Auditing and Assurance Services 7th Edition Louwers Solutions Manual

Auditing and Assurance Services 7th Edition
Louwers Solutions Manual
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Auditing and Assurance Services 7th Edition Louwers Solutions Manual
Chapter 08 - Acquisition and Expenditure Cycle
CHAPTER 08
Acquisition and Expenditure Cycle
LEARNING OBJECTIVES
Review Exercises,
Multiple Choice
Checkpoints Problems, and
Simulations
1. Describe the acquisition and 1, 2, 3 29, 30, 31 47(*), 52(*)

expenditure cycle, including typical
source documents.
2. Identify significant accounts and 4, 5, 6 32 47(*), 55(*),

relevant assertions related to the 56(*)
acquisition and expenditure cycle.
3. Discuss the risk of material 7, 8 49(*)

misstatement in the acquisition
and expenditure cycle.
4. Identify important internal control 9, 10 33, 34, 39, 40, 45 51(*), 52(*)
activities present in a properly
designed system to mitigate the risk
of material misstatements for each
relevant assertion in the acquisition
and expenditure cycle.
5. Give examples of tests of controls 11, 12 44 47(*), 51(*)

to test the operating effectiveness
of internal controls in the
acquisition and expenditure cycle.
6. Give examples of substantive 13, 14, 14, 16, 17, 35, 36, 37, 38, 41, 48, 49(*), 50,
procedures in the acquisition and 18, 19, 20, 21 42, 43, 46 51(*), 54(*),
55(*), 56(*), 57
expenditure cycle and relate them
to assertions about significant
account balances at the end of the
8-1
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period.
7. Apply your knowledge to 22, 23, 24, 25, 26, 53, 54(*), 58, 59,
perform audit procedures in the 27 60, 61
acquisition and expenditure
cycle and evaluate the findings
of your tests.
8. Describe the payroll cycle 8C1, 8C2 8C3, 8C8, 8C9, 8C10, 8C18, 8C19,
including risks, source documents 8C4, 8C5, 8C6, 8C11, 8C12, 8C13, 8C20, 8C21,
8C7, 8C14, 8C15, 8C16, 8C22
and controls (Appendix 8C) 8C17
(*) Item relates to multiple learning objectives
SOLUTIONS FOR REVIEW CHECKPOINTS
8.1 A voucher is a package of documents, usually with a cover page. (The package can be a small envelope.)
The voucher package contains supporting documents for a transaction. For example, a purchase voucher
usually contains a purchase requisition, purchase order, receiving report, vendor invoice, and a negotiable
check (check copy when the vendor invoice has been paid). Required approvals and signatures are on the
documents. The voucher presents evidence of the documentation and control over a transaction.
Computerized systems may have all this documentation in memory.
In a voucher system, each voucher is “payable” and the detail of the payables is the vouchers themselves.
At any time, the company may owe a single vendor more than one invoice represented on several vouchers.
In a voucher system, there is no balance payable to each vendor—just a file of different vouchers payable.
8.2 A purchasing manager can direct purchases toward vendors who provide the manager kickbacks or other
inducements. This can be prevented by notifying suppliers that the company will not permit payment of
kickbacks to its employees. The company can also rotate purchasing managers to different vendors. Finally,
significant purchases should be reviewed and approved by a higher level manager.
8.3 A “blind” purchase order is a purchase order that does not display the quantity ordered. It is given to the
receiving department so personnel there will know what has been ordered, but they will have to do an
independent count. If a blind purchase order is not used, receiving personnel may not count the goods
received and just record the amount indicated on the purchase order.
8.4 Management could omit expenses and liabilities if they desired to manipulate the financial statements.
Therefore management might not record, or delay the recording, of expenses and liabilities.
8.5 Management may nit record or delay recording the inventory sale in order to keep inventory accounts high
and cost of goods sold low.
8.6 If a fictitious expense is included in the records (e.g. an expense to pay a fictitious vendor) there must be a
credit to an accounts payable and a debit to a corresponding account. If the debit is for a tangible assets
(e.g. inventory, supplies, PPE) someone will want to see the assets or have a record of the receipt of the
assets. If the corresponding debit is for a service, no asset exists for inspection and it may be more difficult
8-2
to verify via documentation. Also, expense accounts get closed at the end of the year. A fraud near the end
of the year involving service expenses has a smaller window of discovery.
8.7 In the short term, capitalizing ordinary expenditures increases assets and decreases expenditures.
Therefore, this type of manipulation makes the balance sheet and income statements appear better.
However, capitalized expenses need to be amortized in future periods, so these improperly capitalized
expenditures show up in future periods as additional expenses and reduced assets.
8.8 If a credit to accounts payable is omitted, a corresponding debit is also omitted. The debit may include
inventory, PPE, prepaid expenses (e.g. prepaid rent), services (e.g. computer repair) and a variety of
expenses.
8.9 The functions that should be separated to maintain internal control in a purchasing system include (a)
custody of the goods (receiving and stores departments), (b) authority to initiate a transaction (purchasing
department), (c) bookkeeping (accounts payable department, inventory record-keeping department), and (d)
periodic physical counts (reconciliation) of inventory and fixed assets.
8.10 In the acquisition and expenditure cycle those individuals authorizing procurement of goods and services
(i.e. purchasing) should be separate from record keeping (i.e. accounts payable) and from the various
departments that receive, store, and use the material received (e.g. inventory, production, warehousing,
engineering, receiving).
8.11 The best testing for proper authorization is to select a sample of received materials (select the sample form
the accounts payable journal or receiving report file) and vouch the order to purchase order. The purchase
order should be inspected for evidence of authorization by the appropriate purchasing agent(s)
8.12 Payment of a vendor is authorized using a voucher package. Once a “three-way” match is performed
(matching and reconciling the purchase order, receiving report and vendor invoice) the voucher package is
signed off. This sign off is the authorization to pay the vendor.
8.13 You will find evidence about losses on purchase commitments in the open purchase order file. Evidence
about unrecorded liabilities to vendors is in the (a) unmatched invoice file and (b) unmatched receiving
report file.
8.14 Management reports that can be used for audit evidence, and information in them can be useful to auditors
are as follows:
• Open purchase orders: Purchase commitments, losses on purchase commitments.
• Unmatched receiving reports: Goods received but not recorded as purchases or liabilities.
• Unmatched vendor invoices: Unrecorded invoices that may represent unrecorded liabilities or
items in dispute
• Accounts payable trial balance: Subsidiary ledger of accounts payable that may show balances by
vendors, indicating small balances that should be large. Invoice dates may reveal failure to record
invoices late in the accounting period.
• Purchases journal: Listing of all purchases available for analysis of purchasing patterns and
oddities. Population for sample of purchases for tests of controls.
• Fixed asset reports: Fixed assets subsidiary ledger trial balance. Scan for negative balances,
capitalized repairs, and depreciation in excess of salvage value; depreciation recalculation.
8-3
8.15 (a) A low risk of material misstatement would normally result in a strategy by which the auditor relies on
controls and reduces substantive tests. First, the auditor would confirm the low control risk evaluation by
testing controls for effectiveness. More reliance would also be placed on analytical procedures. (b) High
risk of material misstatement would result in a more substantive approach with little control testing.
8.16 The purpose of the auditor’s search for unrecorded liabilities is to gather evidence as to whether the
completeness assertion is true. From an evidence-gathering perspective, it is much more difficult to gather
evidence on unrecorded transactions than to gather evidence that recorded account balances exist.
• Inquire of client personnel about their procedures for ensuring that all liabilities are recorded.
• Scan the open purchase order file at year-end for indications of material purchase commitments at
fixed prices. Obtain current prices and determine whether any adjustments for loss and liability for
purchase commitments are needed.
• Examine the unmatched vendor invoices listing and determine when the goods were received, looking
to the unmatched receiving report file and receiving reports prepared after the year-end. Determine
which invoices, if any, should be recorded.
• Trace the unmatched receiving reports to accounts payable entries, and determine whether entries
recorded in the next accounting period need to be adjusted to report them in the current accounting
period under audit.
• Select a sample of cash disbursements from the accounting period following the balance sheet date.
Vouch them to supporting documents (invoice, receiving report) to determine whether the related
liabilities were recorded in the proper accounting period.
• Confirm accounts payable with vendors (especially regular suppliers showing small or zero balances in
the year-end accounts payable.
8.17 Financial statement users are most troubled by overstated assets and understated liabilities. Therefore, they
need to audit more for the existence of assets and the completeness of liabilities.
8.18 Typically, when auditing prepaids and accruals, the auditor uses audit documentation that shows beginning
balances, payments, expense, and ending balance. By agreeing beginning balance to prior-years audit
documentation, vouching payments, and calculating the accuracy of the ending balance, the auditor knows
that the amount charged to expense will be correct.
8.19 Noncurrent assets such as property, plant, and equipment and intangibles usually pertain to all four
management assertions about account balances: existence, completeness, rights and obligations, and
valuation and allocation. The auditor must ensure that they exist and are owned. In addition, the valuation
determined by depreciation, amortization, or impairment charges is usually an important issue. Of the four
assertions, completeness is probably the least important, but it cannot be ignored.
8.20 The auditor is primarily concerned with current-year transactions in property, plant, and equipment
accounts. Previous years require less attention because they were audited in prior years. Thus, additions,
disposals, and depreciation charges warrant the most attention.
8.21 Most expense accounts can be tested through analytical review procedures, substantive tests of transactions,
or by testing them in conjunction with tests of related assets and liabilities (e.g., depreciation). Some
expenses should be examined separately because of their unique nature (e.g., legal expenses or
miscellaneous expense).
8.22 The following are possible red flags indicating a risk of fraud:
8-4
• Photocopies of invoices in the files.

