Chapter 15

Risk Assessment Procedures in the Expenditure Cycle

Expenditure Cycle consist of activities related to acquisition of and payment for goods
and services.
1. Purchase Transaction: purchasing goods or services
2. Cash Disbursement: making payment
3. Purchase Adjustment: purchase return and price adjustment
Understand the Entity and Its Environment

Transaction objectives
Occurrence (OE) Recorded purchase transactions represent goods and services received
during the period under audit (OE1).
Recorded payment transactions represent payments made during the
period to suppliers and creditors (OE2).
Recorded payroll expenses relate to employee services received in the
period (OE3).
Completeness (C) All purchase transactions that occurred during the period and that
should have been recorded have been recorded (C1).
All payments that occurred during the period and that should have been
recorded have been recorded (C2).
Recorded payroll expenses include all such expenses incurred during
the year (C3).
Accuracy (AV) Purchase, payment and payroll transactions are properly (accurately)
recorded (AV1).

Cut-off (CO) Particularly relevant to transactions around the year end; all purchases,
cash payments, purchase adjustment and payroll transactions arising
before the period end are recorded in the current period and those
arising after the period end are included in the next accounting period
(CO1).
Classification (PD) All purchases (PD1), payments (PD2) and payroll transactions (PD3)
are recorded in the correct accounts.
Balances objectives
Existence (OE) Recorded accounts payable represent amounts owed by the entity at the
end of the reporting period (OE4).
Accrued payroll liability balances represent amounts owed at the end of
the reporting period (OE5).
Rights and obligations Accounts payable (RO1) and accrued payroll liabilities (RO2) are
(RO) liabilities of the entity at the end of the reporting period.
Completeness (C) Accounts payable include all amounts owed by the entity to suppliers
of goods and services at the end of the reporting period (C4).
Chapter 15

Accrued payroll liabilities include all amounts owed in respect of

payroll and deductions therefrom at the end of the reporting period
(C5).
Valuation and Accounts payable represent gross amounts due to suppliers and agree
allocation (AV) with the sum of the accounts payable in the payables subsidiary ledger
(AV2).
Accrued payroll liabilities are stated at the appropriate amounts (AV3).
Related expense balances conform to applicable accounting standards
(AV4).
Presentation and disclosure objectives (PD)
Occurrence and rights Disclosed purchase and payroll events have occurred and pertain to the
and obligations entity (PD4).
Completeness Accounts payable, accrued payroll liabilities and related expenses are
properly identified and classified in the financial statements (PD5).
Disclosures pertaining to commitments, contingent liabilities and
related party creditors are adequate (PD6).
Classification and Purchase cycle and payroll information is appropriately presented and
understandability information disclosed is clearly expressed (PD7).
Accuracy and valuation Purchase cycle and payroll information is
disclosed accurately and at appropriate amounts (PD8).

Inherent Risk Including the Risk of Fraud

Pervasive Factor
1. Pressures to understate expenses in order to report achieved announced profitability
targets or industry norms.
2. Pressures to understate payables in order to report a higher level of working capital when
the entity is experiencing liquidity problems or going-concern doubts
3. Vendors may be tardy in sending invoices resulting in cutoff problems in recording
payables.
Other Factor
1. There is usually a high volume of transactions.
2. Unauthorized purchases and cash disbursements may be made.
3. Purchased assets may be misappropriated.
4. There may be duplicate payment of vendor's invoices.
5. Contentious accounting issues may arise concerning such matters as whether a cost
should be capitalized or expensed
Analytical Procedures (Boynton Book Page 695)
Consider Internal Control Components
Chapter 15

