Chapter 7

Audit of the Expenditure Cycle

Major classes of transactions in this cycle are:

1. Acquisition of goods and services
2. Cash Disbursements
3. Purchase returns and allowances and purchase discounts

Accounts affected by the expenditure cycle are:

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

Documents used in the Expenditure Cycle & their Audit Significance

1. Purchase requisition – a purchase requisition provides evidence that the purchasing department
was authorized to initiate a purchase
2. Purchase order – a purchase order contains the signature of the employee who authorized a
purchase from a vendor
3. Receiving report – this report is prepared within the entity and provides evidence that goods
were received
4. Vendor’s invoice – this document is created externally and provides evidence about a purchase
of goods or services
5. Debit memo
6. Voucher – a voucher provides documentation or the recording of a transaction
7. Check – a check that has been presented for payment is referred to as paid or canceled check. A
paid check provides evidence about payments that an entity has made, such as date, payee, and
amount
8. Vendor’s statement – may be used to determine that all transactions recorded on the
statements have been recorded in the books.

Accounting Records Involved in the Expenditure Cycle

1. Purchase journal – a journal for recording purchase transactions.
2. Cash disbursement transaction file / journal – a file for recording the individual payments made
by check.
3. Accounts payable master file/ subsidiary ledger – a file for recording individual acquisitions,
cash disbursements, and acquisition returns and allowances for each vendor.
4. Cost Accounting Records – these records in a manufacturing company are used to summarize
transactions affecting Raw Materials, Goods in Process, Finished Goods, Labor Costs and
Manufacturing Overhead.
Examples of fraud in the acquisition and payment cycle include:

 Theft of inventory by the employee

 Inventory shrinkage, which is a reduction in inventory presumed to be due to physical loss or
theft
 Employee schemes involving fictitious vendors as means to transfer payments to themselves
 Executives recording fictitious vendors as means to transfer payments to themselves
 Executive recording fictitious inventory or inappropriately recording higher values for existing
inventory by creating false records for items that do not exist (for example, inflated inventory
count sheets and bogus receiving reports or purchase orders)
 Large manual adjustments to inventory accounts
 Schemes to classify expenses as assets (for example, inappropriately capitalizing items that are
truly current-period expenses)
 Executives misusing travel and entertainment accounts and charging them as company expenses

Auditing of Acquisition Transactions

It involves the following business activities:

a. Processing purchase orders

b. Receiving goods and services
c. Recognizing the liability
d. Cash Disbursements

Assertions related to acquisitions transactions (Test of Control)

1. Existence or occurrence – recorded transactions are for items that were acquired (3 TOC)
2. Completeness – acquisitions that occurred are recorded (2 TOC)
3. Rights and obligations – recorded acquisitions are the entity’s purchases and liabilities (1 TOC)
4. Valuation or allocation – acquisitions are recorded for the proper amounts (1 TOC)
5. Presentation and disclosure – acquisitions are recorded to result in presentation and disclosure
in accordance with PAS/PFRS (1 TOC)

* TOC = Test of Control, read pg 216-217

* TAKE NOTE:

In test of control – we test the internal control of the management, so we will usually look sa mga
process na ginagawa nila on how to conduct this activity.

In substantive test – we test naman ung mismong evidences or records (ie. Accounts), so madalas yung
mga documents na mismo ang tinitignan and not yung process ng management.
Substantive Tests of Acquisition Transactions

1. Existence or Occurrence
- Audit Objectives – to determine that recorded purchases are for items that were acquired
- Audit Procedures – examine underlying documents for authenticity and reasonableness
2. Completeness
- Audit Objectives – to determine that purchases occurred are recorded
- Audit Procedures – trace a sequence of receiving reports to entries in the voucher register.
Test cutoff.
3. Rights and Obligations
- Audit Objectives – to determine that purchases are the entity’s acquisitions and liabilities
- Audit Procedures – trace from invoices to perpetual inventory records.
4. Valuation or Allocation
- Audit Objectives – to determine that purchases are recorded for the proper amounts
- Audit Procedures – recomputed invoices and compare invoice price to purchase order
5. Presentation and Disclosure
- Audit Objectives – to determine that purchases are recorded to result in presentation and
disclosure in accordance with PAS/PFRS
- Audit Procedures – check accuracy of accounts on invoices by reference to chart of accounts.

Auditing of Cash Disbursements

It involves the following business activities:

a) Recording of transactions in a voucher register with appropriate supporting documents such as

purchase order and receiving report.
b) Submission of approved vouchers and supporting papers and unsigned check to the Finance
Department
c) Release of checks signed by authorized signatories
d) Recording of checks issued

Assertions related to Cash Disbursement Transactions (Test of Control)

1. Existence or occurrence – recorded cash disbursements occured (2 TOC)

2. Completeness – all cash disbursements made are recorded (2 TOC)
3. Rights and obligations – all cash disbursements made are for obligations of the entity (1 TOC)
4. Valuation or allocation – debits to various accounts and credits to cash are valued at proper
amounts (1 TOC)
5. Presentation and disclosure – cash disbursements are recorded to result in presentation and
disclosure in accordance with PAS/PFRS (1 TOC)
Substantive Tests of Cash Disbursements

1. Existence or Occurrence
- Audit Objectives – to determine that recorded cash disbursements occured
- Audit Procedures – examine paid checks for appropriate endorsements. Examine documents
underlying payments.
2. Completeness
- Audit Objectives – to determine that all cash disbursements made are recorded
- Audit Procedures – reconcile cash disbursements per books with cash disbursements per the
bank. Prepare or test bank reconciliation.
3. Rights and Obligations
- Audit Objectives – to determine that all cash disbursements made were the entity’s
obligations
- Audit Procedures – examine underlying documents.
4. Valuation or Allocation
- Audit Objectives – to determine that debits to various accounts and credits to cash are
valued at proper amounts
- Audit Procedures – recalculate invoices paid
5. Presentation and Disclosure
- Audit Objectives – to determine that cash disbursements are recorded to result in
presentation and disclosure in accordance with PAS/PFRS
- Audit Procedures – check accuracy of accounts on invoices by reference to chart of accounts.