11-1

Chapter Eleven
Auditing the Purchasing Process

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.

11-2

Expense and Liability Recognition

Expenses are outflows or Liabilities are probable
other using up of assets future sacrifices of
or incurrences of liabilities economic benefits arising
from delivering or from present obligations
producing goods, of a particular entity to
rendering services or transfer assets or provide
carrying out other services to other entities
activities that constitute in the future as a result of
the entity’s ongoing major past transactions or
or central operations. events.

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.

11-3

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 Receiving
requisition order report and
Vendor
liability
recorded

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.

11-4

Types of Transactions and Financial
Statement Accounts Affected

There are three types of transactions:
1. Purchase of goods and services for cash or
credit.
2. Payment of the liabilities arising from such
purchases.
3. Return of goods to suppliers for cash or credit.

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.

All rights reserved. 11-5 Types of Transactions and Financial Statement Accounts Affected Type of Transaction Account Affected Purchase Transaction Accounts payable Inventory Purchases or cost of goods sold Various asset and expense accounts Cash disbursement transaction Cash Accounts payable Cash discounts Various asset and expense accounts Purchase return transaction Purchase returns Purchase allowances Accounts payable Various asset and expense accounts McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies. Inc. .

11-6 Flowchart of the Purchasing Process – EarthWear Clothiers Department Requesting Purchasing IT Approved Accounts Purchase purchase Purchase payable requisition requisition order file master file received Purchase Input order program Error Error Vendor Purchase corrections report order A/P (4 part) Receiving PO #2 Filed Purchasing Numer -ically McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies. . Inc. All rights reserved.

11-7 Flowchart of the Purchasing Process – EarthWear Clothiers Department Receiving Accounts Payable (A/P) PO #1 PO #3 Compare invoice to PO and RR Receiving Review Goods report account received. . and Vendor inspected Voucher invoice packet Enter vendor. All rights reserved. Receiving quantity. distribution counted. Inc. and To IT report (RR) Input PO # Error From IT Daily correction receiving log McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies.

Inc. 11-8 Flowchart of the Purchasing Process – EarthWear Clothiers Department IT Purchase A/P master General order file file ledger file Open PO report A/P expense Accounts distribution report Input Weekly Monthly from A/P payable Monthly A/P reporting reports Voucher register update Daily Cash disbursements A/P listing journal Report Error to A/P report Cash Daily disbursement General report ledger McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies. . All rights reserved.

Inc. . All rights reserved. 11-9 Flowchart of the Purchasing Process – EarthWear Clothiers Department Accounts Payable (A/P) IT Cashier Cash A/P master disbursement Checks file report Review documents Cash Review checks and authorize payment disbursement and mail to program vendors Cash disbursement Checks Checks report Input To Vendors McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies.

3. 6. 9. 4. Inc. Check Register – contains columns to record credits to cash and debits to accounts payable and cash discounts. Voucher Register – used to record vouchers for goods and services. Check – pays for goods or services. 2. 5. . 8. Vendor Invoice – the bill from the vendor. 10. . 7. Purchase Requisition – request to purchase goods or services. 1. . Purchase Order – includes description. All rights reserved. 11-10 Types of Documents and Records Purchasing documents and records . Vendor Statement – represents the purchase activity with vendor. Accounts Payable Subsidiary Ledger – includes amount owed to individual vendors. and quantity or goods or services being purchased. quality. McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies. Receiving Report – records the receipt of goods. Voucher – serves as the basis for recording a vendor’s invoice.

and returns. and payables in the general ledger. . discounts. quantity. cash disbursements. also. processing of adjustments for allowances. classification. and summarization of General ledger purchases. quality. Disbursements Processing of payment to vendors. Recording of all vendor invoices. cash disbursements. Approval of purchase orders and proper execution as to Purchasing price. and vendor. and Accounts payable adjustments in individual vendor accounts. Proper accumulation. Receiving Receipt of properly authorized goods and services. McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies. All rights reserved. Inc. 11-11 The Major Functions Functions of the Purchasing Process Initiation and approval of requests for goods and services Requisitioning by authorized individuals consistent with management criteria. Processing of vendor invoices for goods and services Invoice processing received.

