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Audit of the Acquisition and Payment

Cycle: Tests of Controls, Substantive
Tests of Transactions, and Accounts
Payable.

Chapter 18

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley

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Learning Objective 1
Identify the accounts and the
classes of transactions in the
acquisition and payment cycle.

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley

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Transactions in the Acquisition
and Payment Cycle
1. Acquisitions of goods and services
2. Cash disbursements
3. Purchase returns and allowances
and purchase discounts

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley

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Auditing 13/e. Arens/Elder/Beasley Property.4 . Plant and Equipment Prepaid Expenses 18 .Accounts in the Acquisition and Payment Cycle Cash in Bank Accounts Payable Raw Material Purchases Cash Acquisitions disbursements of goods and services Purchase Returns and Allowances Purchase Discounts Purchase returns and allowances Purchase discounts ©2010 Prentice Hall Business Publishing.

Arens/Elder/Beasley Subsidiary accounts Supplies. Taxes 18 . delivery expenses Repairs. Supplies Freight in. Officers’ travel Legal fees Auditing fees. Auditing 13/e. Utilities Accounts Payable Selling Expense Control Account Subsidiary accounts Commissions Travel. Advertising Acquisitions of goods and services Administrative Expense Control Account ©2010 Prentice Hall Business Publishing.Accounts in the Acquisition and Payment Cycle Manufacturing Expense Control Account Subsidiary accounts Repair and maintenance Taxes.5 .

©2010 Prentice Hall Business Publishing. Auditing 13/e. Arens/Elder/Beasley 18 .Learning Objective 2 Describe the business functions and the related documents and records in the acquisition and payment cycle.6 .

Auditing 13/e. Arens/Elder/Beasley 18 . and equipment  Prepaid expenses  Leasehold improvements  Accounts payable  Manufacturing expenses  Selling and administrative expenses  ©2010 Prentice Hall Business Publishing.Classes of Transactions and Accounts Acquisitions: Inventory  Property. plant.7 .

Auditing 13/e.Classes of Transactions and Accounts Cash disbursements: Cash in bank (from cash disbursements)  Accounts payable  Purchase discounts  ©2010 Prentice Hall Business Publishing. Arens/Elder/Beasley 18 .8 .

Arens/Elder/Beasley 18 .Business Functions in the Cycle  Processing purchase orders  Receiving goods and services  Recognizing the liability  Processing and recording cash disbursements ©2010 Prentice Hall Business Publishing.9 . Auditing 13/e.

Arens/Elder/Beasley 18 .Related Documents and Reports Processing purchase orders:  Purchase requisition  Purchase order Receiving goods and services:  Receiving report ©2010 Prentice Hall Business Publishing.10 . Auditing 13/e.

Related Documents and Reports Recognizing the liability:  Vendor’s invoice  Debit memo  Voucher  Acquisitions transaction file ©2010 Prentice Hall Business Publishing.11 . Arens/Elder/Beasley 18 . Auditing 13/e.

Arens/Elder/Beasley 18 .Related Documents and Reports Recognizing the liability:  Acquisitions journal or listing  Accounts payable master file  Accounts payable trial balance  Vendor’s statement ©2010 Prentice Hall Business Publishing. Auditing 13/e.12 .

Arens/Elder/Beasley 18 . Auditing 13/e.13 .Related Documents and Reports Processing and recording cash disbursements:  Check  Cash disbursements transaction file  Cash disbursements journal or listing ©2010 Prentice Hall Business Publishing.

©2010 Prentice Hall Business Publishing.Learning Objective 3 Understand internal control. Arens/Elder/Beasley 18 .14 . and design and perform tests of controls and substantive tests of transactions for the acquisition and payment cycle. Auditing 13/e.

Methodology for Designing Controls and Substantive Tests Understand internal control – acquisitions and cash disbursements Assess planned control risk – acquisitions and cash disbursements Determine extent of testing controls Design tests of controls and Audit procedures substantive tests of transactions Sample size for acquisitions and cash Items to select disbursements to meet Timing transaction-related audit objectives ©2010 Prentice Hall Business Publishing. Arens/Elder/Beasley 18 .15 . Auditing 13/e.

Auditing 13/e.16 .Understand Internal Control  Study the client’s flowcharts  Review internal control questionnaires  Perform walk-through tests ©2010 Prentice Hall Business Publishing. Arens/Elder/Beasley 18 .

Auditing 13/e. Arens/Elder/Beasley 18 .17 .Assess Planned Control Risk  Authorization of purchases  Separation of asset custody from other functions  Timely recording and independent review of transactions  Authorization of payments ©2010 Prentice Hall Business Publishing.

18 .Determine Extent of Testing of Controls  The auditor identifies the key internal controls and weaknesses and assesses control risk  The auditor performs tests of controls to obtain evidence that controls are operating effectively ©2010 Prentice Hall Business Publishing. Arens/Elder/Beasley 18 . Auditing 13/e.

19 . Auditing 13/e. Arens/Elder/Beasley 18 .Controls and Substantive Tests of Transactions for Acquisitions  Recorded acquisitions are for goods and services received (occurrence)  Existing acquisitions are recorded (completeness)  Acquisitions are accurately recorded (accuracy) ©2010 Prentice Hall Business Publishing.

Auditing 13/e.20 . Arens/Elder/Beasley 18 .Controls and Substantive Tests of Transactions for Acquisitions  Acquisitions are correctly included in the master files (posting and summarization)  Acquisitions are correctly classified (classification)  Acquisitions are recorded on the correct dates (timing) ©2010 Prentice Hall Business Publishing.

