Slides - Chapter 18 - ST Version

2/20/2024
AUDIT OF THE
ACQUISITION AND
PAYMENT CYCLE: TESTS OF
CONTROLS, SUBSTANTIVE
TESTS OF TRANSACTIONS,
AND ACCOUNTS PAYABLE
CHAPTER 18
Copyright ©2017 Pearson Education, Inc. 18-1
CHAPTER 18 LEARNING OBJECTIVES
18-1 Identify the accounts and the classes of transactions in the

acquisition and payment cycle.
18-2 Describe the business functions and the related documents and
records in the acquisition and payment cycle.
18-3 Understand internal control, and design and perform tests of
controls and substantive tests of transactions for the acquisition
and payment cycle.
18-4 Describe the methodology for designing tests of details of
balances for accounts payable using the audit risk model.
Copyright © 2017 Pearson Education, Inc. 18-2
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CHAPTER 18 LEARNING OBJECTIVES
18-5 Design and perform substantive analytical procedures for

accounts payable.
18-6 Design and perform tests of details of balances for accounts
payable, including out-of-period liability tests.
18-7 Distinguish the reliability of vendors’ invoices, vendors’
statements, and confirmations of accounts payable as audit
evidence.
OBJECTIVE 18-1
Identify the accounts and the classes
of transactions in the
acquisition and payment cycle.
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ACCOUNTS AND CLASSES OF TRANSACTIONS IN THE

ACQUISITION AND PAYMENT CYCLE
There are three classes of transactions in the acquisition and

payment cycle:
1. Acquisitions of goods and services
2. Cash disbursements
3. Purchase returns and allowances and purchase
discounts
The typical accounts involved in the acquisition and payment
cycle are shown in Figure 18-1.
Figure 18.1 Accounts in the Acquisition and Payment Cycle
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OBJECTIVE 18-2
Describe the business functions and
the related documents and
records in the acquisition and
payment cycle.
BUSINESS FUNCTIONS IN THE CYCLE AND RELATED

DOCUMENTS AND RECORDS
There are four business functions involved in the

acquisitions and payment cycle: These business functions
and the related documents are detailed in Table 18-1.
1. Processing Purchase Orders—Includes a purchase
requisition which is used to request authorization for
goods or services and a purchase order which is used
for the order after it has been authorized.
2. Receiving Goods and Services—Includes a receiving
report which is prepared at the time the goods are
received.
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BUSINESS FUNCTIONS IN THE CYCLE AND

RELATED DOCUMENTS AND RECORDS(CONT.)
3. Recognizing the Liability—Proper recognition requires
prompt and accurate recording. Documents that may be
involved:
• Vendor’s Invoice—Document from the vendor that shows the amount
owed for an acquisition
• Debit Memo—Also from the vendor; indicates a reduction in the
amount owed
• Voucher—A formal means of recording and controlling acquisitions
• Acquisitions Transaction File—Computer-generated file including all
acquisitions transactions

3. Recognizing the Liability (cont.) Documents involved:
• Acquisitions Journal or Listing—Often referred to as the purchases
journal; includes vendor name, date, amount, and account
classification
• Accounts Payable Master File—Records acquisitions, cash
disbursements, and acquisition returns and allowances for each
vendor
• Accounts Payable Trial Balance—A listing of the amount owed each
vendor at a point in time
• Vendor’s Statement—A document prepared monthly by the vendor
that indicates the beginning balance, acquisitions, returns and
allowances, payments to the vendor, and ending balance
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4. Processing and Recording Cash Disbursements—The
payment for goods and services represent a significant
activity for all entities. Documents that auditors examine
associated with this activity:
• Check—Document used to pay for an acquisition; may be paper or
an electronic funds transfer (EFT)
• Cash Disbursements Transaction File—A computer-generated file
that includes all cash disbursement transactions processed during
a period
• Cash Disbursements Journal or Listing—Includes all disbursement
transactions for a period
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OBJECTIVE 18-3
Understand internal control, and
design and perform tests of
controls and substantive tests of
transactions for the acquisition
and payment cycle.
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METHODOLOGY FOR DESIGNING TESTS OF CONTROLS

