CHAPTER 8 Acquisition and Expenditure Cycle LEARNING OB ECTI!

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Review Checkpoints 1. Identif si!nificant inherent risks in the ac"uisition and expenditure c cle. %escribe the ac"uisition and expenditure c cle, includin! t pical source documents and controls. *ive examples of tests of controls for auditin! the controls over purchase of inventor and services, and disbursement of cash. Explain the importance of the completeness assertion for the audit of accounts pa able liabilities, and list some procedures for a -search for unrecorded liabilities.%iscuss audit procedures for other accounts affected b the ac"uisition and expenditure c cle. Specif some wa s fraud can be found in accounts pa able and cash disbursements. %escribe some common errors and frauds in the ac"uisition and expenditure c cle, and desi!n some audit and investi!ation procedures for detectin! them. 1

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purchase commitments. Population for sample selection for ph sical observation.listin! of all purchases available for anal sis of purchasin! patterns and oddities. and depreciation in excess of salva!e value. indicatin! small balances that should be lar!e. but the will have to do an independent count. Population for sample of purchases for tests of controls. $.) +2$ .!oods received but not recorded as purchases or liabilities @nmatched Aendor Invoices. Scan for ne!ative balances.purchase order is one that does not show the "uantit ordered.. Inc. 5ouwers et al.subsidiar led!er of accounts pa able. receivin! report. 8&9 bookkeepin! 8accounts pa able department. Purchases Cournal. In a voucher s stem. :or example. there is no balance pa able to each vendor. the compan ma owe a sin!le vendor more than one invoice represented on several vouchers. 4t an time.. inventor record2keepin! department9 and 8#9 periodic ph sical counts 8reconciliation9 of inventor and propert assets. 1a show balances b vendors. 0he lon!2term effect is the same because the assets are eventuall char!ed to expense as depreciation. si!nificant purchases should be reviewed and approved b a hi!her level mana!er. Scan it for oddities like ne!ative balances. purchase order.# +. usuall with a cover pa!e. It is !iven to the receivin! department so the will know what has been ordered. 1ana!ement reports that can be used for audit evidence.1 0he short2term effect on the financial statements for improperl capitali7in! expenditures is to increase net income because items that should be expensed are included as assets. Invoice dates ma reveal failure to record invoices late in the accountin! period. 4 -blind.9 0he packa!e2voucher contains supportin! documents for a transaction.( 0he functions that should be separated to maintain internal control in a purchasin! s stem include 819 custod of the !oods 8receivin! and stores departments9. ma represent unrecorded liabilities or items in dispute 4ccounts Pa able 0rial Balance. =ou will find evidence about losses on purchase commitments in the open purchase order file. losses on purchase commitments @nmatched Receivin! Reports. Inventor Reports 80rial Balance9 . McGraw-Hill/Irwin 4uditin! and 4ssurance Services.' +. $6e / 0he 1c*raw23ill Companies.<ust a file of different vouchers pa able.unrecorded invoices. each voucher is -pa able..is a packa!e of documents. 0he voucher presents evidence of the documentation and control over a transaction. vendor invoice. :ixed 4sset Reports. 8$9 authorit to initiate a transaction 8purchasin! department9.and the detail of the pa ables is the vouchers themselves. 80he packa!e can be a small envelope. and information in them can be useful to auditors are as follows> • • • • • • • +. 0his can be prevented b notif in! suppliers that the compan will not permit pa ment of kick2backs to its emplo ees. and a ne!otiable check 8check cop when the vendor invoice has been paid9.fixed assets subsidiar led!er trial balance. +.) ?pen Purchase ?rders. Re"uired approvals and si!natures are on the documents. Evidence about unrecorded liabilities to vendors is in the 819 unmatched invoice file. 4 -voucher. Computer s stems ma have all this documentation on disk. capitali7ed repairs.. a purchase voucher usuall contains a purchase re"uisition.subsidiar led!er of inventor .$ +.& 4 purchasin! mana!er can direct purchases toward vendors who provide the mana!er kick2backs or other inducements. %epreciation recalculation. :inall ."OL#TION" $OR RE!IE% CHEC&POINT" +. 0he compan can also rotate purchasin! mana!ers to different vendors. +. and 8$9 unmatched receivin! report file. In a voucher s stem.

