ALDERSGATE COLLEGE APPLIED AUDITING

SCHOOL OF BUSINESS AND ACCOUNTANCY

MODULE 4: AUDIT OF THE EXPENDITURE CYCLE: TESTS OF CONTROLS AND SUBSTANTIVE TESTS OF TRANSACTIONS I

OVERVIEW

This module covers the explanation of the expenditure cycle and the internal control environment and objectives
pertaining thereto. Then, consideration & given to internal controls over acquisitions and cash disbursements
transactions and to the study and evaluation of controls over these two classes of transactions.

The following activities should be undertaken by the auditor in relation to the audit of the expenditure cycle:

1. Diagram the flow of transaction in a typical expenditure cycle, the specific accounts affected and the
elements of control within the cycle.
2. Relate the effect of controls on the assertions embodied in the finance statement.
3. Determine the essential features of internal control over the transactions m the expenditure cycle.
4. Prepare an audit program to gather evidence regarding compliance control procedures that reduce
control risk.
5. Evaluate effectiveness of controls and perform the substantive tests of transactions to gather evidence
to determine whether financial statement assertions are materially correct on accounts affected by the
expenditure cycle.
6. Design tests of details of account balances and analytical procedures to satisfy balance-related audit
objectives.

OBJECTIVES

After studying this module, you should be able to:

1. Describe the nature of the expenditure cycle.

2. Describe the major classes of transactions in the expenditure cycle.
3. Identify the documents and accounting records used in the expenditure cycle.
4. Identify essential elements of internal control over acquisitions and cash disbursements transactions.
5. Describe how to apply compliance tests of controls and substantive tests over the acquisitions and cash
disbursements transactions.

LEARNING FOCUS

Nature of the Expenditure Cycle

The expenditure cycle involves the activities associated with the acquisition and payment of goods and services,
plant assets and labor. For a trading concern, the major classes of transactions in this cycle are:

1. Acquisitions
2. Cash Disbursements
3. Payroll

For a manufacturing firm, production cycle transactions and inventory warehousing transactions are included in
the expenditure cycle in addition to the above-mentioned major classes of transactions.

This cycle does not include the acquisition of short-term or long-term securities, the redemption of long-term
debt, or the reacquisition of a company s share capital. These transactions are considered to be part of the
investing and financing cycles and are explained in Module 6.

Transactions in the expenditure cycle often affect more financial statement accounts than the other cycles
combined. On the balance sheet, the expenditure cycle impacts on all current assets, except marketable
securities and receivables, all plant and intangible assets, and many current liabilities. Transactions in this cycle
ALDERSGATE COLLEGE APPLIED AUDITING
SCHOOL OF BUSINESS AND ACCOUNTANCY

involve major expenses reflected in the Income Statement such as salaries and wages, taxes, utilities,
advertising, repairs and other expenses.

Typically, the accounts affected by the expenditure cycle are:

1. Purchases
2. Accounts and notes payable - trade
3. Purchase returns and allowances
4. Cash in bank (credits for cash disbursements)
5. Purchase discount
6. Inventories (merchandise; finished goods; raw materials; goods process)
7. Manufacturing and operating expenses requiring cash payments.

Documents Used in the Expenditure Cycle and their Audit Significance

Documents Audit Significance

Purchase requisition
A prenumbered document that originates in the A purchase requisition provides evidence that the
inventory stockroom or an operating department and purchasing department was authorized to initiate a
indicates to the purchasing department that goods purchase.
should be ordered, A requisition describes the items,
specifies the quantity needed, and indicates the
requester.
Purchase order
A prenumbered document recording the description, A purchase order contains the signature of the
quantity, and related information for goods and employee who authorized a purchase from a vendor.
services the company intends to purchase. This
document is frequently used to indicate authorization
to procure goods and services.
Receiving report
A prenumbered document prepared at the time This report is prepared within the entity and provides
tangible goods are received that indicates the evidence that goods were received.
description of goods, the quantity received, the date
received, and other relevant data.
Vendor's invoice
A document that indicates the description and quantity This document is created externally and provides
of goods and services received, price, including freight, evidence about a purchase of goods or services.
cash discount terms, and date of the billing.
Debit memo
A prenumbered document indicating a reduction in the
amount owed to a vendor because of returned goods
or an allowance granted.
Voucher
A prenumbered document to establish a formal means A voucher provides documentation for the recording of
of recording and controlling acquisitions prepared by a a transaction.
payables clerk for each payment. A vendor's invoice, a
receiving report, and a purchase order are attached to
it.
Check
A prenumbered written authorization to a bank to A check that has been presented for payment is
transfer funds to the payee. Checks are used as a referred to as paid or canceled check. A paid check
means of payment. provides evidence about payments that an entity has
made, such as date, payee, and amount.
Vendor's statement
A statement prepared monthly by the vendor indicating Vendors’ statements may be used to determine that all
ALDERSGATE COLLEGE APPLIED AUDITING
SCHOOL OF BUSINESS AND ACCOUNTANCY

the beginning balance, acquisitions, returns and transactions recorded on the statements have been
allowances, payments to the vendor, and ending recorded in the books
balance

Accounting Records Involved in the Expenditure Cycle

Purchase journal

A journal for recording purchase transactions.

