1. Chapter 8 Acquisition and Expenditure Cycle
“Show those numbers to the damn auditors and I'll throw you out the window.”----(Buddy Yates, director of WorldCom, Inc. general accounting, to an employee asking for an explanation of a large accounting discrepancy).
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Learning Objectives
Identify significant inherent risks in the acquisition and expenditure cycle.
Describe the acquisition and expenditure cycle, including typical source documents and controls.
Give examples of tests of controls over purchases of inventory and services.
Explain the importance of the completeness assertion for the audit of accounts payable liabilities, and list some procedures for a “search for unrecorded liabilities.”
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3. Learning Objectives (cont.)
Discuss audit procedures for other accounts affected by the acquisition and expenditure cycle.
Specify some ways fraud can be found in accounts payable and cash disbursements.
Describe some common errors and frauds in the acquisition and expenditure cycle, and design some audit and investigation procedures for detecting them.
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4. Acquisition and Expenditure Cycle
Concerned with transactions involving:
the purchase of merchandise and materials necessary for the continued operations of business and
the subsequent payment for such purchases.
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5. Exhibit 8.1 Cost and Expense Capers
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Inherent Risks
Unrecorded liabilities
Noncancelable purchase agreements
Capitalizing expenses
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7. Acquisition and Expenditure Cycle: Typical Activities
Department requesting purchase of item(s) prepares a PURCHASE REQUISITION
Purchase is approved by preparation of a PURCHASE ORDER
After vendor approval, goods are received by company and evidenced by preparing a RECEIVING REPORT
Vendor bills company for goods using a VENDOR'S INVOICE
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8. EXHIBIT8.2 ACQUISITION AND EXPENDITURE CYCLE
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Control Procedures
Information processing controls
Compare quantities against receiving report and purchase order
Compare prices against quoted price or catalog listing
Mathematically verify vendor's invoice
Determine when to pay invoice and prepare VOUCHER
Segregation of duties
AUTHORIZATION of the purchase is done by the purchasing department.
Custody of the inventory item(s) is held by the receiving department and, ultimately, the requesting department.
Transactions are recorded by general accounting (control account) and accounts payable department (subsidiary accounts)
Physical controls
Prepare a receiving report upon initial receipt of inventory
Count and verify inventory quantities upon delivery to the inventory warehouse
Restrict access to inventories by keeping them in a secured location
Performance reviews
Compare purchases data to data from previous years or expected purchases data
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10. Audit Evidence in Management Reports and Data Files
Open purchase orders
Unmatched receiving reports
Unmatched vendor invoices
Accounts payable trial balance
Purchases journal
Inventory reports
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EXHIBIT 8.4
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13. The Completeness Assertion
Search for Unrecorded Liabilities
Scan open purchase order file
Examine all UNMATCHED VENDOR STATEMENTS/INVOICES
Examine all UNMATCHED RECEIVING REPORTS occurring near year-end
TRACE from unpaid VOUCHERS in A/P
Confirm A/P with NORMAL SUPPLIERS (even those with zero balances)
Review CASH DISBURSEMENTS occurring after year-end
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Purchase Cutoffs
Verify CUT-OFFs for purchases
Examine Receiving Reports and Vendor Sales Invoices occurring around year-end to ensure inventory received is included in the appropriate period.
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15. Other Accounts in Cycle
Accrued Expenses
Prepaid Expenses
Expenses
Inventory
Property Plant and Equipment
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Accrued Payables
Major differences between ACCRUED PAYABLES and ACCOUNTS PAYABLE
Examples include INTEREST, PROPERTY TAXES, WAGES, and INCOME TAXES PAYABLE
These payables are not normally INVOICED or EVIDENCED by the RECEIPT OF GOODS
These differences may make it more difficult to detect UNRECORDED ACCRUALS
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17. Auditing Accrued Payables and Prepaid Expenses
Agree balances to PRIOR YEAR WORKPAPERS
Verify PAYMENTS
Examine UNDERLYING AGREEMENTS
RECALCULATE amounts
Search for UNRECORDED ACCRUALS
Review CASH DISBURSEMENTS at year-end
Look for expected accruals at other stages of the audit (BONDS, NOTES, employees paid on 15th, etc.)
ANALYTICAL PROCEDURES
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18. Exhibit 8.5 Account Analysis for Prepaid Expenses
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19. AUDITING PROPERTY, PLANT, AND EQUIPMENT
GENERAL APPROACH
Use TEST OF TRANSACTION approach
Small number of transactions
Relatively high dollar transactions
Authorization of Transactions (Board of Directors) takes on added importance.
Less concern for ACCESS to ASSETS
More concerned with UNRECORDED DISPOSALS
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20. AUDITING PROPERTY, PLANT, AND EQUIPMENT
Agree balances to prior year documentation
PURCHASES OF PPE
VOUCH to INVOICE or COST RECORDS
Inspect TITLE
VOUCH to BOARD MINUTES
EXPENDITURES SUBSEQUENT TO ACQUISITION
VOUCH to INVOICE and WORK DESCRIPTIONS
Consider propriety of classification (EXPENSE or CAPITALIZE)
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21. AUDITING PROPERTY, PLANT, AND EQUIPMENT
DISPOSAL OF PPE
VOUCH from PPE to BOD MINUTES (AUTHORIZATION)
Vouch to cash receipts journal and validated deposit slip
Recalculate gain/loss
TRACE from BD MINUTES to PPE for disposals (COMPLETENESS)
Look for unrecorded disposals
Agree balances to PRIOR YEAR WORKPAPERS
Examine insurance policies, property tax records, etc.
PHYSICALLY INSPECT or CONFIRM fixed assets
Both existing and newly-acquired items
Confirm assets LEASED to others under capital leases
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22. AUDITING PROPERTY, PLANT, AND EQUIPMENT
DEPRECIATION EXPENSE
Recalculate using USEFUL LIFE, SALVAGE VALUE, COST, and METHOD (VA)
Evaluate REASONABLENESS of USEFUL LIFE, SALVAGE VALUE, etc.
Is depreciation consistent with COMPANY POLICY (half year conventions)?
LEASE AGREEMENTS
Verify proper treatment (Capitalized or Operating)
Ensure disclosure in footnotes is appropriate
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Exhibit 8.6
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24. Auditing Expense Accounts
Analytical procedures (e.g. sales commissions)
Agree to related balance sheet account (depreciation)
Substantive tests of transactions (e.g. payroll)
Vouch detail (e.g. legal expense)
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Fraud Signs
Photocopies of invoices
Invoices in numerical order
Round numbers
Slightly below threshold
P.O. Boxes
No listed phone #
Vendor and Employee addresses the same
Multiple vendors at same location
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