Completing the Tests

in the Acquisition
and Payment Cycle

Chapter 19

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 Learning Objective 1

Recognize the many accounts in

the acquisition and payment cycle.

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 Accounts Associated with Acquisition
and Payment Cycle Transactions
Assets
Cash
Inventory
Supplies
Property, plant, and equipment
Patents, trademarks, and copyrights
Prepaid rent
Prepaid taxes
Prepaid insurance
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 Accounts Associated with Acquisition
and Payment Cycle Transactions
Expenses
Cost of goods sold
Rent expense
Property taxes
Income tax expense
Insurance expense
Professional fees
Retirement benefits
Utilities
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 Accounts Associated with Acquisition
and Payment Cycle Transactions
Liabilities
Accounts payable
Rent payable
Accrued professional fees
Accrued property taxes
Other accrued expenses
Income taxes payable

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 Methodology for Designing Tests of
Balances Other Accounts
Identify client business risks
affecting other accounts.

Set tolerable misstatement

and assess inherent risk
for accounts.

Assess control risk for accounts.

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 Methodology for Designing Tests of
Balances Other Accounts
Design and perform tests of
controls and substantive tests
of transactions for the
acquisition and payment cycle.

Design and perform analytical

procedures for the
acquisition and payment cycle.
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 Methodology for Designing Tests of
Balances Other Accounts

Design tests of details of Audit procedures

account balances to Sample size
satisfy balance-related Items to select
audit objectives. Timing

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 Learning Objective 2

Design and perform audit

tests of property, plant, and
equipment related accounts.

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 Classification of Property, Plant,
and Equipment Accounts

Land and land improvements

Building and building improvements
Manufacturing equipment
Furniture and fixtures
Autos and trucks
Leasehold improvements
Construction-in-process for property,
plant, and equipment
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 Manufacturing Equipment
and Related Accounts
Manufacturing Accumulated
Equipment Depreciated
Beginning Disposals Disposals Beginning
balance balance
Acquisitions Current period
depreciation
Ending
balance
Gain or Loss Depreciation
on Disposals Expense

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 Auditing Manufacturing Equipment
and Related Accounts
Analytical procedures

Current year acquisitions

Current year disposals
Ending balance in the asset account
Depreciation expense
Ending balance in accumulated depreciation
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 Analytical Procedures for
Manufacturing Equipment

Analytical Procedure Possible Misstatement

Compare depreciation Misstatement in
expense divided by gross depreciation expense
manufacturing equipment and accumulated
cost with previous years. depreciation
Compare accumulated Misstatement in
depreciation divided by gross accumulated
manufacturing equipment depreciation
cost with previous years.

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 Analytical Procedures for
Manufacturing Equipment
Analytical Procedure Possible Misstatement
Compare monthly or annual Expensing amounts
repairs and maintenance, that should be
supplies expense, small tools capitalized
expense, and similar accounts
with previous years.
Compare gross manufacturing Idle equipment or
cost divided by some measure equipment that has
of production with previous been disposed of, but
years. not written off.
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 Verifying Current Year
Acquisitions

The proper recording of current year additions

is important because of the long-term effect
the assets have on the financial statements.

Because of the importance of current period

acquisitions, seven of the nine balance-related
audit objectives are used as a frame of reference.

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 Major Balance-Related
Audit Objectives

Completeness

Existing acquisitions are recorded.

1. Examine vendors invoices of closely related

accounts to uncover items that should be
manufacturing equipment.
2. Review lease and rental agreements.
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 Major Balance-Related
Audit Objectives

Accuracy

Current year acquisitions as listed are accurate.

1. Examine vendors invoices.

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 Major Balance-Related
Audit Objectives

Classification

Current year acquisitions as

listed are properly classified.
Examine:
1. Vendors invoices in mfg. equipment account.
2. Vendors invoices of closely related accounts.
3. Rent and lease expense for capitalizable leases.
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 Verifying Current Year
Disposals
Review whether newly acquired
assets replace existing assets.
Analyze gains and losses on disposal.
Review documents for indications
of deletion of equipment.

Make inquiries about the possibility

of the disposal of assets.
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 Verifying Ending Balance
of Asset Accounts

1. All equipment owned is recorded.

2. All recorded equipment physically

exists on the balance sheet date.

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 Verifying Depreciation
Expense

The most important objective is accuracy.

Consistent
Correct
depreciation
calculations
policy

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 Verifying Ending Balance in
Accumulated Depreciation

1. Accumulated depreciation as stated

in the property master file agrees
with the general ledger.