11-12 Key Functions and Duties Segregation of Duties Possible Errors or Fraud The purchasing function should be If one individual is responsible for the requisition. unauthorized checks supported by fictitious segregated from the accounts documents can be issued. transactions can be recorded. detected by reconciling subsidiary records with the McGraw-Hill/Irwin general ledger control account. Copyright © 2006 by The McGraw-Hill Companies. If one individual is responsible for the disbursement function and also has access to the accounts payable The disbursement function should be records. and unauthorized payable function. All rights reserved. This can result in overpayment of goods or the theft of cash. goods not received. or a cash disbursement can be processed for accounts payable function. segregated from the requisitioning purchasing. fictitious purchases and receiving functions. can be made. purchase The invoice-processing function transactions can be processed at the wrong price or should be segregated from the terms. Inc. . If one individual isresponsible for the accounts payable The accounts payable function records and also for the general ledger. This can result in theft of the entity's cash. If one individual is responsible for the invoice- processing and accounts payable function. and receiving functions. that individual should be segregated from the can conceal any defalcation that would normally be general ledger function. This can result in the theft of goods and possibly payment for unauthorized purchases.

counting. and inspection of purchased materials X Receipt of vendor invoices/matching to supporting documents X Coding of account distributions X Updating of accounts payable records X X Preparation of vendor checks X Signing and mailing of vendor checks X Preparation of the voucher register X Reconciliation of voucher register to general ledger X McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies. All rights reserved. 11-13 The Key Segregation of Duties Department Purchasing and Accounts Accounts Payable Purchasing Receiving Payable Cashier's IT Preparation and approval of purchase order X Receipt. Inc. .

How volatile are Is the supply of raw raw material materials adequate prices ? ? McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies. Inc. . All rights reserved. 11-14 Inherent Risk Assessment Industry-Related Factors 2. 1.

All rights reserved. However. McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies. the purchasing process is not difficult to audit and does not present contentious accounting issues. . 11-15 Inherent Risk Assessment Misstatements Detected in Prior Audits Generally. Inc. the auditor’s experience in past audits must be considered when assessing inherent risk.

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies. All rights reserved. Setting and documenting the control risk for the purchasing process. Understanding and documenting the purchasing process based on a reliance strategy. Inc. 11-16 Control Risk Assessment Major steps in setting the control risk in the purchasing process. Planning and performing tests of controls of purchase transactions. .

supporting documents. . All rights reserved. How purchase. including computer processing. and accounts involved in processing purchases. The flow of each type of transaction from initiation to inclusion in the financial statements. cash disbursements. The accounting records. 2. 11-17 Control Risk Assessment Information Systems and Communication For each major class of transactions in the purchasing process. and purchase returns. and purchase return transactions are initiated. McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies. The process used to estimate accrued liabilities. 4. cash disbursements. the auditor must obtain the following information: 1. 3. Inc.

. no modifications are necessary to detection risk. When test do not support the planned control risk. the auditor lowers the level of detection risk leading to more substantive procedures. 11-18 Control Risk Assessment After testing controls. The auditor may proceed with the substantive procedures as planned. the auditor sets the level of control risk. McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies. All rights reserved. When tests of controls support the planned level of control risk. Inc.

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies. Inc. Cutoff Purchases and cash disbursements have been recorded in the correct accounting period. All purchase and cash disbursements are properly Authorization authorized. Completeness All purchases and cash disbursements that should have been recorded have been recorded. 11-19 Control Procedures and Tests of Controls – Purchase Transactions Assertions about Classes of Transactions and Events for the Period under Audit All purchases and cash disbursements have been Occurrence recorded and have occurred and pertain to the entity. All rights reserved. Purchases and cash disbursements have been Classification recorded in the proper account. Amounts relating to recorded purchases and cash Accuracy disbursements have been recorded properly. .

