Chapter 12 Auditing Acquisitions and Payments Processes: Cash Disbursements and Related Activities in the Automotive Industries Prepared by Richard J. Campbell Copyright 2011, Wiley and Sons

Learning Objectives 1. Learn the activities, transactions, risks, and accounts associated with acquisition and payments in a variety of business environments. 2. Understand the significant characteristics of the automotive industry that affect acquisitions and payments. 3. Learn the common business processes, ICFR, and documents associated with acquisitions and payments. 4. Link management assertions, risks, procedures, and audit evidence, including the purposes and execution of tests of controls for acquisitions and payments and related accounts. Chapter 12-1

Learning Objectives 5. Describe the extension of control tests into dual purpose tests, and the financial statement audit purposes that the extension accomplishes for acquisition and payment and related accounts. 6. Link management assertions, risks, procedures, and audit evidence, including the purposes and execution of substantive analytical procedures and tests of details of balances for acquisitions and payments and related accounts. 7. Apply the assertions, controls, and audit tests for purchase and payment transactions to prepaid expenses, accrued liabilities, expenses, fixed assets, and intangible assets. Chapter 12-2

ACQUISITION AND PAYMENT ASPECTS OF RETAILING Retailers must decide what inventory to purchase for resale. For any business whose primary activity is the purchase of merchandise and resale of that merchandise to others, the inventory account is a major part of the company’s balance sheet Retailers pay for the goods and services purchased when the payment is due, using a cash disbursements process. The cash disbursement may result from physically preparing a paper check or initiating an electronic transfer. Chapter 12 -3 Learning Objective #1

THE AUTOMOTIVE INDUSTRY: AN OVERVIEW The industry term for the large companies that we usually think of as the leaders in the industry is automotive Original Equipment Manufacturers (OEM). Chapter 12 -4 Learning Objective #2

Business Risks Associated with Purchasing Activities Acquisition and payment activities may seem like routine “back-office” operations, but they are actually critical to the companies in the automotive sector as they strive to accomplish their market-related goals. The success of businesses in the automotive industry is often linked to the performance of the suppliers from which they purchase parts and components. To manage these purchasing risks, automotive companies may investigate suppliers before committing to them and inspect suppliers’ operations on an ongoing basis. Chapter 12 -5 Learning Objective #2

Managing Acquisition-Related Costs Generally, companies seek to mitigate the risk that their costs of manufacturing inputs and inventory will increase, and want to be certain they will have the required supply of inputs. When an automotive company uses significant amounts of commodities such as steel, aluminum, and rubber, it is common to use financial instruments to hedge (or offset the risk of) commodity price changes. A practice common in the automotive industry is to enter into purchase obligation arrangements or execute blanket purchase orders to suppliers. Chapter 12 -6 Learning Objective #2

BUSINESS PROCESSES, DOCUMENTS, AND INTERNAL CONTROL All requests for purchases and purchase transactions should be authorized. All cash disbursements are for goods and services that are actually received by the company and for correct amounts. Another management objective is to properly post transactions. Chapter 12 -7 Learning Objective #3

Documents and Processes Chapter 12-8 Learning Objective #3

Documents and Processes Chapter 12-9 Learning Objective #3

Documents and Processes Chapter 12-10 Learning Objective #3

Documents and Processes Chapter 12-11 Learning Objective #3

Documents and Processes The purchase requisition, purchase order, receiving report, and vendor invoice or statement comprise a payment support package. The payment support packages goes through an approval process prior to the cash being disbursed. Final approval for the payment should be given by the “treasury” or cashier department of the business and should take place before the disbursement. The cash disbursement is recorded, updating the cash disbursements journal or report, accounts payable subsidiary ledger, and general ledger. Chapter 12 -12 Learning Objective #3

Purchase and Payment Activities EXHIBIT 12-1 Chapter 12 -13 Learning Objective #3

Potential Misstatements and Controls Many of the potential misstatements associated with purchases and cash disbursements are prevented or detected by the following: Segregation of duties Authorized approval Reliance on the documentation of the authorized approval Safeguarding the assets Controls over the process and outcomes of recording transactions Chapter 12 -14 Learning Objective #3