?f the five assertions. $. $. the auditor knows that the amount char!ed to expense has to be correct Eon current assets such as propert . Inc.. is usuall an important issue. plant and e"uipment accounts. 0herefore.1$ :inancial statement users are most troubled b missin! overstated assets and understated liabilities. *reater reliance would also be placed on anal tical procedures. when auditin! prepaids and accruals the auditor uses audit documentation that shows be!innin! balances.1# +. check preparation. +. #.indicatin! a risk of fraud> • Photocopies of invoices in the files • AendorFs invoices submitted in numerical order • AendorFs invoice amounts alwa s in round numbers • AendorFs invoices alwa s sli!htl lower than a review threshold • Aendors with onl post office box addresses • Aendors with no listed telephone number • 1atchin! vendor and emplo ee addresses or telephone numbers • 1ultiple vendors at the same address and telephone +. expense and endin! balance.11 +. additions. Aouchers and other supportin! documents reviewed b check si!ners. 5ouwers et al. :irst. depreciation9. Supportin! documents cancelled b Cash %isbursement function when checks are prepared. the need to audit for the existence of assets and the completeness of liabilities. amorti7ation.!.1.. B a!reein! be!innin! balance to prior earDs audit documentation. completeness is probabl the least important. $6e / 0he 1c*raw23ill Companies. 0hus. (. and check si!nin!. Blank supportin! documents 8invoices. plant and e"uipment and intan!ibles usuall pertain to all five mana!ement assertions. but it cannot be i!nored. assumin! that the previous earDs balances were audited. pa ments. vouchin! pa ments. disposals and depreciation char!es warrant the most attention. le!al expenses or miscellaneous expense9. 0he search for unrecorded liabilities includes procedures in other audit areas such as "uestions on bank and insurance confirmations and vouchin! the source of funds for asset additions.1& +. 0he auditor is primaril concerned with current ear transactions in propert .1( McGraw-Hill/Irwin 4uditin! and 4ssurance Services. Separation of duties of preparers of supportin! documents. purchase orders9 kept in secure locations available onl to authori7ed personnel. and calculatin! the accurac of the endin! balance.+. +. or impairment char!es.+ 1.. 0 picall . :rom an evidence !atherin! perspective.. :ifteen specific audit procedures in the search for unrecorded liabilities are listed in Chapter +. it is much more difficult to !ather evidence on unrecorded transactions than to !ather evidence that recorded transactions 8and account balances9 are proper. &. 4 low inherent and control risk would normall result in a strate! where the auditor relies on controls and reduces substantive tests. 3i!h combined inherent and control risk would result in a more substantive approach with little control testin!. Complex *44P re"uirements make presentation and disclosure an area of concern. the valuation determined b depreciation. 1ost expense accounts can be tested throu!h anal tical review procedures or b testin! them in con<unction with tests of related assets and liabilities 8e. re"uisitions. preparation of vouchers. 0he purpose of the auditorDs search for unrecorded liabilities is to !ather evidence as to whether the completeness assertion is true. Blank vouchers kept in secure location available onl to authori7ed personnel. +. '. In addition. 0he auditor must ensure that the exist and are owned.1' +.. receivin! reports.) +2& . 0he followin! are possible -red fla!s. the auditor would confirm the low control risk evaluation b testin! controls for effectiveness. Some expenses should be examined separatel because of their uni"ue nature 8e.!. Checks mailed directl b si!ner and not returned to accounts pa able.

$1 +. $6e / 0he 1c*raw23ill Companies. Incorrect Incorrect Correct Incorrect Correct Incorrect Incorrect Incorrect Incorrect Incorrect Correct Correct Incorrect Incorrect Incorrect Cash disbursements are an important part of the c cle 4lthou!h similar to sales because the are shipped out. Research and %evelopment is a period expense that is recorded as incurred. a. b.1+ +. +. 0he purpose is to identif fraud risk. except that time cards replace receivin! reports. b. Pa ments should not be made without supportin! documentation. c.$& a. b. the would have revealed the fictitious char!es. evaluate the si!nificance of the risk and determine the amounts of an actual fraud on the financial statements.$$ "OL#TION" $OR '#LTIPLE(CHOICE )#E"TION" +. %ifferent people should have authori7ed the cop in! services. 4r!us did not have separation of duties. 0he verbal in"uir procedure mi!ht produce knowled!e of emplo eeDs responsibilities to authori7e purchases of script copies.$( McGraw-Hill/Irwin 4uditin! and 4ssurance Services. c. 0hese procedures are directed at misappropriation of assets b embe77lement.1) 0he auditor should be!in with in"uir of the client about their knowled!e of fraud or fraud risks. and codin! them to pro<ects. Sales are recorded when earned. *iven Beta 1a!neticDs poor internal controls. 3owever. $. c.+. Competitive bids are normall re"uired for onl lar!e purchases. 0his would restrict a compan Ds abilit to do business. 0his has no effect on net income.$. 4nal tical review procedures such as vertical and hori7ontal anal ses can pinpoint accounts that appear to have unusual fluctuations. Someone should have responsibilit for reviewin! and approvin! char!es and comparin! costs to the bud!et. +. overstates net income in the period of capitali7ation overstates net income. Examinin! invoices and vendor files for the red fla!s noted above will help find phon billin!s. 4lthou!h similar to purchases because the re"uire a receivin! report. sales returns are considered part of the Revenue and Collection c cle because the affect accounts receivable. c. It overstates cash and pa ables. Cost of *oods Sold should be matched with Sales b usin! inventor to record cost of !oods not et sold.1. %epreciation is normall also a period expense. +. except in the unusual situation where units2of2production depreciation is used. Emplo ees and their associates are stealin! assets from the compan b havin! it pa phon expenses. approve pa ment. includin! approved time cards. 4uditors are normall not concerned with who the clientDs vendors are. Prepaid Insurance is one of the man accounts in the 4c"uisition and Expenditure C cle. it is possible that 1artha would never have been cau!ht. and code invoices to pro<ects. Inc. receive them.$# a..$' a. purchase returns are considered part of the 4c"uisition and Expenditure c cle because the affect accounts pa able. Controls should be the same as for an other vendor. +. +. d.. and approve the bills for pa ment. 4 supervisor should have been reviewin! the expenses and comparin! them to the bud!et.) +2# . b. 0he completeness assertion is ver important in the audit of liabilities. +. d.. d. 5ouwers et al. if the compan ever contacted emplo ees about their health claims.

