CHAPTER 14

Accounts Payable and

Other Liabilities

Review Questions

14-1 Overstated earnings are associated with understated liabilities. To overstate earnings causes an
overstatement of owners' equity. An overstatement of owners' equity must be accompanied by an
understatement of liabilities or an overstatement of assets—otherwise the balance sheet totals would
not be in agreement. As a specific example, a year-end cutoff error could cause an incoming
shipment of merchandise on December 31 to be included in inventory but not to be recorded as a
liability. The result would be overstated earnings and owners' equity offset by understated liabilities.
In more general terms we can say that many transactions involve debits to expense accounts and
credits to liability accounts. If such a transaction is not recorded at all, the earnings will be overstated
and the liabilities understated.

14-2 The correct answer is (c)—overstatement of owners' equity. Lawsuits against CPA firms alleging
negligence by the auditors leading to losses by stockholders or creditors almost always involve an
overstatement of owners' equity accompanied by an overstatement of assets or understatement of
liabilities or both. Thus, the financial statements give a misleading picture of health and solvency,
and persons who contribute capital to the business sustain losses because of their reliance upon overly
optimistic financial statements.

14-3 The employee who seeks to conceal fraud by deliberately omitting the recording of a large transaction
would choose a transaction creating a liability rather than one creating an asset. The prior theft of
assets by the employee means that total assets on hand are less than the total of liabilities and owners'
equity. Failure to record a transaction that creates a liability of the same dollar amount as the theft
would cause total assets to equal total recorded liabilities plus owners' equity. The understatement of
liabilities conceals the shortage of assets resulting from the theft.

14-4 Adjustments proposed by the independent auditors more often than not have the effect of reducing
recorded earnings for the following reasons. First, management is normally under some degree of
pressure to report higher earnings. Earnings improvement pleases stockholders, reassures creditors,
facilitates financing, and permits larger bonuses and other compensation. Consequently, management
has an incentive to interpret every transaction in the most favorable light. There is a tendency to
minimize bad news, and to postpone recognition of losses. The auditors may need to make
downward adjustments in earnings and owners' equity to offset this optimistic bias on the part of
management. A second reason is that the legal liability of auditors arises from overstatement of
earnings, owners' equity, and assets, and understatement of liabilities. Lawsuits against CPA firms
almost never arise because of understated earnings.

14-5 The auditors are concerned about possible understatement of liabilities, whereas their concern in the
audit of assets is the possibility of overstatements. Also, in the audit of liabilities, the auditors

Solutions Manual, Chapter 14, Page 1 of 14

Copyright © 2022 McGraw Hill. All rights reserved. No reproduction or distribution without the prior written consent of
McGraw Hill.
 seldom have problems with respect to valuation; while much of the work in the audit of assets deals
with the propriety of asset valuations.

14-6 For accounts payable, the auditors will find in the client's possession such externally created
evidence as vendors' invoices and vendors' monthly statements that substantiate the accounts payable.
The only such external evidence is normally the customer's purchase order.

14-7 The official who signs checks should stamp or perforate the voucher and supporting documents so
that they could not be presented to support payment a second time. In an electronic system, controls
to avoid duplicate payments should be included—e.g., controls allowing an electronic receiving
report to only support one payment, preventing the payment of a vendor’s invoice with the same
invoice number as one previously paid, etc.

14-8 Before recording a vendor's invoice as an approved liability, the accounts payable department should
determine whether (a) the goods listed on the invoice were ordered and received, (b) quantities and
condition of goods conformed with specifications, (c) prices, credit terms, and shipment charges
conformed with the purchase agreement, and (d) all computations involved are accurate.

14-9 Major responsibilities of the accounts payable department are the verification of invoices, distribution
of charges to ledger accounts, preparation of journal entries summarizing the month's transactions,
and the maintenance of subsidiary records.

14-10 Proof of extensions and footings on invoices and the review of prices should be evidenced by entering
on the voucher the date of the verification and the signature of the responsible employee.

14-11 The approval of an invoice for payment is the more significant step in establishing strong internal
control over accounts payable transactions. Once an invoice has been approved for payment, the
issuance of a check is very largely an automatic process. If improper cash disbursements are to be
avoided, invoices must not be approved for payment until all aspects of the purchase transaction have
been verified.

