8-1

Chapter 5
Acquisition and Expenditure Cycle

“Show those numbers to the damn auditors and I'll throw you out the $%*@@
window.”----(Buddy Yates, director of WorldCom, Inc. general accounting, to an
employee asking for an explanation of a large accounting discrepancy).
 8-2

Presentation Outline
I. The Expenditure Cycle
II. Expenditure Cycle Risk, Control
Procedures, and Testing
III. Audit Evidence in Management Reports
and Data Files
IV. Other Accounts in Cycle
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I. The Expenditure Cycle
A. Requisitioning in Stores
B. Order Processing in Purchasing
C. Receiving
D. Delivery Acknowledgement in Stores
E. Invoice Verification in Purchasing
F. Accounts Payable Prepares the Voucher
Package
G. Cash Disbursements
H. General Ledger
I. Internal Audit
 8-4
A. Requisitioning in Stores

❖Requests for purchases

originate outside the
Prepare
purchasing department.
Requisition
❖Purchase requisitions
arise in stores or other
Requisition departments.
Processing Purchase
Database
❖Requisitions should be
approved in the
originating department.
❖Purchasing has access to
the requisition thru the
purchase database.
 B. Order Processing in Purchasing 8-5
❖ Purchase requisitions may
Prepare be overridden due to a
Order
lack of funds, improper
Purchase
Requisition authorization by the
Select requesting department,
Vendor
etc.
❖ Purchasing selects a
vendor using an approved
Retrieve Order vendor list or a bidding
Purchase Purchase Processing
Requisition Database process.
❖ Accounts payable, the
Purchase
requesting department,
Order and receiving all have
access to the purchase
order through the
purchase database.
To Vendor
From Vendor
C. Receiving 8-6

❖ Receiving accesses the

Match to Purchase
Delivery
Purchase Order
purchase order and matches
Order it with the vendor delivery.
❖ Receiving only accepts
Retrieve
Purchase deliveries for which there is
Order
an existing purchase order.
❖ Blind counts are often used to
force counters to actually
Purchase
Database count the items received.
❖ A receiving supervisor later
verifies the quantity against
Blind Order
Count
Enter
Receipt Processing the purchase order.
❖ Stores has access to this
report thru the purchase
Delivery
To Stores database.
 8-7
D. Delivery Acknowledgement in Stores
From
Receiving

Delivery
Receiving ❖ The stores department
Match to Report
Delivery acknowledges receipt of
the delivery on the
Retrieve receiving report in the
Receiving purchase database.
Report
❖ Purchasing and
accounts payable have
Goods access to the
Receipt
Processing
Purchase
Database
acknowledged report
thru the purchase
database.
 8-8
E. Invoice Verification in Purchasing
From Vendor
❖ Purchasing uses the
purchase database to
compare the purchase order,
Vendor acknowledged receiving
Invoice
report, and vendor invoice
for any discrepancies.
❖ Purchasing authorizes the
Purchase Invoice
Database Verification invoice for payment once
they are satisfied that the
invoice is correct per the
Vendor
Invoice
order and what was
received.

To Accounts
Payable
 F. Accounts Payable Prepares the Voucher Package
8-9
From Purchasing
❖ The purchase
requisition, purchase
Vendor
Invoice order, acknowledged
receiving report, and
Prepare approved vendor
Voucher
Purchase
Requisition
invoice provide the
Purchase
support for the
Order Accounts preparation of a
Voucher Payable
Receiving
Processing or voucher.
Report
Voucher
Register ❖ The voucher serves to
summarize the
Retrieve Voucher Voucher Journal
Documents Check Voucher purchase for entry on
the records as a
liability.
Purchase To General
Database To Cash Ledger
Disbursements
 G. Cash Disbursements 8-10
Voucher
Sign Cancel
From Accounts
Payable
Voucher
Check
Checks Voucher
after ❖Cash
Signing
Check
disbursements
Voucher Voucher received the
Check
voucher
package and
Post
check for
Check
Register signing.
❖Cash
disbursements
Voucher Control
maintains a
Check Total check register
and forwards a
journal entry to
Forward to To General general ledger.
Payee Ledger
 H. General Ledger 8-11

