid taxes existing contracts minutes of board meetings attorney and auditor invoices cutoff tests for reciprocal accounts (inventory and fixed assets)

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Search for Unrecorded LiabilitiesSearch for Unrecorded Liabilities

During the search,auditors will be watchful

for related partytransactions.

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What audit procedures will address What audit procedures will address the the accuracyaccuracy of payables? of payables?

- recalculate year-end accruals (interest, wages, taxes, vacation benefits, warranties)

- recalculate amortization of bond premiums and discounts

- confirm a sample of a/p balances

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When is When is confirmation of confirmation of payablespayables appropriate? appropriate?

- client has poor internal controls- client’s vendors do not send month- end statements- client is having financial problems (existing a/p may be understated)- client has “problem” vendors that frequently dispute the client debt- client has “critical” vendors upon which the client’s production depends

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What are What are less expensiveless expensive alternatives to confirmations if alternatives to confirmations if

the auditor is concerned the auditor is concerned about the about the existenceexistence of a/p? of a/p?

- trace year-end vendor a/p balances to evidence of subsequent payment (cash disbursements, cancelled checks)- trace year-end vendor a/p balances to vendors statements/invoices

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a/p audit exercisesa/p audit exercisesThe auditor suspects that unauthorizedpurchases have occurred.

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a/p audit exercisesa/p audit exercisesThe auditor suspects that unauthorizedpurchases have occurred.

Trace a sample of cancelled checks topurchase orders, receiving reports, andrequisitions.

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a/p audit exercisesa/p audit exercisesThe auditor suspects unrecorded

liabilities of related parties.- examine all receiving reports for several days before and after year-end for names of related parties. If any are discovered, trace to a/p master file.- examine cash disbursements for the first several days after year-end for names of related parties. If any are discovered, trace to a/p master file.

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SALES INVOICE 4527 Date: Big Pencil Co. Customer: 834 Reynolda Rd. Winston-Salem, NC27109 Sales Representative: Quantity Description Price

total invoice amount

Est. shipment date: Terms of sale (including discounts and freight costs): Carrier:

Credit authorization:

The auditor suspects double pay-ment of some vendor invoices.

a/p audit a/p audit exercisesexercises

Ace Company 235

Ace Company 236

Ace Company

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The auditor suspects double paymentof some vendor invoices.Scan cashdisbursementsfor vendors thathave received multiple pay-ments for thesame amount.Trace these topurchase ordersand receivingreports.

SALES INVOICE 4527 Date: Big Pencil Co. Customer: 834 Reynolda Rd. Winston-Salem, NC27109 Sales Representative: Quantity Description Price

total invoice amount

Est. shipment date: Terms of sale (including discounts and freight costs): Carrier:

Credit authorization:

Ace Company 235

Ace Company

Ace Company 236

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SALES INVOICE 4527 Date: Big Pencil Co. Customer: 834 Reynolda Rd. Winston-Salem, NC27109 Sales Representative: Quantity Description Price

total invoice amount

Est. shipment date: Terms of sale (including discounts and freight costs): Carrier:

Credit authorization:

Ace Company

The auditor suspects double paymentof some vendor invoices.

Additionally,look forpaymentindicationon the vendorinvoices.

Ace Company 235

Ace Company 236

PAID 3/29 ck #235