• Vendor’s invoices submitted in numerical order.
• Vendor’s invoice amounts always in round numbers.
• Vendor’s invoices are consistently slightly lower than the review threshold set by management.
• Vendors with only post office box addresses.
• Vendors with no listed telephone number.
• Matching vendor and employee addresses or telephone numbers.
• Multiple vendors at the same address and telephone number.
• Vendors not on the approved vendor list.
• Knowing the address of the local mail drops (e.g., shipping and packaging stores that accept client
mail). These stores could provide a street address for fraudulent companies, adding false
legitimacy to their fraudulent invoices.
8.23 The auditor should begin by inquiring of the client about its knowledge of fraud or fraud risks. Analytical
review procedures such as vertical and horizontal analyses can pinpoint accounts that appear to have
unusual fluctuations. Examining invoices and vendor files for the red flags noted in 8.12 will help find
phony billings. The purpose is to identify fraud risk, evaluate the significance of the risk, and determine the
amounts of any actual fraud on the financial statements.
8.24 Most of the procedures are designed to prevent misappropriation of assets. The expenditure cycle is an
area where employees may attempt to receive payments for fictitious purchases or have the company pay
for personal items run through the expenditure system as a company expense. Procedures targeted at
financial statement fraud include searching for unrecorded liabilities and ensuring that expenditures are
properly recorded.
8.25 Argus did not have separation of duties. Different people should have authorized the copying services,
approved the bills for payment, and coded them to projects. A supervisor should have been reviewing the
expenses and comparing them to the budget.
8.26 The verbal inquiry procedure might produce knowledge of employee’s responsibilities to authorize
purchases of script copies, receive them, approve payment, and code invoices to projects.
8.27 Given Beta Magnetic’s poor internal controls, it is possible that Martha would never have been caught.
However, if the company ever contacted employees about their health claims, they would have revealed the
fictitious charges.
8.28 If Martha had taken a mandatory vacation, her replacement would probably have questioned the billings
from unknown physicians. If the billings stopped, the sharp drop in insurance costs for that period would
likely be questioned by Martha’s superior and the fraud may be uncovered.
8-5
SOLUTIONS FOR MULTIPLE-CHOICE QUESTIONS

8.29 a. Incorrect Cash disbursements are an important part of the cycle.
b. Incorrect Although similar to sales because they are shipped out, purchase returns are
considered part of the acquisition and expenditure cycle because they affect
accounts payable.
c. Correct Although similar to purchases because they require a receiving report, sales
returns are considered part of the revenue and collection cycle because they
affect accounts receivable.
d. Incorrect Prepaid Insurance is one of the many accounts in the acquisition and expenditure
cycle.
8.30 a. Correct Cost of goods sold should be matched with sales by using inventory to record
cost of goods not yet sold.
b. Incorrect Research and development is a period expense that is recorded as incurred.
c. Incorrect Depreciation allocated over time on a systematic and rational basis except in the
unusual situation in which units-of-production depreciation is used.
d. Incorrect Sales are recorded when earned.
8.31 a. Incorrect Overstates net income in the period of capitalization.

b. Incorrect Overstates net income.
c. Correct Has no effect on net income. It overstates cash and payables.
d. Incorrect Since a & b overstate net income and c does not, all of the answers above are not
correct
8.32 a. Correct The completeness assertion is very important in the audit of liabilities.
b. Incorrect This would restrict a company’s ability to do business.
c. Incorrect Auditors are normally not concerned with whom the client’s vendors are.
d. Incorrect Competitive bids are normally required for only large purchases.
8.33 a. Incorrect These duties should be separated.

