Messier 11e Chap11 PPT TB

Auditing and Assurance Services
A Systematic Approach
Eleventh Edition
CHAPTER 11
Auditing the
Purchasing Process
Copyright © 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution

without the prior written consent of McGraw-Hill Education.
Learning Objective 11-1
Expense and Liability Recognition
Expenses are outflows or Liabilities are probable

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

without the prior written consent of McGraw-Hill Education. 11-2
Expense Categories
PRODUCT COSTS
PERIOD COSTS
SYSTEMATIC ALLOCATION

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

Three types of transactions are processed through the

purchasing process:
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

Types of Transactions and Financial

Statement Accounts Affected
Three types of transactions are processed through the
purchasing process:
Type of Transaction Account Affected

Purchase Transaction Accounts payable
Inventory
Purchase or cost of goods sold
Various asset and expense accounts
Cash disbursement transaction Cash
Accounts payable
Cash discounts
Purchase return transaction Purchase returns
Purchase allowances
Accounts payable

Flowchart of the Purchasing Process – EarthWear Clothiers (1 of 4)
Requesting Purchasing IT Department
Approved Accounts
Purchase purchase Purchase payable
requisition requisition order file master file
received
Purchase
Input order
program
Vendor
Error
corrections A/P
Purchase
order Receiving
PO #4 Error (4 part)
Filed
report Purchasing
Numerically

Receiving Accounts Payable (A/P)
PO #3 PO #2 Compare
Filed Filed
Numerically Numerically invoice to
PO and RR
Goods Review
Receiving
received, account
report
counted and distribution
inspected
Vendor
Voucher
Enter vendor, invoice
Receiving packet
quantity, and
report (RR)
PO # To IT
Input
Daily
receiving log Error From IT
correction
IT Department
Purchase A/P master General

order file file ledger file
• Open PO report
Input Accounts Weekly • A/P expense

Monthly
payable A/P reporting distribution
from A/P Monthly reports report
update
• Voucher
Daily register
A/P listing
• Cash
disbursements
Report journal
Error report Daily Cash General
to A/P disbursement ledge
report

Accounts Payable (A/P) IT Department Cashier
Error A/P master

correction file
Review
documents Review checks
Cash and EFT listing
and authorize disbursement
payment program
Cash
disbursement Checks /EFTs
report Checks
and EFT
Listing
Input
To Vendors

Types of Documents and Records

1. Purchase requisition – request to purchase goods or services.
2. Purchase order – includes description, quality, and quantity of
goods or services being purchased.
3. Receiving report – records the receipt of goods.
4. Vendor invoice – the bill from the vendor.
5. Voucher – serves as the basis for recording a vendor’s invoice.
6. Voucher register/purchases journal – used to record vouchers
for goods and services.
7. Accounts payable subsidiary ledger – includes amount owed to
individual vendors.
8. Vendor statement – represents the purchase activity with vendor.
9. Check/EFT – pays for goods or services.
10. Cash disbursements journal/check register – contains columns
to record credits to cash and debits to accounts payable and cash
discounts.

The Major Functions

Functions of the Purchasing Process
Initiation and approval of requests for goods and services by
Requisitioning
authorized individuals consistent with management criteria.
Approval of purchase orders and proper execution as to

Purchasing
price, quantity, quality, and vendor.
Receiving Receipt of properly authorized goods and services.
Processing of vendor invoices for goods and services

Invoice Processing received; also, processing of adjustment for allowances,
discounts, and returns.
Disbursements Processing of payment to vendors.
Recording of all vendor invoices, cash disbursements, and

Accounts payable
adjustments in individual vendor accounts.
Proper accumulation, classification, and summarization of

General ledger purchases, cash disbursements, and payables in the general
ledger.

