1. Electronic Presentations in Microsoft ® PowerPoint ® Prepared by Brad MacDonald SIAST © 2003 McGraw-Hill Ryerson Limited

2. Copyright © 2003 McGraw-Hill Ryerson Limited Chapte r 1010 2 Acquisition and Expenditure Cycle Including Audit of Accounts Payable and Inventory Existence

3. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 10 3 Learning Objective 1 Describe the acquisition and expenditure cycle, including typical source documents and controls.

4. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 10 4 Acquisition and Expenditure Cycle: Typical Activities Exhibit 10-1 shows the activities and transactions, accounts and records in the acquisition and expenditure cycle. –Purchase goods and services. –Pay the bills.

5. Acquisition and Expenditure Cycle Start Here Request for purchases Enter accounts payable Cash disbursement Receive vendor invoice Receive goods and services 5Chapter 10 Copyright © 2003 McGraw-Hill Ryerson Limited

6. Chapter 10 6 Acquisition Cycle: Typical Activities –Authorization - Purchase requisition, order and payment Assembly of payment voucher, paid stamp Authorized cheque signatories –Custody - Receipt of goods, and supporting documents and records –Recording - Record in accounts payable and cash accounts –Periodic Reconciliation - Periodic comparison of existing assets to recorded amounts in various accounts

7. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 10 7 Audit Evidence in Management Reports Computer processing of acquisition and payment transactions include –Open purchase orders - Contain purchase orders for goods ordered, but not yet received. –Unmatched receiving reports - Reports for goods received for which the vendor invoice has not yet been received or matched. –Unmatched vendor invoices - Invoices received for goods not yet received or matched.

8. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 10 8 Audit evidence in management reports –Accounts payable trial balance - A list of balances owed to specific vendors –Purchases journal - A detailed list of all purchase for the period –Inventory reports (trial balance) - A detailed list of all inventory items –Fixed asset reports - A detailed list of all fixed assets –Cash disbursements report - A detailed list of all cash disbursements

9. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 10 9 Learning Objective 2 Give examples of detail test of controls procedures for auditing the controls over purchase of inventory and services, acquisition of fixed assets, and disbursement of cash.

10. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 10 10 Control Risk Assessment Control risk assessment governs the nature, timing, and extent of substantive audit procedures. –Accounts included in acquisition and expenditure: inventory capital assets amortization expense accumulated amortization accounts and notes payable cash expense categories (administrative, selling, and manufacturing)

11. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 10 11 General Control Considerations Ensure proper segregation of responsibilities for authorization, custody, recording, and reconciliation. –Persons who have custody of assets and cash disbursements authority should not do accounting. Controls should provide evidence for detail control checking activities. –Signatures, initials, physical security, policies and procedures

12. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 10 12 Detail Test of Controls Audit Procedures Tests of controls should address all of the control objectives. –Cut-off is important to valuation of inventory. –Tests include identification of population and expression of the action to be taken. Note dual direction of testing for completeness and validity requires selection of sample from appropriate population. –See Exhibit 10-5.

13. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 10 13 Detail Test of Controls for Inventory Records Auditors need to determine whether they can rely on the accuracy of perpetual records. –Tests over accuracy involve tests of the additions (purchases) and reductions (issues) of the item balances. – A dual direction test of audit samples should be performed.

14. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 10 14 Summary: Control Risk Assessment The purpose of testing controls is to determine nature, extent, and timing of substantive procedures. –Good controls – low control risk Smaller sample sizes, earlier timing for substantive tests. –Poor controls – high control risk Larger samples, more work at year end.

15. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 10 15 Learning Objective 3 Describe some common errors, irregularities, and frauds in the acquisition and expenditure cycle, and design some audit and investigation procedures for detecting them.

16. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 10 16 Audit Cases: Substantive Audit Procedures The audit of account balances consists of procedural efforts to detect errors, irregularities, and frauds that may exist in the balances, thus making them misleading in financial statements.

17. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 10 17 Substantive Procedures Specific examples of test of controls and substantive procedures are in the form of casettes (mini-case studies). –Each casette has the following parts: Method Paper Trail Amount Audit ObjectiveControl Test of Controls Audit of Balance Audit Approach

18. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 10 18 Audit Casettes: Substantive Audit Procedures 10.1 Printing (Copying) Money –Improper expenditures for company services charged to motion picture production costs. 10.2 Real Cash Paid to Phony Doctors –Cash disbursements fraud to determine whether employee medical benefits “existed” in the sense of being valid claims paid to valid doctors.

19. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 10 19 Audit Casettes: Substantive Audit Procedures 10.3 Receiving the Missing Oil –Fuel oil supplies inventory and fuel expenses inflated because of short shipments. 10.4 Go For The Gold –Fixed assets in the form of mining properties were overstated through a series of “flip” transactions involving related parties.

20. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 10 20 Audit Casettes: Substantive Audit Procedures 10.5 Retread Tires –Inventory and income overstated by substitution of retread tires for inventory at new tire prices. 10.6 Amortize “The Drum” Slowly –Net asset values (unamortized cost of films) was overstated by taking too little amortization expense.

21. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 10 21 Learning Objective 4 Explain the importance of the completeness assertion of the audit of accounts payable liabilities, and list some procedures for a “search for unrecorded liabilities.”

22. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 10 22 Special Note: The Completeness Assertion When considering assertions and obtaining evidence about accounts payable and other liabilities, auditors must put emphasis on the completeness and obligations assertions. –Emphasis because companies tend to be less concerned about recording expenses and liabilities. –Auditors cannot rely entirely on the management assertion of completeness.

23. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 10 23 Search for Unrecorded Liabilities The search for unrecorded liabilities is designed to yield audit evidence of liabilities that were not recorded in the reporting period. –Objective is to search all the places where evidence of liabilities might exist. –See list of procedures in text.

24. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 10 24 Learning Objective 5 Identify and describe considerations involved in the audit observation of physical inventory-taking.

25. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 10 25 Special Note: Physical Inventory Observation The auditing procedures for inventory and related sales accounts frequently are extensive in an audit engagement. –A material error or irregularity in inventory has a pervasive effect on the financial statement. –Auditing standards require that the auditor observe the inventory taking and make test counts. They seldom take or count the entire inventory.

26. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 10 26 Auditor’s Observation of Inventory First task is to review client’s inventory- taking instructions. –This is a test of controls. –If count procedures are sound, auditor can rely on count to produce good results. Auditor will also perform test counts. –Testing of counts will be a dual-direction test. –The physical observation procedures are designed to audit for existence, completeness, and valuation.

27. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 10 27 Special Note: Physical Inventory Observation Physical inventory not on year-end date: –The inventory on the count date is reconciled to the year-end inventory and auditing procedures are performed on inventory additions and issues for the intervening period. Cycle inventory counting: –Company does not take a complete count on a single date, but rather in cycles or uses statistical counting plan. Accuracy of perpetual records must be determined.

28. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 10 28 Special Note: Physical Inventory Observation Auditors not present at client’s inventory count: –The auditor must review the client’s plans for the completed count. –Some test counts of current inventory should be made and traced to current records to determine reliability of perpetual records.

29. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 10 29 Special Note: Physical Inventory Observation Inventories located off the client’s premises: –Determine the amount and location of the inventory off the client’s premises. –If amounts are material and controls are not strong, the auditor may wish to visit locations and conduct on-site tests counts. –If amounts are not material and control risk is low, direct confirmation with the custodian may be sufficient competent evidence.

30. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 10 30 Appendix 10A Internal Control Questionnaires: –Purchasing and Accounts Payable –Cash Disbursements Processing –Acquisition and Expenditure Computer Controls –Inventory Transaction Processing –Fixed Asset and Related Transactions Processing –Selected Computer Questionnaire Items: General and Application Controls

31. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 10 31 Appendix 10B Substantive Audit Programs: –Audit Program for Inventory and Cost of Goods Sold –Audit Program for Capital Assets and Related Accounts –Audit Program for Accounts Payable –Audit Program for Prepaid, Deferred, and Accrued Expenses

32. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 10 32 EDI Systems and Accounts Payable Audits - Appendix 10C Partnership with suppliers Elimination of statements of account Billing of accounts payable Audit approach Confirmation