2. Accumulated depreciation in the

master file is accurate.

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 Learning Objective 3

Design and perform audit

tests of prepaid expenses.

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 Audit of Prepaid Expenses

Prepaid rent
Organization cost
Prepaid taxes
Patents Prepaid insurance
Trademarks
Deferred charges
Copyrights

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 Prepaid Insurance
and Related Accounts
Prepaid Insurance
Beginning balance Current period
insurance expense
Acquisitions

Ending balance

Insurance Expense

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 Prepaid Insurance
Internal Controls

1. Controls over the acquisition and

recording of insurance
2. Controls over the insurance register
3. Controls over the charge-off of
insurance expense

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 Prepaid Insurance
Audit Tests

Compare total prepaid insurance and insurance

expense with previous years.
Compute the ratio of prepaid insurance to insurance
expense and compare it with previous years.
Compare the individual insurance policy coverage
on the schedule of insurance obtained with the
preceding years schedule.

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 Prepaid Insurance
Audit Tests

Compare the computed prepaid insurance balance

for the current year on a policy-by-policy basis
with that of the preceding year.
Review the insurance coverage listed on the
prepaid insurance schedule with an appropriate
client official or insurance broker.

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 Balance-Related
Audit Objectives

Existence and
Rights
Completeness

Insurance policies The client has rights

in the prepaid to all insurance
insurance schedule policies in the
exist and existing prepaid insurance
policies are listed. schedule.
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 Balance-Related
Audit Objectives

Accuracy and
Classification
Detail tie-in

Prepaid amounts are

accurate and the total
Insurance expense is
is correctly added
properly classified.
and agrees with
the general ledger.
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 Balance-Related
Audit Objectives

Presentation
Cutoff
and Disclosure

Insurance
Prepaid insurance is
transactions
properly presented
are recorded in
and disclosed.
the proper period.

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 Learning Objective 4

Design and perform audit

tests of accrued liabilities.

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 Audit of Accrued Liabilities

Accrued income taxes

Accrued interest
Accrued pension costs
Accrued professional fees
Accrued rent
Accrued warranty costs

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 Accrued Property Taxes
and Related Accounts
Accrued Property Taxes
Beginning balance
Payments Current period
(property taxes) property tax expense
Ending balance
Property Tax Expense

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 Learning Objective 5

Design and perform audit tests

of income and expense accounts.

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 Approach to Auditing Income
and Expense Accounts

Analytical procedures

Tests of controls and substantive

tests of transactions

Tests of details of account balances

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 Analytical Procedures for
Income and Expense Accounts

Analytical Procedure Possible Misstatement

Compare individual Overstatement or
expenses with previous understatement of a
year. balance in an expense
sheet.

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 Analytical Procedures for
Income and Expense Accounts

Analytical Procedure Possible Misstatement

Compare individual asset Overstatement or
and liability balances with understatement of a
previous years. balance sheet account
that would also affect
an income statement
account

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 Analytical Procedures for
Income and Expense Accounts

Analytical Procedure Possible Misstatement

Compare individual Misstatement of
expenses with budgets. expenses and related
balance sheet
accounts
Compare gross margin Misstatement of cost
percentage with previous of goods sold and
years. inventory
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 Analytical Procedures for
Income and Expense Accounts

Analytical Procedure Possible Misstatement

Compare inventory Misstatement of cost
turnover ratio with of goods sold and
previous years. inventory
Compare prepaid insurance Misstatement of
expense with previous insurance expense
years. and prepaid insurance

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 Analytical Procedures for
Income and Expense Accounts

Analytical Procedure Possible Misstatement

Compare commission Misstatement of
expense divided by sales commission expense,
with previous years. accrued commissions
Compare individual Misstatement of
manufacturing expenses individual mfg.
divided by total mfg. expenses and related
expenses with previous years. balance sheet accounts
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 Tests of Controls and Substantive
Test of Transactions

Understanding internal control and the

related tests of controls and substantive
tests of transactions to determine the
appropriate assessed control risk are
the most important means of verifying
many of the income statement accounts
in each of the transaction cycles.

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 Tests of Details of Account Balances
and Expense Analysis

Expense account analysis

Tests of details of account

balances allocation

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 Allocation

Several expense accounts result from the allocation

of accounting data rather than discrete transactions.
These include depreciation, depletion, and the
amortization of copyrights and catalog cost.
The allocation of manufacturing overhead between
inventory and cost of goods sold is an example of
a different type of allocation that affects expenses.

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 End of Chapter 19

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