Auditing the Expenditure Cycle

Transaction and Account Balances
1. Transactions and account balances
involve in expenditures cycle are those
related to providing goods and services
for operational acti
activities,
ities incl
including
ding the
payment of its payable.
2. However in this chapter the discuss will
be focused on the transactions related
to purchase of inventory, it can be raw
material or merchandise inventory. y
Transaction and Account Balances
Credit Debit
Account Payable

Debit Credit
• Merchandise Inventory • Cash
• Raw material inventory • Purchase discounts
• Purchases • Purchase returns
• Prepaid expenses
• Plant
Pl t assets
t
• Other assets
p
• Various expenses

Purchase Payment
 Audit Objectives
Assertion Transaction Specific Audit Objectives
Category or Balance
Existence or Transaction ¾ Recorded purchases represent goods,
goods
Occurrence services, and productive assets received
during the period.
¾ Recorded cash disbursement transactions
were made during the period to suppliers
and creditors.
B l
Balance ¾ Recorded
R d d accountst payable
bl representt the
th
amounts the entity owes at the balance
sheet date.
C
Completeness
l t T
Transaction
ti ¾ All purchases
h andd cashh di
disbursements
b t
made during the period were recorded.
Balance ¾ Accounts payable include all amounts
owed to suppliers of goods and services at
the balance sheet date.
 Audit Objectives
Assertion Transac- Specific Audit Objectives
Category tion or
Balance
Rights and Transacti ¾ The entity is liable for the
Obligations on payables resulting from the
recorded purchase transactions.
Balance ¾ Accounts payable are
obligations of the entity at the
balance sheet date.
Valuation or Transac- ¾ All purchase transactions and
Allocations tion cash disbursements are valued
using GAAP and correctly
journalized, summarized, and
posted.
 Audit Objectives
Assertion Transac- Specific Audit Objectives
Category tion or
Balance
Balance ¾ Accounts payable are stated at the correct amount
owed.
¾ Related expense balances are in conformity with
GAAP.
GAAP
Presentation Transaction ¾ The details of purchases and cash disbursements
and support their presentation in the financial
Di l
Disclosure statements including
i l di their
h i classification
l ifi i andd related
l d
disclosures.
Balance ¾ Accounts payable and related expenses are
properly identified and classified in the financial
statements.
¾ Adequate disclosures have been made pertaining
to commitments,
commitments contingent liabilities,
liabilities and
collateralized and related party payables.
 Materiality and Inherent Risks
1. Materiality is depend on the level of
control
co o risks
s sa andd inherent
e e risks.
s s
2. Inherent risks
a. P
Pressures to
t understate
d t t expenses to t
increase profitability targets or industry
norms.
norms
b. Pressures to understate payables to
increase liquidity
liquidity.
c. The high volume of transactions, it cause
increasing risk of material misstatement,
except otherwise supported by reliable ICS
Materiality and Inherent Risks
d. Unauthorized purchases and cash
disbursements mayy be made.
e. Purchase assets may be misappropriated.
f. There mayy be duplicate
p p
payment
y of vendor’s
invoices.
g. Contentious accounting issues may arise
concerning such matters as whether a cost
should be capitalized or expensed (e.g. the
treatment of repairs and maintenance costs or
the classification of a lease as an operating or
capital lease).
 Analytical Procedures
• Analytical procedures are commonly
cost effective.
• If the company is growing it is common
to expect purchase, inventory, and
accounts payable to grow at consistent
rates.
rates
• The auditor’s knowledge of the volume
or purchases
purchases, combined with prior
experience is useful in estimating
c rrent year’s
current ear’s pa
payables.
ables
 Analytical Procedures
Ratio Formula Audit Significance

