1. 16 - 1 Copyright  2003 Pearson Education Canada Inc. CHAPTER 16 Audit of the Acquisition and Payment Cycle

2. 16 - 2 Copyright  2003 Pearson Education Canada Inc. What accounts are typically involved in the acquisition and payment cycle?

3. 16 - 3 Copyright  2003 Pearson Education Canada Inc. - purchases - purchase returns and allowances - purchase discounts - cash in bank - accounts payable - property, plant, and equipment - prepaid expenses - manufacturing, administrative, selling expenses What accounts are typically involved in the acquisition and payment cycle?

4. 16 - 4 Copyright  2003 Pearson Education Canada Inc. What classes of transactions occur in the acquisition and payment cycle?

5. 16 - 5 Copyright  2003 Pearson Education Canada Inc. - acquisition of goods and services What classes of transactions occur in the acquisition and payment cycle?

6. 16 - 6 Copyright  2003 Pearson Education Canada Inc. - acquisition of goods and services - cash disbursements for those acquisitions What classes of transactions occur in the acquisition and payment cycle?

7. 16 - 7 Copyright  2003 Pearson Education Canada Inc. What is the relationship between the sales and collection cycle and the acquisition and payment cycle?

8. 16 - 8 Copyright  2003 Pearson Education Canada Inc. mmm...an expenditure mmm... a revenue What is the relationship between the sales and collection cycle and the acquisition and payment cycle? They are different perspectives of the same transaction.

9. 16 - 9 Copyright  2003 Pearson Education Canada Inc. What is the sequence of business functions that occurs in the acquisition and payment cycle?

10. 16 - 10 Copyright  2003 Pearson Education Canada Inc. 1. An employee recognizes a need for a purchase; com- pletes a requisition and sends it to purchasing. PURCHASING DEPARTMENT Ace Company PURCHASE REQUISITION The engineering dept. needs 200 yellow #2 pencils. authorized employee

11. 16 - 11 Copyright  2003 Pearson Education Canada Inc. 2. Purchasing shops for the ap- propriate quality at the best price, then prepares a pur- chase order. PURCHASING DEPARTMENT Ace Company PURCHASE ORDER To: Big Pencil Co. Please ship 200 yellow #2 pencils by 6/2/04. Price.04/each purchasing agent BIG Pencil Co.

12. 16 - 12 Copyright  2003 Pearson Education Canada Inc. 3. When goods arrive from the vendor, the receiving dept. inspects, counts, and pre- pares a receiving report. RECEIVING DEPARTMENT Ace Company RECEIVING REPORT Received one case (count 200) yellow #2 pencils on 6/1/04 Condition: OK receiving employee BIG Pencil Co. BIG Pencil Co.

13. 16 - 13 Copyright  2003 Pearson Education Canada Inc. 4. When the vendor’s invoice arrives, accounts pay- able enters the amount in the acquisitions journal and the a/p master file. Accounts Payable DEPARTMENT Big Pencil Co. INVOICE Thanks for buy- ing 200 yellow #2 pencils. Please pay $8 by 6/15/04 BIG Pencil Co.

14. 16 - 14 Copyright  2003 Pearson Education Canada Inc. 4. When the vendor’s invoice arrives, accounts pay- able enters the amount in the acquisitions journal and the a/p master file. Accounts Payable DEPARTMENT acquisitions journal description _ $$ _ June 1, 2004 Pencils - Big Pencil Co. 8.00 a/p master file vendor _ $$ _ June 1, 2004 Big Pencil Co. 8.00 balance 8.00

15. 16 - 15 Copyright  2003 Pearson Education Canada Inc. 5. Before the due date, a cheque is mailed to the vendor a/p master file vendor _ $$ _ June 1, 19x0 Big Pencil Co. 8 payment-6/12 8 balance 0 Ace Company BIG Pencil Co. Canada 48 Pace Company Big Pencil Co. Ace Company CANADIAN BANK

