Audit of the Acquisition and Payment Cycle: Tests of Controls, Substantive Tests of Transactions, and Accounts Payable. Chapter 18

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1 Audit of the Acquisition and Payment Cycle: Tests of Controls, Substantive Tests of Transactions, and Accounts Payable. Chapter Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 5-5

2 Learning Objective 1 Identify the accounts and the classes of transactions in the acquisition and payment cycle Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 18-2

3 Transactions in the Acquisition and Payment Cycle Three classes of transactions: 1. Acquisitions of goods and services 2. Cash disbursements 3. Purchase returns and allowances and purchase discounts 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 18-3

4 Accounts in the Acquisition and Payment Cycle 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 18-4

5 Learning Objective 2 Describe the business functions and the related documents and records in the acquisition and payment cycle Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 18-5

6 Classes of Transactions and Accounts Acquisitions: Inventory Property, plant, and equipment Prepaid expenses Leasehold improvements Accounts payable Manufacturing expenses Selling and administrative expenses 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 18-6

7 Classes of Transactions and Accounts Cash disbursements: Cash in bank (from cash disbursements) Accounts payable Purchase discounts 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 18-7

8 Business Functions in the Cycle Processing Purchase Orders Receiving Goods and Services Recognizing the Liability Processing & Recording cash disbursements 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 18-8

9 Related Documents and Reports Processing purchase orders: Purchase requisition Purchase order Receiving goods and services: Receiving report 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 18-9

10 Related Documents and Reports Recognizing the liability: Vendor s invoice Debit memo Voucher Acquisitions transaction file 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 18-10

11 Related Documents and Reports Recognizing the liability: Acquisitions journal or listing Accounts payable master file Accounts payable trial balance Vendor statement 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 18-11

12 Related Documents and Reports Processing and recording cash disbursements: Check Cash disbursements transaction file Cash disbursements journal or listing 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 18-12

13 Learning Objective 3 Understand internal control, and design and perform tests of controls and substantive tests of transactions for the acquisition and payment cycle Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 18-13

Methodology for Designing Controls and Substantive Tests Understand internal control acquisitions and cash disbursements Assess planned control risk acquisitions and cash disbursements Determine

14 Methodology for Designing Controls and Substantive Tests Understand internal control acquisitions and cash disbursements Assess planned control risk acquisitions and cash disbursements Determine extent of testing controls Design tests of controls and Audit procedures substantive tests of transactions Sample size for acquisitions and cash disbursements to meet Items to select transaction-related audit objectives Timing 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 18-14

15 Understand Internal Control Study the client s flowcharts Review internal control questionnaires Perform walk-through tests 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 18-15

16 Assess Planned Control Risk Authorization of purchases Separation of asset custody from other functions Timely recording and independent review of transactions Authorization of payments 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 18-16

17 Determine Extent of Testing of Controls The auditor identifies the key internal controls and weaknesses and assesses control risk The auditor performs tests of controls to obtain evidence that controls are operating effectively 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 18-17

18 Controls and Substantive Tests of Transactions for Acquisitions Recorded acquisitions are for goods and services received (occurrence) Existing acquisitions are recorded (completeness) Acquisitions are accurately recorded (accuracy) 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 18-18

19 Controls and Substantive Tests of Transactions for Acquisitions Acquisitions are correctly included in the master files (posting and summarization) Acquisitions are correctly classified (classification) Acquisitions are recorded on the correct dates (timing) 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 18-19

20 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 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 18-20

21 Important Differences Compared to other Cycles Acquisitions and Payments Cycle transactions: Larger number of transactions Significant judgment Wide range of dollar amount 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 18-21

22 Learning Objective 4 Describe the methodology for designing tests of details of balances for accounts payable using the audit risk model Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 18-22

23 Methodology for Designing Tests of Balances for Accounts Payable Identify client business risks affecting accounts payable Set tolerable misstatement and assess inherent risk for accounts payable Assess control risk for the acquisition and payment cycle Phase I Phase I Phase I 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 18-23

24 Methodology for Designing Tests of Balances for Accounts Payable Design and perform tests of controls and substantive tests of transactions for the acquisition and payment cycle Phase II 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 18-24

25 Methodology for Designing Tests of Balances for Accounts Payable Design and perform analytical procedures for accounts payable balance Design tests of details of accounts payable balance to satisfy balancerelated audit objectives Phase III Audit procedures Sample size Items to select Timing Phase III 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 18-25

26 Learning Objective 5 Design and perform analytical procedures for accounts payable Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 18-26

27 Analytical Procedures for the Acquisition and Payment Cycle Analytical procedure Compare acquisitionrelated expense account balances with prior years Review list of accounts payable for unusual, nonvendor, and interestbearing payables Possible misstatement Misstatement of accounts payable and expenses Classification misstatement for nontrade liabilities 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 18-27

28 Analytical Procedures for the Acquisition and Payment Cycle Analytical procedure Compare individual accounts payable with previous years Possible misstatement 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 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 18-28

29 Learning Objective 6 Design and perform tests of details of balances for accounts payable, including out-of-period liability tests Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 18-29

Out-of-Period Liability Tests Examine underlying documentation for subsequent cash disbursements Examine underlying documentation for bills not paid several weeks after

30 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 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 18-30

31 Out-of-Period Liability Tests Trace vendors statements that show a balance due to the accounts payable trial balance Send confirmations to vendors with whom the client does business 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 18-31

32 Cutoff Tests Relationship of cutoff to physical observation of inventory Inventory in transit FOB destination FOB origin 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 18-32

33 Learning Objective 7 Distinguish the reliability of vendors invoices, vendors statements, and confirmations of accounts payable as audit evidence Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 18-33

34 Reliability of Evidence Distinction between vendors invoices and vendors statements Difference between vendors statements and confirmations 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 18-34

35 Accounts Payable Confirmation 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 18-35

36 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 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 18-36

37 Types of Audit Tests for the Acquisition and Payment Cycle Cash in Bank Accounts Payable Acquisition Expenses Payments Audited by TOC, STOT, and AP Expenses Audited by TOC, STOT, and AP Ending balance Audited by AP and TDB Ending balance Audited by AP and TDB TOC + STOT + AP + TDB = Sufficient appropriate evidence per GAAS 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 18-37

38 Types of Audit Tests for the Acquisition and Payment Cycle Accounts Payable Acquisition Assets Acquisition of assets Audited by TOC, STOT, and AP Ending balance Audited by AP and TDB TOC + STOT + AP + TDB = Sufficient appropriate evidence per GAAS 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 18-38

39 End of Chapter Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 5-5

Chapter 21 Audit of the Payroll and Personnel Cycle. Copyright 2014 Pearson Education

Chapter 21 Audit of the Payroll and Personnel Cycle Identify the accounts and transactions in the payroll and personnel cycle. Describe the business functions and the related documents and records in the