. Compare the dates of vouchers with the dates they were recorded in the purchases journal. Examine reconciliation of vouchers to daily accounts payable report. Compare the dates on receiving reports with the dates on the Cutoff relevant vouchers. Trace a sample of vouchers to the purchases journal. Trace a sample Completeness of receiving reports to their vendor invoices and vouchers. 11-20 Control Procedures and Tests of Controls – Purchase Transactions Assertions Substantive Tests of Controls Observe and evaluate proper segregation of duties. Classification McGraw-Hill/Irwin Examine a sample of vouchers for properCopyright ©classification. Review client's competitive bidding process. Review purchases journal and general ledger for reasonableness. All rights reserved. and Accuracy price. Inc. Review procedures for accounting for numerical sequence of purchase orders. quantity. receiving reports and vouchers. Examine paid vouchers and supporting documents for indication of cancellation. Recompute the mathematical accuracy of vendor invoice. 2006 by The McGraw-Hill Companies. Examine purchase requisitions or purchase orders for proper Authorization approval. Agree information in the sample of vouchers for product. Test a sample of vouchers for the presence of an authorized purchase order Occurrence and receiving report.

11-21 Control Procedures 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 client’s record when no payment was made. McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies. . and monthly bank reconciliations. The primary control procedures to prevent such misstatements include proper segregation of duties. independent reconciliation and review of vendor statements. All rights reserved. Inc.

11-22 Control Procedures and Tests of Controls – Cash Disbursement Transactions Completeness of Cash Disbursement Transactions The major audit concern is that a cash disbursement is made but not recorded in the records. Inc. . McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies. All rights reserved. The auditor should account for the numerical sequence of checks and reconcile the daily cash disbursements with posting to the accounts payable subsidiary records.

11-23 Control Procedures and Tests of Controls – Cash Disbursement Transactions Authorization of Cash Disbursement Transactions Proper segregation of duties reduces the likelihood that unauthorized cash disbursements are made. . All rights reserved. The individual who approves a purchase should not have direct access to the cash disbursement. McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies. Inc.

11-24 Control Procedures 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. All rights reserved. Inc. . client personnel should reconcile the total of the checks issued each day with the daily cash disbursements report. To detect such an error. McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies.

. McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies. Inc. 11-25 Control Procedures and Tests of Controls – Cash Disbursement Transactions Cutoff of Cash Disbursement Transactions The auditor’s tests of controls include reviewing the reconciliation of checks 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. All rights reserved.

All rights reserved. as well as independent approval and review of the account code on the voucher should provide adequate control. McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies. 11-26 Control Procedures and Tests of Controls – Cash Disbursement Transactions Classification of Cash Disbursement Transactions The auditor is concerned that a cash disbursement may be charged to the wrong general ledger account. . The use of a chart of accounts. Inc.

the number and magnitude of purchase return transactions are not material. 11-27 Control Procedures and Tests of Controls – Purchase Return Transactions Generally. Substantive testing is used to test the reasonableness of the amount. The auditor normally does not test controls relating to purchase returns. Inc. All rights reserved. . McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies.

the auditor reduces the detection risk. McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies. 11-28 Relating the Assessed Level of Control Risk to Substantive Procedures If the results of the tests of controls support the achieved level of control risk. . All rights reserved. the auditor conducts substantive procedures at the planned level. Inc. which will increase substantive procedures. If the results do not support the achieved level of control risk.

Completeness . Rights and obligations. Inc. . McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies. Accounts payable and accrued expenses are obligations of the entity. All rights reserved. Accounts payable and accrued expenses are vaild liabilities. 11-29 Auditing Accounts Payable and Accrued Expenses Assertions about Account Balances at the Period End: Existence. Accounts payable and accrued expenses are included in the financial statements at appropriate amounts. All accounts payable and accrued expenses have been recorded. Valuation and allocation. and any resulting valuation or allocation adjustments are appropriately recorded.

11-30 Auditing Accounts Payable and Accrued Expenses Assertions about Presentation and Disclosure: Occurrence and rights and obligations. All rights reserved. and disclosures are clearly expressed. Classification and understandability. transactions. . Financial information relating to accounts payable and accrued expenses is appropriately presented and described. All disclosures relating to accounts payable and accrued expenses that should have been included in the financial statements have been included. Completeness. All disclosed events. Financial and other information relating to accounts payable and accrued expenses are disclosed fairly and at appropriate amounts. Accuracy and valuation. Inc. and other matters relating to accounts payable and accrued expenses have occurred and pertain to the entity. McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies.

or overstatment of liabilities and accounts payable and accruals with prior expenses.or overstatement of purchase cost of sales to prior years' and industry returns. Compare current-year balances in Under.or overstatment of liabilities and vendors in the current year's accounts expenses. previous years' and industry data. Compare amounts owed to individual Under. Inc. 11-31 Auditing Accounts Payable and Accrued Expenses Substantive Analytical Procedures Substantive Analytical Procedure Possible Misstatement Detected Compare payables turnover and days Under. payable listing to amounts owed in prior Compare purchase returns and allowances as a percentage of revenue or Under. .or overstatment of liabilities and outstanding in accounts payable to expenses. data. years' balances. McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies. All rights reserved.