Business Activities and Related Documents EXHIBIT 12-2 Chapter 12 -15 Learning Objective #3

Segregation of Duties The following functions should be conducted by individuals or within departments that are independent of each other: • Approving the need for the purchase • Executing the purchase • Receiving the shipment • Recording the account payable • Authorizing the cash disbursement Chapter 12 - 16 Learning Objective #3

TESTS OF CONTROLS FOR PURCHASE AND EXPENDITURE TRANSACTIONS Management’s overall assertions continue to apply to all cycles of the business. As a reminder, they are: 1. Existence or occurrence 2. Completeness 3. Rights and obligations 4. Valuation or allocation 5. Presentation and disclosure Chapter 12 - 17 Learning Objective #4

Examples of Tests of Controls for Purchase Transactions EXHIBIT 12-3 Chapter 12 - 18 Learning Objective #4

Examples of Tests of Controls for Purchase Transactions EXHIBIT 12-3 Chapter 12 - 19 Learning Objective #4

Examples of Tests of Controls for Purchase Transactions EXHIBIT 12-3 Chapter 12 - 20 Learning Objective #4

Examples of Tests of Controls for Purchase Transactions EXHIBIT 12-3 Chapter 12 - 21 Learning Objective #4

Examples of Tests of Controls for Purchase Transactions EXHIBIT 12-3 Chapter 12 - 22 Learning Objective #4

Examples of Tests of Controls for Purchase Transactions EXHIBIT 12-3 Chapter 12 - 23 Learning Objective #4

Examples of Tests of Controls for Purchase Transactions EXHIBIT 12-3 Chapter 12 - 24 Learning Objective #4

Examples of Tests of Controls for Cash Disbursements EXHIBIT 12-4 Chapter 12-25 Learning Objective #4

Examples of Tests of Controls for Cash Disbursements EXHIBIT 12-4 Chapter 12-26 Learning Objective #4

Examples of Tests of Controls for Cash Disbursements EXHIBIT 12-4 Chapter 12-27 Learning Objective #4

Examples of Tests of Controls for Cash Disbursements EXHIBIT 12-4 Chapter 12-28 Learning Objective #4

Examples of Tests of Controls for Cash Disbursements EXHIBIT 12-4 Chapter 12-29 Learning Objective #4

Examples of Tests of Controls for Cash Disbursements EXHIBIT 12-4 Chapter 12-30 Learning Objective #4

Examples of Dual Purpose Tests for Purchase Transactions EXHIBIT 12-5 Learning Objective #5 Chapter 12-31

Examples of Dual Purpose Tests for Purchase Transactions EXHIBIT 12-5 Learning Objective #5 Chapter 12-32

Examples of Dual Purpose Tests for Purchase Transactions EXHIBIT 12-5 Learning Objective #5 Chapter 12-33

Examples of Dual Purpose Tests for Cash Disbursements EXHIBIT 12-6 Learning Objective #5 Chapter 12-34

Examples of Dual Purpose Tests for Cash Disbursements EXHIBIT 12-6 Learning Objective #5 Chapter 12-35

Examples of Dual Purpose Tests for Cash Disbursements EXHIBIT 12-6 Learning Objective #5 Chapter 12-36

SUBSTANTIVE ANALYTICAL PROCEDURES The auditor performs substantive analytical procedures to obtain audit evidence for the financial statement audit. Substantive analytical procedures augment the audit evidence collected through dual purpose tests and tests of details of balances. Analytical procedures can involve comparing an account balance with prior years, a budget, or an industry benchmark Analytical procedures also take the form of calculating a ratio or statistic and using the outcome of the calculation for comparison. Learning Objective #6 Chapter 12-37

Examples of Substantive Analytical Procedures EXHIBIT 12-7 Learning Objective #6 Chapter 12-38