b. Incorrect This would not necessarily prevent a duplicate payment.
c. Incorrect The voucher date may be several weeks before the payment is due.
d. Correct Cancellation of vouchers (by marking them asPAID) prevents their use a
second time.
8.34 a. Incorrect The requisition would not result in the improper delivery.
b. Incorrect No cash is received at Lake.
c. Incorrect No inventory is ordered for Lake or entered into Lake’s inventory records.
d. Correct Nobody at Lake was reviewing purchase orders to notice the delivery and
payment by another party (Budd’s relative’s store). This deviation caused no
direct loss to Lake, but it is a misuse of Lake’s pricing agreements with its
vendors and puts Lake at risk.
8.35 a. Incorrect If the liability is unrecorded, it would not be on the trial balance.
b. Correct Auditors may be able to determine that cash disbursements in the subsequent
period are paying liabilities of the period under audit.
c. Incorrect This is a cutoff test; (b) is a more direct test.
d. Incorrect This is only an indirect test; (b) is a more direct test.
8.36 a. Incorrect This is often performed before the balance-sheet date.

b. Incorrect This is often performed before the balance-sheet date.
c. Correct The search for unrecorded liabilities generally depends upon using accounting
records created in the period after the year end.
d. Incorrect This is often performed before the balance-sheet date.
8-6
8.37 a. Incorrect Some liabilities may be incurred but not invoiced by the vendor.
b. Incorrect Purchase orders do not normally incur liabilities.
c. Correct The receiving reports are the population that contains the record of all goods
received for which liabilities should be recorded.
d. Incorrect The invoice or receiving report must be examined to determine when the
liability occurred.
8.38 a. Incorrect Approvals do not necessarily result in purchases or debits to the inventory.
b. Incorrect Purchase requisitions may not represent the actual amount received.
c. Correct Invoices supply relevant information about the quantities purchased and the
prices paid.
d. Incorrect Purchase orders do not always represent the actual amount received.
8.39 a. Incorrect This would have ensured a proper count of the tables.
b. Incorrect This would insure the invoice was for the amount received.
c. Incorrect This would insure the check was for the amount received.
d. Correct The purchase order and requisition would both show 84 tables.
8.40 a. Incorrect The check signer is probably not familiar with all the vendors.
b. Incorrect This is possible, but the maintenance costs may not have been unusual (i.e., the
costs before the fraud were below budget).
c. Correct Vendors should be approved by an independent purchasing department before
an order can be placed.
d. Incorrect Since a and b are incorrect, all of the above are not correct
8.41 a. Incorrect Payroll is generally audited by tests of controls, analytical procedures and
substantive tests of transactions.
b. Incorrect Cost of goods sold is generally audited by tests of controls, analytical
procedures and substantive tests of transactions.
c. Incorrect Supplies expense is usually audited in connection with supplies inventory.
d. Correct The auditor examines the specific charges to determine potential litigation.
8.42 a. Correct Property tax expense is audited in conjunction with accrued property taxes.
b. Incorrect Payroll is generally audited by tests of controls, analytical procedures and
substantive tests of transactions.
c. Incorrect There’s no asset directly related to R&D.
d. Incorrect The auditor examines the specific charges to determine potential litigation.
8.43 a, b,. Incorrect Although auditors are always concerned about existence and rights and
obligations, these issues usually arise because of errors in the accounts.
However, it is unlikely that management would intentionally add nonexistent
liabilities, or accounts for which management has no obligation to pay.
c. Correct Completeness is the most important assertion in this cycle. The hiding of
liabilities is a primary concern for all auditors in the liability and expense areas.
Supplies expense is generally audited in connection with supplies inventory.
d. Incorrect Valuation and allocation would be the second best answer since recording
liabilities at an amount less than its proper value might be a ploy management
can use to “cook the books”. However, auditors are usually more concerned
about unrecorded liabilities affecting the completeness assertion.
8.44 a. Incorrect Testing occurrence would require vouching from the vouchers recorded in the
voucher register to receiving reports.
b. Correct This test ensures that liabilities generated by the receipt of goods are recorded in
the voucher register.
c. Incorrect This does not test classification, which would require examining the chart of
accounts.
8-7
d. Incorrect This does not test cutoff, which would require comparing the date of the
receiving report to the date recorded.
8.45 a, Incorrect Clerk 1 reviews vendor invoices, therefore clerk 1 has access to the vender
invoices. Opening the mail would not provide any additional access or violate
the separation of duties that already exist.
b. Incorrect Clerk 2 has recordkeeping responsibilities. Reconciling the accounts payable
account and the general ledger would not violate the separation of duties.
c. Correct Clerk 3 has recordkeeping responsibilities. Providing a signed check to Clerk 3
provides the clerk access to an asset and violates the separation of duties.
d. Incorrect The treasurer may use a stamp for signing checks as long as the stamp is
controlled. Whether the Treasurer uses a stamp or manually signs the check
does not change the treasurer’s responsibility as the authorization for the
payment.
8.46 a, Incorrect A reduction in returns would not provide evidence regarding the valuation of the
account payable.
b. Correct A purchased item listed on the monthly vendor statement should be included in
the accounts payable. If it cannot be traced to the accounts payable record, the
vendor account will be understated.
c. Incorrect Customer returned goods would affect accounts receivable, not accounts
payable.
d. Incorrect Cash received form customers would affect accounts receivable, not accounts
payable.
SOLUTIONS FOR EXERCISES, PROBLEMS, AND SIMULATIONS

8.47 Payable ICQ Items: Assertions, Tests of Controls, and Possible Errors or Frauds
1. a. Purchases and accounts payable are authorized to assure compliance with company
policy (authorization).
b. For a sample of cash disbursements, vouch to approval signatures on invoices, receiving

reports and purchase orders.
c. Costs and expenses might be incurred that are not properly supported.
d. Select a sample of current-year debits in accounts (e.g., inventory, fixed assets,

