Chapter 11Chapter 11Auditing the Auditing the Purchasing Purchasing

ProcessProcess

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Expense and Liability Expense and Liability RecognitionRecognition

Expenses are outflows or Expenses are outflows or other using up of assets other using up of assets or incurrences of liabilities or incurrences of liabilities from delivering or from delivering or producing goods, producing goods, rendering services, or rendering services, or carrying out other carrying out other activities that constitute activities that constitute the entity’s ongoing major the entity’s ongoing major or central operations.or central operations.

Expenses are outflows or Expenses are outflows or other using up of assets other using up of assets or incurrences of liabilities or incurrences of liabilities from delivering or from delivering or producing goods, producing goods, rendering services, or rendering services, or carrying out other carrying out other activities that constitute activities that constitute the entity’s ongoing major the entity’s ongoing major or central operations.or central operations.

Liabilities are probable Liabilities are probable future sacrifices of future sacrifices of economic benefits arising economic benefits arising from present obligations from present obligations of a particular entity to of a particular entity to transfer assets or provide transfer assets or provide services to other entities services to other entities in the future as a result of in the future as a result of past transactions or past transactions or events.events.

Liabilities are probable Liabilities are probable future sacrifices of future sacrifices of economic benefits arising economic benefits arising from present obligations from present obligations of a particular entity to of a particular entity to transfer assets or provide transfer assets or provide services to other entities services to other entities in the future as a result of in the future as a result of past transactions or past transactions or events.events.

LO# 1

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Overview of the Purchasing Overview of the Purchasing ProcessProcess

A purchase transaction usually begins with a A purchase transaction usually begins with a purchase requisitionpurchase requisition generated by the user generated by the user

department. The purchasing department department. The purchasing department prepares a prepares a purchase orderpurchase order that is sent to the that is sent to the vendor. When the goods are received or the vendor. When the goods are received or the

services rendered, a services rendered, a liability is recordedliability is recorded. . Finally, the entity Finally, the entity pays the vendorpays the vendor..

A purchase transaction usually begins with a A purchase transaction usually begins with a purchase requisitionpurchase requisition generated by the user generated by the user

department. The purchasing department department. The purchasing department prepares a prepares a purchase orderpurchase order that is sent to the that is sent to the vendor. When the goods are received or the vendor. When the goods are received or the

services rendered, a services rendered, a liability is recordedliability is recorded. . Finally, the entity Finally, the entity pays the vendorpays the vendor..

Purchase requisition

Purchase requisition

Purchase order

Purchase order

Receivingreport and

liability recorded

Receivingreport and

liability recorded

Vendor

LO# 2

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Type of Transaction Account AffectedPurchase Transaction Accounts payable

InventoryPurchases or cost of goods soldVarious asset and expense accounts

Cash disbursement transaction CashAccounts payableCash discountsVarious asset and expense accounts

Purchase return transaction Purchase returnsPurchase allowancesAccounts payableVarious asset and expense accounts

LO# 3

Types of Transactions and Financial Types of Transactions and Financial Statement Accounts AffectedStatement Accounts Affected

Three types of transactions are processed Three types of transactions are processed through the purchasing process:through the purchasing process:

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Types of Documents and RecordsTypes of Documents and Records

Purchasing documents and records . . .Purchasing documents and records . . .1.1. Purchase Requisition – request to purchase goods or services.Purchase Requisition – request to purchase goods or services.

2.2. Purchase Order – includes description, quality, and quantity of goods Purchase Order – includes description, quality, and quantity of goods or services being purchased.or services being purchased.

3.3. Receiving Report – records the receipt of goods.Receiving Report – records the receipt of goods.

4.4. Vendor Invoice – the bill from the vendor.Vendor Invoice – the bill from the vendor.

5.5. Voucher – serves as the basis for recording a vendor’s invoice.Voucher – serves as the basis for recording a vendor’s invoice.