Cash disbursement transaction file /journal

A file for recording the individual payments made by check. It contains the total cash paid, the debit to accounts
payable at the amount the transaction was recorded in the acquisition transaction file, discounts taken, and other
debits and credits.

Accounts payable master file /subsidiary ledger

A file for recording individual acquisitions, cash disbursements, and acquisition returns and allowances for each
vendor.

A. AUDIT OF ACQUISITIONS AND CASH DISBURSEMENTS TRANSACTIONS

The transactions typically classified in the acquisition and cash disbursements cycle flow through these business
activities:

1. Processing purchase orders

2. Reserving goods and services
3. Recognizing the liability
4. Processing and recording cash disbursements

AUDIT OF ACQUISITIONS

Figures 1.1 and 1.2 show the flowchart of the manual system for executing purchases and purchase returns
transactions, respectively.

Figure 1.1 Purchases Flowchart

ALDERSGATE COLLEGE APPLIED AUDITING
SCHOOL OF BUSINESS AND ACCOUNTANCY

Figure 1.2 Purchase Returns

I. Evaluation of Internal Control over Acquisitions

Figure 4.3 Internal Control Questionnaire for Acquisitions

Cycle: Expenditure Class of Transactions: Acquisitions

Yes No NA Remarks
Executing
1. Is there separation between authority,
recording, and custody of
merchandise/supplies purchases?
2. Are steps taken to ensure the best price for
merchandise?
3. Is immediate control established over
merchandise received from vendors?
4. Are receiving reports made out after an
independent count?
5. is a signed receipt obtained from storeroom
on delivery of goods by receiving?
6. Are purchase orders, receiving reports, and
vendors' invoices matched in preparing
vouchers?
7. Are vouchers internally verified for accuracy?
8. Are vouchers approved by authorized
personnel?
ALDERSGATE COLLEGE APPLIED AUDITING
SCHOOL OF BUSINESS AND ACCOUNTANCY

9. Are daily voucher summaries prepared and

agreed to vouchers issued?
Recording
1. Are ail issued vouchers accounted for in
journalizing?
2. Are voucher register entries reviewed for
reasonableness?
3. Are unpaid voucher file and perpetual
inventory records independently maintained?
4. Are there periodic independent reconciliations
of control accounts and subsidiary records?
Custody
1. Are goods stored in locked areas with
restricted access?
2. Are there periodic independent comparisons
of inventory records with goods on hand?

II. Tests of Controls: Acquisitions

The following assertions relate to acquisitions transactions.

General Specific
1. Existence or occurrence 1. Recorded acquisitions are for items that were
acquired.
2. Completeness 2. Acquisitions that occurred are recorded.
3. Rights and obligations 3. Recorded acquisitions are the entity's
purchases and liabilities.
4. Valuation or allocation 4. Acquisitions are recorded for the proper
amounts.
5. Presentation and disclosure 5. Acquisitions are recorded to result in
presentation and disclosure in accordance
with PAS/PFRS.

In many instances, more than one control is required to ensure the validity of an assertion. Because specific
controls may vary with the client, the tests of controls discussed in this section should be viewed as illustrative
only.

The following sections present the controls an entity should have to ensure the propriety of each assertion and
the tests an auditor might perform to determine the effectiveness of the controls on acquisitions transactions.

Discussion:

A. Existence or Occurrence: Recorded acquisitions are for items that were acquired.
Controls
1. Acquisitions should be approved by
authorized personnel. Approval of acquisition
is evidenced by signature on the purchase
order.
2. A voucher should be prepared for the
purchase of goods. This should be supported
by properly executed purchase requisition,
purchase order, receiving report, and vendor's
invoice.
Tests of Controls
1. Auditor should examine the approval
signature.
2. To test this control, the auditor observes the
procedure and examines file of documents. If
the entity does not prepare vouchers, the
auditor should review the entries in the
purchases journal and examine the
documents underlying them for authenticity
ALDERSGATE COLLEGE APPLIED AUDITING
SCHOOL OF BUSINESS AND ACCOUNTANCY