1. Control Environment
Determine how management is held accountable for resources:
a. The reports used by management to evaluate the entity's performance review.
b. How often and how quickly management reports are reviewed.
c. The decisions that are based on the reports.
d. The entity's policies for following up on issues raised by key reports.
2. Risk Assessment
a. The risk of purchasing kickbacks
b. The risk of employee fraud through fraudulent purchases or cash disbursements.
c. The entity's ability to meet cash flow requirements for purchase transactions.
d. Loss contingencies associated with purchase commitments.
3. Information and Communication (Accounting System)
4. Monitoring
Monitoring activities about which the auditor should obtain knowledge include
a. Ongoing feedback from the entity's suppliers concerning any payment problems
or future delivery problems,
b. Communications from external auditors regarding reportable conditions or
material weakness in relevant internal controls found in prior audits,
c. Periodic assessments by internal auditors of control policies and procedures
related to the expenditure cycle.
Control Activities_Purchase Transactions
Common Document and Records
1. Purchase requisition: Written request for goods or services by an authorized individual or
department to the purchasing department.
2. Purchase orders: Written offer from the purchasing department to a vendor c supplier to
purchase goods or services specified in the order.
3. Approved vendor master file: Computer file containing pertinent information on vendors
and suppliers that have been approved to purchase services from and make payments to.
4. Open the purchase order file: Computer file of purchase orders submitted to vendors for
which the goods or services have not been received.
5. Receiving report: Report prepared on the receipt of goods showing the Ni and quantities
of goods received from vendors.
6. Receiving files: Computer files with receiving information on tory received from
vendors.
7. Vendor invoice: The bill from the vendor stating the items shipped of se rendered, the
amount due, the payment terms, and the date billed.
8. Voucher: An internal form indicating the vendor, the amount due, and payment date for
purchases received. It is used to authorize recording and paying a liability. Many
purchase systems require a complete voucher packet before approving payment.
Chapter 15

9. Exception reports: Reports with information about transactions identified for further
investigation by computer application controls.
10. Voucher summary: Report of total vouchers processed in a batch
11. Voucher register: Formal accounting records of recorded liabilities approved for
payment.
12. Purchase transactions file: Computer files containing data for approved vendors for
purchases that have been received.
13. Accounts payable master file: Computer files containing data on approved unpaid
vouchers.
14. Suspense files: Computer files that hold transactions that have not been processed
because they have been rejected by computer application controls.
Functions and Control Activities
1. Requisitioning Goods and Services
Originate from stores (the warehouse) for inventory or from any department for
other items. Purchase requisitions are usually pre-numbered to ensure that goods
requisitioned are duly ordered and received (OE1).
2. Preparing Purchase Order
Issue purchase orders only if the receipt of requisitions properly approved by an
employee who has appropriate requisitioning authority (except for programmed inventory
replenishment). Purchase orders should contain a precise description of the goods and
services required, quantities, price, delivery instructions, and the supplier's name and
address (OE1 and OC1).
3. Receiving Goods
A valid purchase order represents the authorization for the receiving department
to accept goods delivered by suppliers. A pre-numbered receiving report (also known as a
goods received note) should be prepared for each delivery. Receiving report supporting
the occurrence of purchase transaction (OE1) and completeness of purchase and account
payable (OC1).
4. Storing Good Received for Inventory
On delivery of the goods to stores or other requisitioning department, receiving
clerks should obtain a signed receipt on the copy of the receiving report retained by the
receiving department (OE1).
5. Checking and Approving the Supplier’s Invoice
Procedures Applicable:
a. Numbering suppliers' invoices to confirm that all invoices are recorded (C1)
b. Details of suppliers' invoices and purchase orders for valid purchase transactions
(OE1)
c. Mathematical accuracy of the suppliers' invoices (AV1)
d. Coding the account distributions on the suppliers' invoices (AV1, PD1)
e. Approving invoices for payment (OE1)
Chapter 15

f. Preparing a daily prelist of suppliers' invoices (OE1, C1, and AV1).