16. 16 - 16 Copyright  2003 Pearson Education Canada Inc. Canada48 cash payments journal description _ $$ _ June 12, 2004 Big Pencil Co. 8.00 Ace Company Pace Company Big Pencil Co. Ace Company 5. Before the due date, a cheque is mailed to the ven- dor and the payment is recorded in the cash pay- ments journal BIG Pencil Co. CANADIAN BANK

17. 16 - 17 Copyright  2003 Pearson Education Canada Inc. Canada 45 cash payments journal description _ $$ _ June 12, 2004 Big Pencil Co 8.00 Ace Company Pace Company Big Pencil Co. Ace Company 5. Before the due date, a cheque is mailed to the ven- dor and the payment is recorded in the cash pay- ments journal and the a/p master file. a/p master file vendor _ $$ _ June 1, 2004 Big Pencil Co. 8.00 payment-6/12 8.00 balance 0 BIG Pencil Co. CANADIAN BANK

18. 16 - 18 Copyright  2003 Pearson Education Canada Inc. DEBIT MEMO A document indicating a re- duction in the amount owed to a vendor because of re- turned goods or an allow- ance granted.

19. 16 - 19 Copyright  2003 Pearson Education Canada Inc. VOUCHER A document used by organi- zations to establish a formal means of recording and controlling acquisitions.

20. 16 - 20 Copyright  2003 Pearson Education Canada Inc. How does an auditor design tests of controls for the acquisitions and payments cycle?

21. 16 - 21 Copyright  2003 Pearson Education Canada Inc. Understand controls as they relate to acquisi- tions and payments As discussed in chapter 9 How does an auditor design tests of controls for the acquisitions and payments cycle?

22. 16 - 22 Copyright  2003 Pearson Education Canada Inc. Assess the planned con- trol risk related to acqui- sitions and payments Understand controls as they relate to acquisi- tions and payments How does an auditor design tests of controls for the acquisitions and payments cycle?

23. 16 - 23 Copyright  2003 Pearson Education Canada Inc. In assessing control risk, the auditor should consider: Assess the planned con- trol risk related to acqui- sitions and payments Understand controls as they relate to acquisi- tions and payments ?

24. 16 - 24 Copyright  2003 Pearson Education Canada Inc. In assessing control risk, the auditor should consider: - adequate segregation of duties - proper authorization - adequate documents and records - use of prenumbered documents - internal verification procedures Assess the planned con- trol risk related to acqui- sitions and payments Understand controls as they relate to acquisi- tions and payments

25. 16 - 25 Copyright  2003 Pearson Education Canada Inc. Evaluate cost- benefit of test- ing controls Assess the planned con- trol risk related to acqui- sitions and payments Understand controls as they relate to acquisi- tions and payments How does an auditor design tests of controls for the acquisitions and payments cycle?

26. 16 - 26 Copyright  2003 Pearson Education Canada Inc. Will substantive tests be reduced sufficiently to justify the cost of performing tests of controls? Assess the planned con- trol risk related to acqui- sitions and payments Understand controls as they relate to acquisi- tions and payments Evaluate cost- benefit of test- ing controls

27. 16 - 27 Copyright  2003 Pearson Education Canada Inc. Evaluate cost- benefit of test- ing controls Design tests of controls related to acquisitions & payments Assess the planned con- trol risk related to acqui- sitions and payments Understand controls as they relate to acquisi- tions and payments How does an auditor design tests of controls for the acquisitions and payments cycle?

