You are on page 1of 41

Chapter Eleven

Auditing the
Purchasing Process

The McGraw-Hill Companies 2010

Expense and Liability Recognition


(IASB)
Expenses are
decreases in economic
benefits during the
accounting period in
the form of outflows or
depletions of assets or
incurrences of liabilities
that result in decreases
in equity, other than
those relating to
distributions to equity
participants
The McGraw-Hill Companies 2010

A liability is a present
obligation of the entity
arising from past
events, the settlement
of which is expected to
result in an outflow from
the entity of resources
embodying economic
benefits

Overview of the Purchasing


Process
A purchase transaction usually begins with a
purchase requisition generated by the user
department. The purchasing department
prepares a purchase order that is sent to the
vendor. When the goods are received or the
services rendered, a liability is recorded.
Finally, the entity pays the vendor.
Purchase
Purchase
requisition
requisition

Purchase
Purchase
order
order

The McGraw-Hill Companies 2010

Receiving
Receiving
report
reportand
and
liability
liability
recorded
recorded

Vendor

Types of Transactions and


Financial Statement Accounts
Affected
Three types of transactions are processed
through the purchasing process:

The McGraw-Hill Companies 2010

Flowchart of the Purchasing


Process EarthWear
Clothiers
Department

Requesting
Purchase
requisition

Purchasing
Approved
purchase
requisition
received
Input

Error
corrections
PO #2
Filed
Numerically

The McGraw-Hill Companies 2010

IT
Purchase
order file

Accounts
payable
master file

Purchase
order
program
Error
report

Purchase
order
(4 part)

Vendor
A/P
Receiving
Purchasing

Flowchart of the Purchasing


Process EarthWear
Clothiers
Department

Receiving

Accounts Payable (A/P)

PO
#1

PO
#3

Receiving
report

Goods
received,
counted and
inspected
Receiving
report (RR)

Vendor
invoice
Enter vendor,
quantity, and
PO #
Daily receiving log

The McGraw-Hill Companies 2010

Compare invoice
to PO and RR
Review
account
distribution
Voucher
packet
Input
Error
correction

To IT

From IT

Flowchart of the Purchasing


Process EarthWear
Clothiers
Department
IT
Purchase
order file

A/P master
file

General
ledger file
Open PO report

Input
from A/P

Accounts
payable
update

Weekly
Monthly

Daily
Report
to A/P

Error
report

A/P reporting

Daily

Monthly
reports

The McGraw-Hill Companies 2010

Voucher register
Cash disbursements
journal

A/P listing
Cash
disbursement
report

A/P expense
distribution report

General
ledger

Flowchart of the Purchasing


Process EarthWear
Clothiers
Department
Accounts Payable (A/P)

IT

Cash
disbursement
report

A/P master
file

Review documents
and authorize payment

Cash
disbursement
program

Cash
disbursement
report
Input
The McGraw-Hill Companies 2010

Cheques

Cashier
Cheques

Review cheques
and mail to
vendors

Cheques

To Vendors

Types of Documents and


Records
Purchasing
Purchasing documents
documents and
and records
records .. .. ..
1.
1. Purchase
Purchase Requisition
Requisition request
request to
to purchase
purchase goods
goods or
or services.
services.
2.
2. Purchase
Purchase Order
Order includes
includes description,
description, quality,
quality, and
and quantity
quantity or
or goods
goods
or
or services
services being
being purchased.
purchased.
3.
3. Receiving
Receiving Report
Report records
records the
the receipt
receipt of
of goods.
goods.
4.
4. Vendor
Vendor Invoice
Invoice the
the bill
bill from
from the
the vendor.
vendor.
5.
5. Voucher
Voucher serves
serves as
as the
the basis
basis for
for recording
recording aa vendors
vendors invoice.
invoice.
6.
6. Voucher
Voucher Register
Register used
used to
to record
record vouchers
vouchers for
for goods
goods and
and services.
services.
7.
7. Accounts
Accounts Payable
Payable Subsidiary
Subsidiary Ledger
Ledger includes
includes amount
amount owed
owed to
to
individual
individual vendors.
vendors.
8.
8. Vendor
Vendor Statement
Statement represents
represents the
the purchase
purchase activity
activity with
with vendor.
vendor.
9.
9. Electronic
Electronic Funds
Funds Transfer
Transfer and
and Cheques
Cheques pays
pays for
for goods
goods or
or services.
services.
10.
10. Cash
Cash Disbursements
Disbursements Journal
Journal contains
contains columns
columns to
to record
record credits
credits to
to
cash
cash and
and debits
debits to
to accounts
accounts payable
payable and
and cash
cash discounts.
discounts.