6.6. Voucher Register – used to record vouchers for goods and services.Voucher Register – used to record vouchers for goods and services.

7.7. Accounts Payable Subsidiary Ledger – includes amount owed to Accounts Payable Subsidiary Ledger – includes amount owed to individual vendors.individual vendors.

8.8. Vendor Statement – represents the purchase activity with vendor.Vendor Statement – represents the purchase activity with vendor.

9.9. Check – pays for goods or services.Check – pays for goods or services.

10.10. Check Register – contains columns to record credits to cash and Check Register – contains columns to record credits to cash and debits to accounts payable and cash discounts.debits to accounts payable and cash discounts.

Purchasing documents and records . . .Purchasing documents and records . . .1.1. Purchase Requisition – request to purchase goods or services.Purchase Requisition – request to purchase goods or services.

2.2. Purchase Order – includes description, quality, and quantity of goods Purchase Order – includes description, quality, and quantity of goods or services being purchased.or services being purchased.

3.3. Receiving Report – records the receipt of goods.Receiving Report – records the receipt of goods.

4.4. Vendor Invoice – the bill from the vendor.Vendor Invoice – the bill from the vendor.

5.5. Voucher – serves as the basis for recording a vendor’s invoice.Voucher – serves as the basis for recording a vendor’s invoice.

6.6. Voucher Register – used to record vouchers for goods and services.Voucher Register – used to record vouchers for goods and services.

7.7. Accounts Payable Subsidiary Ledger – includes amount owed to Accounts Payable Subsidiary Ledger – includes amount owed to individual vendors.individual vendors.

8.8. Vendor Statement – represents the purchase activity with vendor.Vendor Statement – represents the purchase activity with vendor.

9.9. Check – pays for goods or services.Check – pays for goods or services.

10.10. Check Register – contains columns to record credits to cash and Check Register – contains columns to record credits to cash and debits to accounts payable and cash discounts.debits to accounts payable and cash discounts.

LO# 4

11-5

The Major FunctionsThe Major FunctionsFunctions of the Purchasing Process

RequisitioningInitiation and approval of requests for goods and services by authorized individuals consistent with management criteria.

PurchasingApproval of purchase orders and proper execution as to price, quantity, quality, and vendor.

Receiving Receipt of properly authorized goods and services.

Invoice processingProcessing of vendor invoices for goods and services received; also, processing of adjustments for allowances, discounts, and returns.

Disbursements Processing of payment to vendors.

Accounts payableRecording of all vendor invoices, cash disbursements, and adjustments in individual vendor accounts.

General ledgerProper accumulation, classification, and summarization of purchases, cash disbursements, and payables in the general ledger.

LO# 5

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Key Segregation of DutiesKey Segregation of DutiesSegregation of Duties Possible Errors or Fraud

The purchasing function should be segregated from the requisitioning and receiving functions.

If one individual is responsible for the requisition, purchasing, and receiving functions, fictitious purchases can be made. This can result in the theft of goods and possibly payment for unauthorized purchases.

The invoice-processing function should be segregated from the accounts payable function.

If one individual is responsible for the invoice-processing and accounts payable function, purchase transactions can be processed at the wrong price or terms, or a cash disbursement can be processed for goods not received. This can result in overpayment of goods or the theft of cash.

The disbursement function should be segregated from the accounts payable function.

If one individual is responsible for the disbursement function and also has access to the accounts payable records, unauthorized checks supported by fictitious documents can be issued, and unauthorized transactions can be recorded. This can result in theft of the entity's cash.

The accounts payable function should be segregated from the general ledger function.

If one individual is responsible for the accounts payable records and also for the general ledger, that individual can conceal any defalcation that would normally be detected by reconciling subsidiary records with the general ledger control account.