14-12 The use of serial numbers as an internal control device is applicable to purchase orders, receiving
reports, vendors' invoices, vouchers, remittance advices, debit and credit memoranda, checks, and
virtually all other documents in regular use in the accounts payable operation.

14-13 Recording invoices at the net amount will clearly disclose any failure to process an invoice within the
discount period, since the extra payment required must be charged to a "Discounts Lost" expense
account.

14-14 Recording of invoices as liabilities prior to receipt of goods suggests lack of internal control and
unsatisfactory procedures for verification of invoices. The auditors should investigate fully the
reasons for this situation. If the accounts payable department does not verify receipt of the goods
before approving an invoice, what assurance is there that the company receives the goods it pays for?
The auditors should ascertain the disposition of the receiving report when the shipments in question
arrived, and whether the invoices were paid before receipt of goods. One possible explanation is that
a year-end adjusting entry was made to include goods in transit before the year-end cutoff. On the
other hand, the company may be guilty of careless processing of invoices.

14-15 By vouching entries in selected creditors' accounts back through the journals to original documents,
the auditors acquire a firsthand knowledge of internal control in use. They may find that recording
practices and internal control procedures differ significantly from those described by internal control
documentation.

Solutions Manual, Chapter 14, Page 2 of 14

Copyright © 2022 McGraw Hill. All rights reserved. No reproduction or distribution without the prior written consent of
McGraw Hill.
14-16 The auditors should compute the ratio of cash discounts earned to total purchases for the period. This
ratio should be compared with ratios prevailing in prior years, and any significant variations fully
investigated.

14-17 No, the confirmation of accounts payable is not as useful and important an audit procedure as is the
confirmation of accounts receivable. This statement does not disparage the importance or usefulness
of confirming accounts payable, but recognizes that for accounts receivable confirmation is generally
the most important single audit procedure. The greatest hazard in the verification of liabilities is the
existence of unrecorded liabilities. To confirm the recorded accounts payable does not prove whether
any unrecorded accounts payable exist.
The auditors seek to obtain the best available supporting evidence with a minimum of effort
and expense. In most cases, the best evidence that accounts receivable are correctly recorded is direct
written acknowledgment by the debtor. This is not normally true of accounts payable. The nature of
the supporting evidence in the possession of the company is also a factor. Receivables records are
usually originated entirely by the company. Records of payables are based, at least in part, on
evidence prepared and sent in by outside parties, such as vendors' invoices, statements, etc.
Confirmation of accounts receivable is a presumptively mandatory audit procedure. In effect,
the burden of proof is on the auditors to justify an omission of the receivables confirmation procedure
and the auditors are, therefore, reluctant to omit it.

14-18 Sending a confirmation request to Ranchero Company would be entirely appropriate even though the
accounting records show a zero balance for this large supplier at year-end. In the verification of
liabilities, emphasis is placed on the possible existence of unrecorded liabilities. The reply from
Ranchero might indicate that a liability exists.

14-19 Accounts payable confirmation requests represent higher quality evidence than vendors' statements
because ordinarily the vendors' statements will have passed through the hands of client personnel
whereas the confirmations are sent directly by vendors to the auditors' office.

14-20 The cutoff of accounts payable is closely connected with the cutoff of purchase invoices in
determining the year-end inventory. When observing the taking of a physical inventory on December
31, the auditors will make a record of the serial numbers of the last receiving report issued. This
number should be identified with the corresponding vendor's invoice on the list of accounts payable at
December 31. Any invoices associated with later receiving reports should not be part of the year-end
amount for accounts payable. In other words, the year-end cutoff must assure that a liability is
recorded for any goods received on the last day of the year and included in the physical inventory.
Otherwise, income before taxes would be overstated by the full amount of the omitted invoice.

14-21 Audit procedures that are concerned directly or indirectly with disclosing unrecorded accounts
payable are the following:

(1) Reconcile liabilities with monthly statements from creditors.

(2) Confirm accounts payable by direct correspondence with vendors.
(3) Perform a cutoff of inventory purchases.

