chapter 20 – completing the tests in the acquisition and payment cycle: verification...
TRANSCRIPT
©2010 Prentice Hall Business Publishing, ©2010 Prentice Hall Business Publishing, Auditing 13/e,Auditing 13/e, Arens//Elder/Beasley Arens//Elder/Beasley 19 - 1
Completing the Tests in the Acquisition Completing the Tests in the Acquisition and Payment Cycle: Verification of and Payment Cycle: Verification of
Selected AccountsSelected Accounts
Chapter 19Chapter 19
©2010 Prentice Hall Business Publishing, ©2010 Prentice Hall Business Publishing, Auditing 13/e,Auditing 13/e, Arens//Elder/Beasley Arens//Elder/Beasley 19 - 19 - 22
Learning Objective 1Learning Objective 1
Recognize the many accountsRecognize the many accountsin the acquisition andin the acquisition andpayment cycle.payment cycle.
©2010 Prentice Hall Business Publishing, ©2010 Prentice Hall Business Publishing, Auditing 13/e,Auditing 13/e, Arens//Elder/Beasley Arens//Elder/Beasley 19 - 19 - 33
Accounts Associated with the Accounts Associated with the Acquisition and Payment CycleAcquisition and Payment Cycle
Cash Inventory Supplies Property, plant, and equipment Patents, trademarks, and copyrights Prepaid rent Prepaid taxes Prepaid insurance
Assets:
©2010 Prentice Hall Business Publishing, ©2010 Prentice Hall Business Publishing, Auditing 13/e,Auditing 13/e, Arens//Elder/Beasley Arens//Elder/Beasley 19 - 19 - 44
Accounts Associated with the Accounts Associated with the Acquisition and Payment CycleAcquisition and Payment Cycle
Cost of goods sold Rent expense Property taxes Income tax expense Insurance expense Professional fees Retirement benefits Utilities
Expenses:
©2010 Prentice Hall Business Publishing, ©2010 Prentice Hall Business Publishing, Auditing 13/e,Auditing 13/e, Arens//Elder/Beasley Arens//Elder/Beasley 19 - 19 - 55
Accounts Associated with the Accounts Associated with the Acquisition and Payment CycleAcquisition and Payment Cycle
Accounts payable Rent payable Accrued professional fees Accrued property taxes Other accrued expenses Income taxes payable
Liabilities:
©2010 Prentice Hall Business Publishing, ©2010 Prentice Hall Business Publishing, Auditing 13/e,Auditing 13/e, Arens//Elder/Beasley Arens//Elder/Beasley 19 - 19 - 66
Identify client businessrisks affectingother accounts
Methodology for Designing Methodology for Designing Tests of Details of BalancesTests of Details of Balances
Set tolerable misstatementand assess inherent
risk for accounts
Assess control risk foraccounts
Phase I
Phase I
Phase I
©2010 Prentice Hall Business Publishing, ©2010 Prentice Hall Business Publishing, Auditing 13/e,Auditing 13/e, Arens//Elder/Beasley Arens//Elder/Beasley 19 - 19 - 77
Methodology for Designing Methodology for Designing Tests of Details of BalancesTests of Details of Balances
Design and performtests of controls and
substantive testsof transactions
for the acquisitionand payment cycle
Phase II
©2010 Prentice Hall Business Publishing, ©2010 Prentice Hall Business Publishing, Auditing 13/e,Auditing 13/e, Arens//Elder/Beasley Arens//Elder/Beasley 19 - 19 - 88
Timing
Items to select
Sample size
Audit procedures
Methodology for Designing Methodology for Designing Tests of Details of BalancesTests of Details of Balances
Design and performanalytical procedures
for the acquisitionand payment cycle
Design tests of detailsof account balances
to satisfybalance-relatedaudit objectives
Phase III
Phase III
©2010 Prentice Hall Business Publishing, ©2010 Prentice Hall Business Publishing, Auditing 13/e,Auditing 13/e, Arens//Elder/Beasley Arens//Elder/Beasley 19 - 19 - 99
Learning Objective 2Learning Objective 2
Design and perform audit tests of Design and perform audit tests of property, plant, and equipmentproperty, plant, and equipmentand related accounts.and related accounts.