❖General ledger
Control Journal
Total Voucher
From Cash From Accounts
Disbursements Payable receives the journal
entry from accounts
Compare
Post payable (Debit –
Accounts payable
General
Ledger
and Credit – Cash)
General
Processing Ledger and compares it to
the control total for
Control
Total
cash disbursements.
Journal
Voucher
❖The journal entry is
then posted into the
general ledger.
 8-12
I. Internal Audit
Bank
Statement
From Cancelled
Bank Checks An independent
reconciliation
of the bank
Bank
Reconciliation
Check account is
Register
performed by
Bank
internal audit.
Reconciliation

Bank
Statement

Cancelled
Checks
 8-13

II. Expenditure Cycle Risk, Control

Procedures, and Testing
A. Inherent Risks
B. Cost and Expense Capers
C. Expenditure Control Procedures
D. Assertions of Classes of Transactions and Events
for the Period: Acquisition and Expenditure
Cycle
E. Direction of Tests
F. The Completeness Assertion
G. Purchase Cutoffs
 8-14

A. Inherent Risks
❖Unrecorded liabilities – may arise when invoice
verification has not been completed for what should be
a liability.
❖Noncancelable purchase agreements – drop in market
prices below agree contractual price should result in
loss recognition.
❖Capitalizing expenses – expenditures with no future
value may be capitalized when they should be
expensed.
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B. Cost and Expense Capers

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C. Expenditure Control Procedures
• Information processing controls
– Compare quantities against receiving report and purchase order
– Compare prices against purchase order (i.e., quoted price)
– Mathematically verify vendor's invoice
– Determine when to pay invoice and prepare VOUCHER
• Segregation of duties
– AUTHORIZATION of the purchase is done by the purchasing department.
– Custody of the inventory item(s) is held by the receiving department and,
ultimately, the requesting department.
– Transactions are recorded by general accounting (control account) and accounts
payable department (subsidiary accounts) or vouchers payable
• Physical controls
– Prepare a receiving report upon initial receipt of inventory
– Count and verify inventory quantities upon delivery to the inventory
warehouse
– Restrict access to inventories by keeping them in a secured location
• Performance reviews
– Compare purchases data to data from previous years or expected
purchases data
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D. Assertions
of Classes of
Transactions
and Events
for the
Period:
Acquisition
and
Expenditure
Cycle
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E. Direction of Tests
 8-19

F. The Completeness Assertion

• Search for Unrecorded Liabilities
– Inquire of client about their procedures
– Scan open purchase order file
– Examine all UNMATCHED VENDOR
STATEMENTS/INVOICES
– Examine all UNMATCHED RECEIVING REPORTS
occurring near year-end
– Confirm A/P with NORMAL SUPPLIERS (even those
with zero balances)
– Review CASH DISBURSEMENTS occurring after
year-end
 8-20

G. Purchase Cutoffs
• Verify CUT-OFFs for purchases
– Examine Receiving Reports and Vendor Sales
Invoices occurring around year-end to ensure
inventory received is included in the
appropriate period.
 8-21

III. Audit Evidence in Management

Reports and Data Files
A. Open Purchase Orders
B. Unmatched Receiving Reports
C. Unmatched Vendor Invoices
D. Accounts (Vouchers) Payable Trial
Balance
E. Purchases Journal
F. Fixed Asset Reports
 8-22

A. Open Purchase Orders

❖Purchase orders are open from the time they
are issued until goods are received.
❖Auditors can find evidence of losses on
purchase commitments in this file (i.e.,
market prices are below price in purchase
order).
 8-23

B. Unmatched Receiving Reports

Auditors can inspect unmatched receiving

report file to determine whether the
company has material unrecorded liabilities
on the financial statement date.
 8-24

C. Unmatched Vendor Invoices

Auditors can inspect unmatched vendor
invoice file and compare it to the
unmatched receiving report file to
determine whether the company has
material unrecorded liabilities on the
financial statement date.
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D. Accounts (Vouchers) Payable