14-22 The most important single procedure in the auditors' search for unrecorded accounts payable is the
review of cash transactions during the first few weeks following the balance sheet date. Close study
by the auditors of cash disbursements subsequent to the balance sheet date may reveal some items
that should have appeared as liabilities on the balance sheet but were omitted.

14-23 The purpose of the auditors' review of cash payments subsequent to the balance sheet date is to
disclose any accounts payable which existed at the balance sheet date but were unrecorded.

Solutions Manual, Chapter 14, Page 3 of 14

Copyright © 2022 McGraw Hill. All rights reserved. No reproduction or distribution without the prior written consent of
McGraw Hill.
 Comparison of the cash payments made after the balance sheet date with the accounts payable trial
balance also furnishes evidence of the existence and valuation of the recorded payables.

14-24 The fact that accounts payable may change greatly within a few weeks' time indicates the need for
verifying these accounts on or shortly after the balance sheet date. The search for unrecorded
liabilities is another phase of the examination that cannot be performed satisfactorily in advance of
the year-end.

14-25 Property tax bills are the most important documentary evidence created outside the client's
organization and used by the auditors in verifying accrued property taxes.

14-26 Accounts payable arising from purchases of goods or services are usually evidenced by invoices and
monthly statements received from the suppliers. In contrast, accrued liabilities generally accumulate
on a time basis as a result of the company's obligation to pay salaries, pensions, interest, rent, taxes,
and similar items. Invoices and monthly statements usually are not received for accrued liabilities

Questions Requiring Analysis

14-27 (a) Confirmation of accounts receivable is presumptively required, while confirmation of

accounts payable is not.

(b) Both forms of confirmation requests should be mailed by the auditors to ensure that such
requests are not tampered with by client personnel.

(c) Confirmations most directly address existence in that they are sent to recorded accounts.
They less directly address completeness since accounts may exist of which the auditor may
be completely unaware, and therefore, not confirm.

14-28 The monthly statements of the six creditors should be compared with the client's voucher register or
accounts payable ledger, and any exceptions should be carefully noted. These exceptions should be
investigated by reference to invoice, debit or credit memoranda, receiving records, correspondence
files, or other supporting data.
The auditors should also compare the cash payments to these creditors during the subsequent
period with the items shown by the accounting records as liabilities at the balance sheet date. This
comparison may show that some of the payments in the subsequent period are for liabilities which
existed but were unrecorded at the balance sheet date.

14-29 The subsequent period plays a major part in the auditors' work on accounts payable. One of the
auditors' principal objectives in the examination of accounts payable is to determine that all liabilities
existing at the balance sheet date have been recorded. Few audit procedures can be carried out at an
interim date to accomplish this objective. Instead, the auditors' review of vendors' statement, confir-
mation of accounts payable, review of subsequent cash disbursements, and other procedures designed
to disclose unrecorded accounts payable, are all carried out during the subsequent period.

14-30 The information available does not include any legitimate reason why accounts payable have
decreased while sales and inventory are almost unchanged from the prior year. The change in these
relationships appears both abnormal and unexplained; therefore, the auditors should pursue the matter
until a reasonable explanation is determined.
Both the decrease in accounts payable and decrease in cost of goods sold could have been
caused by including in the year-end inventory inbound shipments of merchandise for which no
account payable was recorded. Such increases in inventory (without any debit to purchases or credit
to accounts payable) would cause an understatement of cost of goods sold and an understatement of
accounts payable. This would also explain the increase in gross profit. The lack of perpetual
Solutions Manual, Chapter 14, Page 4 of 14
Copyright © 2022 McGraw Hill. All rights reserved. No reproduction or distribution without the prior written consent of
McGraw Hill.
 inventory records increases the risk that unrecorded inbound shipments of goods near year-end may
materially overstate earnings and owners' equity while understating liabilities. With control risk
further increased by the apparent weaknesses in internal controls, the risk of management fraud
should not be ignored. The increase in executive salaries may be an effort to drain funds from the
company while concealing the real state of affairs by the omission of liabilities from the balance
sheet. These are the ingredients from which lawsuits against CPAs by investors and creditors often
arise, hence the auditors should proceed with caution and skepticism.