©2010 Prentice Hall Business Publishing, ©2010 Prentice Hall Business Publishing, Auditing 13/e,Auditing 13/e, Arens//Elder/Beasley Arens//Elder/Beasley 19 - 19 - 1010
Classifications of Property, Plant, Classifications of Property, Plant, and Equipment Accountsand Equipment Accounts
Land and land improvements Buildings and building improvements Manufacturing equipment Furniture and fixtures Autos and trucks Leasehold improvements Construction-in-process for property,
plant, and equipment
©2010 Prentice Hall Business Publishing, ©2010 Prentice Hall Business Publishing, Auditing 13/e,Auditing 13/e, Arens//Elder/Beasley Arens//Elder/Beasley 19 - 19 - 1111
Manufacturing EquipmentManufacturing Equipmentand Related Accountsand Related Accounts
Manufacturing Equipment
AccumulatedDepreciated
Beginningbalance
Beginningbalance
DepreciationExpense
Gain or Losson Disposals
Current perioddepreciationEnding balance
DisposalsDisposals
AcquisitionsEndingbalance
©2010 Prentice Hall Business Publishing, ©2010 Prentice Hall Business Publishing, Auditing 13/e,Auditing 13/e, Arens//Elder/Beasley Arens//Elder/Beasley 19 - 19 - 1212
Auditing Manufacturing Equipment Auditing Manufacturing Equipment and Related Accountsand Related Accounts
Perform analytical procedures
Current year acquisitions Current year disposals Ending balance in the asset account Depreciation expense Ending balance in accumulated depreciation
Plus verify:
©2010 Prentice Hall Business Publishing, ©2010 Prentice Hall Business Publishing, Auditing 13/e,Auditing 13/e, Arens//Elder/Beasley Arens//Elder/Beasley 19 - 19 - 1313
Analytical Procedures for Analytical Procedures for Manufacturing EquipmentManufacturing Equipment
Compare accumulateddepreciation divided by grossmanufacturing equipment costwith previous years
Misstatement inaccumulated depreciation
Analytical procedure
Compare depreciation expensedivided by gross manufacturingequipment cost with previousyears
Misstatement indepreciation expense andaccumulated depreciation
Possible misstatement
©2010 Prentice Hall Business Publishing, ©2010 Prentice Hall Business Publishing, Auditing 13/e,Auditing 13/e, Arens//Elder/Beasley Arens//Elder/Beasley 19 - 19 - 1414
Analytical Procedures for Analytical Procedures for Manufacturing EquipmentManufacturing Equipment
Analytical procedure
Compare monthly or annualrepairs and maintenance,supplies expense, small toolsexpense, and similar accountswith previous years
Expensing accounts thatshould be capitalized
Possible misstatement
Compare gross manufacturingcost divided by some measureof production with previousyears
Idle equipment orequipment that wasdisposed of but notwritten off
©2010 Prentice Hall Business Publishing, ©2010 Prentice Hall Business Publishing, Auditing 13/e,Auditing 13/e, Arens//Elder/Beasley Arens//Elder/Beasley 19 - 19 - 1515
Verify Current Year AcquisitionsVerify Current Year Acquisitions
The correct recording of current year additionsis important because of the long-term effectthe assets have on the financial statements.
Because of the importance of current periodacquisitions, seven of the eight balance-relatedaudit objectives are used as a frame of reference.
©2010 Prentice Hall Business Publishing, ©2010 Prentice Hall Business Publishing, Auditing 13/e,Auditing 13/e, Arens//Elder/Beasley Arens//Elder/Beasley 19 - 19 - 1616
Balance-Related Audit Balance-Related Audit ObjectivesObjectives
Current acquisitions agreewith the master file.
Detail tie-in:
1. Foot the acquisition schedule.2. Trace the individual acquisitions to the master file.3. Trace the total to the general ledger.
©2010 Prentice Hall Business Publishing, ©2010 Prentice Hall Business Publishing, Auditing 13/e,Auditing 13/e, Arens//Elder/Beasley Arens//Elder/Beasley 19 - 19 - 1717
Balance-Related Audit Balance-Related Audit ObjectivesObjectives
Current acquisitions as listed exist.Existence:
1. Examine vendors’ invoices andreceiving reports
2. Physically examine assets.
©2010 Prentice Hall Business Publishing, ©2010 Prentice Hall Business Publishing, Auditing 13/e,Auditing 13/e, Arens//Elder/Beasley Arens//Elder/Beasley 19 - 19 - 1818
Balance-Related Audit Balance-Related Audit ObjectivesObjectives
Existing acquisitions are recorded.Completeness:
1. Examine vendors’ invoices of closelyrelated accounts to uncover items thatshould be manufacturing equipment.
2. Review lease and rental agreements.
©2010 Prentice Hall Business Publishing, ©2010 Prentice Hall Business Publishing, Auditing 13/e,Auditing 13/e, Arens//Elder/Beasley Arens//Elder/Beasley 19 - 19 - 1919
Balance-Related Audit Balance-Related Audit ObjectivesObjectives
Current year acquisitions as listedare accurate.
