Audit of the Acquisition and Payment Cycle Chapter 18

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

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

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

Accounts in the Acquisition and Payment Cycle Accounts Payable Acquisitions of goods and services Manufacturing Expense Control Selling Expense Control Administrative 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

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

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

Classes of Transactions and Accounts Cash Disbursements Cash in bank (from cash disbursements) Accounts payable Purchase discounts

Business Functions in the Cycle Processing Purchase Orders Receiving Goods and Services Recognizing the Liability Processing and Recording Cash Disbursements

Related Documents and Reports Processing Purchase Orders Purchase requisition Purchase order Receiving Goods and Services Receiving report

Related Documents and Reports 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

Related Documents and Reports Processing and Recording Cash Disbursements Check Cash disbursements transaction file Cash disbursements journal or listing

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

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. Suppliers Customers EDI EDI Customer orders Purchase orders

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.

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

Methodology for Designing Tests of Balances – Accounts Receivable Understand internal control – acquisitions and cash disbursements. Assess planned control risk – acquisitions and cash disbursements. Evaluate cost-benefit of testing controls.

Methodology for Designing Tests of Balances – Accounts Receivable Design tests of controls and substantive tests of transactions for acquisitions and cash disbursements to meet transaction-related audit objectives. Audit procedures Sample size Items to select Timing

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.

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

Evaluate Cost-Benefit of 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.

Controls and Substantive Tests of Transactions 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).

Controls and Substantive Tests of Transactions 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.

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

Methodology for Designing Tests of Details of Balances for A/P Phase I Set tolerable misstatement and assess inherent risk. Identify client risks affecting accounts payable.

Methodology for Designing Tests of Details of Balances for A/P Phases I and II Assess control risk and design and perform tests of controls and substantive tests of transactions.

Methodology for Designing Tests of Details of Balances for A/P Phase III Design and perform analytical procedures. Design and perform tests of details of accounts payable balance.

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

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.

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.

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

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.

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.

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

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

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

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.

Types of Audit Tests for the Acquisition and Payment Cycle Cash in Bank Accounts Payable Acquisition Expenses Payments Expenses Audited by TOC, STOT, and AP Audited by TOC, STOT, and AP Ending balance Ending balance Audited by AP and TDP Audited by AP TOC + STOT + AP + TDP = Sufficient competent evidence per GAAS

Types of Audit Tests for the Acquisition and Payment Cycle Accounts Payable Acquisition Assets Acquisition of assets Audited by TOC, STOT, and AP Ending balance Audited by AP and TDP TOC + STOT + AP + TDP = Sufficient competent evidence per GAAS

End of Chapter 18