14-31 (a) Unrecorded liabilities subject to discovery during the audit of construction in
progress are unpaid contractor progress billings, unrecorded progress billing retentions, and
unpaid architect fees. Examination of construction contracts, architectural contracts, and
progress billings would disclose the liabilities.

(b) In the audit of prepaid insurance, the auditors might find unrecorded liens on insured
properties, unrecorded policy loans utilized to pay officers' life insurance premiums, unpaid
premiums, and premiums not accrued. Audit procedures that would reveal these liabilities
are examination of policies and confirmation with insurance agents or carriers.

(c) Unrecorded royalties payable might be discovered in the review of licensing agreements.

(d) Unrecorded liabilities subject to disclosure by review of directors' minutes are dividends
declared but unpaid, obligations under employment contracts, "finders fees" due to
consultants who arrange business combinations, and numerous others. By tracing all such
transactions to the accounts, the auditors will ascertain those liabilities that have not been
properly recorded.

14-32 (a) To determine the status of the liability for federal income taxes of prior years:

(1) Through inquiry and review of correspondence files, determine which years are
subject to possible additional assessments based on Internal Revenue Service
examinations.
(2) Ascertain that those years for which the statute of limitations has expired have not
been extended by waiver.
(3) Inspect revenue agents' reports of recent years, if any, and ascertain that any
assessments have been paid or provided for. Determine whether assessments
resulting from examination of prior years' returns would give rise to tax deficiencies
or refunds in other open years not yet examined.
(4) Review claims for refund of prior years' taxes, if any, and evaluate their collectibility.
(5) Review the reconciliation of pretax accounting income with taxable income reported
in returns for open years and ascertain that reconciling items are proper.
(6) Obtain client's permission to correspond with the prior auditors if any unusual
matters are discovered.

(b) To determine the propriety of the provision for income tax on the current year's income:

(1) Reconcile pretax accounting income with taxable income to be reported in the current
year's tax returns and compare with prior year's reconciliation.
(2) Determine whether the computation of taxable income requires giving effect to
adjustments resulting from Internal Revenue Service examinations of prior years.
(3) Review operating or capital loss carryforwards, if any, and determine to what extent
such losses may be offset against taxable income of the current year.
(4) Verify client's calculation of federal income tax for the current year.
(5) Determine that estimated tax has been paid, if required.
Solutions Manual, Chapter 14, Page 5 of 14
Copyright © 2022 McGraw Hill. All rights reserved. No reproduction or distribution without the prior written consent of
McGraw Hill.
 (6) Consider the effect on the tax liability of elections that are available to the client in
computing taxable income (accelerated depreciation, consolidated versus separate
returns, deferral of development costs, LIFO method for inventories, etc.) and discuss
with client.
(7) If taxable income materially differs from pretax accounting income, make certain
client has provided income tax allocation for any resulting deferral or prepayment.

Objective Questions

14-33 Multiple Choice Questions

(a) (2) Because a significant portion of the search for unrecorded liabilities
deals with transactions recorded after year-end, it is least likely to be completed
before the balance sheet date.

(b) (1) The auditors do not have as an objective the determination of whether
accounts payable are past due.

(c) (4) Examining selected cash disbursements in the period subsequent to the year-
end is the best audit procedure for determining the existence of unrecorded liabilities.
All liabilities must eventually be paid, and will therefore be reflected in the accounts
when paid if not when incurred. By close study of payments made subsequent to the
balance sheet date, the auditors may find items that should have appeared in the
balance sheet.

(d) (4) Auditors will usually find in the client's possession externally created
evidence such as vendors' invoices and statements that substantiate the accounts
payable. No such external evidence is on hand to support accounts receivable.

(e) (2) The most efficient way in which the duplicate recording of a purchase
transaction may be detected is by reconciling the related payable accounts with
vendors' statements.

(f) (1) Each vendor's invoice should be compared with the receiving report (to
determine that it was received) and the purchase order (to determine that it was
ordered). Answer (2) is incomplete because of the omission of the purchase order.
Answers (3) and (4) are incorrect because the receiving report, prepared by the
company itself, provides better evidence of what has been received than the vendor's
packing slip.