. but it is a misuse of 5akeDs pricin! a!reements with its vendors and puts 5ake at risk. d. a. +. $. and re"uisition would both show +# tables. b. Cancellation 8-paid-9 of vouchers prevent their use a second time. 0his is a cut2off test. c. c. anal tical procedures and substantive tests of transactions. c.&1 a..&. Incorrect Correct Incorrect Incorrect Incorrect Incorrect Correct Incorrect Incorrect Incorrect Correct Incorrect Incorrect Incorrect Correct Incorrect Incorrect Incorrect Incorrect Correct Incorrect Incorrect Correct Incorrect Incorrect Incorrect Correct +. b is a more direct test. 0his is often performed before the balance sheet date. but the maintenance costs ma not have been unusual 8i.e. d.&# +. 0he check si!ner is probabl not familiar with all the vendors. 0his deviation caused no direct loss to 5ake.. 0his is often performed before the balance sheet date. the costs before the fraud were below bud!et9 Aendors should be approved b an independent purchasin! department. c. Inc. If the liabilit wasnDt recorded. 0his would insure the check was for the amount received. Some liabilities ma be incurred but not invoiced b the vendor. McGraw-Hill/Irwin 4uditin! and 4ssurance Services. b.&& a. 0he P. b. 0he receivin! reports are the population that contains the record of all !oods received for which liabilities should be recorded. b.&$ a. Eobod at 5ake was reviewin! purchase orders to notice the deliver and pa ment b another part 8BuddDs relativeDs store9. 0his would insure the invoice was for the amount received. +. b. c.) +2' . Purchase re"uisitions ma not represent the actual amount received. d. 0he re"uisition would not result in the improper deliver . d. a check wouldnDt be issued. $6e / 0he 1c*raw23ill Companies. d. 4pprovals do not necessaril result in debits to the inventor . +. 5ouwers et al. 0he auditor examines the specific char!es to determine potential liti!ation. b. b is a more direct test 0his is onl an indirect test. b. anal tical procedures and substantive tests of transactions. 0his is often performed before the balance sheet date. Cost of !oods sold is !enerall audited b tests of controls.+. c.. c. 0he voucher date ma be several weeks before the pa ment is due. If the liabilit is unrecorded. b. a. a. d. 0he search for unrecorded liabilities !enerall depends upon usin! accountin! records created in the period after the ear end.$+ +. c. Supplies expense is !enerall audited in connection with supplies inventor . Purchase orders do not normall incur liabilities. a.&' a. d. Pa roll is !enerall audited b tests of controls. Purchase orders ma not represent the actual amount received.$. Incorrect Incorrect Incorrect Correct Incorrect Correct 0hese duties should be separated. +. it would not be on the trial balance.$) a. 4uditors ma be able to determine that cash disbursements in the subse"uent period are pa in! liabilities of the period under audit. d. +. 0his would not necessaril prevent a duplicate pa ment. ?. 0his would have insured a proper count of the tables. Invoices suppl relevant information about the "uantities purchased and the prices paid. 0his is possible.

. ?bserve client personnel makin! comparisons.+. d. Correct Incorrect Incorrect Incorrect Propert tax expense is audited in con<unction with accrued propert taxes. Select a sample of recorded <ournal entries and reperform calculations and review for appropriate accounts. b. c.) +2( . b. ?bserve the clientDs inventor account and test the reconciliation of the count to the perpetual inventor . Examine entries for approval initials.&( a. 5iabilities are recorded for actual purchases at the appropriate amounts 8sound error checkin! practices for occurrence and valuation9. Pa roll is !enerall audited b tests of controls.. b. :or a sample of cash disbursements. d. d. McGraw-Hill/Irwin 4uditin! and 4ssurance Services. Cournal entries are authori7ed and prepared in accordance with !enerall accepted accountin! principles 8presentation and disclosure9. 5iabilities mi!ht be incurred in the compan Ds name without the knowled!e of responsible officers. $. Tests of Controls. receivin! reports and purchase orders. vouch to approval si!natures on invoices. c. 1. Purchases and accounts pa able are authori7ed accordin! to compan polic 8proper authori7ation9. a.. $. b. 5ouwers et al. b. a. "OL#TION" $OR E*ERCI"E"+ PROBLE'"+ AN. and vouch them to supportin! documents attestin! to the compan Ds business purpose for the transaction. Review correctin! <ournal entries that result from the comparison. "I'#LATION" +.!. expenses9. and Possible Errors or Frauds. fixed assets. Select a sample of current2 ear debits in accounts 8e. overstatin! costs or expenses. a. c. Reperform comparison on a test basis.&) Payable ICQ Items: Assertions. Purchases or other liabilities ma be recorded for transactions that didnDt exist or at incorrect amounts. d. 0he auditor examines the specific char!es to determine potential liti!ation. &.. $6e / 0he 1c*raw23ill Companies. a. ?bserve receivin! department countin! receipts. d. Examine initials for approval. Aendors could bill for "uantities !reater than the amount actuall shipped. Inc. inventor . 0he compan mi!ht override controls to create fraudulent entries. c. 0hereDs no asset directl related to RG%. anal tical procedures and substantive tests of transactions. #. c. 5iabilities are recorded at the appropriate "uantit and description 8valuation9 Select a sample of invoices and a!ree them to the receivin! report.

