1. Completing the Tests in the Acquisition and Payment Cycle: Verification of Selected Accounts
Chapter 19

2. Learning Objective 1 Recognize the many accounts
in the acquisition and
payment cycle.

3. Accounts Associated with the Acquisition and Payment Cycle
Assets:
Cash
Inventory
Supplies
Property, plant, and equipment
Patents, trademarks, and copyrights
Prepaid rent
Prepaid taxes
Prepaid insurance

4. Accounts Associated with the Acquisition and Payment Cycle
Expenses:
Cost of goods sold
Rent expense
Property taxes
Income tax expense
Insurance expense
Professional fees
Retirement benefits
Utilities

5. Accounts Associated with the Acquisition and Payment Cycle
Liabilities:
Accounts payable
Rent payable
Accrued professional fees
Accrued property taxes
Other accrued expenses
Income taxes payable

6. Methodology for Designing Tests of Details of Balances
Identify client business
risks affecting
other accounts
Phase I
Set tolerable misstatement
and assess inherent
risk for accounts
Phase I
Assess control risk for
accounts
Phase I

7. Methodology for Designing Tests of Details of Balances
Design and perform
tests of controls and
substantive tests
of transactions
for the acquisition
and payment cycle
Phase II

8. Methodology for Designing Tests of Details of Balances
Design and perform
analytical procedures
for the acquisition
and payment cycle
Phase III
Phase III
Design tests of details
of account balances
to satisfy
balance-related
audit objectives
Audit procedures
Sample size
Items to select
Timing

9. Learning Objective 2 Design and perform audit tests of
property, plant, and equipment
and related accounts.

10. Classifications of Property, Plant, and Equipment Accounts
Land and land improvements
Buildings and building improvements
Manufacturing equipment
Furniture and fixtures
Autos and trucks
Leasehold improvements
Construction-in-process for property,
plant, and equipment

11. Manufacturing Equipment and Related Accounts
Accumulated
Depreciated
Beginning
balance
Disposals
Disposals
Beginning
balance
Acquisitions
Current period
depreciation
Ending
balance
Ending balance
Gain or Loss
on Disposals
Depreciation
Expense

12. Auditing Manufacturing Equipment and Related Accounts
Perform analytical procedures
Plus verify:
Current year acquisitions
Current year disposals
Ending balance in the asset account
Depreciation expense
Ending balance in accumulated depreciation

13. Analytical Procedures for Manufacturing Equipment
Possible misstatement
Compare depreciation expense
divided by gross manufacturing
equipment cost with previous
years
Misstatement in
depreciation expense and
accumulated depreciation
Compare accumulated
depreciation divided by gross
manufacturing equipment cost
with previous years
Misstatement in
accumulated depreciation

14. Analytical Procedures for Manufacturing Equipment
Possible misstatement
Compare monthly or annual
repairs and maintenance,
supplies expense, small tools
expense, and similar accounts
with previous years
Expensing accounts that
should be capitalized
Compare gross manufacturing
cost divided by some measure
of production with previous
years
Idle equipment or
equipment that was
disposed of but not
written off

15. Verify Current Year Acquisitions
The correct recording of current year additions
is important because of the long-term effect
the assets have on the financial statements.
Because of the importance of current period
acquisitions, seven of the eight balance-related
audit objectives are used as a frame of reference.

16. Balance-Related Audit Objectives
Detail tie-in:
Current acquisitions agree
with the master file.
1. Foot the acquisition schedule.
2. Trace the individual acquisitions
to the master file.
3. Trace the total to the general ledger.

17. Balance-Related Audit Objectives
Existence:
Current acquisitions as listed exist.
1. Examine vendors’ invoices and
receiving reports
2. Physically examine assets.

18. Balance-Related Audit Objectives
Completeness:
Existing acquisitions are recorded.
1. Examine vendors’ invoices of closely
related accounts to uncover items that
should be manufacturing equipment.
2. Review lease and rental agreements.

19. Balance-Related Audit Objectives
Accuracy:
Current year acquisitions as listed
are accurate.
1. Examine vendors’ invoices.

20. Balance-Related Audit Objectives
Classification:
Current year acquisitions as listed
are correctly classified.
1. Examine vendors’ invoices in
manufacturing equipment account.
2. Examine vendors’ invoices of closely
related accounts.
3. Examine rent and lease expense
for capitalizable leases.

21. Balance-Related Audit Objectives
Cutoff:
Current year acquisitions are recorded
in the correct period.
1. Review transactions near the balance
sheet date for correct period.

22. Major Balance-Related Audit Objectives
Rights:
The client has rights to current year
acquisitions.
1. Examine vendors’ invoices.