expenses), and vouch them to supporting documents.
2. a. Liabilities are recorded at the appropriate quantity and description (accuracy).
b. Select a sample of invoices and agree them to the receiving report. Observe receiving
department counting receipts.
c. Vendors could bill for quantities greater than the amount actually shipped, overstating
costs or expenses.
d. Observe the client’s inventory account and test the reconciliation of the count to the
perpetual inventory.
8-8
3. a. Liabilities are recorded for actual purchases at the appropriate amounts (accuracy).
b. Observe client personnel making comparisons. Examine initials for approval. Review
correcting journal entries that result from the comparison.
c. Purchases or other liabilities may be recorded for transactions that didn’t exist or at
incorrect amounts.
d. Reperform comparison on a test basis.
4. a. Journal entries are authorized and prepared in accordance with generally accepted
accounting principles (accuracy, classification).
b. Examine entries for approval initials.
c. The company might override controls to create fraudulent entries.
d. Select a sample of recorded journal entries and reperform calculations and review for
appropriate accounts.
8.48 Unrecorded Liabilities Procedures
a. The fact that the client made a journal entry to record vendors’ invoices that were received late
should simplify the auditors’ audit for unrecorded liabilities and reduce the possibility of a need
for a further adjustment, but the audit is nevertheless required. If the client has not journalized late
invoices, the auditors are compelled in their testing to substantiate what will ultimately be
recorded as an adjusting entry. In this examination, the auditors should audit entries in the voucher
register, for the year being audited, to ascertain that all items, which according to dates of
receiving reports or vendors’ invoices were applicable to that year, have been included in the
journal entry recorded by the client.
b. No. The auditors should obtain a letter in which responsible executives of the client’s organization
represent that to the best of their knowledge all liabilities have been recognized. However, this is
done as a normal audit procedure to afford additional assurance to the auditors, and it does not
relieve the responsibility for doing other substantive audit work.
c. Whenever auditors are justified in relying on work done by an internal auditor, they should curtail
(but not eliminate) their own audit work. In this case, the auditors should have ascertained early in
the examination that Ozine’s internal auditor is qualified by being both technically competent and
objective. Once satisfied as to these points, the auditors should discuss the nature and scope of the
internal audit program with the internal auditor and review the working papers in order that the
auditors may properly coordinate the audit program with that of the internal auditor. If the Ozine
internal auditor is qualified and has made tests for unrecorded liabilities, the auditors may reduce
further audit work in this audit area.
d. In addition to the 2011 voucher register, the auditors should consider the following sources for
possible unrecorded liabilities:
1. Unentered vendors’ invoice file.

2. Status of tax returns for prior years still open.
3. Discussions with employees.
4. Representations from management.
5. Comparison of account balances with preceding year.
6. Examination of individual accounts during the audit.
7. Existing contracts and agreements.
8. Board minutes.
8-9
9. Attorney’s bills and letter of representation.

10. Status of renegotiable business.
11. Correspondence with principal suppliers.
12. Audit testing of cutoff date for reciprocal accounts (e.g., inventory and fixed assets).
8.49 Accounts Payable Confirmations
a. The accounts payable audit procedures should be directed toward searching for proper inclusion of
all accounts payable and ascertaining that recorded amounts are reasonably stated because the
primary audit purpose is to reveal any possible material understatements.
The principal objectives of the accounts payable examination are:
(1) To determine the adequacy of internal control for processing and payment of invoices.
(2) To prove that amounts shown on the balance sheet are in agreement with supporting
accounting records.
(3) To determine that liabilities existing at the balance-sheet date have been recorded.
b. Clark and Kent are not required to use accounts payable confirmation procedures. For accounts
payable the auditor can examine external evidence such as vendor invoices and vendor statements
that substantiate the accounts payable balance. Although not required, the accounts payable
confirmation is often used. The auditor might consider such use when:
(1) Internal controls are weak.