1. but the CP4Ds audit is nevertheless re"uired. Eo.. (. e. $6e / 0he 1c*raw23ill Companies. 4udit testin! of cutoff date for reciprocal accounts. 1$. Comparison of account balances with precedin! ear. '. $. If the client has not <ournali7ed late invoices. $. McGraw-Hill/Irwin 4uditin! and 4ssurance Services. inventor and fixed assets. b.&+ Unrecorded Liabilities Procedures a. 11. Status of tax returns for prior ears still open. If the ?7ine internal auditor is "ualified and has made tests for unrecorded liabilities. Correspondence with principal suppliers. Representations from mana!ement. @nentered vendorsD invoice file. the CP4 should discuss the nature and scope of the internal audit pro!ram with the internal auditor and review the workin! papers in order that the CP4 ma properl coordinate the audit pro!ram with that of the internal auditor.+. Examination of individual accounts durin! the audit. Hhenever a CP4 is <ustified in rel in! on work done b an internal auditor. &. the CP4 should have ascertained earl in the examination that ?7ineDs internal auditor is "ualified b bein! both technicall competent and reasonabl independent.. ).!. c. the CP4 should consider the followin! sources for possible unrecorded liabilities> 1. ?nce satisfied as to these points.... #. the CP4 ma reduce further audit work in this audit area. Existin! contracts and a!reements. d. In addition to the next2 ear voucher re!ister. 0he fact that the client made a <ournal entr to record vendorsD invoices which were received late should simplif the CP4Ds audit for unrecorded liabilities and reduce the possibilit of a need for a further ad<ustment. %iscussions with emplo ees. +. . 5ouwers et al. In this examination the CP4 should audit entries in the voucher re!ister for the ear bein! audited to ascertain that all items which accordin! to dates of receivin! reports or vendorsD invoices were applicable to that ear have been included in the <ournal entr recorded b the client.. this is done as a normal audit procedure to afford additional assurance to the CP4 and it does not relieve the responsibilit for doin! other substantive audit work. 0he CP4 should obtain a letter in which responsible executives of the clientDs or!ani7ation represent that to the best of their knowled!e all liabilities have been reco!ni7ed. Inc. 4ttorne Ds bills and letter of representation. 3owever. the CP4 is compelled in his testin! to substantiate what will ultimatel be recorded as an ad<ustin! entr . he or she should curtail 8but not eliminate9 his or her own audit work. Status of rene!otiable business. In this case.) +2) . 1inutes.

accounts with small balances. etc.. 0he compan is in a -ti!ht. Ph sical inventories exceed !eneral led!er inventor balances b si!nificant amounts.. 0o prove that amounts shown on the balance sheet are in a!reement with supportin! accountin! records. 5ouwers et al. Hhen selectin! accounts pa able for confirmation. #. #. Aendor accounts are pled!ed b assets.. '. 0o determine ade"uac of internal control for processin! and pa ment of invoices. Selection of accounts with relativel small or no balances for confirmation is the more efficient direction of testin! since understatements are more likel to be detected when examinin! such accounts. Hhen auditin! accounts pa able the auditor is primaril concerned with the possibilit of unrecorded pa ables or understatement of recorded pa ables. Select vendors that do not provide periodic statements. the accounts pa able confirmation is often used. Certain vendors do not send statements. c.) +2+ . Internal controls are weak. accounts with 7ero balances. $.&. Inc. 4lthou!h not re"uired. $. @se a samplin! techni"ue that selects items based on criteria other than the dollar amount of the items 8e. Select accounts reflectin! unusual transactions durin! the ear. 0he auditor mi!ht consider such use when 1. (. Select new vendors used in the subse"uent ears. $.. Accounts Payable Confirmations a. &.cash position and bill2pa in! is slow. $6e / 0he 1c*raw23ill Companies. Select accounts secured b pled!ed assets. select ever nth item based on predetermined interval. particularl when the client has had substantial transactions with such vendors durin! the ear. Select prior2 ear vendors who are no lon!er used. %esi!n a statistical samplin! plan that will place more emphasis on selectin! accounts with 7ero balances or relativel small balances. +. :or accounts pa able the auditor can examine external evidence such as vendor invoices and vendor statements that substantiate the accounts pa able balance. 0o determine that liabilities existin! at the balance sheet date have been recorded. '.!. McGraw-Hill/Irwin 4uditin! and 4ssurance Services. &. 0he principal ob<ectives of the accounts pa able examination are 1. (. Clark and Ient are not re"uired to use accounts pa able confirmation procedures. b. etc9. 0he accounts pa able audit procedures should be directed toward searchin! for proper inclusion of all accounts pa able and ascertainin! that recorded amounts are reasonabl stated because the primar audit purpose is to reveal an possible material understatements. select based on terminal di!its.+. the followin! procedures could be followed> 1. 4nal 7e the accounts pa able population and stratif it into accounts with lar!e balances. &. Aendor accounts include unusual transactions. ). $.