The McGraw-Hill Companies 2010

The Major Functions

The McGraw-Hill Companies 2010

Key Functions and Duties

The McGraw-Hill Companies 2010

The Key Segregation of


Duties

The McGraw-Hill Companies 2010

Inherent Risk Assessment


Industry-Related Factors

1.Is the supply of raw


materials
adequate?

The McGraw-Hill Companies 2010

2.
How volatile are
raw material
prices?

Inherent Risk Assessment


Misstatements Detected in Prior Audits
Generally,
Generally, the
the purchasing
purchasing process
process is
is not
not
difficult
difficult to
to audit
audit and
and does
does not
not present
present
contentious
contentious accounting
accounting issues.
issues. However,
However, the
the
auditors
auditors experience
experience in
in past
past audits
audits must
must be
be
considered
considered when
when assessing
assessing inherent
inherent risk.
risk.

The McGraw-Hill Companies 2010

Control Risk Assessment


Major steps in setting the control risk in the
purchasing process.
Understand
Understand and
and document
document the
the purchasing
purchasing process
process
based
based on
on aa reliance
reliance strategy.
strategy.

Plan
Plan and
and perform
perform tests
tests of
of controls
controls of
of purchase
purchase
transactions.
transactions.

Set
Set and
and document
document the
the control
control risk
risk for
for the
the purchasing
purchasing
process.
process.
The McGraw-Hill Companies 2010

Control Risk Assessment


Information Systems and Communication
For each major class of transactions in the purchasing
process, the auditor must obtain the following
information:
1. How purchase, cash disbursements and purchase return
transactions are initiated.
2. The accounting records, supporting documents and
accounts involved in processing purchases, cash
disbursements and purchase returns.
3. The flow of each type of transaction from initiation to
inclusion in the financial statements, including computer
processing.
4. The process used to estimate accrued liabilities.
The McGraw-Hill Companies 2010

Control Risk Assessment


After testing controls, the auditor sets the level
of control risk. When tests of controls support
the planned level of control risk, no
modifications are necessary to detection risk.
The auditor may proceed with the substantive
procedures as planned.
When tests do not support
the planned control risk, the
auditor lowers the level of
detection risk leading to more
substantive procedures.
The McGraw-Hill Companies 2010

Control Activities and Tests of


Controls Purchase
Transactions

Assertions about Classes of Transactions and Events for


the Period under Audit

The McGraw-Hill Companies 2010

Control Activities and Tests of


Controls Purchase
Transactions

The McGraw-Hill Companies 2010

Control Activities and Tests of


Controls Cash Disbursement
Transactions

Occurrence of Cash Disbursement Transactions

The auditor is concerned with a misstatement


caused by a cash disbursement being
recorded in the clients record when no
payment was made. The primary control
activities to prevent such misstatements
include proper segregation of duties,
independent reconciliation and review of
vendor statements, and monthly bank
reconciliations.
The McGraw-Hill Companies 2010

Control Activities and Tests of


Controls Cash Disbursement
Transactions
Completeness of Cash Disbursement
Transactions

The
The major
major audit
audit concern
concern is
is that
that aa cash
cash
disbursement
disbursement is
is made
made but
but not
not recorded
recorded in
in the
the
records.
records. The
The auditor
auditor should
should examine
examine and
and test
test the
the
clients
clients procedures
procedures for
for reviewing
reviewing vendor
vendor
payments
payments lists
lists and
and reconcile
reconcile the
the daily
daily cash
cash
disbursements
disbursements with
with posting
posting to
to the
the accounts
accounts
payable
payable subsidiary
subsidiary records.
records.