3. The check signer should examine the
supporting documentation and cancel the
documents, making them "paid" or writing the
date and number of the check on the
document.
B. Completeness: Acquisitions that occurred are recorded.
4. Prenumbered receiving reports should be
used and accounted for to determine that a
liability is recorded for all goods received.
5. Vouchers are prenumbered and accounted
for as they are entered in the voucher
register.
C. Rights and Obligations: Recorded acquisitions are the entity's purchases and liabilities.
6. Receiving reports should be prepared by
persons having access only to a blind copy of
purchase order details. Requiring a purchase
order for the recording of all acquisitions will
preclude recording consigned goods as well
as goods ordered for personal use of
employees.
D. Valuation or Allocation: Acquisitions are recorded in the proper amounts.
7. Invoice amounts are verified by a clerk by
reference to the purchase orders and
receiving reports. Mathematical accuracy of
the invoice is also rechecked.
E. Presentation and Disclosure: Acquisitions are recorded to result in presentation and disclosure in
accordance with PAS/PFRS.
8. Require employees to use a chart of accounts
that adequately describes accounts to be
debited. Account coding is assigned by one
person and checked by another.
and reasonableness.
3. The auditor can examine cancellations on the
documents to test this control. If an entity
does not effectively cancel supporting
documents, the auditor should be concerned
that duplicate payment may have been made
and should scan the voucher register for
multiple entries of similar amounts.
4. To test this control the auditor should observe
the procedure and account for the numerical
sequence of the receiving report
5. The auditor should observe procedure and
account for the numerical sequence of the
voucher.
6. To test this control, the auditor should observe
that the procedure is being performed
7. The auditor should examine the voucher for
signature indicating performance.
8. Auditor should examine the chart of accounts.
Also, he or she should examine the signature
of employee performing the checking or
verification.

III. Audit Program for Tests of Controls: Acquisitions Transactions

The following audit program summarizes the audit procedures that auditors may use to test controls on
acquisitions transactions.

Happy Sounds Corporation

Test of Controls: Acquisitions
December 31, 2006

WP Done
Audit Procedures
Ref By Date
1. For a sample of purchases, examine the
related purchase requisition and purchase
order.
2. For a sample of purchases, trace the
transaction to the voucher register and the
perpetual inventory records maintained in
stores.
3. Check vendor invoice for mathematical
ALDERSGATE COLLEGE APPLIED AUDITING
SCHOOL OF BUSINESS AND ACCOUNTANCY

accuracy.
4. Trace posting from the voucher register to the
general ledger.

Possible errors that may result due to control weaknesses over acquisitions transactions follow:

Control Weakness Possible Errors

1. Documentation of purchase transactions
incomplete and inadequate.
2. Documents not properly reviewed approved.
3. Accounting manuals not used.
4. Voucher does not show account distribution
or indication of review.
5. Creditors' statements not examined for
possible errors.
6. Lack of perpetual inventory record.
1. Payments made to vendors for goods and
services not received by client.
2. Unauthorized purchases
a. Payments made for goods received but
not ordered.
3. Error in recording purchases transactions.
4. Error in recording purchase transaction.
5. Undetected errors in recording purchases
transactions.
6. Undetected errors in recording inventory
transaction

IV. Substantive Tests of Transactions: Acquisitions

Assertions Audit Objectives Audit Procedures

I. Existence or Occurrence
II. Completeness
III. Rights and Obligations
IV. Valuation or Allocation
V. Presentation and Disclosure
A. To determine that recorded 1. Examine underlying documents
purchases are for items that were for authenticity and
acquired. reasonableness. Scan voucher
register for large or unusual items.
Inspect acquired property, plant
and equipment. Trace inventory
purchased to perpetual records.
Scan voucher register for duplicate
payments.
B. To determine that purchases 2. Trace a sequence of receiving
that occurred are recorded. reports to entries in the voucher
register. Test cutoff. Account for a
sequence of entries in the voucher
register.
C. To determine that purchases are 3. Trace from invoices to perpetual
the entity's acquisitions and inventory records. Examine
liabilities. vendor's invoices to determine that
goods were purchased.
D. To determine that purchases are 4. Recompute invoices and
recorded for the proper amounts. compare invoice price to purchase
order.
E. To determine that purchases are 5. Check accuracy of accounts on
recorded to result in presentation invoices by reference to chart of
and disclosure in accordance with accounts.
PAS/PFRS.

Discussion of Audit Procedures

1. Examine underlying documents for authenticity and reasonableness. Scan voucher register for
large or unusual items. Inspect acquired property, plant, and equipment Trace inventory
purchased to perpetual records. Scan voucher register for duplicate payments.
ALDERSGATE COLLEGE APPLIED AUDITING
SCHOOL OF BUSINESS AND ACCOUNTANCY

To test the existence of acquisitions transactions in the voucher register, an auditor should examine for selected
transactions, the underlying documents - the voucher, purchase order, receiving report, and vendor's invoice.
The auditor should also physically inspect additions to fixed assets to substantiate their existence and trace
inventory purchases to perpetual records. The auditor can scan the voucher register as well as files of check
copies to them for possible duplicate payments of invoices.

2. Trace a sequence of receiving reports to entries in the voucher register. Test cutoff. Account for
a sequence of entries in the voucher register.