AND SUBSTANTIVE TESTS OF TRANSACTIONS
The most time-consuming accounts to verify by tests of

details of balances are accounts receivable, inventory, fixed
assets, accounts payable, and expense accounts. Four of these
are directly related to the acquisition and payment cycle.
• If the auditor can reduce the tests of details of the account
balances by using tests of controls and substantive tests of
transactions for acquisitions and cash disbursements, the time
saved can be dramatic.
The methodology for designing tests of controls and
substantive tests of transactions is illustrated in Figure 18-2.
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AND SUBSTANTIVE TESTS OF TRANSACTIONS (CONT.)
Understand Internal Control: The auditor gains an understanding

of internal control for the acquisition and payment cycle as part of
performing risk assessment procedures.
Assess Planned Control Risk: Key internal controls for the business
functions in this cycle are:
• Authorization of purchases
• Separation of asset custody from other functions
• Timely recording and independent review of transactions
• Authorization of payments
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Determine Extent of Tests of Controls:

• If the auditor intends to rely on controls to support a preliminary
control risk assessment below maximum, the auditor performs tests
of controls to obtain evidence that controls are operating effectively.
Design Tests of Controls and Substantive Tests of Transactions for
Acquisitions:
• Key internal controls, common tests of controls, and common
substantive tests of transactions for each transaction-related audit
objective are summarized in Table 18-2 on page 624.
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On page 624 of
Text book
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Copyright ©2017 Pearson Education, Inc. 19
19


Acquisitions (cont): Four of the six transaction-related audit
objectives should be examined more closely:
1. Recorded acquisitions are for goods and services received,
consistent with the best interests of the client (Occurrence).
2. Existing acquisitions are recorded (Completeness).
3. Acquisitions are accurately recorded (Accuracy).
4. Acquisitions are correctly classified (Classification).
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Cash Disbursements:
• Key internal controls, common tests of controls, and common substantive
tests of transactions for each transaction-related audit objective are
summarized in Table 18-3 on page 627.
Attributes Sampling for Tests of Controls and Substantive Tests of
Transactions: Important differences in acquisition and payment cycle:
• a larger number of accounts involved in this cycle, including both income
statement and balance sheet accounts.
• more common for transactions to require significant judgment, such as for
leases and construction costs.
• dollar amounts of individual transactions in the cycle cover a wide range.
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On page 627 of
Text book
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Cash Disbursements:
• Key internal controls, common tests of controls, and common substantive
tests of transactions for each transaction-related audit objective are
summarized in Table 18-3 on page 615.
Attributes Sampling for Tests of Controls and Substantive Tests of
Transactions: Important differences in acquisition and payment cycle:
• a larger number of accounts involved in this cycle, including both income
statement and balance sheet accounts.
• more common for transactions to require significant judgment, such as for
leases and construction costs.
• dollar amounts of individual transactions in the cycle cover a wide range.
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Question: 18-16
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OBJECTIVE 18-4
Describe the methodology for
designing tests of details of
balances for accounts payable using
the audit risk model.
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METHODOLOGY FOR DESIGNING TESTS OF DETAILS OF

BALANCES FOR ACCOUNTS PAYABLE
Because all acquisition and payment cycle transactions typically

flow through accounts payable, it is critical to any audit.
The methodology for designing tests of details for accounts
payable is summarized in Figure 18-3.
• Identify Significant Risks and Assess the Risk of Material
Misstatement for Accounts Payable (Phase I).
• Set Performance Materiality (Phase I).
• Assess Control Risk and Design and Perform Tests of Controls
and Substantive Tests of Transactions (Phases I and II).
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METHODOLOGY FOR DESIGNING TESTS OF DETAILS OF