(2) The company is in a “tight” cash position and bill-paying is slow.
(3) Physical inventories exceed general ledger inventory balances by significant amounts.
(4) Certain vendors do not send statements.
(5) Vendor accounts are pledged by assets.
(6) Vendor accounts include unusual transactions.
c. When auditing accounts payable the auditor is primarily concerned with the possibility of
unrecorded payables or understatement of recorded payables. Selection of accounts with relatively
small or no balances for confirmation is the more efficient direction of testing since
understatements are more likely to be detected when examining such accounts.
When selecting accounts payable for confirmation, the following procedures could be followed:
1. Analyze the accounts payable population and stratify it into accounts with large balances,
accounts with small balances, accounts with zero balances and so on.
2. Use a sampling technique that selects items based on criteria other than the dollar amount
of the items (e.g., select based on terminal digits, select every nth item based on
predetermined interval (etc.).
3. Design a statistical sampling plan that will place more emphasis on selecting accounts
with zero balances or relatively small balances, particularly when the client has had
substantial transactions with such vendors during the year.
4. Select prior-year vendors who are no longer used.
5. Select new vendors used in the subsequent years.
6. Select vendors that do not provide periodic statements.
7. Select accounts reflecting unusual transactions during the year.
8-10
8. Select accounts secured by pledged assets.
8.50 Search for Unrecorded Liabilities
1. Scan the open purchase order file at year-end for indications of material purchase commitments at
fixed prices. Obtain current prices and determine whether any adjustments for loss and liability for
purchase commitments are needed.
2. List the unmatched vendor invoices and determine when the goods were received, focusing on the
unmatched receiving reports and receiving reports prepared after the year-end. Determine which
invoices, if any, should be recorded.
3. Review the year-end unmatched receiving reports and determine whether entries are recorded in
the proper accounting period.
4. Select a sample of cash disbursements from the accounting period following the balance-sheet
date. Vouch them to supporting documents (invoice, receiving report) to determine whether the
related liabilities were recorded in the proper accounting period.
5. Study IRS examination reports for evidence of income or other taxes in dispute, and decide
whether actual or estimated liabilities need to be recorded.
6. Confirm accounts payable with vendors, especially regular suppliers showing small or zero
balances in the year-end accounts payable. These are the ones most likely to be understated.
(Vendors’ monthly statements controlled by the auditors also may be used for this procedure.) Be
sure to verify the vendors’ addresses so that confirmations will not be misdirected, perhaps to
conspirators in a scheme to understate liabilities.
7. Study the accounts payable trial balance for indications of dates showing fewer payables than
usual recorded near the year-end. (A financial officer may be delaying the recording of vendor
invoices.)
8. Use a checklist of accrued expenses to determine whether the company has been conscientious
about expense and liability accruals including accruals for wages, interest, utilities, sales and
excise taxes, payroll taxes, income taxes, real property taxes, rent, sales commissions, royalties,
and warranty and guarantee expense.
9. When auditing the details of sales revenue, pay attention to the terms of sales to determine
whether any amounts should be deferred as unearned revenue. Inquiries directed to management
about terms of sales can be used to obtain initial information, such as inquiries about customers’
rights of cancellation or return. The terms may signal the need for deferred revenue accounting.
10. Perform analytical procedures appropriate in the circumstances. Calculate and compare the gross
margin percent of the current year to that of prior year(s), and compare important expense account
balances to those of prior years to notice any that this year appear to be too low.
8.51 Fictitious Vendors, Theft, and Embezzlement
In this case, let your initial objective be to select one vendor for investigation. Instead of a “tests of
controls” section, name the one vendor you would select from those in Exhibit 8.51-1 and tell your reasons.
In the “test of balances” section, tell how you would investigate the situation. In the “discovery summary”
section, speculate about how your investigation might reveal the culprit.
8-11
Audit Approach
Objective: Select one vendor for investigation, and try to obtain evidence of purchasing at inflated prices.
Control: Purchasing operations should be performed under rules and procedures designed to motivate
purchasing agents to buy at the best prices available from competing vendors. Competitive bidding should
be required unless conditions make the best prices available without bid.
However, purchasing agents should have flexibility within operating procedures to move quickly to obtain
the best balance of quantities, delivery terms, and prices as events dictate. Thus, they may not always
obtain competitive bids.
A higher manager level should supervise and review the results of purchasing activity on a regular basis,
perhaps reperforming some price-obtaining actions occasionally to determine whether the agents are
achieving efficiency. Such review might also involve selecting odd situations for extensive review.
Tests of controls: The one vendor selected is Orion Corp. Key reasons for this selection are:
• Volume is high and has increased almost 1000 percent, more than for any other vendor.
• Last bid was obtained in 2007, older than other vendors’ bids.
• The percent purchased on bid is lowest among those bids.
• Collins, the manager, is in charge.
• Collins purchases from several vendors without bids.
Audit of balance: Investigation of purchases from Orion:
• Review purchase invoices to determine unit prices for paper.
• Compare unit prices with other suppliers.
• Interview other suppliers and their salespersons to try to determine whether Collins solicited kickbacks.
• Review bid records to determine the dates of submitted bids and bid prices.
• Examine Collins’ personnel file. Investigate references if they were not consulted earlier. Might investigate
again with more determination to notice telltale signs.
• Conduct interviews with Collins and other purchasing agents under a front of learning about purchasing
procedures. Carefully seek information or impressions about Collins relations with Orion.
• Inquire at secretary of state office for names of Orion incorporators to see if Collins is connected.
Look up officers in national executives directory to see if she is listed as an officer of Orion.
• Covertly observe Collins’ lifestyle and spending habits. A ruse might be used to get information
about Collins’ bank balance and activity. (Overt action such as subpoena should not be used until
clear evidence of guilt is available.)
Discovery Summary
If Collins is taking kickbacks in return for causing Bailey to pay higher prices, the price comparison
information should show evidence. If this is the case, the other procedures should also bear fruit—past
employment history problems, police record, derogatory gossip from co-workers, more wealth than
justified by salary, maybe even a direct connection with Orion.
8-12
Collins has plenty of “room” to cause Bailey a significant financial drain. Purchases from Orion were
$1,220,000 over the last two years, and about $500,000 of supplies and sundries without bid from other
suppliers. If the overpricing to Bailey were 10 percent of all these purchases, it could amount to $172,000
for two years’ “work.”
P.S. The title of the case “Purchasing Stars” is a clue to the solution (Orion)
8.52 Bidding Process
a. While it might seem logical that the vendors would split the bids fairly evenly over time, in the real
world, this is not usually the case. As a matter of fact, an even split would likely be a red flag. (c).
Generally, one vendor turns out to be a low bidder the majority of the time. The fact that Wright has
been the winning bidder about half the time is not by itself a red flag.
b. The situation in which Wright has been the last bidder in each of the winning bids changes the
situation dramatically. When the final bidder is the winning bidder the majority of the time, it may be
an indication of an information leak. The contracts being bid are worth a considerable amount of
money, and bribes paid for information must be considered. We can control this by keeping the bids
locked and unopened until the bidding deadline has passed. Bids should be opened by someone other
than the purchasing agent and should be opened and recorded by two people.
c. It is unusual for venders to split contracts in such a manner. This may be indicative of collusion
among the venders. Controls might include having more than three vendors and having a different mix
of vendors bid on each contract. A detailed proposal listing all components of the bid may detect
collusion. Vendor approvals should be reviewed periodically for changes in management or ownership
(it is possible that one company has purchased another and may be operating under two different
names).
d. This may or may not be a problem. Bids may be awarded on criteria other than just price. Delgado
may have been able to meet a deadline other bidders could not or might have special expertise that
make him preferable on a specific job. The auditor should inquire of management about the criteria for
awarding these bids. Controls might include documentation with the bids regarding the rationale for
choosing a specific vendor. This documentation should be reviewed and approved by an appropriate
member of management.
8.53 Grounds for Dismissal

Audit Approach
Objective: To detect the fraudulent hiring of a consulting firm.
Control: The contract should have been approved by someone above Doe’s level. Payments should not
have been made without such approval. After being signed, checks should be mailed directly from the
treasurer’s office.
Test of controls: Examine disbursements for indication of authorization. Endorsements on checks can be
examined for double signatures.
Audit of balance: Tests of charges to the capital account should reveal the large amount of expenses being
capitalized. In addition to vouching these charges, auditors should inquire about whether they are properly
capitalized as long-term assets.
8-13
Discovery Summary
Company employees in charge of capital projects began noticing the large charges. In March 2001, Doe
and her husband were named in a $2.4 million civil judgment, the largest fraud in the history of King
County, Washington. The settlement required a list of possessions the Does had acquired. The 19-page list
contained 489 items. Cars, pianos, and other items were sold at auction and netted The Coffee Co. about
$1.8 million.
Doe was a compulsive shopper. The police reported there was only a small path through the rooms of her
house because boxes of her purchases were stacked to the ceiling.
Red flags that should have tipped off her supervisor and co-workers included:
• Doe was evasive and never satisfactorily answered questions about FCC.
• When the supervisor asked to meet with FCC, he was told they were working out of the office.
• FCC was not registered in the State of Washington or listed in telephone directories.
• FCC’s mailing address was a P.O. box. The physical address was Doe’s residence.
• Doe requested special handling for FCC checks whereby she picked them up personally.
8.54 Audit Simulation: Audit the PP&E and Depreciation Schedule
a. The Computer B system is depreciated for a full year ($583,000), but depreciation should be
calculated for only eight months. Correct amount is $389,000.
The depreciation on the press should be $75,000 instead of $150,000. Somebody doubled the
depreciation expense for this year.
Accumulated Depreciation 269,000