The auditor may select a sequence of receiving reports and vouchers to determine that entries have been made
few them in the voucher register or purchases journal. He or she can perform a cut-off test at year-end to
ascertain that all acquisitions occurring during the year have been recorded.

3. Trace from invoices to perpetual Inventory records; Examine vendor's invoices to determine that
goods were purchased*

The auditor should examine supporting documents to ascertain that goods were not received cm consignment,
that the goods were not delivered to another location, simply that the ordered goods were received. These
supporting documents include the voucher, vendor's invoice, receiving report, purchase order, and purchase
requisition.

4. Recompute invoices and compare invoice price to purchase order.

To ensure that acquisitions are recorded for proper amounts, auditor may select a sample of transactions and
examine the purchase requisition, trace the price to the purchase order, compare the quantity on the invoice with
the quantity on the receiving repent and recalculate the invoice total. The auditor might also choose to perform
the substantive testing of prices paid by tracing prices in published catalogs at the time of the purchase.

5. Check accuracy of accounts on invoices by reference to chart of accounts.

Auditors can review documents underlying entries in the voucher register to determine whether the invoice was
correctly coded and will be properly presented and disclosed in the financial statements. This procedure can be
performed simultaneously with substantive tests of valuation.
ALDERSGATE COLLEGE APPLIED AUDITING
SCHOOL OF BUSINESS AND ACCOUNTANCY

Figure 1.4 Cash Disbursement Processing

I. Evaluation of Internal Control over Cash Disbursements Transactions

Figure 1.5 Internal Control Questionnaire for Cash Disbursements Transactions

Cycle: Expenditure Class of Transactions: Cash Disbursements

Yes No NA Remarks
Executing
1. Are all disbursements (except for petty cash)
made by checks?
2. Are imprinted and prenumbered checks
used?
3. Is a check-protection device used in printing
the check amount?
4. Is each check supported by an approved
voucher?
5. Is supporting documentation mutilated after
payment?
ALDERSGATE COLLEGE APPLIED AUDITING
SCHOOL OF BUSINESS AND ACCOUNTANCY

6. Are two signatures required on each check?

7. Does last check signer mail the check and
remittance advice?
8. Are there prohibitions against issuing checks
to cash or bearer?
9. Is the signing of blank checks prohibited?
10. Is a daily summary of checks prepared and
agreed to checks issued?
Recording
1. Are accounting personnel prohibited from
signing checks?
2. Are daily summaries of checks compared with
check register totals?
3. Are checks recorded in numerical sequence?
Custody
1. Are there periodic independent reconciliations
of bank accounts?

II. Test of Controls: Cash Disbursements Transactions

Auditors are interested in the effect of controls in the financial statements assertions embodied in the cash
disbursements. Auditors address the following assertions when testing cash disbursements:

General Specific
1. Existence or occurrence 1. Recorded cash disbursements occurred.
2. Completeness 2. All cash disbursements made are recorded.
3. Rights and obligations 3. All cash disbursements made are for
obligations of the entity.
4. Valuation or allocation 4. Debits to various accounts and credits to cash
are valued at proper amounts.
5. Presentation and disclosure 5. Cash disbursements are recorded to result in
presentation and disclosure in accordance
with PAS/PFRS.

The following sections present the controls an entity should have to ensure the propriety of each assertion and
the tests an auditor might perform to determine the effectiveness of the controls on cash disbursement
transactions.

Discussion:

A. Existence or Occurrence: Recorded cash disbursements occurred.

Controls Tests of Controls
Authorized individual signs and mails promptly the The auditor may inquire of the check signer and
checks after reviewing documentation. employees who work with him or her about whether
this procedure is followed. The auditor may also
observe if the procedure is being followed.
A review should be made by a person not responsible The auditor may inquire about whether this procedure
for handling disbursements to determine that checks is being followed or may examine the outstanding
are processed on a timely basis. checks list to determine that checks are being
processed promptly.
B. Completeness: All cash disbursements made are recorded.
Checks should be prenumbered and accounted for to To test this control, the auditor should observe whether
ensure that all checks that were written are entered in the employee who prepares the check register
the check register. accounts for the sequence of the checks.
ALDERSGATE COLLEGE APPLIED AUDITING
SCHOOL OF BUSINESS AND ACCOUNTANCY

An employee who does not handle cash The auditor observes that the employee who prepares
disbursements and cash receipts prepares the bank the reconciliation does not handle cash receipts or
reconciliation. disbursements. In addition, the auditor inspects the
reconciliation.
C. Rights and Obligations: All cash disbursements made are for obligations of the entity.
Check signer who is independent of voucher 5. The auditor tests this control by inquiring about the
preparation should examine the supporting segregation of duties and observing whether
documentation before signing checks to determine that separation really exists. He or she can also inquire
the payment is for an obligation of the entity. about the check signer's procedures for reviewing
documents in support of cash disbursement and may
observe the check signer performing these
procedures.
D. Valuation or Allocation: Debits to various accounts and credits to cash are valued at proper amounts.
Amounts (including discounts taken) and calculations To test this control, the auditor should observe the
on vendors' invoices are independently verified. procedure. He or she can examine signatures on paid
Employee signs the voucher after verification is done. invoices.