BALANCES FOR ACCOUNTS PAYABLE
Because all acquisition and payment cycle transactions typically

flow through accounts payable, it is critical to any audit.
The methodology for designing tests of details for accounts
payable is summarized in Figure 18-3.
• Identify Significant Risks and Assess the Risk of Material
Misstatement for Accounts Payable (Phase I).
• Set Performance Materiality (Phase I).
• Assess Control Risk and Design and Perform Tests of Controls
and Substantive Tests of Transactions (Phases I and II).
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OBJECTIVE 18-5
Design and perform substantive
analytical procedures for
accounts payable.
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DESIGN AND PERFORM SUBSTANTIVE ANALYTICAL

PROCEDURES (PHASE III)
The use of analytical procedures is as important in the

acquisition and payment cycle as it is in every other cycle,
especially for uncovering misstatements in accounts
payable.
Analytical procedures for the balance sheet and income

statement accounts in the acquisition and payment cycle
that are useful in uncovering areas in which additional
investigation is desirable are illustrated in Table 18-4.
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OBJECTIVE 18-6
Design and perform tests of details
of balances for accounts
payable, including out-of-period
liability tests.
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DESIGN AND PERFORM TESTS OF DETAILS OF

ACCOUNTS PAYABLE BALANCE (PHASE III)
The overall objective in the audit of accounts payable is to

determine whether the accounts payable balance is fairly
stated and properly disclosed.
Balance-related audit objectives and common tests of details of

balances procedures for accounts payable are included in Table
18-5.
Difference in the emphasis in auditing assets and liabilities: In

auditing assets, auditors are concerned about overstatements;
for liabilities, auditors are concerned about understatements.
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ACCOUNTS PAYABLE BALANCE (CONT.)
Because auditors are concerned with understatement of liabilities, the
following tests are performed:
Out-of-Period Liability Tests: Also called search for unrecorded accounts
payable
• Examine underlying documentation for subsequent cash disbursements.
• Examine underlying documentation for bills not paid several weeks after
year-end.
• Trace receiving reports issued before year-end to related vendor’s invoices.
• Trace vendor’s statements that show a balance due to the accounts payable
trial balance.
• Send confirmations to vendors with which the client does business.
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Examine Underlying Documentation for Subsequent cash disbursements
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Because auditors are concerned with understatement of liabilities, the
following tests are performed:
Out-of-Period Liability Tests: Also called search for unrecorded accounts
payable
• Examine underlying documentation for subsequent cash disbursements.
• Examine underlying documentation for bills not paid several weeks after
year-end.
• Trace receiving reports issued before year-end to related vendor’s invoices.
• Trace vendor’s statements that show a balance due to the accounts payable
trial balance.
• Send confirmations to vendors with which the client does business.
39

Cutoff Tests: Cutoff Tests—To determine whether transactions
recorded a few days before and after the balance sheet date are
included in the correct period. Focus on 2 aspects:
• Relationship of cutoff to physical observation of inventory—
Cutoff tests must be coordinated with the physical observation
of inventory to determine that both the asset and liability are
recorded in the proper period.
• Inventory in Transit—Determine whether inventory in transit
at year-end was FOB destination or FOB origin.
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OBJECTIVE 18-7
Distinguish the reliability of
vendors’ invoices, and
confirmations of accounts payable
as audit evidence.
41
RELIABILITY OF EVIDENCE
Distinction Between Vendors’ Invoices and Vendors’ Statements:
Vendors’ invoices and supporting documents provide reliable
evidence about individual transactions .
The vendor’s statement is superior for verifying accounts payable
because it includes the ending balance.
Difference between Vendors’ Statements and Confirmations:
• Vendors’ statements have been prepared by the vendor, but is in
the hands of the client.
• Confirmations (example shown in Figure 18-4) are sent by the
auditor and responses from the vendor are sent directly to the
auditor, and are therefore more reliable.
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RELIABILITY OF EVIDENCE
Distinction Between Vendors’ Invoices and Vendors’ Statements:
Vendors’ invoices and supporting documents provide reliable
evidence about individual transactions .
The vendor’s statement is superior for verifying accounts payable
because it includes the ending balance.
Difference between Vendors’ Statements and Confirmations:
• Vendors’ statements have been prepared by the vendor, but is in
the hands of the client.
• Confirmations (example shown in Figure 18-4) are sent by the
auditor and responses from the vendor are sent directly to the
auditor, and are therefore more reliable.
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SUMMARY
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Question: 18-17, 18, 19, 20, 24
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2/20/2024