Cost of Goods Sold 67,500
Inventory 7,500
General and Admin. Expense 194,000
b. The best way to approach this requirement is to write a procedure for each assertion.
Building 2
Existence: Inspect the building to determine that it is in “productive use” (evidence of existence).
Rights (ownership): Vouch the legal title papers and recorded deed for evidence of ownership.
Valuation: Vouch the contractor’s billings and the payments for evidence of appropriate cost
valuation.
Presentation and disclosure: Study any related loan agreements for pledge as security for loans in
relation to necessary disclosure. Inspect insurance policies for evidence of adequate insurance
(inadequate insurance may require disclosure).
Computer B system
Existence: Inspect the computer and observe it in operation.
Rights (ownership) and valuation: Vouch purchase and title documents (ownership and cost
valuation).
Completeness: Vouch expenses in the repairs and maintenance accounts (or similar accounts) for
installation and testing costs that should be capitalized (evidence of completeness of recording
asset cost).
8-14
Auto 2
Existence: Inspect the auto and observe it in operation.
Rights and valuation: Vouch purchase and title documents (ownership and cost valuation).
Completeness: Vouch expenses in the repairs and maintenance accounts (or similar accounts) for
typical additional costs (e.g., tax, title, and license) that should be capitalized (evidence of
completeness of recording asset cost).
c. The loss on the sale of the Computer A system should be $542,000 ($5,000,000 - $3,958,000 -
$500,000). The gain on the sale of Auto 1 (fully depreciated) should be $1,000. The cash flow
from investing activities should show cash inflow from sale of assets in the amount of $501,000.
There should be cash outflow for purchase of assets in the amount of $45,522,000.
8.55 PP&E Assertions and Substantive Procedures
1. Rights evidence:
d. Examine deeds and title insurance certificates.
2. Existence evidence:
g. Physically examine all major property and equipment additions.
3. Valuation evidence:
b. Review the provision for depreciation expense and determine whether depreciable lives
and methods used in the current year are consistent with those used in the prior year.
8.56 Assertions and Substantive Procedures for Property, Plant, and Equipment (PP&E)
a. Valuation, Existence
b. Valuation
c. Valuation
d. Valuation and Allocation
e. Existence
f. Existence
g. Completeness
h. Valuation and Allocation
i. Rights and Obligations
j. Rights
k. Valuation
8-15
8.57 CAATS Application—PP&E
a. The information needed to reconcile subsidiary detail records to general ledger balances:
• Asset type.
• Location code.
• Cost.
• Accumulated depreciation, end of year.
The task of footing the subsidiary ledger and comparing the recalculation to the general ledger
balance(s) does not complete the audit of fixed assets. Additional evidence is needed to be
persuaded of existence of the assets (observation), valuation (vouching invoices, recalculating
depreciation), completeness (vouching and tracing transactions dated around the year-end), and
presentation and disclosure (in-use-status, inquiries about hypothecation, liens).
b. The assistant will also need to know the asset number, description, as well as asset type and
location code mentioned in (a).
8.58 Search for Unrecorded Liabilities
a. Audit plan
Procedure Performed by Ref
1. Obtain a trial balance of recorded accounts payable as

of year-end and vouch to receiving reports to ensure
goods were received in the current year
2. Select a sample of cash disbursements from the accounting

period following the balance-sheet date. Vouch disbursements to
supporting documents (invoice, receiving report) to determine
whether the related liabilities were recorded in the proper
accounting period.
3. Send confirmations
(a) to creditors with small or zero balances
(b) to creditors with whom the company has done significant
business
3. Inquire of client personnel about their procedures for ensuring

that all liabilities are recorded.
4. Obtain a list of unmatched vendor invoices and review

receiving reports to identify when the goods were received.
5. Trace the unmatched receiving reports to accounts payable,

and determine whether items recorded in the next accounting
period need to be adjusted.
8-16
b. Adjusting journal entry
Vouchers Payable 53,000

Rent Expense 53,0001
To reverse January rent expense recorded in December
Miscellaneous Expense 6,300.00

Cost of Goods Sold 12,889.66
Office Expense 8,644.862
Vouchers Payable 27,834.52
To record unrecorded liabilities
8.59 TBD
8.60 TBD
8.61 TBD
8.62 TBD
APPENDIX 8C
The Payroll Cycle
SOLUTIONS FOR REVIEW CHECKPOINTS
8C.1 The functions in a payroll cycle include:
• Personnel and labor relations - hiring and firing (authorization).

• Supervision - approval of work time (authorization).
• Timekeeping and cost accounting - payroll preparation and cost accounting (recordkeeping).
• Payroll accounting - check preparation and related payroll reports (custody of cash).
• Check signing (custody).
• Payroll distribution - actual custody of checks and distribution to employees (custody of cash).
8C.2 In a payroll cycle, the functional responsibilities which should be separated include:
1. Personnel or labor relations department.

2. Supervision.
3. Timekeeping and cost accounting.
4. Payroll accounting.
5. Payroll distribution.
1
May omit if students assume the charge was made to prepaid rent.
2
Includes unbilled amount for December
8-17
8C.3 When employees are terminated, the employee should be interviewed by the personnel department, who
can then remove them from the payroll files. Separation of responsibility for handing out paychecks from
authorization and record keeping can reduce the incentive for supervisors to keep terminated employees on
the payroll. Labor cost analyses also reduce incentives for supervisors to have too many employees listed in
their departments. Finally, W-2s should be sent directly to the employees’ homes so they can spot any
fictitious wages.
8C.4 a. A walkthrough of a personnel and payroll transaction would include discussions with each person
handling personnel and payroll records. The following illustrates the steps and documents
collected.
Steps Document(s) Collected

Hiring—personnel department Authorization to hire and rate assignment
Deductions—personnel department Personnel forms, employee authorization for
deductions (e.g., W-4 form)
Timekeeping Clock card
Shops Production time ticket
Cost distribution Labor distribution work sheet
Accounts payable Payroll voucher
Cash disbursement Payroll checks
b. If the payroll is processed by computer, the clock cards and production time tickets would be
traced to batch control in the timekeeping and production departments, to data preparation (input),
to edit and validation error reports and other computer output indicating control, and finally to
computer-prepared checks, labor distribution reports, and summary general ledger entries.
8C.5 Important documents in employee’s personnel files:
• Employment application.
• Background investigation report.
• Notice of hiring.
• Job classification with pay rate authorization.
• Authorizations for deductions (e.g., health insurance, life insurance, retirement contribution, union
dues, W-4 form for income tax exemptions).
• Termination notice, if applicable.
8C.6 a. Prevent or detect payment to a fictitious employee:
• Paychecks prepared only for persons with employment authorization from the personnel
department.
• Paychecks prepared only for persons with approved work attendance, time.
• Paychecks distributed only in person to persons identified as employees (or by electronic