Key Segregation of Duties (1 of 2)

Segregation of Duties Possible Errors or Fraud
The purchasing function If one individual is responsible for the requisition, purchasing,
should be segregated from and receiving functions, fictitious purchase can be made. This
the requisitioning and can result in the theft of goods and possibly payment for
receiving functions. unauthorized purchases.
If one individual is responsible for the invoice-processing and
The invoice-processing
accounts payable functions, purchase transactions can be
function should be
processed at the wrong price or terms, or a cash
segregated from the
disbursement can be processed for goods not received. This
accounts payable function.
can result in overpayment of goods or the theft of cash.
If one individual is responsible for the disbursement function
The disbursement function
and has access to the accounts payable records, unauthorized
should be segregated from
checks supported by fictitious documents can be issued, and
the accounts payable
unauthorized transactions can be recorded. This can result in
function.
theft of the entity’s cash.
The accounts payable If one individual is responsible for the accounts payable
function should be records and for the general ledger, that individual can conceal
segregated from the any defalcation that would normally be detected by reconciling
general ledger function. subsidiary records with the general ledger control account.

Key Segregation of Duties (2 of 2)

Department
Purchasing Process Accounts

Purchasing Receiving Cashier IT
Functions Payable
Preparation and approval of
purchase order X
Receipt, counting and inspection
of purchased materials X
Receipt of vendor invoices and
matching them with supporting
documents
X
Coding (or checking) 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 voucher register X
Reconciliation of voucher
register to general ledger X
Inherent Risk Assessment (1 of 2)

Industry-Related Factors
1. Is the supply of 2. How volatile are

raw materials raw material
adequate? prices?

Inherent Risk Assessment (2 of 2)

Misstatements Detected in
Prior Audits
Generally, the purchasing process is not difficult to audit

and does not present contentious accounting issues.
However, the auditor’s experience in past audits must be
considered when assessing inherent risk.

Control Risk Assessment (1 of 3)

Major steps in setting control risk for
the purchasing process
Understand and document the purchasing process

based on a reliance strategy.
Plan and perform tests of controls on purchase

transactions.
Set and document the control risk for the purchasing

process.


Information Systems and Communication
For each major class of transactions in the purchasing

process, the auditor should 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 of data.
4. The process used to estimate accrued liabilities.


After testing controls, the auditor sets the achieved level
of control risk. When tests of controls support the
planned level of control risk, no modifications are
necessary to planned 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 planned
detection risk, leading to more
substantive procedures.

Control Activities and Tests of Controls – Purchase

Transactions
Assertions about Purchase and Cash Disbursement Transactions and Events,
and related disclosures, for the Period under Audit
All purchase and cash disbursement transactions and events that have been
Occurrence recorded or disclosed have occurred, and such transactions and events pertain to
the entity.
All purchase and cash disbursement transactions and events that should have been
Completeness recorded have been recorded, and all related disclosures that should have been
included in the financial statements have been included.
All purchase and cash disbursement transactions and events have been properly
Authorization
authorized.
Amounts and other data relating to recorded purchase and cash disbursement
Accuracy transactions and events have been recorded appropriately, and related disclosures
have been appropriately measured and described.
Purchase and cash disbursement transactions and events have been recorded in the
Cutoff
correct accounting period.
All purchase and cash disbursement transactions and events have been recorded in
Classification
the proper accounts.
All purchase and cash disbursement transactions and events are appropriately
aggregated or disaggregated and clearly described, and related disclosures are
Presentation
relevant and understandable in the context of the requirements of the applicable
financial reporting framework.

Examples of Control Activities and Tests of Controls –

Purchase Transactions
Assertions Tests of Controls
Observe and evaluate proper segregation of duties. Test a sample of vouchers for the presence
of an authorized purchase order and receiving report. If data is available, use audit data
Occurrence
analytics to match the populations of vouchers to related purchase orders and receiving
reports.
Review procedures for accounting for numerical sequence of purchase orders, receiving
reports, and vouchers. Trace a sample of receiving reports to their vendor invoices and
Completeness
vouchers. Trace a sample of vouchers to the purchases journal. Review financial statement
disclosure checklist.
Examine purchase requisitions or purchase orders for proper approval. Review client's
Authorization
competitive bidding process.
Recompute the mathematical accuracy of vendor invoice. Agree information in the sample of
Accuracy vouchers for product, quantity, and price. Examine reconciliation of vouchers to daily accounts
payable report.
Compare the dates on receiving reports with the dates on the relevant vouchers. Compare the
Cutoff
dates of vouchers with the dates they were recorded in the purchases journal.
Review purchases journal and general ledger for reasonableness. Examine a sample of
Classification
vouchers for proper classification.
Review purchases journal and general ledger for proper aggregation or disaggregation of
Presentation
purchase transactions, and determine if disclosure is needed