should be recorded. rent. and decide whether actual or estimated liabilities need to be recorded. and warrant and !uarantee expense. receivin! report9 to determine whether the related liabilities were recorded in the proper accountin! period. Scan the open purchase order file at ear2end for indications of material purchase commitments at fixed prices. Inc. pa attention to the terms of sales to determine whether an amounts should be deferred as unearned revenue. if an . Confirm accounts pa able with vendors.9 @se a checklist of accrued expenses to determine whether the compan has been conscientious about expense and liabilit accrualsJ includin! accruals for wa!es. 8AendorsD monthl statements controlled b the auditors also ma be used for this procedure. $. 0hese are the ones most likel to be understated. and determine whether ones recorded in the next accountin! period need to be ad<usted to report them in the current accountin! period under audit.9 Be sure to verif the vendorsD addresses so confirmations will not be misdirected. 1. ). 5ist the unmatched vendor invoices and determine when the !oods were received. (. utilities. %etermine which invoices.) +2. 84 financial officer ma be dela in! the recordin! of vendor invoices. real propert taxes. ?btain current prices and determine whether an ad<ustments for loss and liabilit for purchase commitments are needed. 4ppl anal tical procedures appropriate in the circumstances. &.+. $. . ro alties.. Stud the accounts pa able trial balance for indications of dates showin! fewer pa ables than usual recorded near the ear2end. $6e / 0he 1c*raw23ill Companies. interest. especiall re!ular suppliers showin! small or 7ero balances in the ear2end accounts pa able. 5ouwers et al. #. sales commissions. Aouch them to supportin! documents 8invoice. +. sales and excise taxes. pa roll taxes. Searc for Unrecorded Liabilities !List of substanti"e #rocedures$ 1.. . In"uiries directed to mana!ement about terms of sales can be used to obtain initial information.#. '. 0race the ear2end unmatched receivin! reports to accounts pa able entries. McGraw-Hill/Irwin 4uditin! and 4ssurance Services. 0he terms ma si!nal the need for deferred revenue accountin!. lookin! to the unmatched receivin! report file and receivin! reports prepared after the ear2end. Stud IRS examination reports for evidence of income or other taxes in dispute. Hhen auditin! the details of sales revenue.. Calculate and compare the !ross mar!in percent of the current ear to prior ear8s9. such as in"uiries about customersD ri!hts of cancellation or return.. and compare important expense account balances to prior ears to notice an that this ear appear to be too low. perhaps to conspirators in a scheme to understate liabilities.. income taxes. Select a sample of cash disbursements from the accountin! period followin! the balance sheet date.

#121 and tell our reasons. b. Control> Purchasin! operations should be performed under rules and procedures desi!ned to motivate purchasin! a!ents to bu at the best prices available from competin! vendors. Inc.. Review bid records to determine the dates of submitted bids and bid prices. Review purchase invoices to determine unit prices for paper. Ie reasons for this selection are> • • • • • Aolume is hi!h and has increased almost 1. is in char!e. perhaps reperformin! some price2obtainin! actions occasionall to determine whether the a!ents are achievin! efficienc . . the mana!er. 1i!ht investi!ate a!ain with more determination to notice telltale si!ns. purchasin! a!ents should have flexibilit within operatin! procedures to move "uickl to obtain the best balance of "uantities. older than other vendorsD bids. and prices as events dictate. and tr to obtain evidence of purchasin! at inflated prices. name the one vendor ou would select from those in Exhibit +. $6e / 0he 1c*raw23ill Companies.. 0he percent purchased on bid is lowest amon! those bid. Covertl observe CollinsD lifest le and spendin! habits. !.IT APP%-AC& ?b<ective> Select one vendor for investi!ation. 4 ruse mi!ht be used to !et information about CollinsD bank balance and activit .. e. Competitive biddin! should be re"uired unless conditions make the best prices available without bid. Collins. Carefull seek information or impressions about Collins relations with ?rion. 5ouwers et al. In the -discover summar section. 5ook up officers in national executives director to see if she is listed as an officer of ?rion. Instead of a -tests of controls. In the -test of balances. In"uire at secretar of state office for names of ?rion incorporators to see if Collins is connected.K.section.9 McGraw-Hill/Irwin 4uditin! and 4ssurance Services. $. Investi!ate references if the were not consulted earlier.+. other vendor 4udit of Balance> Investi!ation of purchases from ?rion> a. speculate about how our investi!ation mi!ht reveal the culprit. d.. Examine CollinsD personnel file. 0ests of Controls> 0he one vendor selected is ?rion Corp. Conduct interviews with Collins and other purchasin! a!ents under a front of learnin! about purchasin! procedures. AU. 3owever. c. more than an 5ast bid was obtained last ear. f. 0hus the ma not alwa s obtain competitive bids. tell how ou would investi!ate the situation.) +21. Compare unit prices with other suppliers. deliver terms. Collins purchases from several vendors without bids. 4 hi!her mana!er level should supervise and review the results of purchasin! activit on a re!ular basis.. let our initial ob<ective be to select one vendor for investi!ation. 8?vert action such as subpoena should not be used until clear evidence of !uilt is available. h. Interview other suppliers and their salespersons to tr to determine whether Collins solicited kickbacks.section. Such review mi!ht also involve selectin! odd situations for extensive review.#1 PU%C&ASI'( STA%S: Purc asin) *ic+bac+s In this case.