transfer to validated employee bank accounts).
• Payroll register or list confirmed by the supervisor after paychecks are prepared or
distributed.
b. Employees are expected to complain if they are not paid!
8-18
8C.7 The common errors and frauds in the personnel and payroll cycle are
a) Recorded employee transactions are not valid (fictitious employee),
b) Recorded attendance transactions are not valid (fictitious hours), and
c) Incorrect cost accounting classification for labor.
Auditors look for separation of duties, proper authorizations and good reconciliations to prevent or correct these
errors or frauds. Auditors should be alert to a supervisor having too many incompatible responsibilities (e.g., hiring,
authorization of hours, authorization of pay rate, distribution of pay checks and dismissal--only authorization of
hours is a proper responsibility).
SOLUTIONS FOR MULTIPLE-CHOICE QUESTIONS
8C.8 a. Incorrect It is an appropriate control to have the payroll department supervisor examine
authorization forms for new employees to ensure the information as been
properly recorded in the payroll system.
b. Incorrect It is an appropriate control for the payrool department supervisor to compare the
batch total with the payroll register to ensure that the appropriate number of
payments have been made.
c. Correct The payroll department should be independent of the personnel department,
which would be responsible for authorizing all payroll rate changes for the
employees of the entity. A supervisor would be authorized, however, to initiate
requests for rate increases for supervised employees.
d. Incorrect A department supervisor should have approval on all employees hired into their
department.
8C.9 a. Correct The personnel department provides the authorization for payroll-related
transactions (e.g., hiring, termination, and changes in pay rates and deductions).
a. IncorrectThe treasurer’s department is not a part of the pay rate process.
b. Incorrect The controller is the chief accountant and manages the recordkeeping processes
and should not have any authorization responsibilities.
c. Incorrect Payroll is a recordkeeping function and should not have authorization over pay
rates.
8C.10 a. Incorrect A generalized program would not be sufficiently sophisticated to test this
procedure.
b. Correct In a manual payroll system, a paper trail of documents would be created to
provide audit evidence that controls over each step in processing were in place
and functioning. One element of a computer system that differentiates it from a
manual system is that a transaction trail useful for auditing purposes might exist
only for a brief time or only in computer-readable form.
c. Incorrect This may be true, but there is not enough information about built-in controls.
d. Incorrect This is a real-time system as records are updated when employees record their
time.
8C.11 a. Incorrect The payroll clerk has access to recording and custody.
b. Incorrect Unclaimed pay should be given to the treasurer.
c. Correct Under a cash payroll system, the receipt signed by the employee is the only
document in support of payment. The signed receipt is essential to verify both
occurrence and accuracy of payment.
d. Incorrect This would not be applicable to cash payroll.
8C.12 a. Incorrect An absence of an approved time record would prevent the employee being paid.
8-19
b. Incorrect This is a good by-product of the policy, but it is unlikely that real employees
would fail to pick up their checks for several weeks.
c. Incorrect This procedure would not prevent another employee from picking up the check.
d. Correct A follow-up of unclaimed checks may result in identification of fictitious or
terminated employees, thus eliminating an employee’s opportunity to claim a
paycheck belonging to a terminated employee. The unclaimed checks should
then be turned over to a custodian so the internal audit function does not assume
operating responsibilities.
8C.13 a. Correct Ordinarily, the auditor examines the endorsements on payroll checks while
obtaining an understanding of and testing the payroll cycle, which includes
consideration of clock cards.
b. Incorrect The voucher system does not pertain to payroll.
c. Incorrect This is a possibility, but (a) is better. As part of the cash audit, the auditor would
normally only examine checks returned with the cut-off bank statement.
d. Incorrect Test of accruals would not involve examination of canceled paychecks.
8C.14 a. Correct In considering whether transactions actually occurred, the auditor is most
concerned about the proper separation of duties between the personnel
department (authorization) and the payroll department (processing the
transactions).
b. Incorrect This relates to completeness.
c. Incorrect This relates to accuracy.
d. Incorrect This would not provide evidence about occurrence of payroll transactions.
8-20
8C.15 a. Incorrect Accounting is a recordkeeping function and may prepare a voucher for
execution in other departments
b. Incorrect Accounts payable is a recordkeeping function and may prepare checks as long as
they are not the signer (authorization function)
c. Correct The payroll department assembles payroll information, which is a recording
function. Custody of assets, such as unclaimed payroll checks, is incompatible
with record keeping.
d. Incorrect Personnel is authorization function and it is within this function to authorize
terminations and provide proper documentation to the appropriate departments.
8C.16 a. Incorrect Clock in and out indicates the time spent at the facility and includes breaks,
lunch and other time that is spent when not working.
b. Incorrect Recalculating time cards provides evidence that hours were totaled correctly.
This does not indicate that these hours were only for work performed.
c. Incorrect Signing the time cards would not provide evidence that the employee performed
work for the hours listed on the time card.
d. Correct The employee’s direct supervisor is in the best position to know if the employee
worked the hours indicated on the time card. The supervisor’s approval is the
best evidence that the hours on the time card were for hours worked.
8C.17 a. Incorrect Supervisors are an authorizer for time worked. Giving the supervisor the pay
checks for distributions violates the separation of duties because the supervisor
has custody of the asset.
b. Incorrect Setting the pay rate for the department would not prevent fraud. In fact, the
supervisor might take a kick back for authorizing a higher rate creating another
possibility of fraud.
c. Incorrect The ability of a supervisor to authorize the hiring and firing of employees
provides an opportunity for ghost payroll.
d. Correct A summary of hours worked would not provide any additional opportunities for
fraud and may detect a payroll fraud if some employees were working a
significant number of hours above other employees in the same areas.
SOLUTIONS FOR EXERCISES AND PROBLEMS
8C.18 Major Risks in Payroll Cycle
Payroll Cycle Risk Assertion
Paying fictitious “employees” Occurrence, employees exist
Overpaying for time or production Accuracy of payroll amounts, proper inventory, cost of goods sold, and
expense amounts
Incorrect accounting for costs and Accuracy, classification