LO# 6

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Inherent Risk AssessmentInherent Risk Assessment

Industry Related FactorsIndustry Related Factors

1.1. Is the supply of raw materials adequate?Is the supply of raw materials adequate?

2.2. How volatile are raw materials prices?How volatile are raw materials prices?

1.1. Is the supply of raw materials adequate?Is the supply of raw materials adequate?

2.2. How volatile are raw materials prices?How volatile are raw materials prices?

LO# 7

Generally, the purchasing process is not difficult Generally, the purchasing process is not difficult to audit and does not present contentious to audit and does not present contentious accounting issues. However, the auditor’s accounting issues. However, the auditor’s

experience in past audits must be considered experience in past audits must be considered when assessing inherent risk.when assessing inherent risk.

Generally, the purchasing process is not difficult Generally, the purchasing process is not difficult to audit and does not present contentious to audit and does not present contentious accounting issues. However, the auditor’s accounting issues. However, the auditor’s

experience in past audits must be considered experience in past audits must be considered when assessing inherent risk.when assessing inherent risk.

Misstatements Detected in Prior AuditsMisstatements Detected in Prior Audits

11-8

Control Risk AssessmentControl Risk Assessment

Major steps in setting the control risk in the Major steps in setting the control risk in the purchasing process.purchasing process.

Understand and document the purchasing Understand and document the purchasing process based on a reliance strategy.process based on a reliance strategy.

Understand and document the purchasing Understand and document the purchasing process based on a reliance strategy.process based on a reliance strategy.

Plan and perform tests of controls on purchase Plan and perform tests of controls on purchase transactions.transactions.

Plan and perform tests of controls on purchase Plan and perform tests of controls on purchase transactions.transactions.

Set and document the control risk for the Set and document the control risk for the purchasing process.purchasing process.

Set and document the control risk for the Set and document the control risk for the purchasing process.purchasing process.

LO# 8

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Control Activities and Tests of Control Activities and Tests of Controls – Purchase TransactionsControls – Purchase Transactions

Assertions about Classes of Transactions and Events for the Period under Audit

LO# 9

OccurrenceAll purchase and cash disbursements have been recorded and have occurred and pertain to the entity.

Completeness All purchase and cash disbursements that should have been recorded have been recorded.

AuthorizationAll purchase and cash disbursements are properly authorized.

AccuracyAmounts relating to recorded purchase and cash disbursements have been recorded appropriately and properly accumulated from journals and ledgers.

Cutoff Purchase and cash disbursements have been recorded in the correct accounting period.

Classification Purchase and cash disbursements have been recorded in the proper account.

OccurrenceAll purchase and cash disbursements have been recorded and have occurred and pertain to the entity.

Completeness All purchase and cash disbursements that should have been recorded have been recorded.

AuthorizationAll purchase and cash disbursements are properly authorized.

AccuracyAmounts relating to recorded purchase and cash disbursements have been recorded appropriately and properly accumulated from journals and ledgers.

Cutoff Purchase and cash disbursements have been recorded in the correct accounting period.

Classification Purchase and cash disbursements have been recorded in the proper account.

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Auditing Accounts Payable Auditing Accounts Payable and Accrued Expensesand Accrued Expenses

Assertions about Account Balances at the Period End:Existence. Accounts payable and accrued expenses are valid liabilities.

Rights and obligations. Accounts payable and accrued expenses are obligations of the entity.

Completeness. All accounts payable and accrued expenses have been recorded.

Valuation and allocation. Accounts payable and accrued expenses are included in the financial statements at appropriate amounts, and any resulting valuation or allocation adjustments are appropriately recorded.

Assertions about Account Balances at the Period End:Existence. Accounts payable and accrued expenses are valid liabilities.

Rights and obligations. Accounts payable and accrued expenses are obligations of the entity.

Completeness. All accounts payable and accrued expenses have been recorded.

Valuation and allocation. Accounts payable and accrued expenses are included in the financial statements at appropriate amounts, and any resulting valuation or allocation adjustments are appropriately recorded.