CHAPTER 18 LEARNING OBJECTIVES

18-1 Identify the accounts and the classes of transactions in the

Copyright © 2017 Pearson Education, Inc. 18-2

CHAPTER 18 LEARNING OBJECTIVES

18-5 Design and perform substantive analytical procedures for

Copyright © 2017 Pearson Education, Inc. 18-3

Copyright © 2017 Pearson Education, Inc. 18-4

ACCOUNTS AND CLASSES OF TRANSACTIONS IN THE

There are three classes of transactions in the acquisition and

Copyright © 2017 Pearson Education, Inc. 18-5

Figure 18.1 Accounts in the Acquisition and Payment Cycle

Copyright ©2017 Pearson Education, Inc. 18-6

Copyright © 2017 Pearson Education, Inc. 18-7

BUSINESS FUNCTIONS IN THE CYCLE AND RELATED

There are four business functions involved in the

Copyright © 2017 Pearson Education, Inc. 18-8

BUSINESS FUNCTIONS IN THE CYCLE AND

Copyright ©2017 Pearson Education, Inc. 18-9

BUSINESS FUNCTIONS IN THE CYCLE AND

Copyright ©2017 Pearson Education, Inc. 18-10

BUSINESS FUNCTIONS IN THE CYCLE AND

Copyright ©2017 Pearson Education, Inc. 18-11

Copyright ©2017 Pearson Education, Inc. 18-12

Copyright © 2017 Pearson Education, Inc. 18-13

METHODOLOGY FOR DESIGNING TESTS OF CONTROLS

The most time-consuming accounts to verify by tests of

Copyright © 2017 Pearson Education, Inc. 18-14

Copyright ©2017 Pearson Education, Inc. 18-15

METHODOLOGY FOR DESIGNING TESTS OF CONTROLS

Understand Internal Control: The auditor gains an understanding

Copyright ©2017 Pearson Education, Inc. 18-16

METHODOLOGY FOR DESIGNING TESTS OF CONTROLS

Determine Extent of Tests of Controls:

Copyright ©2017 Pearson Education, Inc. 18-17

Copyright ©2017 Pearson Education, Inc. 19

METHODOLOGY FOR DESIGNING TESTS OF CONTROLS

Design Tests of Controls and Substantive Tests of Transactions for

Copyright ©2017 Pearson Education, Inc. 18-20

METHODOLOGY FOR DESIGNING TESTS OF CONTROLS

Copyright ©2017 Pearson Education, Inc. 18-21

Copyright ©2017 Pearson Education, Inc. 23

METHODOLOGY FOR DESIGNING TESTS OF CONTROLS

Copyright ©2017 Pearson Education, Inc. 18-24

Copyright © 2017 Pearson Education, Inc. 18-26

METHODOLOGY FOR DESIGNING TESTS OF DETAILS OF

Because all acquisition and payment cycle transactions typically

Copyright © 2017 Pearson Education, Inc. 18-27

Copyright ©2017 Pearson Education, Inc. 18-28

METHODOLOGY FOR DESIGNING TESTS OF DETAILS OF

Because all acquisition and payment cycle transactions typically

Copyright © 2017 Pearson Education, Inc. 18-29

Copyright ©2017 Pearson Education, Inc. 18-30

Copyright © 2017 Pearson Education, Inc. 18-31

DESIGN AND PERFORM SUBSTANTIVE ANALYTICAL

The use of analytical procedures is as important in the

Analytical procedures for the balance sheet and income

Copyright © 2017 Pearson Education, Inc. 18-32

Copyright ©2017 Pearson Education, Inc. 18-33

Copyright © 2017 Pearson Education, Inc. 18-34

DESIGN AND PERFORM TESTS OF DETAILS OF

The overall objective in the audit of accounts payable is to

Balance-related audit objectives and common tests of details of