(g) (2) Accounts payable confirmations are ordinarily sent to suppliers with whom
the client has done the most business. This is because the largest potential for an
understatement may exist due to the client having established high levels of credit. A
sample of other accounts will ordinarily also be selected.

(h) (1) The best procedure to determine valuation of payables is confirmation.

Examination of cash disbursements in the subsequent period is more directed towards
completeness of payables. Analytical procedures may be useful but would not be as
effective as confirmation with respect to the valuation assertion.

(i) (1) Because an understatement of liabilities overstates income, auditors are

ordinarily most concerned with the completeness assertion for payables. Note,

Solutions Manual, Chapter 14, Page 6 of 14

Copyright © 2022 McGraw Hill. All rights reserved. No reproduction or distribution without the prior written consent of
McGraw Hill.
 however, that in circumstances in which a client may be motivated to understate
income (e.g., to minimize taxes), existence becomes a bigger concern.

(j) (4) Auditors audit estimates through (1) independently developing an estimate,
(2) reviewing management’s process, and (3) reviewing subsequent events. There
often is no one to send a confirmation related to the estimate.

(k) (3) The individual who signs the checks should ordinarily be provided with
supporting documents that provide support for the disbursement. That individual
should then manually or electronically “cancel” the documents so that the amount
isn’t paid a second time.

(l) (2) Vouching from the purchases journal to the supporting documents provides
evidence with respect to the existence assertion for purchases.

14-34 Adapted AICPA Task-Based Simulation

(a) Disagree. Someone independent of requisitioning should select the supplier.
(b) Agree.
(c) Disagree. Often, factors in addition to cost are considered (e.g., quality,
dependability).
(d) Agree.
(e) Agree.
(f) Agree.
(g) Disagree. A comparison of quantities is not possible because the quantity is blacked out on
the purchase order provided to receiving.
(h) Disagree. No receiving report is ordinarily necessary for purchases of services.
(i) Agree.
(j) Agree.
(k) Agree.
(l) Disagree. The reconciliation should be performed by an independent party.
(m) Disagree. Documentation should be marked “paid” by the individual making the payment.
(n) Agree.
(o) Agree.

14-35 Adapted AICPA Task-Based Simulation

(a) (9) Answer (9) is correct because confirming the outstanding year-end balances will
result in replies from suppliers as to those balances.

(b) (3) Answer (3) is correct because vouching purchases recorded after year-end may result
in identification of purchases that should have been recorded prior to year-end.

(c) (6) Answer (6) is correct because inquiry of management is a basic procedure for
identifying related party transactions which, if material, should be disclosed.

(d) (7) Answer (7) is correct because testing computations made by the client to set up the
accrual will provide evidence about the appropriate amount of the warranty reserve.
Solutions Manual, Chapter 14, Page 7 of 14
Copyright © 2022 McGraw Hill. All rights reserved. No reproduction or distribution without the prior written consent of
McGraw Hill.
 (e) AU-C 230.13 states that “If, in rare circumstances, the auditor judges it necessary to
depart from a relevant presumptively mandatory requirement, the auditor must document in
the working papers his or her justification for the departures and how the alternative audit
procedures performed in the circumstances were sufficient to achieve the intent of that
requirements.

14-36
(a) Related party
(b) Related party
(c) Noncompliance with laws
(d) Related party
(e) Noncompliance with laws