TESTS OF DETAILS OF BALANCES The bigger audit concern for accounts payable is completeness. The auditor addresses the risk that some accounts payable are omitted or recorded at less than their full amounts. A major audit goal is to identify any un- or underrecorded payables. Learning Objective #6 Chapter 12-39

Search for Unrecorded Liabilities An example of an unrecorded liability is an accrued expense that goes unrecorded because the service provider’s invoice for utilities used during the year under audit was not received by year end. Another example is when inventory is received before year end, but the invoice is not received until the following fiscal year. Chapter 12-40 Learning Objective #6

Search for Unrecorded Liabilities The following procedures are generally included in the search for unrecorded liabilities: 1. Ask the client what procedures it has established and followed to be sure that all liabilities are recorded. 2. Review cash disbursements and related supporting documents in the subsequent accounting period. 3. Review invoices and statements and relating supporting documents for liabilities not paid at the time the audit work at the client’s location is completed. 4. Understand the client’s year-end cutoff policies for inventory. 5. Perform analytical procedures for the reasonableness of the accounts payable balance. 6. Read contracts that may indicate any purchase commitments that may need to be recorded or disclosed in the financial statements. Chapter 12-41 Learning Objective #6

Examples of Tests of Details of Balances EXHIBIT 12-8 Chapter 12-42 Learning Objective #6

AUDIT OF PREPAID EXPENSES AND ACCRUED LIABILITIES Chapter 12-43 Learning Objective #7

AUDIT OF PREPAID EXPENSES AND ACCRUED LIABILITIES Chapter 12-44 Learning Objective #7

Examples of Substantive Analytical Procedures EXHIBIT 12-9 Chapter 12-45 Learning Objective #7

AUDIT OF EXPENSES Chapter 12-46 Learning Objective #7

AUDIT OF PROPERTY, PLANT AND EQUIPMENT EXHIBIT 12-10 Chapter 12-47 Learning Objective #1

Sample Property, Plant and Equipment Work Paper Chapter 12-48 Learning Objective #7

Examples of Substantive Analytical Procedures EXHIBIT 12-11 Chapter 12-49 Learning Objective #1

AUDIT OF INTANGIBLE ASSETS Intangible assets are very important in some industries, yet virtually nonexistent in others. Dual purpose tests, substantive analytical procedures, and tests of details of balances similar to those applied to property, plant, and equipment and depreciation are appropriate for identifiable intangible assets. Information from the company’s legal counsel is also used by the auditor when the information indicates other impairment of an intangible asset’s value. Chapter 12-50 Learning Objective #7

AUDITING ACQUISITIONS AND PAYMENTS IN THE AUTOMOTIVE INDUSTRY Businesses in the automotive industry usually have a high volume of inventory purchase transactions for many different items and from multiple vendors. Assuming an automotive industry client has good ICFR, the most challenging consideration for testing expenses or assets and related accounts payable and cash disbursements is the large volume of transactions. Many automotive companies engage in global purchase and sale activities. Consequently, the companies receive or extend payment for transactions using foreign currencies. This exposes the companies to foreign currency exchange risks. Learning Objective #1 Chapter 12-51

Review Question Which of the following sets of accounts is not affected by the acquisition and payment cycle? (a) Cash, inventory, intangible assets (b) Accounts payable, prepaid assets, accrued liabilities (c) Accounts receivable, capital stock, retained earnings (d) Cash, fixed assets, accounts payable Chapter 12-52

Review Question Information about inventory is extremely important for retailers and wholesalers to conduct business. Identify which of the following is not relevant information for retailers and wholesalers concerning their inventory. (a) How many items were last purchased (b) How many items remain in inventory (c) The date the items were received (d) All of the above are relevant. Chapter 12-53

Review Question Retail and wholesale businesses may need to return some of the inventory items that they purchase, or may receive a discount when items are paid for in a certain time frame. This process of purchase returns and allowances is the “mirror” image of (a) the sales returns and allowances transaction. (b) purchasing fixed assets from outside parties. (c) the sale of inventory to the end user. (d) financing a purchase by using a trade account. Chapter 12-54

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