#1 PU%C&ASI'( STA%S: Purc asin) *ic+bac+s !Continued$ . the other procedures should also bear fruit... about L1. the lar!est fraud in the histor of Iin! Count . she picked them up personall . box. of supplies and sundries without bid from other suppliers. .. Control> 0he control should have been approval b someone above %oeDs level.+ million.K on all these purchases.ISC-. pianos. over the last two ears. Pa ments should not have been made without such approval. dero!ator !ossip from coworkers. $.. Cars. %oe was a compulsive shopper. 0he title of the case -Purchasin! Stars. • %oe re"uested special handlin! for :CC checks whereb .. • Hhen the supervisor asked to meet with :CC he was told the were workin! out of the office. 4udit of Balance> 0ests of char!es to the capital account should reveal the lar!e amount of expenses bein! capitali7ed. 0he 1. Collins has plent of -room.E%/ SU00A%/ If Collins is takin! kickbacks in return for causin! Baile to pa hi!her prices.+.# million civil <ud!ment. In 1arch $.. items..to cause Baile a si!nificant financial drain..E%/ SU00A%/ Compan emplo ees in char!e of capital pro<ects be!an noticin! the lar!e char!es. checks should be mailed directl from the treasurerDs office..S. In addition to vouchin! these char!es.2pa!e list contained #+. Purchases from ?rion were L1. with boxes of her purchases stacked to the ceilin!.is a clue to the solution 8?rion9 +..past emplo ment histor problems. If the overpricin! to Baile were 1. 5ouwers et al. Inc. Red fla!s that should have tipped off her supervisor and co2workers included> • %oe was evasive and never satisfactoril answered "uestions about :CC.. auditors should in"uire about whether the are properl capitali7ed as lon!2term assets.$$. Hashin!ton.#$ (rounds for . more wealth than <ustified b salar . $6e / 0he 1c*raw23ill Companies. 0he ph sical address was %oeDs residence. McGraw-Hill/Irwin 4uditin! and 4ssurance Services.) +211 . 0est of Controls> Examine disbursements for indication of authori7ation. 0he settlement re"uired a list of possession the %oes had ac"uired. and about L'. for two earsD -work.. and other items were sold at auction and netted 0he Coffee Co. • :CC was not re!istered in the State of Hashin!ton or listed in telephone directories. 4fter bein! si!ned.IT APP%-AC& ?b<ective> 0o detect fraudulent hirin! of consultin! firm. it could amount to L1)$.ismissal AU.ISC-. If this is the case.?.P... police record. 0he police reported there was onl a small path throu!h the rooms of her house.1 %oe and her husband were named in a L$.. the price comparison information should show evidence. • :CCDs mailin! address was a P. ma be even a direct connection with ?rion. Endorsements on checks can be examined for double si!natures..

Aaluation> Aouch the contractorDs billin!s and the pa ments for evidence of appropriate cost valuation.. Completeness> Aouch expenses in the repairs and maintenance accounts 8or similar accounts9 for installation and testin! costs that should be capitali7ed 8evidence of completeness of recordin! asset cost9.. Inc. 4ccumulated %epreciation Cost of *oods Sold Inventor *eneral and 4dmit Expense 8b9 5ist two audit procedures for auditin! the fixed asset additions.) +21$ ..#& Audit Simulation11Audit t e Fi2ed Asset and .. Inspect insurance policies for evidence of ade"uate insurance 8inade"uate insurance ma re"uire disclosure9. Presentation and %isclosure> Stud an related loan a!reements for pled!e as securit for loans in relation to necessar disclosure..8evidence of existence9. 4uto $ Existence> Inspect the auto and observe it in operation 8existence9.'... 5ouwers et al. Presentation and %isclosure> Stud an related loan a!reements for pled!e as securit for loans in relation to necessar disclosure..e#reciation Sc edule 8a9 0he Computer B s stem is depreciated for a full ear 8L'+&. McGraw-Hill/Irwin 4uditin! and 4ssurance Services.. Buildin! $> Existence> Inspect the buildin! to determine that it is -in productive use. Existence> Inspect the computer and observe it in operation 8existence9 Ri!hts 8?wnership9 and Aaluation> Aouch purchase and title documents 8ownership and cost valuation9. 0he best wa to approach this re"uirement is to write a procedure for each assertion. $.9.. Ri!hts 8?wnership9 and Aaluation> Aouch purchase and title documents 8ownership and cost valuation9.+. if an 9.. Ri!hts 8?wnership9> Aouch the le!al title papers and recorded deed for evidence of ownership. )....... Completeness> Inspect Buildin! 1 and make in"uiries about whether an part of it has been sold or leased since the new buildin! was occupied 8evidence of completeness of recordin! of dispositions.. but depreciation should be calculated for onl + months. Inspect insurance policies for evidence of ade"uate insurance 8inade"uate insurance ma re"uire disclosure9...... instead of L1'.#.. Correct amount is L&+. 1. Computer B s stem. $(.. 0he depreciation on the Press should be L)'... ().. $6e / 0he 1c*raw23ill Companies.'. Somebod doubled the depreciation expense for this ear.