Accuracy:
1. Examine vendors’ invoices.
©2010 Prentice Hall Business Publishing, ©2010 Prentice Hall Business Publishing, Auditing 13/e,Auditing 13/e, Arens//Elder/Beasley Arens//Elder/Beasley 19 - 19 - 2020
Balance-Related Audit Balance-Related Audit ObjectivesObjectives
Current year acquisitions as listedare correctly classified.
Classification:
1. Examine vendors’ invoices inmanufacturing equipment account.
2. Examine vendors’ invoices of closelyrelated accounts.
3. Examine rent and lease expensefor capitalizable leases.
©2010 Prentice Hall Business Publishing, ©2010 Prentice Hall Business Publishing, Auditing 13/e,Auditing 13/e, Arens//Elder/Beasley Arens//Elder/Beasley 19 - 19 - 2121
Current year acquisitions are recordedin the correct period.
Balance-Related Audit Balance-Related Audit ObjectivesObjectives
Cutoff:
1. Review transactions near the balancesheet date for correct period.
©2010 Prentice Hall Business Publishing, ©2010 Prentice Hall Business Publishing, Auditing 13/e,Auditing 13/e, Arens//Elder/Beasley Arens//Elder/Beasley 19 - 19 - 2222
The client has rights to current yearacquisitions.
Major Balance-RelatedMajor Balance-RelatedAudit ObjectivesAudit Objectives
Rights:
1. Examine vendors’ invoices.
©2010 Prentice Hall Business Publishing, ©2010 Prentice Hall Business Publishing, Auditing 13/e,Auditing 13/e, Arens//Elder/Beasley Arens//Elder/Beasley 19 - 19 - 2323
Verify Current Year DisposalsVerify Current Year Disposals
Review whether newly acquired assetsreplace existing assets
Analyze gains and losses on disposal
Review documents for indications ofdeletion of equipment
Make inquiries about the possibility ofthe disposal of assets
©2010 Prentice Hall Business Publishing, ©2010 Prentice Hall Business Publishing, Auditing 13/e,Auditing 13/e, Arens//Elder/Beasley Arens//Elder/Beasley 19 - 19 - 2424
Verify Ending BalanceVerify Ending Balanceof Asset Accountsof Asset Accounts
2. All equipment owned is recorded.
1. All recorded equipment physicallyexists on the balance sheet date.
©2010 Prentice Hall Business Publishing, ©2010 Prentice Hall Business Publishing, Auditing 13/e,Auditing 13/e, Arens//Elder/Beasley Arens//Elder/Beasley 19 - 19 - 2525
Verify Depreciation ExpenseVerify Depreciation Expense
The most important objective is accuracy.
Consistent depreciation policy
Correct calculations
©2010 Prentice Hall Business Publishing, ©2010 Prentice Hall Business Publishing, Auditing 13/e,Auditing 13/e, Arens//Elder/Beasley Arens//Elder/Beasley 19 - 19 - 2626
Verify Ending Balance in Verify Ending Balance in Accumulated DepreciationAccumulated Depreciation
1. Accumulated depreciation as statedin the property master file agreeswith the general ledger.
2. Accumulated depreciation in themaster file is accurate.
©2010 Prentice Hall Business Publishing, ©2010 Prentice Hall Business Publishing, Auditing 13/e,Auditing 13/e, Arens//Elder/Beasley Arens//Elder/Beasley 19 - 19 - 2727
Learning Objective 3Learning Objective 3
Design and perform audit testsDesign and perform audit testsof prepaid expenses.of prepaid expenses.