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies. 11-32 Tests of Details of Transactions. All rights reserved. foot the listing. and Disclosures Completeness Obtain a listing of accounts payable. Account Balances. 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. Inc.

receiving reports. All rights reserved. 5. and vendor invoices for any unrecorded liabilities. Vouch large-dollar items from the purchases journal and cash disbursements journal for a limited time after year-end. 2. Examine the files of unmatched purchase orders. including accounts with small or zero balances. 3. Confirm vendor accounts. . Inc. McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies. 11-33 Tests of Details of Transactions. 4. and Disclosures Completeness The auditor should conduct a test for unrecorded liabilities that include the following procedures: 1. Ask management about control procedures used to identify unrecorded liabilities at the end of the period. Account Balances. Obtain copies of vendors’ monthly statements and reconcile the amounts to the client’s accounts payable records.

The auditor should vouch a sample of items on the listing of accounts payable to other supporting documents. Account Balances. Inc. 11-34 Tests of Details of Transactions. and Disclosures Existence The auditor’s major concern is whether the recorded liabilities are valid obligations of the entity. All rights reserved. . McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies.

the purchase cutoff is coordinated with the client’s physical inventory count. 11-35 Tests of Details of Transactions. Account Balances. All rights reserved. Proper cutoff should also be determined for purchase return transactions. On most audits. McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies. Inc. . and Disclosures Cutoff The auditor attempts to determine if all purchase transactions are recorded in the proper period.

11-36 Tests of Details of Transactions. All rights reserved. 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. Account Balances. . McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies. Inc.

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies. All rights reserved. Inc. and Disclosures Valuation Accounts payable are recorded at either the gross amount of the invoice or net of cash discount amount. Most accruals are relatively easy to value. 11-37 Tests of Details of Transactions. The valuation of accruals depends upon the type and nature of the accrued expense. Account Balances. .

Identifying and reclassifying any material debits contained in accounts payable. and Disclosure Major classification issues include . All rights reserved. Account Balances. 1. Presentation. Segregating short-term and long-term payables. . Inc. McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies. 2. Ensuring that different types of payables are properly classified. . . 11-38 Tests of Details of Transactions. 3. and Disclosures Classification.

11-39 Tests of Details of Transactions. and Disclosures Disclosure Items for the Purchasing Process Payables by type (trade.and long-term vendor or a small number payables. Long-term purchase contracts. Dependence on a single Short. All rights reserved. Account Balances. commitments. etc.). Inc. Purchases from and employees. of vendors. McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies. . including any Costs by reportable unusual purchase segment of the business. payables to related parties.

Account Balances. McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies. All rights reserved. adequate disclosure of the terms must be made. Inc. 11-40 Tests of Details of Transactions. and Disclosures Other Presentation Disclosure Assertion The auditor must ensure that all related party transactions have been identified. When the client has entered into formal long-term purchase contracts. .

The auditor is able to examine externally created source documents relating to accounts payable. All rights reserved. Inc. . When confirmations are used they are usually positive and referred to as blank confirmations. The vendor is asked to supply the balance owed by the client. 11-41 Accounts Payable Confirmation Accounts payable confirmations are used less often than accounts receivable confirmations. McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies.

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies. The likely misstatement is then compared to tolerable misstatement. Inc. . it the likely misstatement exceeds the tolerable. All rights reserved. 11-42 Evaluating the Audit Findings All identified misstatements should be aggregated. If the likely misstatement is less than the tolerable misstatement. Conversely. the auditor has evidence that the account is fairly presented. the auditor should conclude that the account is not fairly presented.

All rights reserved. 11-43 End of Chapter 11 McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies. . Inc.