The McGraw-Hill Companies 2010

Control Activities and Tests of


Controls Cash Disbursement
Transactions
Authorization of Cash Disbursement Transactions

Proper
Proper segregation
segregation of
of duties
duties reduces
reduces the
the
likelihood
likelihood that
that unauthorized
unauthorized cash
cash disbursements
disbursements
are
are made.
made. The
The individual
individual who
who approves
approves aa
purchase
purchase should
should not
not have
have direct
direct access
access to
to the
the
cash
cash disbursement.
disbursement.

The McGraw-Hill Companies 2010

Control Activities and Tests of


Controls Cash Disbursement
Transactions
Accuracy of Cash Disbursement Transactions
One of the major audit concerns is that the
payment amount is recorded incorrectly. To
detect such an error, client personnel should
reconcile the total of electronic cash
disbursements transfer and the cheques issued
each day with the daily cash disbursements
report.

The McGraw-Hill Companies 2010

Control Activities and Tests of


Controls Cash Disbursement
Transactions
Cut-off of Cash Disbursement Transactions
The auditors tests of controls include reviewing
the reconciliation of payments transfers with
postings to the cash disbursements journal and
accounts payable subsidiary records. The auditor
also tests cash disbursements before and after
year-end to ensure that transactions are
recorded in the proper period.

The McGraw-Hill Companies 2010

Control Activities and Tests of


Controls Cash Disbursement
Transactions
Classification of Cash Disbursement
Transactions
The
The auditor
auditor is
is concerned
concerned that
that aa cash
cash
disbursement
disbursement may
may be
be charged
charged to
to the
the wrong
wrong
general
general ledger
ledger account.
account. The
The use
use of
of aa chart
chart of
of
accounts,
accounts, as
as well
well as
as independent
independent approval
approval and
and
review
review of
of the
the account
account code
code on
on the
the voucher
voucher
should
should provide
provide adequate
adequate control.
control.

The McGraw-Hill Companies 2010

Control Activities and Tests of


Controls Purchase Return
Transactions
Generally, the number and magnitude of
purchase return transactions are not material.
The auditor normally does not test controls
relating to purchase returns. Substantive testing
is used to test the reasonableness of the amount.

The McGraw-Hill Companies 2010

Relating the Assessed Level of


Control Risk to Substantive
Procedures
IfIf the
the results
results of
of the
the tests
tests of
of controls
controls support
support the
the
achieved
achieved level
level of
of control
control risk,
risk, the
the auditor
auditor
conducts
conducts substantive
substantive procedures
procedures at
at the
the planned
planned
level.
level. IfIf the
the results
results do
do not
not support
support the
the achieved
achieved
level
level of
of control
control risk,
risk, the
the auditor
auditor reduces
reduces the
the
detection
detection risk,
risk, which
which will
will increase
increase substantive
substantive
procedures.
procedures.

The McGraw-Hill Companies 2010

Auditing Accounts Payable


and Accrued Expenses

The McGraw-Hill Companies 2010

Auditing Accounts Payable


and Accrued Expenses

The McGraw-Hill Companies 2010

Auditing Accounts Payable


and Accrued Expenses
Substantive Analytical Procedures

The McGraw-Hill Companies 2010

Tests of Details of
Transactions, Account
Balances and Disclosures
Accuracy
Obtain a listing of accounts payable, foot the
listing, and agree it to the general ledger
control account. Selected vouchers or vendor
accounts should be traced to the supporting
documents or subsidiary accounts payable
records to verify the accuracy of the details.

The McGraw-Hill Companies 2010

Tests of Details of
Transactions, Account
Balances and Disclosures
Completeness

The auditor should conduct a test for unrecorded


liabilities that include the following procedures:
1. Ask management about control activities used to identify
unrecorded liabilities at the end of the period.
2. Obtain copies of vendors monthly statements and reconcile
the amounts to the clients accounts payable records.
3. Confirm vendor accounts, including accounts with small or
zero balances.
4. Vouch large monetary items from the purchases journal and
cash disbursements journal for a limited time after year-end.
5. Examine the files of unmatched purchase orders, receiving
reports, and vendor invoices for any unrecorded liabilities.
The McGraw-Hill Companies 2010

Tests of Details of
Transactions, Account
Balances and Disclosures
Existence

The auditors major concern is whether the


recorded liabilities are valid obligations of the
entity. The auditor should vouch a sample of
items on the listing of accounts payable to
other supporting documents.