LO# 10

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Auditing Accounts Payable Auditing Accounts Payable and Accrued Expensesand Accrued Expenses

Assertions about Presentation and Disclosure:Occurrence and rights and obligations. All disclosed events, transactions, and other matters relating to accounts payable and accrued expenses have occurred and pertain to the entity.

Completeness. All disclosures relating to accounts payable and accrued expenses that should have been included in the financial statements have been included.

Classification and understandability. Financial information relating to accounts payable and accrued expenses is appropriately presented and described, and disclosures are clearly expressed.

Accuracy and valuation. Financial and other information relating to accounts payable and accrued expenses are disclosed fairly and in appropriate amounts.

LO# 10

11-12

Tests of Details of Transactions, Tests of Details of Transactions, Account Balances, and DisclosuresAccount Balances, and Disclosures

CompletenessCompletenessThe auditor should conduct a search for unrecorded The auditor should conduct a search for unrecorded liabilities that includes the following:liabilities that includes the following:The auditor should conduct a search for unrecorded The auditor should conduct a search for unrecorded liabilities that includes the following:liabilities that includes the following:

1.1. Ask management about control procedures used to identify Ask management about control procedures used to identify unrecorded liabilities at the end of the period.unrecorded liabilities at the end of the period.

2.2. Obtain copies of vendors’ monthly statements and reconcile Obtain copies of vendors’ monthly statements and reconcile the amounts to the client’s accounts payable records.the amounts to the client’s accounts payable records.

3.3. Confirm vendor accounts, including accounts with small or Confirm vendor accounts, including accounts with small or zero balances.zero balances.

4.4. Vouch large-dollar items from the purchases journal and Vouch large-dollar items from the purchases journal and cash disbursements journal for a limited time after year-end.cash disbursements journal for a limited time after year-end.

5.5. Examine the files of unmatched purchase orders, receiving Examine the files of unmatched purchase orders, receiving reports, and vendor invoices for any unrecorded liabilities.reports, and vendor invoices for any unrecorded liabilities.

1.1. Ask management about control procedures used to identify Ask management about control procedures used to identify unrecorded liabilities at the end of the period.unrecorded liabilities at the end of the period.

2.2. Obtain copies of vendors’ monthly statements and reconcile Obtain copies of vendors’ monthly statements and reconcile the amounts to the client’s accounts payable records.the amounts to the client’s accounts payable records.

3.3. Confirm vendor accounts, including accounts with small or Confirm vendor accounts, including accounts with small or zero balances.zero balances.

4.4. Vouch large-dollar items from the purchases journal and Vouch large-dollar items from the purchases journal and cash disbursements journal for a limited time after year-end.cash disbursements journal for a limited time after year-end.

5.5. Examine the files of unmatched purchase orders, receiving Examine the files of unmatched purchase orders, receiving reports, and vendor invoices for any unrecorded liabilities.reports, and vendor invoices for any unrecorded liabilities.

LO# 12

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Tests of Details of Transactions, Tests of Details of Transactions, Account Balances, and DisclosuresAccount Balances, and Disclosures

Disclosure Items for the Purchasing ProcessDisclosure Items for the Purchasing ProcessPayables by type (trade, Payables by type (trade, officers, employees, officers, employees, etc.).etc.).

Payables by type (trade, Payables by type (trade, officers, employees, officers, employees, etc.).etc.).

Short- and long-term Short- and long-term payables.payables.Short- and long-term Short- and long-term payables.payables.

Long-term purchase Long-term purchase contracts, including any contracts, including any unusual purchase unusual purchase commitments.commitments.

Long-term purchase Long-term purchase contracts, including any contracts, including any unusual purchase unusual purchase commitments.commitments.

Purchases from and Purchases from and payables to related parties.payables to related parties.Purchases from and Purchases from and payables to related parties.payables to related parties.

Dependence on a single Dependence on a single vendor or a small number vendor or a small number of vendors.of vendors.

Dependence on a single Dependence on a single vendor or a small number vendor or a small number of vendors.of vendors.