Account Average Prior experience in accounts

payable turn Accounts payable turn days combined
days Payable : with knowledge of current
P h
Purchases x
purchases
h can bbe useful
f l iin
365 estimating current payables. A
shortening of the period may
indicate completeness
problems.
Cost of Cost of Unless the company has
goods sold Goods Sold changed its payment policy,
to accounts : Accounts these amounts should change
payable Payable by approximately the same
percentage from year to year.
 Analytical Procedures
Payable as a Account Common-sized balances in
% of total Payable
y : accounts ppayable
y are useful in
assets Total Assets comparing with industry data. A
significant decline in this ratio
may indicate
i di t completeness
l t
problems.
Current ratio Current A significant increase in the
Assets : current ratio compared to prior
Current year’s experience may indicate a
Liabilities completeness problem. However,
this ratio may also be influenced
by changes in asset accounts.
accounts
 Analytical Procedures

Quick Current A significant increase in

ratio
ti M t
Monetary th currentt ratio
the ti
Assets : compared to prior year’s
C
Current t experience
i may iindicate
di t
Monetary a completeness problem.
Liabilities Ho e er this ratio ma
However, may
also be influenced by
changes in asset
accounts.
Documents and Records – Payable
1. Purchase requisition. Written request for goods
or services by an authorized individual or
d
department
t t to
t the
th purchasing
h i department.
d t t
2. Purchase order. Written offer from the purchasing
department to a vendor or supplier to purchase
goods or services specified in the order.
3. Receiving g report.
p Report
p p prepared
p on the receipt
p
of goods showing the kinds and quantities of goods
received from vendors.
4. Vendor invoice. The bill from the vendor stating
the items shipped or services rendered, the
amount due
due, the payment terms
terms, and the date
billed.
Common Documents and Records
5. Voucher. An internal form indicating the vendor, the
amount due, and payment date for purchase received.
It is used to authorize recording and paying a liability.
liability
6. Exception reports. Reports with information about
transactions identified for further investigation by
computer application controls.
7. Voucher summary. Report of total vouchers
processed in a batch or during a day day.
8. Voucher register. Formal accounting record of
recorded liabilities approved
pp for p
payment.
y
9. Approved vendor master file. Computer file
containing pertinent information on vendors and
suppliers that have been approved to purchase service
from and make payments to.
Common Documents and Records
10. Open purchase order file. Computer file of
purchase orders submitted to vendors for which
th goods
the d or services
i h
have nott bbeen received.
i d
11. Receiving file. Computer file with receiving
information on quantities or inventory received
from vendors.
12. Purchase transactions file
13. Account payable master file
14. Suspense
p files. Computer
p files that hold
transactions that have not been processed
because the have rejected by computer
application controls
controls.
 Functions
1. Initiating purchases, including: placing
vendors on an authorized vendor list,
requisitioning goods and services, preparing
purchases orders.
2. Receipt of goods and services, including:
receiving the goods, storing goods received
for inventory, returning goods to vendor.
3. Recording liabilities, including: preparing
the payment voucher and recording the
liability, accountability for recorded
transactions.
Control Risk – Purchase Transactions
Initiating Purchases
Potential Misstatement
• Lack of control over purchases and unrecorded
liabilities, control: prenumbered purchase
requisitions and purchase order, and checks
numerical sequence.
• Purchases
P h ffor unauthorized
th i d purposes, control:
t l
verification of employee authorization code to enter
requisition
q or p
purchase order.
• Fictitious vendor and bill for services not received,
control: compare vendor on purchase order to
mastert file
fil vendor.
d AAccess control
t l tto vendor
d master
t
file.
Control Risk – Purchase Transactions
R
Receiving
i i Goods
G d abd
bd Services
S i
Potential Misstatement
• Goods
G d may be b received
i db butt nott recorded,
d d control:
t l
checks for goods ordered and not received within a
reasonable p period of time.
• Accepting goods that were not ordered or authorized,
control, checks validity of purchase order in order to
i iti t receiving
initiate i i report. t
Recording Liabilities