14.37 SOLUTION: Document Review Simulation—Keystone Audit Request List (time: 30 minutes)

Callout #1: c. Accounts receivable aged by date due. Aging by date due directly addresses the
degree to which specific accounts are overdue and, therefore, less likely to be collected, thereby
addressing account valuation.
Callout #2: e. Schedule of details of depreciation expense calculation for 20X5. Depreciation
expense is ordinarily a calculation (or series of calculations) audited primarily by recalculation and
consideration of the reasonableness of the related assumptions.
Callout #3: a. [Original Text] Software development cost invoices and other support. Based
on Exhibit 3, and GAAP, serious questions exists as to whether these costs are capitalizable or should
be expensed as research and development. A possible starting point in auditing the account may be
examining related invoices and other support. One does not expect physical examples of software to
be a primary form of evidence. No amortization has occurred. Details will not ordinarily be
confirmed.
Callout #4: b. [Delete Text] Other than amortization, no changes in leasehold improvements
appear to have occurred during the year.
Callout #5: c. Trial balance of accounts payable at the balance sheet date. A detailed analysis is
not required at this point, and the nature of the requested reconciliation is unclear. Accounts payable
are not an amortizable account. It is doubtful that a detailed analysis of current and past credit ratings
of suppliers is necessary.
Callout #6: b. [Delete Text] No change in capital stock occurred during the year.
Callout #7: e. Copy of loan agreement with Mr. Best. Details of the related party loan agreement
with Mr. Best will be of audit interest. Management probably didn’t review the loan to the president.
Exhibit 2 points out that there is an agreement with respect to the loan to the president, which was not
approved by the board of directors due to its relatively small size. There is no “cash deposit receipt”
for this transaction.
Callout #8: d. Account 7100.10 Expense Analysis. Recorded rent expense went down during the
year, which by itself is a surprise. But Exhibit 3 mentions a new lease with no payments due the first
three months. It would seem that an adjusting entry related to this may be necessary.

Solutions Manual, Chapter 14, Page 8 of 14

Copyright © 2022 McGraw Hill. All rights reserved. No reproduction or distribution without the prior written consent of
McGraw Hill.
Problems

14-38 SOLUTION: Internal Control, Tests of Controls, Substantive Procedures. (Estimated time: 20
minutes)

(a) (1) Reconciliation of vendors' monthly statements with accounts payable is a

procedure that is designed to reduce the risk of understatement or overstatement of
accounts payable.
(2) Matching of vendors' invoices with receiving reports is an internal control procedure
that reduces the risk that the client will pay for goods that were not received.

(b) (1) The operating effectiveness of reconciliation of vendors' invoices to accounts

payable may be tested by reviewing the client's documentation of the reconciliations.
This evidence could be supplemented with inquiries of client personnel regarding the
performance of reconciliations during the year.
(2) The matching of receiving reports to vendors' invoices could be tested by vouching a
sample of vendors' payments made during the year to the supporting receiving
reports.

(c) (1) To compensate for failure of client personnel to reconcile payables to

vendors' statements, the auditors might increase the extent of their procedures for
verification of the amount of accounts payable. Procedures that are designed to test
the accuracy of accounts payable include confirmation, review of unmatched
receiving reports, reconciliation of payables to vendors' statements, and the search for
unrecorded liabilities.
(2) The overstatement of purchases due to payments for merchandise that was not
received is not easy to detect. Vouching large numbers of purchase transactions to
receiving reports is not an efficient approach. Analytical procedures applied to cost
of goods sold or gross margin might also reveal a significant overstatement of
purchases.

14-39 SOLUTION: Marina del Rey, Inc. (Estimated time: 15 minutes)

(a) The two accounts payable for which confirmation is most needed are Dayco, Inc., and
Western Supply. The auditors' objective in sending confirmation requests to creditors is to
select accounts in which large balances could reasonably be expected rather than accounts for
which large balances have been recorded by the client. In other words, the auditors are
searching for unrecorded liabilities, rather than trying to verify a large percentage of
recorded dollar liabilities. With this goal in mind, the two accounts from which the client has
made a large amount of purchases during the year are more likely candidates than the vendors
in which the year-end balances are large but the activity for the year relatively small.

(b) If the four companies listed are assumed to be customers and the dollar amounts to represent
year-end balances of accounts receivable and total sales for the year, the answer would be
different. Under these assumptions, the two most important accounts to confirm would be
Western Supply and Landon Co. because they have the largest year-end balances. In the
verification of assets, the auditors are primarily concerned with the possibility of overstated
asset valuations. By confirming a large proportion of the total dollar amount of accounts
receivable, the auditors gain assurance that there is not a material overstatement. They are
less concerned with the unlikely possibility that the client has material amounts of unrecorded
receivables.

Solutions Manual, Chapter 14, Page 9 of 14

Copyright © 2022 McGraw Hill. All rights reserved. No reproduction or distribution without the prior written consent of
McGraw Hill.
14-40 SOLUTION: Tower Wholesaling (Estimated time: 20 minutes)
Clark should perform, the following additional substantive audit procedures:

(1) Foot the client-prepared schedule.