28. 16 - 28 Copyright  2003 Pearson Education Canada Inc. Evaluate cost- benefit of test- ing controls Design tests of controls related to acquisitions & payments Are recorded ac- quisitions for goods and serv- ices received ? Assess the planned con- trol risk related to acqui- sitions and payments In designing audit tests for acquisi- tions and pay- ments, the auditor should consider: Understand controls as they relate to acquisi- tions and payments

29. 16 - 29 Copyright  2003 Pearson Education Canada Inc. Evaluate cost- benefit of test- ing controls Design tests of controls related to acquisitions & payments Assess the planned con- trol risk related to acqui- sitions and payments In designing audit tests for acquisi- tions and pay- ments, the auditor should consider: Are recorded ac- quisitions consist- ent with the best interests of the company? Understand controls as they relate to acquisi- tions and payments

30. 16 - 30 Copyright  2003 Pearson Education Canada Inc. Evaluate cost- benefit of test- ing controls Design tests of controls related to acquisitions & payments Are all acquisitions recorded ? Assess the planned con- trol risk related to acqui- sitions and payments In designing audit tests for acquisi- tions and pay- ments, the auditor should consider: Understand controls as they relate to acquisi- tions and payments

31. 16 - 31 Copyright  2003 Pearson Education Canada Inc. Evaluate cost- benefit of test- ing controls Design tests of controls related to acquisitions & payments Assess the planned con- trol risk related to acqui- sitions and payments In designing audit tests for acquisi- tions and pay- ments, the auditor should consider: Are acquisitions accurately recorded? Understand controls as they relate to acquisi- tions and payments

32. 16 - 32 Copyright  2003 Pearson Education Canada Inc. Evaluate cost- benefit of test- ing controls Design tests of controls related to acquisitions & payments In designing audit tests for acquisi- tions and pay- ments, the auditor should consider: Assess the planned con- trol risk related to acqui- sitions and payments Are acquisitions correctly classified ? Understand controls as they relate to acquisi- tions and payments

33. 16 - 33 Copyright  2003 Pearson Education Canada Inc. What is the primary audit objective with regard to payables?

34. 16 - 34 Copyright  2003 Pearson Education Canada Inc. What is the primary audit objective with regard to payables? completeness

35. 16 - 35 Copyright  2003 Pearson Education Canada Inc. What audit procedures will address the completeness of payables?

36. 16 - 36 Copyright  2003 Pearson Education Canada Inc. What audit procedures will address the completeness of payables? - enquire of management regarding completeness of payables

37. 16 - 37 Copyright  2003 Pearson Education Canada Inc. What audit procedures will address the completeness of payables? - enquire of management regarding completeness of payables - perform analytical procedures on payables (examples: a/p / current liabilities; a/p / purchases)

38. 16 - 38 Copyright  2003 Pearson Education Canada Inc. liab ility What audit procedures will address the completeness of payables? - enquire of management regarding completeness of payables - perform analytical procedures on payables - perform a search for unrecorded liabilities

39. 16 - 39 Copyright  2003 Pearson Education Canada Inc. Search for Unrecorded Liabilities how?

40. 16 - 40 Copyright  2003 Pearson Education Canada Inc. Search for Unrecorded Liabilities - examine the unpaid vendors’ invoice file after the balance sheet date. Examine those invoices and trace them to related receiving reports. Determine whether the transactions are recorded in the appropriate period. January

41. 16 - 41 Copyright  2003 Pearson Education Canada Inc. Search for Unrecorded Liabilities - examine vendors’ invoices/statements that were recorded in the last few days of the year and the first few days of the subsequent year. Trace these invoices to the related receiving reports. Determine whether the transaction are recorded in the appropriate period. December January

42. 16 - 42 Copyright  2003 Pearson Education Canada Inc. Search for Unrecorded Liabilities - examine cash disbursements for several days subsequent to year-end to determine if the related liability was recorded at year- end. Trace these cash disbursements to receiving reports. January

43. 16 - 43 Copyright  2003 Pearson Education Canada Inc. Search for Unrecorded Liabilities December January - examine receiving reports for several days before and after year-end and trace to vendors’ invoices. Determine when title passed, and trace to the a/p master file.

44. 16 - 44 Copyright  2003 Pearson Education Canada Inc. Search for Unrecorded Liabilities - consider: unpaid taxes existing contracts minutes of board meetings legal and other professional invoices cutoff tests for reciprocal accounts (inventory and capital assets)

45. 16 - 45 Copyright  2003 Pearson Education Canada Inc. Search for Unrecorded Liabilities During the search, auditors will be watchful for related party transactions.