Completeness> Aouch expenses in the repairs and maintenance accounts 8or similar accounts9 for t pical additional costs 8e.'+.. it ma need to be reported as compensation in the prox statement 8public companies9. Inspect insurance policies for evidence of ade"uate insurance 8inade"uate insurance ma re"uire disclosure9. 0here should be cash outflow for purchase of assets in the amount of L L#'.. Aaluation evidence> B.. 2 L&. 5ouwers et al.9..!. Insurance ma be re"uired for lawful operation. $. +. 8c9 0he loss on the sale of the Computer 4 s stem should be L'#$..1.e#reciation Sc edule !#art b....+... $6e / 0he 1c*raw23ill Companies. 5e!al ri!ht evidence> %..... and license9 that should be capitali7ed 8evidence of completeness of recordin! asset cost9.. 0he !ain on the sale of 4uto 1 8full depreciated9 should be L1. In"uire about its useJ if b executive officers. Continued$ Presentation and %isclosure> Stud an related loan a!reements for pled!e as securit for loans in relation to necessar disclosure. Existence evidence> *....... 0he cash flow from investin! activities should show cash inflow from sale of assets in the amount of L'. $.... title.. Ph sicall examine all ma<or propert and e"uipment additions..'$$. Examine deeds and title insurance certificates.) +21& ....#& Audit Simulation11Audit t e Fi2ed Asset and .. 8L'. Review the provision for depreciation expense and determine whether depreciable lives and methods used in the current ear are consistent with those used in the prior ear.. McGraw-Hill/Irwin 4uditin! and 4ssurance Services.## Pro#erty and E3ui#ment Assertions and Substanti"e Audit Procedures 1. 2 L'. &... Inc. tax..

:or a sample of capitali7ed P. :or the sample of construction work orders. 4nal 7e the productive economic use of P. ?btain written mana!ement representations about assets pled!ed as securit for loans. 11. %etermine that correspondin! retirements of replaced P. %iscuss plant operations with responsible operatin! personnel. Review the reasonableness of the hours worked.PGE. 1'.PGE to determine whether an other2than2temporar impairment is evident. vouch time and material char!es to supportin! pa roll and material usa!e records. supportin! documentation for expenditure amounts.. 1&. #. the work description. 1.. Plant. and inspect the ph sical assets. and capital work orders. :or ma<or amounts char!ed to P. McGraw-Hill/Irwin 4uditin! and 4ssurance Services. P5E 9 Aaluation Existence Aaluation Aaluation Aaluation and 4llocation Aaluation Existence Existence Ri!hts Presentation and %isclosure Completeness Aaluation and 4llocation Aaluation and 4llocation Presentation and %isclosure Presentation and %isclosure Ri!hts and ?bli!ations Presentation and %isclosure Ri!hts Presentation and %isclosure Aaluation Presentation and %isclosure 1. Stud lease a!reements to determine proper *44P accountin! for lease obli!ations. &. Stud loan documents for terms and securit of loans obtained for purchase of P.) +21# . bud!etar approvals.+. PGE is ade"uatel insured for casualt loss. In"uire about capitali7ation policies and the use of leased assets. Select ma<or additions for the ear and a random sample of other additions. +. Recalculate depreciation.. $6e / 0he 1c*raw23ill Companies. ..PGE have been made and properl accounted entered in the detail records. Stud insurance policies to determine whether P. and E3ui#ment !P. 1$.PGE and a sample of smaller char!es examine. (. Inspect title documents for automotive and real estate assets. and the material used. Review the useful lives. '.#' Assertions and Substanti"e 4alance1Audit Procedures for Pro#erty.. 1#. and salva!e values for reasonableness. Inc. Aouch a sample of char!es in the Repairs account and determine whether the are proper repairs and not capital items. PGE examine construction work orders in detail. $. 5ouwers et al. depreciation methods. ). Evaluate the polic and procedures for allocatin! overhead to the work orders and recalculate their application. $.

5ouwers et al..(( +. 4dditional evidence is needed to be persuaded of existence of the assets 8observation9. 0he assistant will also need to know the asset number. Includes unbilled amount for %ecember McGraw-Hill/Irwin 4uditin! and 4ssurance Services. recalculatin! depreciation9.. description. presentation and disclosure 8in2use2status.) +21' ... in"uiries about h pothecation.#) Searc for Unrecorded Liabilities 4.(##. valuation 8vouchin! invoices.#( CAATTS A##lication6P. liens9. Aouch them to supportin! documents 8invoice.. L'&. b..++. ?btain a list of unmatched vendor invoices and determine when the !oods were received. 1$. Send confirmations to creditors with small or 7ero balances and those with whom the compan has done si!nificant business.+($ L$).+&#. Select a sample of cash disbursements from the accountin! period followin! the balance sheet date. 4udit Pro!ram 1 $ & # ' ( ?btain a trial balance of recorded accounts pa able as of ear2end. P5E a.'$ 1a omit if students assume the char!e was made to prepaid rent.. $...1 0o reverse Canuar rent expense recorded in %ecember 1iscellaneous expense Cost of *oods Sold ?ffice expense Aouchers Pa able 0o record unrecorded liabilities.+. as well as 4sset 0 pe and 5ocation Code mentioned in 8a9 above... +. receivin! report9 to determine whether the related liabilities were recorded in the proper accountin! period.. 0race the unmatched receivin! reports to accounts pa able. and determine whether items recorded in the next accountin! period need to be ad<usted. B. completeness 8vouchin! and tracin! transactions dated around the ear2end9. 4d<ustin! Cournal Entr Aouchers Pa able Rent Expense L'&. 1 $ L(.. Inc. 0he information needed to reconcile subsidiar detail records to !eneral led!er balances> • 4sset t pe • 5ocation code • Cost • 4ccumulated depreciation. end of ear 0he task of footin! the subsidiar led!er and comparin! the recalculation to the !eneral led!er balance8s9 does not complete the audit of fixed assets. 4sk client personnel about their procedures for ensurin! that all liabilities are recorded..&. $6e / 0he 1c*raw23ill Companies.