(2) Tie the general ledger accounts payable controlling account to the client-prepared accounts
payable schedule.

(3) Examine vendors' statements in support of items on the client-prepared schedule.

(4) Examine other documents (such as approved vouchers) in support of items on the client-
prepared schedule.

(5) Review the general ledger controlling account for non-cash debits or unusual items, and
investigate them.

(6) Confirm, with positive confirmation requests, account balances from selected vendors.

(7) Examine unpaid invoices on hand (to ascertain whether any were erroneously omitted from
the client-prepared schedule of accounts payable).

(8) Examine documents in support of invoices paid subsequent to the year end (to ascertain
whether the payable was recorded in the appropriate year).

(9) Inspect receiving reports (to test the accuracy of the year-end cutoff).

(10) Ascertain whether year-end outstanding checks to vendors were returned with the cutoff bank
statement.

(11) Review correspondence files with respect to disputed items.

(12) Review open purchase orders for unusual or old items that may have been received but not
recorded.

(13) Examine unmatched receiving reports.

(14) Make certain that the client representation letter includes the proper assertions concerning
accounts payable.

(15) Investigate and resolve confirmation exceptions and other matters requiring follow-up.

Solutions Manual, Chapter 14, Page 10 of 14

Copyright © 2022 McGraw Hill. All rights reserved. No reproduction or distribution without the prior written consent of
McGraw Hill.
14-41 SOLUTION: Wilcox Company (Estimated time: 25 minutes)

WILCOX COMPANY
Proposed Adjusting Journal Entry
April 30, 20X2

Marketable Securities 2,125

Cost of Goods Sold 5,863
Unexpired Insurance (11/12 x $1,800) 1,650
Insurance Expense 150
Professional Fees Expense 1,000
Accounts Payable 10,788
To record liability for following unpaid invoices:
Hill & Harper $ 1,000
Drew Insurance Agency 1,800
Mays and Sage 2,125
Lane Company 5,863
Total $10,788

14-42 SOLUTION: Software and Stuff (Estimated time: 20 minutes)

The scope of audit procedures will be affected by the materiality of the amounts involved as well as
the assessed level of control risk. Procedures will generally include:

(1) Read the licensing agreement and obtain a copy for the permanent file.

(2) Examine correspondence between Software and Component.

(3) Review production records (and inventory and shipping records) to determine the number of
games manufactured.

(4) Calculate the royalties payable and total royalty expense.

(5) Confirm with Component the royalties due at year-end.

In-Class Team Case

14-43 SOLUTION: Bozarkana Company (Estimated time: 30 minutes)

(The data required for this problem could be obtained using either generalized audit software or
manually. Obtaining the data electronically would in general seem to be a more efficient approach.)

(a) (1) Thirty vouchers may be randomly selected, either manually or electronically.
Because you need the name and address for purposes of confirming, the vendor
number from the voucher register may be matched (joined) to the vendor number in
the vendor master file. When this has been accomplished, you will be able to access
the vendor name and address for purposes of sending the confirmation. Note that the
use of generalized audit software will make this relatively simple as, once the thirty
vouchers are selected, one could electronically join the voucher numbers to obtain the
needed information.

Solutions Manual, Chapter 14, Page 11 of 14

Copyright © 2022 McGraw Hill. All rights reserved. No reproduction or distribution without the prior written consent of
McGraw Hill.
 (2) Because you need to confirm by balance payable per vendor, it will be necessary to
total the voucher register by vendor number, and then perform the procedures
outlined in (1) above.

(3) The cash disbursements file must first be totaled by vendor number. A list of vendor
numbers with whom Bozarkana has transacted more than $500,000 may then be
prepared. That list of vendor numbers should then be compared to the voucher
register, and any numbers not included in the voucher register represent the desired
accounts. Those vendor numbers should be joined with the vendor master file to
obtain the needed name and address.