E. Presentation and Disclosure: Cash disbursements are recorded to result in presentation and disclosure in
accordance with PAS/PFRS.
Chart of accounts adequately describes accounts to be The auditor can test this control by observing the
used, and account coding is assigned by one person procedure. He can also examine the signatures of the
and checked by another. employees performing the review account coding.

III. Audit Program for Tests of Controls: Cash Disbursements Transactions

In summary, typical audit procedures employed by the auditor in testing disbursement for the period under
consideration include the following:

Happy Sounds Corporation

Test of Control: Cash Disbursements
December 31, 2006

WP Done
Audit Procedures
Ref By Date
1. Prove the arithmetical accuracy of the cash
disbursements record and trace postings to
the general ledger.
2. Compare paid bank checks with the cash
disbursement records.
3. Account for ail checks.
4. Reconcile recorded disbursements with the
bank statement.
5. Examine supporting documents.
6. Review cash disbursements records for
unusual items.

Possible errors that may result due to control weaknesses over payments to vendors follow:

Control Weakness Possible Errors

1. Documentation of cash disbursements is
inadequate or incomplete.
2. Payments are not always based on
disbursements
3. Access to disbursement checks not limited
1. Unauthorized disbursements
2. Errors in recording cash approved vouchers.
3. Unauthorized disbursement
ALDERSGATE COLLEGE APPLIED AUDITING
SCHOOL OF BUSINESS AND ACCOUNTANCY

and responsibility not fixed.

4. Disbursement checks mailed to vendors by
personnel in accounts payable section.
5. Checks signed in advance.
6. Documents not effectively canceled upon
payment of vendors' invoices.
4. Unauthorized disbursement
5. Unauthorized disbursement
6. Unauthorized disbursement

IV. Substantive Tests of Transactions: Cash Disbursements

Assertions Audit Objectives Audit Procedures

I. Existence or Occurrence A. To determine that recorded cash 1. Examine paid checks for
disbursements occurred. appropriate endorsements.
Examine documents underlying
payments.
II. Completeness B. To determine that all cash 2. Reconcile cash disbursements
disbursements made are recorded. per books with cash disbursements
per the bank. Prepare or test bank
reconciliation.
III. Rights and Obligations C. To determine that all cash 3. Examine underlying documents.
disbursements made were the
entity's obligations.
IV. Valuation or Allocation D. To determine that debits to 4. Recalculate invoices paid.
various accounts and credits to
cash are valued at proper amounts.
V. Presentation and E. To determine that cash 5. Check accuracy of accounts on
Disclosure disbursements transactions are invoices by reference to chart of
recorded to result in presentation accounts.
and disclosure in accordance with
PAS/PFRS.

Discussion of Audit Procedures

Examining Documents Underlying Cash Disbursements

Auditors examine the documents underlying cash disbursements such as receiving reports, purchase order,
purchase requisitions, and vendors' invoice for consistency with each other and with the entry in the cash
disbursements journal. Approvals on these documents provide evidence that the transaction occurred and that
the payment was the entity's debt. Checks with appropriate endorsements and which have been paid by the
bank provide evidence about the existence of the transactions. The auditor likewise recomputes the discount
taken to verify proper valuation of cash disbursement transactions. Accuracy of accounts charged may also be
verified by the auditor by reference to the chart of accounts.

Reconciling Cash Disbursements per Books to Cash Disbursements per Bank

The auditors may prepare a proof of cash which reconciles cash disbursements as recorded on the bank with
cash disbursement recorded by the bank.

Preparing or Testing Reconciliation

The auditors can prepare bank reconciliation or test a bank reconciliation prepared by the client for an interim
period. When preparing the bank reconciliation, the auditor should receive the bank sentence directly from the
bank. If the bank statement has been opened by the client's employees, the auditor generally compares the
ALDERSGATE COLLEGE APPLIED AUDITING
SCHOOL OF BUSINESS AND ACCOUNTANCY

individual entries on it with the documents returned by the bank and looks for erasures, changes or other
irregularities on the statement.

Posttest

1. Describe the processing of transactions in the expenditure cycle.

2. Identify major risks of misstatements in the expenditure cycle.

3. Identify the financial statement assertions for acquisitions transactions.

4. When an entity's controls are ineffective for payments, what potential misstatements could arise in the
financial statements?

5. Compare a vendor's statement to a vendor's invoice and describe how an auditor might use each.

6. The following questions relate to auditing the expenditure cycle. Choose the best response.

A. An auditor usually examines receiving reports to support entries in the:

a. voucher register and sales returns journal.

b. sales journal and sales returns journal.
c. voucher register and sales journal.
d. check register and sales journal.