+. Bill and hold transactions usuall involve sellin! products for lar!e discounts to retailers and holdin! them 8perhaps in third2part warehouses9 to be delivered at a later date. audit procedures for the allowance for doubtful accounts should reveal an material misstatements of sales and6or sales returns... 4mberl Fs bill and hold transactions ma increase audit risk because such transactions ma result in sales bein! overstated at ear end. :alse 0rue :alse McGraw-Hill/Irwin 4uditin! and 4ssurance Services. net income9.) +21( . Specificall .#+ *a#lan CPA E2am Simulation6-btainin) E"idence6Sales and E2#ense -#tion 0rue Procedure Evidence supportin! the valuation of sales returns will be !ained via the audit procedures for accounts receivable... 4n unexplained increase in the !ross profit ratio ma su!!est the presence of unrecorded expenses in C?*S since unrecorded expenses would understate total expenses and falsel increase the profitabilit ratios 8i. $.e. 0o !ain assurance that expenses were not misclassified for the entire ear. $6e / 0he 1c*raw23ill Companies. Aouchin! expenses performed as part of the search for unrecorded liabilities will onl uncover an material misclassifications of expenses that occurred durin! the ear and were paid subse"uent to ear end. Inc. 5ouwers et al. Clearl the risk is of prematurel recorded or uncollectible sales. the auditor must vouch a sample of expenses based on materialit levels.

0his is to ensure that control risk was appropriatel assessed as low and that the internal controls are operatin! effectivel . Hhether le!al action has been taken a!ainst the client is irrelevant to the confirmation procedure. %isputed accounts are !enerall included in the auditorFs confirmation sample. +. =ear $. Confirmations provide evidence supportin! the obli!ation and ri!hts assertion since all accounts pa able are considered obli!ationsJ the are liabilities. $. Inc. 0o substantiate both the completeness and the existence assertions.. Selectin! vendors from the ear2end pa ables listin! onl addresses the existence assertion. 0rue #. $. Because of the 1#2da pa ment terms. :alse (. includin! completeness. Since the emphasis is on detectin! understated pa ables. it ma be appropriate to confirm the Southland accounts pa able at an interim date. :alse '. materialit is a less important or even irrelevant factor when determinin! which vendor accounts should be confirmed. 0rue :alse McGraw-Hill/Irwin 4uditin! and 4ssurance Services..2da pa ment terms. 0rue ). the review of subse"uent pa ments is the most effective procedure to !ather evidence for the accounts pa able assertions. =ear 1 prior to the start of the audit field work in :ebruar . 5ouwers et al. *a#lan CPA E2am Simulation6Accounts Payable Confirmations 1. sendin! vendor confirmations earl ma provide timel evidence to corroborate the accounts pa able balance. Eorth River will have likel paid their invoices open at %ecember &1. 0rue &.#. vendor balances to be confirmed should be selected from SouthlandFs list of vendors. *iven the (. Since the control risk was assessed as low.. $6e / 0he 1c*raw23ill Companies.) +21) .+. :alse Confirmations should be sent to all vendors re!ardless of whether a pa able is recorded since the ob<ective is to search for unrecorded items that ma have resulted in an understatement of accounts pa able. Southland will probabl not pa some of its vendor balances relatin! to the end of =ear 1 b the completion of fieldwork on :ebruar 1' of =ear $. 0herefore. 0herefore.

0he feed inventor was not received until =ear $ and because it was also a one2time deal. so a liabilit should have been recorded at that time. the amount of the second shipment that was not received until after the end of =ear 1. In this case. E McGraw-Hill/Irwin 4uditin! and 4ssurance Services. E. $6e / 0he 1c*raw23ill Companies. 0he telephone service period was for =ear 1. 4n ad<ustment should be made to record the one2month 81$616=1 M 1$6&16=19 insurance expense included in the service period. It was noted that the inventor was received b Southland prior to the end of =ear 1 on 1$6&. Eo ad<ustment is necessar since the item is properl included in accounts pa able at the end of =ear 1. 0hus.'. $..+. there is no !uidin! precedent in terms of determinin! when the liabilit was actuall incurred. based on the facts. $. Southland has E?0 likel incurred a le!al obli!ation to pa until =ear $ when the inventor was received.6=1 is not relevant to Southland in terms of determinin! when the liabilit was incurred. Eo ad<ustment is necessar since the electrical supplies were received in =ear 1 and properl included in accounts pa able at the end of =ear 1. 4n ad<ustment is necessar since no liabilit for the insurance premium is recorded at the end of =ear 1. 4s it is currentl recorded b Southland. Eo ad<ustment is needed to accounts pa able since it is properl included at the end of =ear 1.. '. 4 (. E E 4 Eo ad<ustment is necessar since the item is properl included in accounts pa able at the end of =ear 1.) +21+ .. &. 0he water service period was for =ear 1. +.. ). 5ouwers et al. Eo ad<ustment is necessar since the item is properl excluded from accounts pa able at the end of =ear 1.6=1.&. the invoice date of 1$6$.. accounts pa able and inventor are overstated b L. *a#lan CPA E2am Simulation6-btainin) E"idence6Accounts Payable 1. B.. 4n ad<ustment is necessar since no liabilit for the inventor is recorded at the end of =ear 1. C. Inc. #. Expenses are overstated since the item should have been capitali7ed.