23. Verify Current Year Disposals
Review whether newly acquired assets
replace existing assets
Analyze gains and losses on disposal
Review documents for indications of
deletion of equipment
Make inquiries about the possibility of
the disposal of assets

24. Verify Ending Balance of Asset Accounts
1. All recorded equipment physically
exists on the balance sheet date.
2. All equipment owned is recorded.

25. Verify Depreciation Expense
The most important objective is accuracy.
Consistent depreciation policy
Correct calculations

26. Verify Ending Balance in Accumulated Depreciation
1. Accumulated depreciation as stated
in the property master file agrees
with the general ledger.
2. Accumulated depreciation in the
master file is accurate.

27. Learning Objective 3 Design and perform audit tests
of prepaid expenses.

28. Audit of Prepaid Expenses
Prepaid rent
Organization costs
Prepaid taxes
Patents
Prepaid insurance
Trademarks
Deferred charges
Copyrights

29. Prepaid Insurance and Related Accounts
Insurance Expense
Beginning
balance
Current period
insurance
expense
Acquisitions
Ending
balance

30. Internal Controls Acquisition and recording of insurance
Insurance register
Insurance expense

31. Audit Tests Compare total prepaid insurance and
insurance expense with previous years
Compute the ratio of prepaid insurance
to insurance expense and compare
it with previous years
Compare the individual insurance policy
coverage on the schedule of insurance
obtained with the preceding year’s schedule

32. Audit Tests Compare the computed prepaid insurance
balance for the current year on a policy-by-
policy basis with that of the preceding year.
Review the insurance coverage listed on
the prepaid insurance schedule with an
appropriate client official or insurance broker.

33. Balance-related Audit Objectives
Existence and completeness:
Insurance policies in the prepaid insurance
schedule exist and existing policies are listed.
Rights:
The client has rights to all insurance policies
in the prepaid insurance schedule.

34. Balance-related Audit Objectives
Accuracy and detail tie-in:
Prepaid amounts are accurate and the total
is correctly added and agrees with the
general ledger.
Classification:
Insurance expense is properly classified.
Cutoff:
Insurance transactions are recorded in the
proper period.

35. Learning Objective 4 Design and perform audit tests
of accrued liabilities.

36. Audit of Accrued Liabilities
Accrued payroll
Accrued payroll taxes
Accrued officers’ bonuses
Accrued commissions
Accrued professional fees
Accrued rent
Accrued interest

37. Accrued Property Taxes and Related Accounts
Property Tax Expense
Payments
(property taxes)
Beginning
balance
Current period
property tax
expense
Ending
balance

38. Learning Objective 5 Design and perform audit tests of
income and expense accounts.

39. Approach to Auditing Income and Expense Accounts
Analytical procedures
Tests of controls and substantive
tests of transactions
Tests of details of account balances

40. Analytical Procedures for Income and Expense Accounts
Possible misstatement
Compare individual expenses
with previous years
Overstatement or
understatement of a
balance in an expense
account
Compare individual asset and
liability balances with previous
years
Overstatement or
understatement of a
balance sheet account that
will also affect an income
statement account

41. Analytical Procedures for Income and Expense Accounts
Possible misstatement
Compare individual expenses
with budgets
Misstatement of expenses
and related balance
sheet accounts
Compare gross margin
percentage with previous
years
Misstatement of cost of
goods sold and inventory
Compare inventory turnover
ratio with previous years
Misstatement of cost of
goods sold and inventory

42. Analytical Procedures for Income and Expense Accounts
Possible misstatement
Compare prepaid insurance
expense with previous years
Misstatement of insurance
expense and prepaid
insurance
Compare commission expense
divided by sales with
previous years
Misstatement of
commission expense and
accrued commissions
Compare individual
manufacturing expenses
divided by total manufacturing
expenses with previous years
Misstatement of individual
manufacturing expenses
and related balance
sheet accounts

43. Tests of Controls and Substantive Test of Transactions
Both tests of controls and substantive
tests of transactions have the effect of
simultaneously verifying balance sheet
and income statement accounts.

44. Tests of Details of Account Balances – Expense Analysis
Expense account analysis:
Repairs and maintenance
Rent and lease
Legal expense

45. Tests of Details of Account Balances – Allocation
Several expense accounts result from the allocation
of accounting data rather than discrete transactions.
These include depreciation, depletion, and the
amortization of copyrights and catalog cost.
The allocation of manufacturing overhead between
inventory and cost of goods sold is an example of
a different type of allocation that affects expenses.

46. End of Chapter 19