Chapter 19

COMPLETING THE TESTS IN THE ACQUISITION AND PAYMENT CYCLE:

VERIFICATION OF SELECTED ACCOUNTS

AUDIT OF PROPERTY, PLANT AND EQUIPMENT

Plant equipment is usually audited differently from current asset accounts because:
1. There is usually very little acquisition of plant equipment in the current year.
2. The amount of a certain gain is often material.
3. Equipment is likely to be recorded and retained in accounting records for several years.
Emphasis is given to the implementation of factory equipment audits on verification of
current year earnings
than against account balances from the previous year.

Overview of EquipmentRelated Accounts

1. Compare the depreciation expense divided by the gross cost of manufacturing equipment
with the previous year.
2. Compare the accumulated depreciation divided by the gross cost of the plant equipment
with the previous year.
3. Compare monthly or annual repair and maintenance expenses, office supplies expense,
small equipment expense, with the same accounts for the previous year.
4. Compare the gross cost of the plant divided by the previous year's production measures.

Verify Current Year Acquisitions

The main objective is assessment and classification. The starting point for verifying
current year earnings is the schedule obtained from the client for all purchases recorded in the
ledger during the year. The schedule contains each acquisition separately and includes the
acquisition date, supplier (vendor), description, records of whether the asset is a new or used
asset, the age of the asset for depreciation purposes, the depreciation method, cost, and
investment credit, which was acquired. from the parent property file.

Supporting Documentation Check

To verify the addition of the current year:
a. Inspection of supplier invoices, goods receipt reports, and supporting documents.
b. Verify both large and unusual transactions for the entire year as well as against a
representative sample for additions.
The extent of verification depends on the control risk that the auditor determines for
acquisition and on the materiality of the additions.

Verification of Current Year Release

The aim is to ensure that existing disposal is recorded and that releases are accurately
recorded.
The starting point for verifying the disposal is the client's recorded disposal schedule, which
contains the date the asset is disposed of, the name of the person or company that purchased /
acquired the asset, the selling price, the cost of the asset, the date of acquisition, the
accumulated depreciation of the asset, and recoverable investment credit if any.
Internal control:
a. A formal method of providing information to management regarding the sale, exchange,
disposal and theft of unrecorded equipment and machinery.
b. Authorization provisions for sale or other disposal to protect assets from improper
disposal.
The procedure performed:
a. Reviewing whether there are new assets to replace old assets.
b. Analyze the gain from disposal of assets and other income from disposal of assets.
c. Review factory modifications and changes to plant lines, taxes, or insurance coverage due
to equipment removal.
d. Questions and answers with the management and executor of the product regarding the
possibility of disposal of assets.

Verification of Asset Balances

The goal is to check whether the details of the plant equipment recorded in the master
file match the ledger. Apart from that to check for existence.
Internal control: includes the use of a master file for each fixed asset, adequate physical
control for each fixed asset, for assets that can be transferred easily, assignment of
identification numbers for each plant asset, periodic physical counting, and reconciliation.
Audit testing: tests are determined based on master files because usually the auditor does not
obtain a list of all assets from the client.
Verification of Depreciation Expense
The purposes are:
a. Determines whether the client implements a consistent depreciation policy from one period
to another.
b. Check if the depreciation calculation is accurate.
Considerations for consistency of depreciation:
a. Useful life.
b. Shrinkage method.
c. Estimated residual value.
d. Depreciation policy for assets in the year of acquisition and disposal.
Depreciation test method: makes a calculation of the overall feasibility.

Verification of Accumulated Depreciation

Its purpose is to check:
a. Accumulated depreciation is stated in the property master file according to the ledger:
tested by summation of the accumulated depreciation or property master file and tracing the
total to the ledger.
b. Accumulated depreciation in the master file is calculated accordingly.

AUDIT OF PREPAID EXPENSE

The purpose is:
a. completeness & existence.
b. rights and obligations.
c. evaluation, accuracy, tie-in details.
d. classification
e. cut off
f. presentation & disclosure.