©2010 Prentice Hall Business Publishing, ©2010 Prentice Hall Business Publishing, Auditing 13/e,Auditing 13/e, Arens//Elder/Beasley Arens//Elder/Beasley 19 - 19 - 2828
Audit of Prepaid ExpensesAudit of Prepaid Expenses
Prepaid rent Organization costs Prepaid taxes Patents Prepaid insurance Trademarks Deferred charges Copyrights
©2010 Prentice Hall Business Publishing, ©2010 Prentice Hall Business Publishing, Auditing 13/e,Auditing 13/e, Arens//Elder/Beasley Arens//Elder/Beasley 19 - 19 - 2929
Prepaid Insurance and Related Prepaid Insurance and Related AccountsAccounts
Prepaid InsuranceBeginning balance
Acquisitions
Ending balance
Current period insurance expense
Insurance Expense
©2010 Prentice Hall Business Publishing, ©2010 Prentice Hall Business Publishing, Auditing 13/e,Auditing 13/e, Arens//Elder/Beasley Arens//Elder/Beasley 19 - 19 - 3030
Internal ControlsInternal Controls
Acquisition and recording of insurance
Insurance register
Insurance expense
©2010 Prentice Hall Business Publishing, ©2010 Prentice Hall Business Publishing, Auditing 13/e,Auditing 13/e, Arens//Elder/Beasley Arens//Elder/Beasley 19 - 19 - 3131
Audit TestsAudit Tests
Compare total prepaid insurance andinsurance expense with previous years
Compute the ratio of prepaid insuranceto insurance expense and compareit with previous years
Compare the individual insurance policycoverage on the schedule of insuranceobtained with the preceding year’s schedule
©2010 Prentice Hall Business Publishing, ©2010 Prentice Hall Business Publishing, Auditing 13/e,Auditing 13/e, Arens//Elder/Beasley Arens//Elder/Beasley 19 - 19 - 3232
Audit TestsAudit Tests
Compare the computed prepaid insurancebalance for the current year on a policy-by-policy basis with that of the preceding year.
Review the insurance coverage listed onthe prepaid insurance schedule with anappropriate client official or insurance broker.
©2010 Prentice Hall Business Publishing, ©2010 Prentice Hall Business Publishing, Auditing 13/e,Auditing 13/e, Arens//Elder/Beasley Arens//Elder/Beasley 19 - 19 - 3333
Balance-related Audit Balance-related Audit ObjectivesObjectives
Existence and completeness:Insurance policies in the prepaid insuranceschedule exist and existing policies are listed.
Rights:The client has rights to all insurance policiesin the prepaid insurance schedule.
©2010 Prentice Hall Business Publishing, ©2010 Prentice Hall Business Publishing, Auditing 13/e,Auditing 13/e, Arens//Elder/Beasley Arens//Elder/Beasley 19 - 19 - 3434
Balance-related Audit Balance-related Audit ObjectivesObjectives
Accuracy and detail tie-in:Prepaid amounts are accurate and the totalis correctly added and agrees with thegeneral ledger.
Classification:Insurance expense is properly classified.
Cutoff:Insurance transactions are recorded in theproper period.
©2010 Prentice Hall Business Publishing, ©2010 Prentice Hall Business Publishing, Auditing 13/e,Auditing 13/e, Arens//Elder/Beasley Arens//Elder/Beasley 19 - 19 - 3535
Learning Objective 4Learning Objective 4
Design and perform audit testsDesign and perform audit testsof accrued liabilities.of accrued liabilities.
©2010 Prentice Hall Business Publishing, ©2010 Prentice Hall Business Publishing, Auditing 13/e,Auditing 13/e, Arens//Elder/Beasley Arens//Elder/Beasley 19 - 19 - 3636
Audit of Accrued LiabilitiesAudit of Accrued Liabilities
Accrued payroll Accrued payroll taxes Accrued officers’ bonuses Accrued commissions Accrued professional fees Accrued rent Accrued interest
©2010 Prentice Hall Business Publishing, ©2010 Prentice Hall Business Publishing, Auditing 13/e,Auditing 13/e, Arens//Elder/Beasley Arens//Elder/Beasley 19 - 19 - 3737
Accrued Property TaxesAccrued Property Taxesand Related Accountsand Related Accounts
Accrued Property TaxesBeginning balance
Current period property tax expense
Ending balance
Property Tax ExpensePayments(property taxes)
©2010 Prentice Hall Business Publishing, ©2010 Prentice Hall Business Publishing, Auditing 13/e,Auditing 13/e, Arens//Elder/Beasley Arens//Elder/Beasley 19 - 19 - 3838
Learning Objective 5Learning Objective 5
Design and perform audit tests ofDesign and perform audit tests ofincome and expense accounts.income and expense accounts.