Control Activities and Tests of Controls –

Cash Disbursement Transactions (1 of 6)
Occurrence of Cash Disbursement

Transactions
The auditor is concerned with a misstatement caused
by a cash disbursement being recorded in the entity’s
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.


Completeness of Cash Disbursement

Transactions
The major audit concern is that a cash disbursement
is made but not recorded in the records. In addition to
the example control tests discussed for occurrence,
the auditor should also account for the numerical
sequence of checks and reconcile the daily cash
disbursements with posting to the accounts payable
subsidiary records.


Authorization of Cash Disbursement

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


Accuracy of Cash Disbursement

Transactions
One of the major audit concerns is that the payment
amount is recorded incorrectly. To detect such an
error, entity personnel should reconcile the total of the
checks and EFTs issued each day with the daily cash
disbursements report.


Cutoff of Cash Disbursement Transactions

The auditor’s tests of controls include reviewing the
reconciliation of cash disbursements 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.


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, as well as independent
approval and review of the account code on the
voucher should provide adequate control.

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
analytical procedures are used to test the
reasonableness of the amount.

Relating the Assessed Level of Control

Risk to Substantive Procedures
If the results of the tests of controls support the

planned level of control risk, the auditor conducts
substantive procedures at the planned level.
If the results do not support the planned level of
control risk, the auditor reduces the detection
risk, which will increase substantive procedures
over the planned level.

Auditing Accounts Payable and

Accrued Expenses (1 of 3)
Assertions about Account Balances, and related disclosures, at the
Period End:
• Existence. Accounts payable and accrued expenses are valid liabilities.
• Rights and obligations. Accounts payable and accrued expenses are

obligations of the entity.
• Completeness. All accounts payable and accrued expenses have been

recorded, and all related disclosures that should have been included in
the financial statements have been included.
• Accuracy, Valuation and allocation. Accounts payable and accrued

expenses are included in the financial statements at appropriate
amounts, any resulting valuation or allocation adjustments have been
appropriately recorded, and related disclosures have been appropriately
measured and described.


Assertions about Account Balances, and related disclosures, at the
Period End (continued):
• Classification: All accounts payable and accrued expenses are
recorded in the proper accounts.
• Presentation: Accounts payable and accrued expenses are

appropriately aggregated or disaggregated and clearly described, and
related disclosures are relevant and understandable in the context of
the requirements of the applicable financial reporting framework.


Substantive Analytical Procedures
Substantive Analytical Procedure Possible Misstatement Detected
Compare payables turnover and days outstanding in Under- or overstatment of liabilities and
accounts payable to previous years' and industry data. expenses.
Compare current-year balances in accounts payable Under- or overstatment of liabilities and

and accruals with prior years' balances. expenses.
Compare amounts owed to individual vendors in the

Under- or overstatment of liabilities and
current year's accounts payable listing to amounts
expenses.
owed in prior years.
Compare purchase returns and allowances as a
Under- or overstatement of purchase
percentage of revenue or cost of sales to prior years'
returns.
and industry data.
Predict accrued interest expense based on loan terms

Understatement of accrued interest
and the outstanding balance.

Tests of Details of Transactions, Account

Balances, and Disclosures (1 of 7)
Completeness
The auditor should conduct a search for unrecorded
liabilities that includes the following:
1. Ask management about control activities used to identify

unrecorded liabilities and accruals at the end of an accounting
period. These controls should be part of the closing process.
2. Vouch large-dollar items from the purchases journal and cash
disbursements journal for a limited time after year-end;
examine the date on each receiving report of vendor invoice
to determine if the liability relates to the current audit period.
3. Examine the files of unmatched purchase orders, receiving
reports, and vendor invoices for any unrecorded liabilities.