The McGraw-Hill Companies 2010

Tests of Details of
Transactions, Account
Balances and Disclosures
Cut-off

The
The auditor
auditor attempts
attempts to
to determine
determine ifif all
all
purchase
purchase transactions
transactions are
are recorded
recorded in
in the
the
proper
proper period.
period. On
On most
most audits,
audits, the
the purchase
purchase
cut-off
cut-off is
is coordinated
coordinated with
with the
the clients
clients physical
physical
inventory
inventory count.
count. Proper
Proper cut-off
cut-off should
should also
also be
be
determined
determined for
for purchase
purchase return
return transactions.
transactions.

The McGraw-Hill Companies 2010

Tests of Details of
Transactions, Account
Balances and Disclosures
Rights and Obligations
There is little risk related to this assertion
because clients seldom have an incentive to
record liabilities that are not obligations of the
entity.

The McGraw-Hill Companies 2010

Tests of Details of
Transactions, Account
Balances and Disclosures
Valuation
Accounts payable are recorded at either the
gross amount of the invoice or net of cash
discount amount. The valuation of accruals
depends upon the type and nature of the
accrued expense. Most accruals are relatively
easy to value.

The McGraw-Hill Companies 2010

Tests of Details of
Transactions, Account
Balances and Disclosures
Classification, Presentation and Disclosure
Major
Major classification
classification issues
issues include
include .. .. ..
1.
1. Identifying
Identifying and
and reclassifying
reclassifying any
any material
material debits
debits
contained
contained in
in accounts
accounts payable.
payable.
2.
2. Segregating
Segregating short-term
short-term and
and long-term
long-term payables.
payables.
3.
3. Ensuring
Ensuring that
that different
different types
types of
of payables
payables are
are
properly
properly classified.
classified.

The McGraw-Hill Companies 2010

Tests of Details of
Transactions, Account
Balances and Disclosures
Disclosure Items for the Purchasing Process
Payables
Payables by
by type
type
(trade,
(trade, employees,
employees,
etc.).
etc.).

Purchases
Purchases from
from and
and
payables
payables to
to related
related
parties.
parties.

ShortShort- and
and long-term
long-term
payables.
payables.

Dependence
Dependence on
on aa single
single
vendor
vendor or
or aa small
small number
number
of
of vendors.
vendors.

Long-term
Long-term purchase
purchase
contracts,
contracts, including
including
any
any unusual
unusual purchase
purchase
commitments.
commitments.

Costs
Costs by
by reportable
reportable
segment
segment of
of the
the business.
business.

The McGraw-Hill Companies 2010

Accounts Payable
Confirmation
Accounts
Accounts payable
payable confirmations
confirmations are
are used
used less
less
often
often than
than accounts
accounts receivable
receivable confirmations.
confirmations.
The
The auditor
auditor is
is able
able to
to examine
examine externally
externally
created
created source
source documents
documents relating
relating to
to accounts
accounts
payable.
payable. When
When confirmations
confirmations are
are used
used they
they
are
are usually
usually positive
positive and
and referred
referred to
to as
as blank
blank
confirmations.
confirmations. The
The vendor
vendor is
is asked
asked to
to supply
supply
the
the balance
balance owed
owed by
by the
the client.
client.

The McGraw-Hill Companies 2010

Evaluating the Audit


Findings
The auditor compares the aggregated identified
misstatement to materiality to determine if the identified
misstatement would affect the audit.
The auditor requests the client to correct the identified
misstatements and then compares the uncorrected
misstatements with materiality to conclude whether the
financial statements are fairly stated.
If uncorrected misstatements in accounts payable, when
considered together with other uncorrected misstatements,
are less than materiality, the auditor may accept that the
financial statements are fairly presented. Conversely, if the
uncorrected misstatement exceeds the materiality, the
auditor should conclude that the financial statements are not
fairly presented.
The McGraw-Hill Companies 2010

End of Chapter 11

The McGraw-Hill Companies 2010