Attributes Sampling Because of the importance of tests of controls and substantive tests of transactions for acquisitions and cash disbursements. Arens/Elder/Beasley 18 . Auditing 13/e. the use of attributes sampling is common in this audit area.21 . ©2010 Prentice Hall Business Publishing.

Important Differences  Larger number of transactions  Significant judgment  Wide range of dollar amount ©2010 Prentice Hall Business Publishing. Arens/Elder/Beasley 18 .22 . Auditing 13/e.

Auditing 13/e.Learning Objective 4 Describe the methodology for designing tests of details of balances for accounts payable using the audit risk model. ©2010 Prentice Hall Business Publishing. Arens/Elder/Beasley 18 .23 .

Methodology for Designing Tests of Balances for Accounts Payable Identify client business risks affecting accounts payable Phase I Set tolerable misstatement and assess inherent risk Phase I for accounts payable Assess control risk for the acquisition and payment cycle Phase I ©2010 Prentice Hall Business Publishing.24 . Arens/Elder/Beasley 18 . Auditing 13/e.

Methodology for Designing Tests of Balances for Accounts Payable Design and perform tests of controls and substantive tests Phase II of transactions for the acquisition and payment cycle ©2010 Prentice Hall Business Publishing. Arens/Elder/Beasley 18 .25 . Auditing 13/e.

Auditing 13/e.26 .Methodology for Designing Tests of Balances for Accounts Payable Design and perform analytical procedures Phase III for accounts payable balance Design tests of Audit procedures details of accounts Sample size payable balance to satisfy balanceItems to select related audit Timing objectives ©2010 Prentice Hall Business Publishing. Arens/Elder/Beasley Phase III 18 .

27 . ©2010 Prentice Hall Business Publishing. Arens/Elder/Beasley 18 . Auditing 13/e.Learning Objective 5 Design and perform analytical procedures for accounts payable.

28 . Auditing 13/e. Arens/Elder/Beasley 18 . Misstatement of accounts payable and expenses Review list of accounts payable Classification misstatement for nontrade liabilities for unusual. nonvendor. and interest-bearing payables ©2010 Prentice Hall Business Publishing.Analytical Procedures for the Acquisition and Payment Cycle Analytical procedure Possible misstatement Compare acquisition-related expense account balances with prior years.

such as Unrecorded or nonexistent purchases divided by accounts accounts. and accounts payable divided by current liabilities ©2010 Prentice Hall Business Publishing. or misstatements Calculate ratios.Analytical Procedures for the Acquisition and Payment Cycle Analytical procedure Possible misstatement Compare individual accounts payable with previous years Unrecorded or nonexistent accounts. or misstatements payable.29 . Arens/Elder/Beasley 18 . Auditing 13/e.

Arens/Elder/Beasley 18 . ©2010 Prentice Hall Business Publishing. including out-of-period liability tests.Learning Objective 6 Design and perform tests of details of balances for accounts payable.30 . Auditing 13/e.

Auditing 13/e.Out-of-Period Liability Tests  Examine underlying documentation for subsequent cash disbursements  Examine underlying documentation for bills not paid several weeks after the year-end  Trace receiving reports issued before year-end to related vendors’ invoices ©2010 Prentice Hall Business Publishing. Arens/Elder/Beasley 18 .31 .

Arens/Elder/Beasley 18 .Out-of-Period Liability Tests  Trace vendors’ statements that show a balance due to the accounts payable trial balance  Send confirmations to vendors with which the client does business ©2010 Prentice Hall Business Publishing. Auditing 13/e.32 .

Cutoff Tests  Relationship of cutoff to physical observation of inventory  Inventory in transit  FOB destination  FOB origin ©2010 Prentice Hall Business Publishing. Auditing 13/e.33 . Arens/Elder/Beasley 18 .

34 .Learning Objective 7 Distinguish the reliability of vendors’ invoices. vendors’ statements. Arens/Elder/Beasley 18 . and confirmations of accounts payable as audit evidence. Auditing 13/e. ©2010 Prentice Hall Business Publishing.

35 . Arens/Elder/Beasley 18 . Auditing 13/e.Reliability of Evidence  Distinction between vendors’ invoices and vendors’ statements  Difference between vendors’ statements and confirmations ©2010 Prentice Hall Business Publishing.

Statistical sampling is less commonly used for the audit of accounts payable than for accounts receivable.Sample Size Sample sizes for accounts payable tests vary considerably.36 . depending on many factors. Auditing 13/e. Arens/Elder/Beasley 18 . ©2010 Prentice Hall Business Publishing.

Types of Audit Tests for the Acquisition and Payment Cycle Accounts Payable Cash in Bank Acquisition Expenses Payments Expenses Audited by TOC. and AP Audited by TOC.37 . Auditing 13/e. Arens/Elder/Beasley 18 . and AP Ending balance Audited by AP and TDB Ending balance Audited by AP and TDB TOC + STOT + AP + TDB = Sufficient appropriate evidence per GAAS ©2010 Prentice Hall Business Publishing. STOT. STOT.

Types of Audit Tests for the Acquisition and Payment Cycle Accounts Payable Acquisition Assets Acquisition of assets Audited by TOC. Auditing 13/e. and AP Ending balance Audited by AP and TDB TOC + STOT + AP + TDB = Sufficient appropriate evidence per GAAS ©2010 Prentice Hall Business Publishing. Arens/Elder/Beasley 18 .38 . STOT.

Arens/Elder/Beasley 18 .End of Chapter 18 ©2010 Prentice Hall Business Publishing. Auditing 13/e.39 .