Existence
The auditor’s 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.


Cutoff
The auditor attempts to determine if all purchase
transactions are recorded in the proper period. On most
audits, the purchase cutoff is coordinated with the entity’s
physical inventory count. Proper cutoff should also be
determined for purchase return transactions.


Rights and Obligations
There is little risk related to this assertion because

entities seldom have an incentive to record liabilities
that are not obligations of the entity.


Accuracy, Valuation, and Allocation
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.


Classification
Major classification issues include:

1. Identifying and reclassifying any material debits
contained in accounts payable.
2. Segregating short-term and long-term payables.
3. Ensuring that different types of payables are properly
classified.


Presentation
Two Disclosure Items are particularly important
for accounts payable and accrued expenses
The other major disclosure

The auditor must ensure that issue is purchase
all related-party purchase commitments. When the
transactions have been entity has entered into a
identified. If material, such formal long-term purchase
related-party purchase contract, adequate disclosure
transactions should be of the terms of the contract
disclosed. should be provided in a
footnote.

Accounts Payable Confirmations
Accounts payable confirmations are used less

often than accounts receivable confirmations. The
auditor is able to examine externally created
source documents relating to accounts payable.
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 entity.

Evaluating the Audit Findings
All identified misstatements should be aggregated

(including any consideration for sampling risk). The
projected misstatement is then compared to tolerable
misstatement. If the projected misstatement is less
than the tolerable misstatement, the auditor has
evidence that the account is fairly presented.
Conversely, if the projected misstatement exceeds the

tolerable misstatement, the auditor should conclude
that the account is not fairly presented.


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Auditing and Assurance Services

Copyright © 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution

Expense and Liability Recognition

Expenses are outflows or Liabilities are probable

Copyright © 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution

Copyright © 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution

Overview of the Purchasing

Purchase Purchase Receiving

Copyright © 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution

Three types of transactions are processed through the

Copyright © 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution

Types of Transactions and Financial

Type of Transaction Account Affected

Copyright © 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution

Flowchart of the Purchasing Process – EarthWear Clothiers (1 of 4)

Requesting Purchasing IT Department

Copyright © 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution

Flowchart of the Purchasing Process – EarthWear Clothiers (2 of 4)

Receiving Accounts Payable (A/P)

Flowchart of the Purchasing Process – EarthWear Clothiers (3 of 4)

Purchase A/P master General

Input Accounts Weekly • A/P expense

Copyright © 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution

Flowchart of the Purchasing Process – EarthWear Clothiers (4 of 4)

Accounts Payable (A/P) IT Department Cashier

Error A/P master

Copyright © 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution

Types of Documents and Records

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The Major Functions

Approval of purchase orders and proper execution as to

Receiving Receipt of properly authorized goods and services.

Processing of vendor invoices for goods and services

Disbursements Processing of payment to vendors.

Recording of all vendor invoices, cash disbursements, and

Proper accumulation, classification, and summarization of

Copyright © 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution

Key Segregation of Duties (1 of 2)

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Key Segregation of Duties (2 of 2)

Purchasing Process Accounts

Inherent Risk Assessment (1 of 2)

1. Is the supply of 2. How volatile are

Copyright © 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution

Inherent Risk Assessment (2 of 2)

Generally, the purchasing process is not difficult to audit

Copyright © 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution

Control Risk Assessment (1 of 3)

Understand and document the purchasing process

Plan and perform tests of controls on purchase

Set and document the control risk for the purchasing

Copyright © 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution

Control Risk Assessment (2 of 3)

For each major class of transactions in the purchasing

Copyright © 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution

Control Risk Assessment (3 of 3)

When tests do not support the

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Control Activities and Tests of Controls – Purchase

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Examples of Control Activities and Tests of Controls –

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Control Activities and Tests of Controls –

Occurrence of Cash Disbursement