2. ©2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley 19 - 1 Audit of the Acquisition and Payment Cycle Chapter 19

3. ©2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley 19 - 2 Learning Objective 1 Identify the accounts and the classes of transactions in the acquisition and payment cycle.

4. ©2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley 19 - 3 Transactions in the Acquisition and Payment Cycle 1.Acquisitions of goods and services 2.Cash disbursements 3.Purchase returns and allowances and purchase discounts

5. ©2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley 19 - 4 Accounts in the Acquisition and Payment Cycle Cash in Bank Purchase Returns and Allowances PurchaseDiscounts Cashdisbursements Purchase returns and allowances Purchasediscounts Acquisitions of goods and services Raw Material Purchases Property, Plant and Equipment PrepaidExpenses Accounts Payable

6. ©2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley 19 - 5 Accounts in the Acquisition and Payment Cycle Acquisitions of goods and services Accounts Payable Manufacturing Expense Control Account Subsidiary accounts Repair and maintenance Taxes, Supplies Freight in, Utilities Administrative Expense Control Account Subsidiary accounts Supplies, Officers’ travel Legal fees Auditing fees, Taxes Selling Expense Control Account Subsidiary accounts Commissions Travel expense Repairs, Advertising

7. ©2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley 19 - 6 Learning Objective 2 Describe the business functions and the related documents and records in the acquisition and payment cycle.

8. ©2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley 19 - 7 Classes of Transactions and Accounts Inventory Property, plant, and equipment Prepaid expenses Leasehold improvements Accounts payable Manufacturing expenses Selling and administrative expenses

9. ©2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley 19 - 8 Classes of Transactions and Accounts Cash in bank (from cash disbursements) (from cash disbursements) Accounts payable Purchase discounts

10. ©2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley 19 - 9 Business Functions in the Cycle Processing purchase orders Receiving goods and services Recognizing the liability Processing and recording cash disbursements

11. ©2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley 19 - 10 Related Documents and Reports Purchase requisition Purchase order Receiving report Processing purchase orders Receiving goods and services

12. ©2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley 19 - 11 Related Documents and Reports Acquisitions transaction file Acquisitions journal or listing Vendor’s invoice Voucher A/P trial balance Debit memo A/P master file Vendor’s statement Recognizing the liability

13. ©2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley 19 - 12 Related Documents and Reports Cash disbursements transaction file Check Cash disbursements journal or listing Processing and recording cash disbursements

14. ©2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley 19 - 13 Learning Objective 3 Describe how e-commerce affects the acquisition of goods and services.

15. ©2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley 19 - 14 How E-Commerce Affects the Acquisition and Payment Cycle SuppliersCustomers Internet-based technologies allow for electronic linkage between suppliers and customers. Purchaseorders Customerorders EDIEDI

16. ©2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley 19 - 15 How E-Commerce Affects the Acquisition and Payment Cycle Some companies use extranets which allow companies to communicate and conduct business in a secure setting. Other companies use business-to-business auctions hosted on the Internet to negotiate purchases. Information about products is available over the Internet.

17. ©2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley 19 - 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.

18. ©2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley 19 - 17 Methodology for Designing Tests of Balances – Accounts Receivable Understand internal control – acquisitions and cash disbursements. Auditprocedures Items to selectSamplesizeTiming Assess planned control risk – acquisitions and cash disbursements. Design tests of controls and substantive tests of transactions for acquisitions and cash disbursements to meet transaction-related audit objectives. Evaluate cost-benefit of testing controls.

19. ©2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley 19 - 18 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.

20. ©2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley 19 - 19 Assess Planned Control Risk Authorization of purchases Separation of asset custody from other functions Timely recording and independent review of transactions Authorization of payments

21. ©2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley 19 - 20 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.

22. ©2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley 19 - 21 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).

23. ©2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley 19 - 22 Controls and Substantive Tests of Transactions for Acquisitions Acquisitions transactions are recorded on the correct dates (timing). Acquisitions transactions are properly included in the accounts payable and inventory master files and are properly summarized (posting and summarization).

24. ©2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley 19 - 23 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.

25. ©2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley 19 - 24 Attributes Sampling Because of the importance of tests of controls and substantive tests of transactions for acquisitions and cash disbursements, the use of attributes sampling is common in this audit area.

26. ©2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley 19 - 25 Learning Objective 5 Describe the methodology for designing tests of details of balances for accounts payable using the audit risk model.

27. ©2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley 19 - 26 Identify client risks affecting accounts payable. Methodology for Designing Tests of Details of Balances for A/P Phase I Set tolerable misstatement and assess inherent risk for accounts payable. Assess control risk for accounts payable.

28. ©2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley 19 - 27 Methodology for Designing Tests of Details of Balances for A/P Design and perform tests of controls and substantive tests of transactions for the acquisition and payment cycle. Phase II

29. ©2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley 19 - 28 Methodology for Designing Tests of Details of Balances for A/P Design and perform analytical procedures for the acquisition and payment cycle. Phase III Auditprocedures Items to selectSamplesizeTiming Design tests of details of accounts payable balance to satisfy balance-related audit objectives.

30. ©2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley 19 - 29 Learning Objective 6 Design and perform analytical procedures for accounts payable.

31. ©2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley 19 - 30 Analytical Procedures for the Acquisition and Payment Cycle Review list of accounts payable for unusual, nonvender, and interest-bearing payables. Classification misstatement for nontrade liabilities. Analytical procedure Compare acquisition-related expense account balances with prior years. Misstatement of accounts payable and expenses. Possible misstatement

32. ©2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley 19 - 31 Analytical Procedures for the Acquisition and Payment Cycle Analytical procedure Compare individual accounts payable with previous years. Unrecorded or nonexistent accounts, or misstatements. Calculate ratios, such as purchases divided by accounts payable, and accounts payable divided by current liabilities. Unrecorded or nonexistent accounts, or misstatements. Possible misstatement

33. ©2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley 19 - 32 Learning Objective 7 Design and perform tests of details of balances for accounts payable, including out-of-period liability tests.

34. ©2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley 19 - 33 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.

35. ©2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley 19 - 34 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.

36. ©2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley 19 - 35 Cutoff Tests Relationship of cutoff to physical observation of inventory Inventory in transit

37. ©2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley 19 - 36 Learning Objective 8 Distinguish the reliability of vendors’ invoices, vendors’ statements, and confirmations of accounts payable as audit evidence.

38. ©2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley 19 - 37 Reliability of Evidence Distinction between vendors’ invoices and vendors’ statements. Difference between vendors’ statements and confirmations.

39. ©2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley 19 - 38 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.

40. ©2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley 19 - 39 Types of Audit Tests for the Acquisition and Payment Cycle TOC + STOT + AP + TDB = Sufficient competent evidence per GAAS Cash in BankAccountsPayableAcquisitionExpensesPaymentsExpenses Audited by TOC, STOT, and AP EndingbalanceEndingbalance Audited by AP and TDB Audited by TOC, STOT, and AP

41. ©2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley 19 - 40 Types of Audit Tests for the Acquisition and Payment Cycle TOC + STOT + AP + TDP = Sufficient competent evidence per GAAS AccountsPayableAcquisitionAssets Acquisition of assets Endingbalance Audited by TOC, STOT, and AP Audited by AP and TDP

42. ©2005 Prentice Hall Business Publishing, Auditing and Assurance Services 10/e, Arens/Elder/Beasley 19 - 41 End of Chapter 19