expenses
8-21
8C.19 Payroll Authorization in a Computer System
Because authorization is an important control activity, the point(s) of authorization should be determined.
Authorization of payroll transactions cannot be determined without understanding the complete flow of
transaction processing (manual and computer).
The following could be points in the flow where authorization takes place:
• When the computer application program is written (and approved) to accept certain employee
codes and to compute the gross payroll and the net amount.
• When the foreperson initials the time card. (Alternatively, the time may be automatically entered
from a time clock into the computer files without foreperson’s initials—then the employee
clocking in and out is the authorization.)
• When payroll batches of time cards are totaled and submitted to data conversion.
• When the time cards are input.
• When the payroll programs are run using the time clock transactions and the payroll master file.
• When the signature plate is installed on the printer and checks are printed.
• When the pay rate is entered into the employee master file.
8C.20 Payroll Processed by a Service Organization
This discussion question brings up the auditors’ responsibility when payroll is processed by a service
bureau, a common occurrence in many smaller businesses. The main point is that the audit control concerns
are the same wherever the data is processed. Following are some of the discussion points that have come up
in the past use of this question.
• Audit planning will require determination of whether a report person is available from the service
bureau. Of particular interest is whether the service auditor’s report covers “design only” or both
“design and certain tests of controls.”
• When a service bureau is used, client personnel are responsible for user input and output control
(e.g., authorization, completeness (batching), reconciliation of input controls to output.
• Specific contractual agreements of control responsibilities between the client and the service
bureau need to be examined and evaluated.
• General controls are the responsibility of the service bureau (e.g., system and program
documentation); backup for computer processing, data files, documentation and staff; and
restrictions over access to computer equipment, data files and programs.
• Service bureau processing requires increased emphasis on client procedures for verifying
continuing authority, completeness, and accuracy of master file.
• Service bureau processing requires increased emphasis on error correction and resubmission
procedures.
8C.21 Payroll Audit Procedures, Computers, and Sampling
a. Audit procedures: Obtain a sample of weekly batches of time cards and recalculate the totals of
labor hours and social security numbers. Labor hour data distributed by the cost accounting
department may serve as a cross-check. These control totals should then be compared to the
payroll register totals for the same period (and to control totals obtained after keyboard entry, if
available).
Deviation rate: The expected deviation rate should be zero. Although some input errors might
occur, they should be detected and corrected using the control totals for labor hours and social
security numbers.
8-22
Auditing and Assurance Services 7th Edition Louwers Solutions Manual
Tolerable rate: Because payroll costs probably represent a significantly large cost item in a
manufacturing company, the tolerable rate might be quite low, say 2 percent or 3 percent.
Sample items: The sample items should be from appropriate populations; in this case, either the
batches as described above, the 300 employee files, or each employee’s weekly payroll (52 x 300
= 15,600 worker/week payments).
Sample size factor: Include expected deviation rate, tolerable deviation rate, risk of assessing
control risk too low, and the population size (if small).
b. Select personnel files at random and compare the authorized job classification and pay rate to the
union contract and to the database (tape or cards) that contains the table used in computer
memory. This procedure yields evidence that the internal computer table is accurate. By reviewing
documented changes in the table, its contents throughout the period under audit may be reviewed.
Extract a sample of names—classifications—rates from the table itself and vouch these to the
personnel files to detect errors of commission in the table. To determine whether rates are actually
used properly, the auditor may test the computer application with simulated transactions
or she or he may audit “around” the calculations by vouching payroll register output to time cards
and personnel files, and by retracing samples from time cards and personnel files forward to the
payroll register.
These procedures differ from a completely manual system only with respect to the need to test the
adequacy of the machine-stored rate table and in the test data application. Otherwise, the
procedures are equally applicable to a manual system for preparing the payroll.
8C.22 Payroll Tests of Controls
Procedure Evidence
Sample of clock cards: Missing approval deviation

Note supervisors’ approval. Wrong hours deviation.
Trace to periodic payroll registers. Wrong employee deviation.
Sample of payroll register entries:
Vouch hours paid to clock cards and supervisors’ Wrong hours deviation.
approval. Missing approval deviation
Recalculate gross pay, deductions, net pay. Inaccurate pay calculation deviation.
Recalculate payroll registers. Inaccurate payroll summary deviation.
Examine canceled payroll checks and endorsements. Inaccurate check amount of deviation.
Invalid endorsement deviation.
Vouch periodic payroll totals to payroll bank account Inaccurate payroll transfer deviation.
transfer vouchers and deposit. Missing payroll transfer deviation.
Trace payroll entries to year-to-date records. Incomplete update deviations.
Reconcile year-to-date records with total payrolls. Inaccurate payroll (tax return) deviation.
Trace payroll to management reports and to general ledger. Accounting incomplete deviation.
Accounting incomplete deviation.
8-23
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Chapter 08 - Acquisition and Expenditure Cycle

Acquisition and Expenditure Cycle

1. Describe the acquisition and 1, 2, 3 29, 30, 31 47(*), 52(*)

2. Identify significant accounts and 4, 5, 6 32 47(*), 55(*),

3. Discuss the risk of material 7, 8 49(*)

5. Give examples of tests of controls 11, 12 44 47(*), 51(*)

(*) Item relates to multiple learning objectives

SOLUTIONS FOR REVIEW CHECKPOINTS

• Open purchase orders: Purchase commitments, losses on purchase commitments.

• Photocopies of invoices in the files.

SOLUTIONS FOR MULTIPLE-CHOICE QUESTIONS

8.31 a. Incorrect Overstates net income in the period of capitalization.

8.33 a. Incorrect These duties should be separated.

8.36 a. Incorrect This is often performed before the balance-sheet date.

SOLUTIONS FOR EXERCISES, PROBLEMS, AND SIMULATIONS

b. For a sample of cash disbursements, vouch to approval signatures on invoices, receiving

d. Select a sample of current-year debits in accounts (e.g., inventory, fixed assets,

2. a. Liabilities are recorded at the appropriate quantity and description (accuracy).

d. Reperform comparison on a test basis.

b. Examine entries for approval initials.

c. The company might override controls to create fraudulent entries.

8.48 Unrecorded Liabilities Procedures

1. Unentered vendors’ invoice file.

9. Attorney’s bills and letter of representation.

8.49 Accounts Payable Confirmations

The principal objectives of the accounts payable examination are:

(1) Internal controls are weak.

4. Select prior-year vendors who are no longer used.

5. Select new vendors used in the subsequent years.

6. Select vendors that do not provide periodic statements.

7. Select accounts reflecting unusual transactions during the year.

8. Select accounts secured by pledged assets.

8.50 Search for Unrecorded Liabilities

8.51 Fictitious Vendors, Theft, and Embezzlement

Audit of balance: Investigation of purchases from Orion:

• Review purchase invoices to determine unit prices for paper.

• Compare unit prices with other suppliers.

8.52 Bidding Process

8.53 Grounds for Dismissal

Objective: To detect the fraudulent hiring of a consulting firm.

8.54 Audit Simulation: Audit the PP&E and Depreciation Schedule

Accumulated Depreciation 269,000

Existence: Inspect the computer and observe it in operation.

Existence: Inspect the auto and observe it in operation.

8.55 PP&E Assertions and Substantive Procedures

d. Examine deeds and title insurance certificates.

g. Physically examine all major property and equipment additions.

d. Valuation and Allocation

h. Valuation and Allocation

i. Rights and Obligations

8.57 CAATS Application—PP&E

8.58 Search for Unrecorded Liabilities

Procedure Performed by Ref

1. Obtain a trial balance of recorded accounts payable as

2. Select a sample of cash disbursements from the accounting

3. Inquire of client personnel about their procedures for ensuring

4. Obtain a list of unmatched vendor invoices and review

5. Trace the unmatched receiving reports to accounts payable,

b. Adjusting journal entry

Vouchers Payable 53,000

To reverse January rent expense recorded in December

1. Describe the acquisition and 1, 2, 3 29, 30, 31 47(), 52()

2. Identify significant accounts and 4, 5, 6 32 47(), 55(),

5. Give examples of tests of controls 11, 12 44 47(), 51()