Audit of the Acquisition and Payment Cycle: Tests of Controls, Substantive Tests of Transactions, and Accounts Payable

1. Audit of the Acquisition andPayment Cycle: Tests of Controls,Substantive Tests of Transactions,and Accounts Payable Chapter 14

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

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

4. Raw Material Purchases Cash in Bank Accounts Payable Cash Acquisitions disbursements of goods and services Purchase returns and allowances Purchase discounts Purchase Returns and Allowances Property, Plant, and Equipment Purchase Discounts Prepaid Expenses Accounts in the Acquisitionand Payment Cycle

5. Accounts in the Acquisitionand Payment Cycle Accounts Payable Acquisitions of goods and services Manufacturing Expense Control Administrative Expense Control Selling Expense Control Subsidiary accounts Repair and maint. Taxes Supplies Freight in Utilities Subsidiary accounts Commissions Travel expense Delivery expense Repairs Advertising Subsidiary Accounts Supplies Officers’ travel Legal fees Auditing fees Taxes

6. Learning Objective 2 Describe the business functions and the related documents and records in the acquisition and payment cycle.

7. Classes of Transactionsand Accounts Acquisitions Inventory Property, plant, and equipment Prepaid expenses Leasehold improvements Accounts payable Manufacturing expenses Selling and administrative expenses

8. Classes of Transactionsand Accounts Cash Disbusements Cash in bank (from cash disbursements) Accounts payable Purchase discounts

9. Business Functionsin the Cycle Processing purchase orders Receiving goods and services Recognizing the liability Processing and recording cash disbursements

10. Documents and Records Processing purchase orders Purchase requisition Purchase order Receiving goods and services Receiving report

11. Documents and Records Recognizing the liability Acquisitions transaction file Acquisitions journal or listing Vendor’s invoice Debit memo Voucher A/P master file A/P trial balance Vendor’s statement

12. Documents and Records Processing and recording cash disbursements Check Cash disbursements transaction file Cash disbursements journal or listing

13. Learning Objective 3 Describe how e-commerce affects the acquisition of goods and services.

14. Suppliers Customers EDI EDI Customer orders Purchase orders How E-Commerce Affects the Acquisition and Payment Cycle Electronic data interchange (EDI) is the electronic exchange of information between companies and their suppliers and consumers.

15. How E-Commerce Affects the Acquisition and Payment Cycle Information about products is available over the Internet. Some companies use extranets which link the intranets of two or more companies. Other companies use business- to-business auctions hosted on the Internet to negotiate purchases.

16. Learning Objective 4 Understand internal control and design and perform tests of controls and substantive tests of transactions for the acquisition and payment cycle.

17. Understand Internal Control The auditor gains an understanding of internal control for the acquisition and payment cycle by studying the client’s flowcharts, preparing internal control questionnaires, and performing walk-through tests for acquisitions and cash disbursements.

18. Assess Planned Control Risk Authorization of purchases Separation of asset custody from other functions Timely recording and independent review of transactions Authorization of payments

19. Evaluate Cost-Benefitof Testing Controls The auditor identifies the key internal controls and weaknesses and assesses control risk. The auditor decides whether substantive tests will be reduced sufficiently to justify the cost of performing tests of controls.

20. Controls and Substantive Tests ofTransactions for Acquisitions Recorded acquisitions are for goods and services received, consistent with the best interests of the client (existence). Existing acquisitions are recorded (completeness). Acquisitions are accurately recorded (accuracy). Acquisitions are correctly classified (classification).

21. Controls and Substantive Tests ofTransactions for Acquisitions Acquisition transactions are recorded on the correct dates (timing). Acquisition transactions are properly included in the accounts payable and inventory master files and are properly summarized (posting and summarization).

22. Controls and Substantive Tests ofTransactions for Cash Disbursements The assumption underlying these controls and audit procedures is separate cash disbursements and acquisitions journals. The acquisitions and cash disbursements tests are typically performed concurrently.

23. Learning Objective 5 Describe the methodology for designing tests of details of balances for accounts payable using the audit risk model.

24. Methodology for Designing Testsof Details of Balances for A/P Identify client risks affecting accounts payable. Set tolerable misstatement and assess inherent risk. Assess control risk and design and perform tests of controls and substantive tests of transactions.

25. Learning Objective 6 Design and perform analytical procedures for accounts payable.

26. Analytical Procedures for the Acquisition and Payment Cycle Analytical Procedure Possible Misstatement Compare acquisition- Misstatement of related expense account accounts payable balances with prior years. and expenses Review list of accounts Classification payable for unusual, misstatement for nonvender, and interest- nontrade liabilities bearing payables.

27. Analytical Procedures for the Acquisition and Payment Cycle Analytical Procedure Possible Misstatement Compare individual Unrecorded or accounts payable with nonexistent accounts, previous years. or misstatements Calculate ratios such as Unrecorded or purchases divided by nonexistent accounts, accounts payable, and or misstatements accounts payable divided by current liabilities.

28. Learning Objective 7 Design and perform tests of details of balances for accounts payable, including out-of-period liability tests.

29. 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.

30. 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.

31. Cutoff Tests • Relationship of cutoff to physical observation of inventory • Inventory in transit

32. Learning Objective 8 Distinguish the reliability of vendors’ invoices, vendors’ statements, and confirmations of accounts payable as audit evidence.

33. Reliability of Evidence Distinction between vendors’ invoices and vendors’ statements Difference between vendors’ statements and confirmations

34. Sample Size Sample sizes for accounts payable tests vary considerably, depending on many factors. Statistical sampling is less commonly used for the audit of accounts payable than for accounts receivable.

35. End of Chapter 14