(b) (1) One approach is to select receiving reports issued shortly before and after
year-end and search for dates shipped prior to year-end. The numbers of those
receiving reports may then be compared to the receiving reports in the voucher
register. Any not included would likely be unrecorded as of year-end. However, if
they were included on vouchers that already had been paid at year-end (which is
doubtful because these are year-end transactions), they also would not be included.

(2) The cash disbursements file for the first week of January should be searched
for disbursements in excess of $300,000. Since the cash disbursements file includes
a voucher number, and since vouchers are issued sequentially, it will be possible to
select those vouchers issued after year-end. The voucher register will include the
receiving report number for those items. Those receiving report numbers can be
compared to the receiving report file to determine which (if any) of these items had
been shipped prior to year-end.

Solutions Manual, Chapter 14, Page 12 of 14

Copyright © 2022 McGraw Hill. All rights reserved. No reproduction or distribution without the prior written consent of
McGraw Hill.
Chapter 14 Appendices
Audit Case Exercises
14A-1 a.
Control
1. Computer matches information
from vendors’ invoices with
purchase order and receiving data.
2. The computer assigns numbers to
receiving report
3. The check signer mails checks.
b.
Control
1. Computer matches information
from vendors' invoice with
purchase order and receiving data.
2. The computer assigns numbers to
receiving reports.
3. The check signer mails checks.
14A-2
Control
1. Approved vendors are selected by
purchasing manager who also
purchases goods.
2. Vendors’ statements are not
reconciled to the accounting
records.
Copyright © 2022 McGraw Hill. All rights reserved. No reproduction or distribution without the prior written consent of
McGraw Hill.
Error or Fraud Controlled
Prevents payment of invoices for
goods not ordered or received.
Controls the recording of
purchases to ensure completeness.
Prevents abstraction of cash by
individuals maintaining the
accounts payable records.
Error or Fraud Controlled
Review a sample of exception
reports for evidence of application
of the control by the computer,
and/or enter test data to evaluate
the control's operating
effectiveness.
Observe that the computer assigns
numbers to receiving reports.
Inquire about the procedure for
mailing checks.
Error or Fraud Controlled
The purchasing manager may be
getting kickbacks from vendors
and/or may have a conflict of
interest.
Accounts payable records may be
misstated due to recording errors.
Solutions Manual, Chapter 14, Page 13 of 14
14A-3
Audit Plan—Test of Controls—Acquisition Cycle

Client: Keystone Computers & Networks, Inc.

Financial Statement Date: 12/31/X5

Procedure

1. Observe and inquire about the segregation of duties for purchase transactions.
2. Observe the purchasing manager when entering purchase orders and enter several test
transactions to determine that:
a. Password is entered to purchase order.
b. The system compares the vendor to the authorized vendor list.
3. Observe that the system assigns a sequential number to each purchase order.
4. Observe the receiving clerk when entering receiving information and enter several test
transactions to determine that:
a. Clerk looks up purchase order in system before receiving goods.
b. Password must be entered to enter receiving information.
5. Observe that the computer assigns sequential numbers to receiving reports.
6. Observe the accounts payable clerk when entering vendor invoice information and enter
several test transactions to determine that the password must be included to enter invoices.
7. Test the procedures for review and follow-up on the exception report from computer
matching of purchase order, receiving, and invoice information. Use the following
procedures:
a. Inquire about the procedures.
b. Select a sample of exception reports and inspect them for evidence of follow-up on
the exceptions. Use the following parameters:
(1) Risk of assessing control risk too low—10%.
(2) Tolerable deviation rate—10%
(3) Expected deviation rate—0%.
8. Observe that unsigned checks are assigned sequential numbers by the computer.
9. Test the procedures for approval of disbursements by:
a. Inquiring about the review of disbursements by the treasurer when the checks are
signed.
b. Review file of authorized disbursement listings for completeness as indicated by the
check numbers.
c. Select a sample of authorized disbursement listings and examine them for evidence
of the treasurers approval. Use the following parameters:
(1) Risk of assessing control risk too low—10%.
(2) Tolerable deviation rate—7%.
(3) Expected deviation rate—0%.

Solutions Manual, Chapter 14, Page 14 of 14

Copyright © 2022 McGraw Hill. All rights reserved. No reproduction or distribution without the prior written consent of
McGraw Hill.