Overview of Prepaid Insurance

Because the source of the debits in the asset account is the acquisitions journal, the
payments of insurance premiums have already been partially tested by means of the tests of
controls and substantive tests of acquisition and cash disbursement transactions.
Internal Controls
1. Control over the acquisition and recording of insurance.
2. Control of the insurance register.
3. Control of insurance expenses.
Audit Tests
The only verification of an expense account balance that is usually required is an analytical
procedure and a short test to ensure that the charge for insurance expense arises from credit
against prepaid insurance. Analytical procedures for prepaid insurance:
1. Compare the total prepaid insurance and insurance expenses with the previous year's total.
2. Calculate the ratio of prepaid insurance against insurance expenses and compare it with the
previous year.
3. Comparing the coverage of each insurance policy on the schedule obtained from the client
with last year's schedule for testing of the elimination of certain policies or changes in
insurance coverage.
4. Compare the balance of prepaid insurance that is calculated for the current year with the
results of the previous year's calculation for the calculation error test.
5. Review the insurance coverage contained in the prepaid insurance schedule with the
appropriate client personnel or the insurance broker on the eligibility of the coverage.

AUDIT OF ACCRUED LIABILITIES

Represents the estimated unpaid liability for services or benefits received prior to the
balance sheet date.Examples: accrued employee bonuses, accrued commissions, accrued
interest, accrued income tax, etc. Methods for testing:
1. Perform accrual test in relation to current year's payments.
2. Comparing current year's accruals with the previous year.
The auditor uses two primary tests for the inclusion of all accruals. Auditors verify the
accruals at the same time as the audit of current year property tax payments. In most audits,
there are few property tax payments, but each payment is often material, and therefore it is
common to verify each one. Auditors also compare the accruals with those of previous years.
The auditor often begins by obtaining a schedule of property tax payments from the client
and comparing each payment with the preceding year’s schedule to determine whether all
payments have been included in the client-prepared schedule.
 The fixed asset audit schedules also must be examined for major additions and
disposals of assets that may affect the property tax accrual. All property affected by local
property tax regulations should be included in the schedule, even if the first tax payment has
not yet been made.

AUDIT OF INCOME AND EXPENSE ACCOUNTS (OPERATION)

It is intended to determine whether the income and expense accounts in the financial
statements are presented fairly in accordance with generally accepted accounting principles.
The auditor must be sure that any total revenue and expenses in the income statement or net
income are not misstated materially.

Approach to Auditing Income and Expense Accounts

Audit of income and expense accounts relating to balance sheets and
does not include a separate part of the audit process. Misstatement in the income statement
accounts affect balance sheet accounts.

Substantive Analytical Procedures

1. Matching periodic income and expenses is essential for the proper determination of
operating results.
2. Consistent application of generally accepted accounting principles for different periods is
important for comparability.

Tests of Controls and Substantive Tests of Transactions

The most important means of verifying many of the income statement accounts in
each transaction cycle are understanding internal control and performing the related tests of
controls and substantive tests of transactions. For example, if the auditor concludes after
adequate tests that control risk can be appropriately assessed as low for transactions in the
acquisition and payment cycle, the only additional verification of related income statement
accounts, such as utilities, advertising, and purchases, will occur through the performance of
substantive analytical procedures and cutoff tests.

Tests of Details of Account Balances— Expense Analysis

Expense account analysis involves auditor examination of underlying documentation
of individual transactions and amounts making up the detail of the total of an expense
account. The documents are the same type as those used for examining transactions as part of
tests of acquisition transactions, including invoices, receiving reports, purchase orders, and
contracts.
Tests of Details of Account Balances— Allocation
Allocations are important because they determine whether an expenditure is an asset
or a current period expense. If the client fails to follow accounting standards or fails to
calculate the allocation correctly, the financial statements can be materially misstated. The
allocation of expenses such as depreciation of fixed assets and amortization of copyrights is
required because the life of the asset is greater than one year. The original cost of the asset is
verified at the time of acquisition, but the charge-off takes place over several years. Other
types of allocations directly affecting the financial statements arise because the life of a short-
lived asset does not expire on the balance sheet date. These may include prepaid rent and
insurance. Finally, accounting standards require the allocation of costs between current
period manufacturing expenses and inventory as a means of reflecting all costs of making a
product.

Types of Audits Important to Company Operations:

1. Analytical procedures.
2. Testing transactions.
3. Analysis of account balances.
4. Detailed test of balances against balance sheet accounts.
5. Allocation testing.

Analytical Procedures for an Audit of Operations:

1. Compare expenses individually with the previous year.
2. Comparing individual assets and liabilities with the previous year.
3. Comparing individual expenses with the budget.
4. Comparing the gross margin percentage with the previous year.
5. Compare the inventory turnover ratio with the previous year.
6. Compare commission expense divided by sales with the previous year.
7. Comparing individual manufacturing expenses divided by total manufacturing expenses
with the previous year.