B. An internal control questionnaire indicates that an approved receiving report is required to

accompany every check request for payment of merchandise. Which of the following procedures
provides the greatest assurance that this control is operating effectively?

a. Select and examine canceled checks, and ascertain that the related receiving reports are
dated no earlier than the checks.
b. Select and examine canceled checks, and ascertain that the related receiving reports are
dated no later than the checks,
c. Select and examine receiving reports, and ascertain that the related canceled checks are
dated no earlier than the receiving reports.
d. Select and examine receiving reports, and ascertain that the related canceled checks are
dated no later than the receiving reports.

C. The accounts payable department receives the purchase order to accomplish all the following
except:

a. comparing the invoice price to the purchase order price.

b. ensuring that the purchase had been properly authorized.
c. ensuring that the goods had been received by the party requesting them.
d. comparing the quantity ordered to the quantity purchased.

AICPA Adapted

7. The following questions relate to internal control for acquisitions and disbursements. Choose the best
response.

A. For effective internal control, which of the following individuals should be responsible for mailing
signed checks?

a. Receptionist
ALDERSGATE COLLEGE APPLIED AUDITING
SCHOOL OF BUSINESS AND ACCOUNTANCY

b. Treasurer
c. Accounts payable clerk
d. Payroll clerk

B. If internal control is properly designed, the same employee should not be permitted to:

a. sign checks and cancel supporting documents.

b. receive merchandise and prepare a receiving report.
c. prepare disbursement vouchers and sign checks.
d. initiate a request to order merchandise and approve merchandise ordered.

C. In a properly designed accounts payable system, a voucher is prepared after the invoice, purchase
order, requisition, and receiving report have been verified. The next step in the system is to

a. cancel the supporting documents.

b. enter the check amount in the check register.
c. approve the voucher for payment.
d. post the voucher amount to the expense ledger.

AICPA Adapted
8. The following questions relate to the expenditure cycle. Choose the best response.

A. You are auditing the December 31, 2005, accounts payable balance of one of your firm's divisions. The
division controller's office has provided you with a schedule listing the creditors and the amount owed to
each at December 31, 2005. Which of the following audit procedures would be your best choice for
determining that no individual account payable has been omitted from the schedule?

a. Send confirmation requests to a randomly selected sample of creditors listed on the schedule.
b. Send confirmation requests to creditors that are listed on the schedule but not listed on the
corresponding December 31, 2004, schedule.
c. Examine support for selected January 2006 payments to creditors, ascertaining that those
relating to 2006 are not on the schedule.
d. Examine support for selected January 2006 payments to creditors, ascertaining that those
relating to 2005 are on this schedule.

B. A company uses an automated accounts payable system to process its disbursements. An internal
auditor wants to reconcile the accounts payable balance listed in the firm's month-end trial balance
report to the master accounts payable file, which is stored on magnetic tape. Which of the following
application audit techniques would be most appropriate to this task?

a. Use general-purpose audit software to recompute the file balance.

b. Review a listing of the accounts payable program source code.
c. Develop and use accounts payable data.
d. Prepare an analytic audit flowchart of the automated accounts payable system.

C. A preliminary survey of the purchasing function indicates the following:

 Department managers initiate purchase requests, which must be approved by the plant
superintendent.
 Purchase orders are typed by the purchasing department by using the prenumbered and controlled
forms.
 Buyers regularly update the official vendor listing as new sources of supply become known.
 Rush orders can be placed with a vendor by telephone but must be followed by a written purchase
order before delivery can be accepted.
 Vendor invoice payment requests must be accompanied by a purchase order and a receiving
report.
ALDERSGATE COLLEGE APPLIED AUDITING
SCHOOL OF BUSINESS AND ACCOUNTANCY

One possible fault of this system is that:

a. purchases can be made at prices higher than normal from a vendor controlled by a buyer.
b. unnecessary supplies can be purchased by department managers.
c. payment can be made for supplies not received.
d. payment can be made for supplies received but not ordered by the purchasing department.

D. Which of the following controls could be used to detect bank deposits that are recorded but never
made?

a. Establishing accountability for receipts at the earlier possible time.

b. Linking receipts to other internal accountabilities (i.e., collections to either accounts receivable
or sales).
c. Consolidating cash receiving points.
d. Having a third party perform bank reconciliations.

E. The treasurer makes disbursements by check and reconciles the monthly bank statements to
accounting records. Which of the following best describes the control impact of this arrangement?

a. Internal control will be enhanced because these are duties a treasurer should perform.
b. The treasurer will be in a position to make and conceal unauthorized payments.
c. The treasurer will be able to make unauthorized adjustments to the cash account.
d. Controls will be enhanced because the treasurer will have two opportunities to discover
inappropriate disbursements.