©2010 Prentice Hall Business Publishing, ©2010 Prentice Hall Business Publishing, Auditing 13/e,Auditing 13/e, Arens//Elder/Beasley Arens//Elder/Beasley 19 - 19 - 3939
Approach to Auditing IncomeApproach to Auditing Incomeand Expense Accountsand Expense Accounts Analytical procedures
Tests of controls and substantivetests of transactions
Tests of details of account balances
©2010 Prentice Hall Business Publishing, ©2010 Prentice Hall Business Publishing, Auditing 13/e,Auditing 13/e, Arens//Elder/Beasley Arens//Elder/Beasley 19 - 19 - 4040
Analytical Procedures for Income Analytical Procedures for Income and Expense Accountsand Expense Accounts
Compare individual asset andliability balances with previousyears
Overstatement orunderstatement of abalance sheet account thatwill also affect an incomestatement account
Analytical procedure
Compare individual expenseswith previous years
Overstatement orunderstatement of abalance in an expenseaccount
Possible misstatement
©2010 Prentice Hall Business Publishing, ©2010 Prentice Hall Business Publishing, Auditing 13/e,Auditing 13/e, Arens//Elder/Beasley Arens//Elder/Beasley 19 - 19 - 4141
Analytical Procedures for Income Analytical Procedures for Income and Expense Accountsand Expense Accounts
Analytical procedure
Compare individual expenseswith budgets
Misstatement of expensesand related balancesheet accounts
Possible misstatement
Compare gross marginpercentage with previousyears
Misstatement of cost ofgoods sold and inventory
Compare inventory turnoverratio with previous years
Misstatement of cost ofgoods sold and inventory
©2010 Prentice Hall Business Publishing, ©2010 Prentice Hall Business Publishing, Auditing 13/e,Auditing 13/e, Arens//Elder/Beasley Arens//Elder/Beasley 19 - 19 - 4242
Analytical Procedures for Income Analytical Procedures for Income and Expense Accountsand Expense Accounts
Analytical procedure
Compare prepaid insuranceexpense with previous years
Misstatement of insuranceexpense and prepaidinsurance
Possible misstatement
Compare commission expensedivided by sales withprevious years
Misstatement ofcommission expense andaccrued commissions
Compare individualmanufacturing expensesdivided by total manufacturingexpenses with previous years
Misstatement of individualmanufacturing expensesand related balancesheet accounts
©2010 Prentice Hall Business Publishing, ©2010 Prentice Hall Business Publishing, Auditing 13/e,Auditing 13/e, Arens//Elder/Beasley Arens//Elder/Beasley 19 - 19 - 4343
Tests of Controls and SubstantiveTests of Controls and SubstantiveTest of TransactionsTest of Transactions
Both tests of controls and substantivetests of transactions have the effect ofsimultaneously verifying balance sheet and income statement accounts.
©2010 Prentice Hall Business Publishing, ©2010 Prentice Hall Business Publishing, Auditing 13/e,Auditing 13/e, Arens//Elder/Beasley Arens//Elder/Beasley 19 - 19 - 4444
Tests of Details of Account Tests of Details of Account Balances – Expense AnalysisBalances – Expense Analysis
Expense account analysis:
Repairs and maintenance
Rent and lease
Legal expense
©2010 Prentice Hall Business Publishing, ©2010 Prentice Hall Business Publishing, Auditing 13/e,Auditing 13/e, Arens//Elder/Beasley Arens//Elder/Beasley 19 - 19 - 4545
Tests of Details of Account Tests of Details of Account Balances – AllocationBalances – Allocation
Several expense accounts result from the allocationof accounting data rather than discrete transactions.
These include depreciation, depletion, and theamortization of copyrights and catalog cost.
The allocation of manufacturing overhead betweeninventory and cost of goods sold is an example ofa different type of allocation that affects expenses.
©2010 Prentice Hall Business Publishing, ©2010 Prentice Hall Business Publishing, Auditing 13/e,Auditing 13/e, Arens//Elder/Beasley Arens//Elder/Beasley 19 - 46
End of Chapter 19End of Chapter 19