Trial Balance
❖The trial balance is a list of payable amounts by
vendor, and the sum should agree with the
accounts payable control account.
❖Some organizations have a trial balance of
individual unpaid vouchers rather than vendor
names.
❖Search for unrecorded liabilities should emphasize
small and zero balances, especially for regular
vendors.
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E. Purchases Journal
Purchases can be scanned for purchasing
patterns indicating error or fraud:
❖Purchase with unapproved vendors
❖Purchases to multiple companies at the
same address
❖Duplicate payments
❖Vendors whose address matches an
employee
 8-27

F. Fixed Asset Reports

Information for depreciation calculation (cost,
useful life, method salvage) can be used for
the audit of depreciation on a sample basis
or by computer applications to recompute
all depreciation.
 8-28

IV. Other Accounts in Cycle

A. Accrued Liabilities v. Accounts Payable
B. Auditing Accrued Liabilities and Prepaid
Expenses
C. Account Analysis for Prepaid Expenses
D. Auditing Property Plant and Equipment
E. Sample PP&E and Depreciation
Document
 8-29

A. Accrued Liabilities v. Accounts

Payable
• Major differences between ACCRUED Liabilities
and ACCOUNTS PAYABLE
– Examples include INTEREST, PROPERTY TAXES,
WAGES, and INCOME TAXES PAYABLE
– These payables are not normally INVOICED or
EVIDENCED by the RECEIPT OF GOODS
• These differences may make it more difficult to
detect UNRECORDED ACCRUALS
 8-30

B. Auditing Accrued Liabilities and Prepaid

Expenses
• Agree balances to PRIOR YEAR WORKPAPERS
• Verify PAYMENTS
• Examine UNDERLYING AGREEMENTS
• RECALCULATE amounts
– Agree EXPENSE ACCOUNTS to trial balance
• Search for UNRECORDED ACCRUALS
– Review CASH DISBURSEMENTS at year-end
– Look for expected accruals at other stages of the audit
(BONDS, NOTES, employees paid on 15th, etc.)
• ANALYTICAL PROCEDURES
 8-31
C. Account Analysis for Prepaid Expenses – Exhibit 8.5
 8-32

D. AUDITING PROPERTY, PLANT, AND

EQUIPMENT
• GENERAL APPROACH
– Small number of transactions
• Relatively high dollar transactions
– Authorization of Transactions (Board of Directors)
takes on added importance.
– Less concern for ACCESS to ASSETS
– More concerned with UNRECORDED DISPOSALS
 8-33

D. AUDITING PROPERTY, PLANT, AND

EQUIPMENT (Continued)
• Agree balances to prior year documentation
• PURCHASES OF PPE
– VOUCH to INVOICE or COST RECORDS
– Inspect TITLE
– VOUCH to BOARD MINUTES
• EXPENDITURES SUBSEQUENT TO ACQUISITION
– VOUCH to INVOICE and WORK DESCRIPTIONS
– Consider propriety of classification (EXPENSE or CAPITALIZE)
 8-34

D. AUDITING PROPERTY, PLANT, AND

EQUIPMENT (Continued)
• DISPOSAL OF PPE
– VOUCH from PPE to BOD MINUTES (AUTHORIZATION)
– Vouch to cash receipts journal and validated deposit slip
– Recalculate gain/loss
– TRACE from BD MINUTES to PPE for disposals (COMPLETENESS)
• Look for unrecorded disposals
– Agree balances to PRIOR YEAR WORKPAPERS
– Examine insurance policies, property tax records, etc.
– PHYSICALLY INSPECT or CONFIRM fixed assets
• Both existing and newly-acquired items
• Confirm assets LEASED to others under capital leases
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D. AUDITING PROPERTY, PLANT, AND

EQUIPMENT (Continued)
• DEPRECIATION EXPENSE
– Recalculate using USEFUL LIFE, SALVAGE VALUE,
COST, and METHOD (VA)
– Evaluate REASONABLENESS of USEFUL LIFE,
SALVAGE VALUE, etc.
– Is depreciation consistent with COMPANY POLICY
(half year conventions)?
• LEASE AGREEMENTS
– Verify proper treatment (Capitalized or Operating)
– Ensure disclosure in footnotes is appropriate
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E. Sample PP&E and Depreciation Documentation

 8-37

Summary
❖Segregation of Duties in Expenditure Cycle
❖Risk and Testing in Expenditure Cycle
❖Searching for Unrecorded Liabilities
❖Audit of Property, Plant & Equipment