F. To minimize the risk that agents in the purchasing department will use their positions for personal gain,
the organization should:

a. rotate purchasing agent assignments periodically.

b. request internal auditors to confirm selected purchases and accounts payable.
c. specify that all items purchased must pass reviews of value per unit of cost.
d. direct the purchasing department to maintain records on purchase prices paid, with review of
such being required each six months.

G. In an audit of a purchasing department, which of the following would ordinarily be considered a risk
factor?

a. Purchase specifications are developed by the department requesting the material.

b. Purchases of certain types of items are made against blanket or open purchase orders.
c. Purchases are made from parties related to buyers or other company officials.
d. Purchases are not rotated among suppliers included on an approved vendor list.

IIA Adapted

9. These questions pertain to basic features of internal control over acquisitions and cash disbursements
transactions. Choose the best response.

A. A client erroneously recorded a large purchase twice. Which of the following internal accounting control
measures would be most likely to detect this error in a timely and efficient manner?

a. Footing the purchases journal.

b. Reconciling vendors' monthly statements with subsidiary payable ledger accounts.
c. Tracing totals from the purchases journal to the ledger accounts*
d. Sending written quarterly confirmations to all vendors.
ALDERSGATE COLLEGE APPLIED AUDITING
SCHOOL OF BUSINESS AND ACCOUNTANCY

B. For effective internal control purposes, which of the following individuals should be responsible for
mailing signed checks?

a. Receptionist
b. Treasurer
c. Accounts payable clerk
d. Payroll clerk

C. The accounts payable department receives the purchase order form to accomplish all of the following
except:

a. Compare invoice price to purchase order price.

b. Ensure the purchase had been properly authorized.
c. Ensure the goods had been received by the party requesting the goods.
d. Compare quantity ordered to quantity purchased.

AICPA Adapted

10. These questions involve the study and evaluation of internal control over acquisitions and cash
disbursements transactions. Choose the best response.

A. In examining cash disbursements, an auditor plans to choose a sample using systematic selection with
a random start The primary advantage of such a systematic selection is that population items.

a. Which include irregularities will not be overlooked when the auditor exercises compatible
reciprocal options.
b. May occur in a systematic pattern, thus making the sample more representative.
c. May occur more than once in a sample.
d. Do not have to be prenumbered in order for the auditor to use the technique.

B. A client's materials-purchasing cycle begins with requisitions from user departments and end with the
receipt of materials and the recognition of a liability. An auditor's primary objective in reviewing this cycle
is to:

a. Evaluate the reliability of information generated as a result of the purchasing process.

b. Investigate the physical handling and recording of unusual acquisitions of materials.
c. Consider the need to be on hand for the annual physical count if this system is not functioning
properly.
d. Ascertain that materials said to be ordered, and paid for are on hand.

11. An auditor discovered the following matters while performing tests of controls.

 An invoice for goods received from PJ Supply Company for P400 was paid, but the client had never
ordered the goods.
 A vendor's invoice was not paid within the discount period because the receiving report was lost.
 A vendor's invoice for hollow steel casing windows was paid. The goods were received, but vinyl
insulated windows had been ordered.
 A vendor was overpaid because the invoice was incorrectly footed.
 A purchase of raw materials was recorded as a purchase of supplies.
 An obligation for insurance was not paid because the voucher that was prepared was never recorded.

Required:

a. What control would have prevented or detected each of the misstatements?

b. What test should the auditor perform to test the control?
ALDERSGATE COLLEGE APPLIED AUDITING
SCHOOL OF BUSINESS AND ACCOUNTANCY

c. To which financial statement assertion does the misstatement relate?

12. The following questions deal with internal control over acquisitions and cash disbursements. Choose the
best response.

A. To avoid potential errors and irregularities, a well-designed internal control structure in the accounts
payable area should include a separation of which of the following functions?

a. Invoice verification and data entry into the computer.

b. Invoice verification and merchandise ordering.
c. Physical handling of merchandise received and preparation of receiving reports.
d. Check signing and cancellation of payment documentation.

B. Which of the following is a standard internal control for cash disbursements?

a. Checks should be signed by the controller and at least one other employee of the company.
b. Checks should be sequentially numbered and the numerical sequence should be accounted
for by the person preparing bank reconciliations.
c. Checks and supporting documents should be marked "paid" immediately after the check is
returned with the bank statement.
d. Checks should be sent directly to the payee by the employee who prepares documents that
authorize check preparation.

13. The following are errors or irregularities that have occurred in Fresh Foods Grocery Store, a retail and
wholesale grocery company.