6. Recording Liabilities
Personnel in the accounts department either send approved suppliers' invoices in
batches to the computer department or, more likely, enter the data direct via terminals.
Additional controls over the accuracy of the data entry process may include the use of
batch totals and exception reports (OE1, C1, and AV1).
Control Activities_Payment Transactions
Common Document and Records
1. Check: Formal order to a bank to pay the payee the amount indicated demand.
2. Check summary: Report of all checks issued in a batch or during a day.
3. Cash disbursements transaction file: Information on payments by check vendors and
others. Used for posting to the accounts payable and generate ledger master files.
4. Cash disbursements journal or check register: Formal accounting records of check issued
to vendors and others.
Functions and Control Activities
1. Paying the Liability
The accounts department is responsible for ensuring that suppliers' invoices are
processed for payment on their due dates. Payment is normally required within 30 days.
Payments can be by cheque, or more typically by bank credit transfer for regular
suppliers. Related to audit objectives of OE2, AV1, and C2.
2. Recording the Payment
The payment transactions file in a computer system is created when cheques or
electronic transfers are prepared. Controls over the recording of payments include OE2,
C2, and AV1.
Chapter 15

Case Study 15.28

Weakness in the internal control:
1. No authorization is required in order for the employees to place order for the goods that
may lead into unauthorized ordering of goods may expose the company to employee
fraud.
2. No evidence of list of authorized supplier to be used with the potential collusion between
employees and unauthorized supplier to manipulate the prices of goods. Since the
purchasing department should be establish strong controls over putting authorized
vendors on an authorized vendors list rather that select suppliers/subcontractors of both
raw material and finished goods based on latest price and the delivery times.
3. No physical checks of goods received against the purchase order and dispatch note
because quality of goods may be compromised that may lead to unsatisfactory stock
valuation. There is no copy of receiving report is forwarded to account department, there
is no inspection for damage goods. Receiving clerks in the warehouse shouldn’t be given
too much trust so there will no fraud. He shouldn’t receive the quantity ordered in the
purchase order so that the personnel really compare the goods received. The late order in
the warehouse indicate that there is inefficiency of through centralization of purchasing in
a specialized department. There may be fraudulent orders due to the high trust.
4. The original is sent to the supplier not the copied ones and another copies are distributed
internally to the receiving department, the accounting department and the requisitioner.
5. Rejected data would produce an error report to be dealt with immediately in on-line
systems, or to be corrected by the user department and resubmitted if the requisition was
valid.

Audit Test
1. Test of Controls
A test of controls is an audit procedure to test the effectiveness of a control used by a
client entity to prevent or detect material misstatements. Depending on the results of this
test, auditors may choose to rely upon a supplier’s system of controls as part of their
auditing activities.
Audit Procedures:
a. Account for a sequence of purchase orders (prenumbered) and trace selected ones
to related suppliers’ invoices and purchase journal entries.
b. Examine signatures of authorized persons on the purchase and payment
documents.
2. Analytical Procedures
Analytical procedures involve a comparison of recorded values with expectations
developed by the auditor. They consists of evaluations of financial information made by a
study of plausible relationships among both financial and nonfinancial data.
Audit Procedures:
a. Obtain list of account payables, recomputed and compare with the general ledger.
b. Re-performance/reconciliation of purchase ledger control account with the list of
account payable.
Chapter 15

c. Compare the purchase account and account payable balances with previous years.
3. Substantive test of transactions
Substantive test of transactions means substantively verifying and checking of value of
the given transactions. The basic element involve in substantive test of transactions is the
value of transaction and substantive test of transactions is done to detect whether
transaction value is overstated or understated.
Audit Procedures:
a. Examine suppliers’ invoices and other internal documentation in support of
recorded transactions in the purchase journal.
b. Compare dates of despatch notes and suppliers’ invoices with the dates in the
purchase journal.
4. Test of details of balances
Test of details of balances means substantively test the financial year ending balances of
the ledgers. The basic element is the ledger account balance and it is done to check for
discrepancy in the different factors affect the balance it is either overstated or
understated.
Audit Procedures:
a. Confirm account payable balances directly with suppliers.
b. Obtain suppliers’ statements directly from suppliers and reconcile to the list of
account payable.

List of Procedures to Test Valuation of Inventory:

1. Computer system information auditor need to check how purchase payment and return of
goods effect the inventory valuation system.
2. Computer system information auditor need to test the inventory valuation cycle whether
the recognition of the inventory when the purchase order was made or when the goods
received.
3. To assess the risk of material misstatement, computer system information auditor can
perform cut off test to maintain whether transactions have been determined according to
predetermined cut-off date / time, so that records have been made in the correct
accounting period or financial year.