Potential Misstatement
• Goods or services may be received but not be
recorded appropriately, control, checks the record of
liabilities for reasonable period of time.
Control Risk – Purchase Transactions
• Liabilities may be recorded for goods or services not
received or may be recorded at an incorrect amount,
control matching information inside the voucher with
control,
the underlying supporting documents, such as
purchase orders and receiving report.
• Payment invoice twice, control, stamp paid to the
paid invoice, and review prior payment before decide
t pay the
to th voucher.
h
• Recording in the wrong accounting period, control,
comparing the date in the invoice with the date of
recording the invoice.
• Mathematical error may be made in processing the
vouchers, control, checks the mathematical accuracy
of the vouchers and supporting documents.
Control Risk – Purchase Transactions
• Purchase may be incorrectly posted or summarized,
control, compare sum of the subsidiary ledger
accounts with the general ledger control account
account.
• Purchase may be posted to the wrong accounts,
control, compares account distribution on the
voucher with the account distribution on purchase
requisition or purchase order.
• Purchase may be recorded for goods or services not
received, they may be posted to the wrong account,
or in the wrong amount, control independent review
to all purchases charged to the responsibility center
as well as reviewing vendors, amount, and accounts
charged
h d on titimely
l bbasis.
i
 Documents and Records
1. Check
2 Check summary
2.
3. Cash disbursements transaction file.
Information on payments by check to
vendors and others. Used for posting to
the accounts payable and general ledger
master files.
4 Cash
4. C h didisbursements
b t jjournall or check
h k
register. Formal accounting record of
check
h k iissued d tto vendors
d and
d others.
th
Control Risk – Cash Disbursement
• A check may not be recorded, control,
computer accounts for prenumbered check
series, compare total on check summary to total
vouchers submitted for payment, control access
to blank check and signature plates.
• A check may not be recorded promptly, control,
prints report of checks due but not yet paid,
compare beginning cash less cash
disbursement with ending cash balance
balance, as well
as, beginning payable less disbursement with
ending payable
payable.
Control Risk – Cash Disbursement
• A check may be issued for unauthorized
purchases control,
purchases, control compare checks with
its supporting documents, such as
authorized purchase order
order, receiving
report, and voucher. Also limit test on
large disbursement,
disbursement and these check
must be manually signed.
twice, control,
• A voucher may be paid twice control
stamp paid to paid voucher package.
Control Risk – Cash Disbursement
• A check may be issued for wrong amount,
control, independent check matching the
check with related voucher package.
• A check mayy be altered after signed,
g , control,,
put certain sign in the beginning and ending
part of the amount of check which written in
word, i.e. by putting sign # and word only#
• Error in recording check, control, independent
check
h k comparing i check,
h k voucher,
h and d check
h k
register.
Purchase Adjusments ‐ Documents
• Purchase return authorization, it is a form
showing the description, quantity, and other
data pertaining to the goods that the vendor has
authorized to return.
• Shipping report, it is a report prepared on the
shipment of goods to vendor showing the kinds
and quantities of goods shipped.
• Debit memo, it is a form stating the particulars
off a debit
d bit to
t accountt payable,
bl iincluding
l di th
the
specific items returned, prices, and amount
credited.
credited
 Substantive Tests of Payable
Initial Procedures
1 Obtain understanding of business and industry and
1.
determine:
a. The significance
g of p
purchases and account
payable to the entity.
b. Key economic drivers that influence the entity’s
purchases and resultant account payables.
c. Standard trade terms in the industry, including
seasonal dating
dating.
d. The extent of concentration of activity with the
suppliers and related purchase commitments
commitments.
 Substantive Tests of Payable
Initial Procedures
1 Obtain understanding of business and industry and
1.
determine:
a. The significance
g of p
purchases and account
payable to the entity.
b. Key economic drivers that influence the entity’s
purchases and resultant account payables.
c. Standard trade terms in the industry, including
seasonal dating
dating.