 The incorrect price was used on sales invoices for billing shipments to customers because the wrong
price was entered into the computer file.
 A vendor's invoice was paid twice for the same shipment. The second payment arose because the
vendor sent a duplicate copy of the original two weeks after the payment was due.
 Employees in the receiving department took sides of beef for their personal use. When a shipment of
meat was received, the receiving department filled out a receiving report and forwarded it to the
accounting department for the amount of goods actually received. At that time, two sides of beef were
put in an employee's pickup truck rather than in the storage freezer.
 During the physical count of inventory of the retail grocery, one counter wrote down the wrong
description of several products and miscounted the quantity.
 A salesperson sold an entire carload of lamb at a price below cost because she did not know the cost of
lamb had increased in the past week.
 On the last day of the year, a truckload of beef was set aside for shipment but was not shipped.
Because it was still on hand the inventory was counted. The shipping document was dated the last day
of the year so it was also included as a current-year sale.

Required:

a. For each error or irregularity, identify one or more types of controls that were absent.
b. For each or irregularity, identify the internal control objectives that have not been met.
c. For each error or irregularity, suggest a control procedure to correct the deficiency.

14. The following control procedures over purchases and cash disbursements transactions are prescribed
by the Love Company:

 Approved purchase order for each purchase

 Prenumbered receiving report for goods received
 Signed receipt from storeroom on acceptance of goods
 Matching of voucher with vendor's invoice
ALDERSGATE COLLEGE APPLIED AUDITING
SCHOOL OF BUSINESS AND ACCOUNTANCY

 Approved voucher for each check

 Cancellation of voucher on payment
 Review of voucher and supporting documentation by check signers
 Internal verification of voucher accuracy
 Locked storerooms for inventory
 Periodic reconciliation of inventory control and perpetual inventory records
 Accounting for all prenumbered checks in journalizing
 Periodic independent bank reconciliations
 No checks payable to cash or bearer
 Approved purchase requisition for each purchase order
 Review of purchase requisitions for reasonableness

Required:

a. Indicate the function served by each procedure.

b. Identify an error on irregularity that may be prevented or detected by the control procedure.
c. Indicate a compliance test that may be performed to determine whether the control procedure above is
operating as prescribed.

15. Long, CPA, has been engaged to examine and report on the financial statements of Maybelle
Corporation, During the review phase of the study of Maybelle's system of internal accounting control
over purchases, Long was given the document flowchart below for purchases.

Required:

a. Identify the procedures, relating to purchase requisitions and purchases orders, that Long would expect
to find if Maybelle's system of internal accounting control over purchases is effective. For example,
purchase orders are prepared only after giving proper consideration to the time to order and quantity to
order. Do not comment on the effectiveness of the flow of documents as presented in the flowchart or
on separation of duties.
b. What are the factors to consider in determining
1. The time to order?
2. The quantity to order?
AICPA Adapted
ALDERSGATE COLLEGE APPLIED AUDITING
SCHOOL OF BUSINESS AND ACCOUNTANCY

16. The following questions related to cash disbursements are included on the internal control questionnaire for
Summer Company.

 Do different people sign checks and reconcile the bank statement?

 Are all supporting documents effectively canceled when checks are signed?
 Are checks mailed promptly after they are signed?
 Are cash discounts to which the entity is entitled taken?
 Are a vendor's invoice, receiving report, and purchase order assembled and filed with a voucher in
support of cash payments?
 Does someone independent of accounts payable reconcile monthly vendor's statements to vouchers
included as liabilities at the end of the period?

Required:

a. Identify the financial statement assertion to which the control relates,

b. Identify a potential misstatement that could arise from the absence of the control.
c. Identify the tests of controls an auditor might perform for controls that exist.
d. Indicate the substantive tests of transactions an auditor might perform after the test of controls
if the control is ineffective.
17. You have completed an audit of activities within the purchasing department of Steven Company. The
department employs thirty buyers, seven supervisors, a manager, and clerical personnel. Purchases total about
P500 million a year. Your audit disclosed the following:

 The company has no formal rules on conflicts of interest. Your analysis produced evidence that one of
the thirty buyers in the department owns a substantial interest in a major supplier and procures supplies
averaging P50, 000 a year from that supplier. The prices charged by the supplier are competitive.
 Buyers select proposed sources without submitting the lists of bidders for review. Your tests disclosed
no evidence that higher costs were incurred as a result of that practice.
 Buyers who originate written requests for quotations from suppliers receive the suppliers' bids directly
from the mailroom. In your test of one hundred purchases based on competitive bids, you found that in
seventy-five cases the low bidders were awarded the purchase orders.
 4> Purchase requisitions received in the purchasing department from other departments in the company
must be signed by persons authorized to do so. Your examination of 200 requests disclosed that three,
all for small amounts, were not properly signed. The buyer who had issued all three orders honored the
requests because he misunderstood the applicable procedure. The clerical personnel charged with
reviewing such requests had given them to the buyer in error.

Required:

For each of the four conditions, provide the following information.

a. What risk, if any, is incurred if each condition is permitted to continue?

b. What control, if any, would you recommend to prevent continuation of the condition described?

AICPA Adapted