Costs by reportable Costs by reportable segment of the business.segment of the business.Costs by reportable Costs by reportable segment of the business.segment of the business.

LO# 12

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Accounts Payable ConfirmationsAccounts Payable Confirmations

Accounts payable confirmations are used less Accounts payable confirmations are used less often than accounts receivable confirmations. The often than accounts receivable confirmations. The

auditor is able to examine externally created auditor is able to examine externally created source documents relating to accounts payable. source documents relating to accounts payable. When confirmations are used, they are usually When confirmations are used, they are usually

positive and referred to as positive and referred to as blank confirmationsblank confirmations. The . The vendor is asked to supply the balance owed by the vendor is asked to supply the balance owed by the

client.client.

Accounts payable confirmations are used less Accounts payable confirmations are used less often than accounts receivable confirmations. The often than accounts receivable confirmations. The

auditor is able to examine externally created auditor is able to examine externally created source documents relating to accounts payable. source documents relating to accounts payable. When confirmations are used, they are usually When confirmations are used, they are usually

positive and referred to as positive and referred to as blank confirmationsblank confirmations. The . The vendor is asked to supply the balance owed by the vendor is asked to supply the balance owed by the

client.client.

LO# 13

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Evaluating the Audit FindingsEvaluating the Audit Findings

All identified misstatements should be aggregated All identified misstatements should be aggregated (including any consideration for sampling risk). The (including any consideration for sampling risk). The likely misstatement is then compared to tolerable likely misstatement is then compared to tolerable

misstatement. If the likely misstatement ismisstatement. If the likely misstatement is less thanless than the tolerable misstatement, the auditor has evidence the tolerable misstatement, the auditor has evidence

that the account is fairly presented. Conversely, if that the account is fairly presented. Conversely, if the likely misstatementthe likely misstatement exceedsexceeds the tolerable the tolerable

misstatement, the auditor should conclude that misstatement, the auditor should conclude that the account is not fairly presented.the account is not fairly presented.

All identified misstatements should be aggregated All identified misstatements should be aggregated (including any consideration for sampling risk). The (including any consideration for sampling risk). The likely misstatement is then compared to tolerable likely misstatement is then compared to tolerable

misstatement. If the likely misstatement ismisstatement. If the likely misstatement is less thanless than the tolerable misstatement, the auditor has evidence the tolerable misstatement, the auditor has evidence

that the account is fairly presented. Conversely, if that the account is fairly presented. Conversely, if the likely misstatementthe likely misstatement exceedsexceeds the tolerable the tolerable

misstatement, the auditor should conclude that misstatement, the auditor should conclude that the account is not fairly presented.the account is not fairly presented.

LO# 14

11-16

Auditing the Tax Provision and Auditing the Tax Provision and Related Balance Sheet AccountsRelated Balance Sheet Accounts

Use of specialist:Use of specialist:

Temporary differences.Temporary differences.Temporary differences.Temporary differences.

Permanent differences.Permanent differences.Permanent differences.Permanent differences.

Accounting for uncertain tax positions.Accounting for uncertain tax positions.Accounting for uncertain tax positions.Accounting for uncertain tax positions.

Multiple locations/foreign Multiple locations/foreign operations.operations.Multiple locations/foreign Multiple locations/foreign operations.operations.

Business combinations.Business combinations.Business combinations.Business combinations.

Changes in ownership or Changes in ownership or tax status.tax status.Changes in ownership or Changes in ownership or tax status.tax status.

LO# 15

The basics:The basics:

GAAP accounting GAAP accounting vsvs. . Tax accounting.Tax accounting.GAAP accounting GAAP accounting vsvs. . Tax accounting.Tax accounting.

Deferred tax assets – Valuation issues.Deferred tax assets – Valuation issues.Deferred tax assets – Valuation issues.Deferred tax assets – Valuation issues.11-17

End of Chapter 11End of Chapter 11

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