d. The extent of concentration of activity with the
suppliers and related purchase commitments
commitments.
 Substantive Tests of Payable
2. Perform initial procedures on the A/P balance
j
and records that will be subjected to further
testing.
a. Trace beginning balance to prior years working
papers.
b. Review activities in the GL accounts and
i
investigate
ti t entries
t i that
th t appear unusuall in
i
amount or source.
c Obtain listing of A/P at balance sheet date and
c.
determine that it accurately represents the
underlying accounting records by:
 Substantive Tests of Payable
i. Footing the listing and determining agreement with
(1) the total of unpaid voucher file, subsidiary
ledger,
g , or A/P master file,, and (2)
( ) the GL control
account balance.
ii. Testing agreement of vendors and balance on
listing with those included in the underlying
accounting records.
Analytical Procedures:
1. Develop an expectation for A/P using knowledge of
entity’s business activities, normal trade terms, and history
of A/P turnover.
turnover
2. Calculate ratio and analyze the results relative to
expectations. Pay attention to indication of
understatement.
d
 Substantive Tests of Payable
Tests of Details of Transactions
1. Vouch sample of recorded transactions to
supporting
ti documents.
d t Credit
C dit A/P tto vouchers
h
package (vouchers + vendor invoices + receiving
reports + purchase orders + other supporting
information. Debit A/P to cash disbursements or
purchase returns memoranda.
2. Perform purchases cut-off test.
a. Select sample of recorded purchase
t
transactions
ti severall d
days b
before
f andd after
ft
balance sheet date, and examine the supporting
documents and tests the appropriateness of
cut-off transactions.
 Substantive Tests of Payable
b. Observe the numbers of the last receiving
report issued on the last day of the audit period
and trace sample of lower and higher
numbered receiving reports to ensure that
purchases were recorded in the proper period.
3. Perform cash disbursements cut-off test.
a. Observe the number of check issued and mail
or the last payment of payable, on the last day
of accounting period, and trace to the
accounting records to verify accuracy of cutoff
cutoff.
b. Trace dates of “paid” checks returned with year-
end cut-off
cut off bank statements to dates recorded.
 Substantive Tests of Payable
4. Purchase return cut-off.
a. Review purchase return on the last days of
accounting period to ensure accuracy the
date of recording.
b. Vouch the last purchased returns in the
books of original entry (journal) to vendor’s
authorization
th i ti and d shipping
hi i reports. t
8. Perform search for unrecorded liabilities.
a. Examine subsequent payments until the
end date of fieldwork and trace it to the
payable
bl bbalance
l att th
the b
balance
l sheet.
h t
 Substantive Tests of Payable
b. Investigate unmatched purchase documents.
c. Inquire accounting and purchasing personnel
about
b t unrecorded
d d liliabilities.
biliti
d. Review capital budgets, work orders, and
construction contracts for evidence of
unrecorded payables.
Tests Details of Balances
1. Confirm account payable.
a. Identify
y major
j vendors by y reviewing
g voucher
register or account payable subsidiary ledger
and send confirmation to vendors with large
balance.
balance
 Substantive Tests of Payable
b. Investigate and reconcile the differences.
2. Reconcile unconfirmed payable to monthly
statements
t t t received
i d by
b client
li t ffrom vendors.
d
Presentation and Disclosures
Compare presentation with GAAP
GAAP.
a. Identify the proper identification and
classification of payable.
payable
b. Determine the existence of debit balance of
payable
p y that need to be reclassified.
c. Determine the sufficiency of disclosures.
d. Inquire about undisclosed commitment and
contingent liabilities.
 Substantive Tests of Payable
e. Evaluate completeness of presentation and
disclosures.
f Read
f. R d the
th disclosures
di l and
d independently
i d d tl
evaluate the appropriateness of classification
and disclosures, as well as the
understandability of classification and
disclosures.
 Example of Confirmation
Title and addressee
Dear Sir or Madam
Will you please send directly to our auditors, Bla & Bla,
Certified Public Accountants, and itemized statement
of the amount owed to you by us at the close of
business on December 31, 20xx? Will you please also
supply the following information:
Amount not yet due Rp…..
Amount past due Rp
Amount of purchase commitments Rp…….
Description of any collateral held. Etc……………….
Very truly yours etc…… etc…..
Thank You