46. 16 - 46 Copyright  2003 Pearson Education Canada Inc. What audit procedures will address the accuracy of payables?

47. 16 - 47 Copyright  2003 Pearson Education Canada Inc. What audit procedures will address the accuracy of payables? - recalculate year-end accruals (interest, wages, CPP, employment insurance, vacation benefits, warranties) - recalculate amortization of bond premiums and discounts - confirm a sample of a/p balances

48. 16 - 48 Copyright  2003 Pearson Education Canada Inc. When is confirmation of payables appropriate?

49. 16 - 49 Copyright  2003 Pearson Education Canada Inc. When is confirmation of payables appropriate? - client has poor internal controls - client’s vendors do not send month- end statements - client is having financial problems (existing a/p may be understated) - client has “problem” vendors that frequently dispute the client debt - client has “critical” vendors upon which the client’s production depends

50. 16 - 50 Copyright  2003 Pearson Education Canada Inc. What are less expensive alternatives to confirmations if the auditor is concerned about the existence of a/p?

51. 16 - 51 Copyright  2003 Pearson Education Canada Inc. What are less expensive alternatives to confirmations if the auditor is concerned about the existence of a/p? - trace year-end vendor a/p balances to evidence of subsequent payment (cash disbursements, cancelled cheques) - trace year-end vendor a/p balances to vendors statements/invoices

52. 16 - 52 Copyright  2003 Pearson Education Canada Inc. a/p audit exercises The auditor suspects that unauthorized purchases have occurred.

53. 16 - 53 Copyright  2003 Pearson Education Canada Inc. a/p audit exercises The auditor suspects that unauthorized purchases have occurred. Trace a sample of cancelled cheques to purchase orders, receiving reports, and requisitions.

54. 16 - 54 Copyright  2003 Pearson Education Canada Inc. a/p audit exercises The auditor suspects unrecorded liabilities of related parties.

55. 16 - 55 Copyright  2003 Pearson Education Canada Inc. a/p audit exercises The auditor suspects unrecorded liabilities of related parties. - examine all receiving reports for several days before and after year-end for names of related parties. If any are discovered, trace to a/p master file. - examine cash disbursements for the first several days after year-end for names of related parties. If any are discovered, trace to a/p master file.

56. 16 - 56 Copyright  2003 Pearson Education Canada Inc. SALES INVOICE 4527 Date: Big Pencil Co. Customer: 834 Reynolds Rd. Winnipeg, MB R2V 4E3 Sales Representative: Quantity Description Price total invoice amount Est. shipment date: Terms of sale (including discounts and freight costs): Carrier: Credit authorization: The auditor suspects double pay- ment of some vendor invoices. a/p audit exercises Ace Company 235Ace Company 236 Ace Company CANADIAN BANK

57. 16 - 57 Copyright  2003 Pearson Education Canada Inc. The auditor suspects double payment of some vendor invoices. Scan cash disbursements for vendors that have received multiple pay- ments for the same amount. Trace these to purchase orders and receiving reports. SALES INVOICE 4527 Date: Big Pencil Co. Customer: 834 Reynolds Rd. Winnipeg, MB R2V 4E3 Sales Representative: Quantity Description Price total invoice amount Est. shipment date: Terms of sale (including discounts and freight costs): Carrier: Credit authorization: Ace Company 235 Ace Company Ace Company 236 CANADIAN BANK

58. 16 - 58 Copyright  2003 Pearson Education Canada Inc. SALES INVOICE 4527 Date: Big Pencil Co. Customer: 834 Reynolds Rd. Winnipeg, MB R2V 4E3 Sales Representative: Quantity Description Price total invoice amount Est. shipment date: Terms of sale (including discounts and freight costs): Carrier: Credit authorization: Ace Company The auditor suspects double payment of some vendor invoices. Additionally, look for payment indication on the vendor invoices. Ace Company 235Ace Company 236 PAID 3/29 ch #235 CANADIAN BANK