The classes of transactions in the acquisition and payment cycle include acquisition of:

In-class Quizzes3)For effective internal control purposes, the accounts payable department generally should:C

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4) The analytical procedure that requires the auditor to review the list of accounts payable forunusual or non-vendor payables would have the best chance of discovering which possibleerror?A

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5) Comparing expenses to prior years' expenses is an effective analytical procedure foraccounts payable because expenses from year to year are:A) relatively stable.B) variable.C) erratic.D) dynamic.Answer:A

6) The purpose of the audit procedure 'examine underlying documentation for subsequentcash payments' is to:A

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Presentation on theme: "Audit of the Acquisition and Payment Cycle: Tests of Controls, Substantive Tests of Transactions, and Accounts Payable. Chapter 18."— Presentation transcript:

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

2 Learning Objective 1 Identify the accounts and the classes of transactions in the acquisition and payment cycle.

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 The objective in the audit of the acquisition and payment cycle is to evaluate whether the accounts affected by the acquisition of goods and services and the cash disbursements for those acquisitions are fairly presented in accordance with accounting standards.

4 Accounts in the Acquisition and Payment Cycle
Ten typical accounts involved in the acquisition and payment cycle are shown above.

5 Learning Objective 2 Describe the business functions and the related documents and records in the acquisition and payment cycle.

6 Classes of Transactions and Accounts
Acquisitions: Inventory Property, plant, and equipment Prepaid expenses Leasehold improvements Accounts payable Manufacturing expenses Selling and administrative expenses The request for goods and services by the client‘s personnel is the starting point for the cycle. Other business functions involved include the processing of purchase orders, the receiving of goods and services ordered and the recognition of the liability for the purchase.

7 Classes of Transactions and Accounts
Cash disbursements: Cash in bank (from cash disbursements) Accounts payable Purchase discounts Payments to vendors reflect an increasing use of electronic payment forms such as wire transfers and/or ACH payments.

8 Business Functions in the Cycle
Processing Purchase Orders Receiving Goods and Services Recognizing the Liability Processing & Recording cash disbursements

9 Related Documents and Reports
Processing purchase orders: Purchase requisition Purchase order Receiving goods and services: Receiving report A purchase requisition is used to request goods and services. A purchase order is a document used to order goods and services from vendors. A receiving report is a paper or electronic document prepared at the time goods are received.

10 Related Documents and Reports
Recognizing the liability: Vendor’s invoice Debit memo Voucher Acquisitions transaction file The vendor invoice is a document received from the vendor and shows the amount owed for an acquisition. A debit memo is also a document received from the vendor and indicates a reduction in the amount owed to a vendor because of returned goods or an allowance granted. A voucher is commonly used by organizations to establish a formal means of recording and controlling acquisitions enabling each acquisition to be sequentially numbered. The acquisitions transaction file is a computer generated file that includes all acquisition transactions processed by the accounting system for a period, and it contains all information entered into the system and includes information for each transaction.

11 Related Documents and Reports
Recognizing the liability: Acquisitions journal or listing Accounts payable master file Accounts payable trial balance Vendor statement The acquisitions journal is often referred to as the purchases journal. It is generated from the acquisitions transaction file and includes the vendor name, date, amount and account classification. The accounts payable master file records acquisitions, cash disbursements and returns for each vendor. The accounts payable trial balance includes the amount owed to each vendor or for each invoice or voucher at a point in time. A vendor’s statement is a document prepared monthly by the vendor and indicates the beginning balance, acquisitions, returns and payments to the vendor, and the ending balance.

12 Related Documents and Reports
Processing and recording cash disbursements: Check Cash disbursements transaction file Cash disbursements journal or listing Most companies use computer-prepared checks based on information included in the acquisition transaction file when good s and services are received. The cash disbursements transaction file is a computer generated file that includes all cash disbursement transactions processed by the accounting systems for a period. The cash disbursement journal is a list from the cash disbursements file that includes all transactions for any time period.

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.

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 Tests of controls and substantive tests of transactions for the acquisition and payment cycle are divided into tests of acquisitions and tests of payments. The auditor gains an understanding of internal control for the cycle as part of performing risk assessment procedures by studying the client’s flowcharts reviewing control questionnaires and performing walkthrough tests for transactions. Assessing control risk involves reviewing proper authorization of purchases, separation of duties, and timely recording and independent review of transactions and authorization of payments to vendors. When the auditor intends to rely on controls to support a preliminary control risk assessment below maximum, the auditor performs tests of controls to obtain evidence that controls are operating effectively. As the effectiveness of controls improves and is supported by additional tests of controls the auditor is able to reduce substantive testing. The audit evidence for an audit engagement will vary with the internal control and other circumstances. Significant audit efficiencies can be achieved on many audits when controls are operating effectively. Design tests of controls and substantive tests of transactions for acquisitions and cash disbursements to meet transaction-related audit objectives Audit procedures Sample size Items to select Timing

15 Understand Internal Control
Study the client’s flowcharts Review internal control questionnaires Perform walk-through tests

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

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

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) Adequate controls over acquisitions prevent the unintentional recording of acquisitions that did not occur and are also likely to prevent the client from including fraudulent transactions that partly benefit management. Failure to record the acquisition of good and services received understates accounts payable and may result in an overstatement of net income and equity. The extent of tests of details of many balance sheet and expense accounts depends on the auditor’s evaluation of the effectiveness of the internal controls over the accuracy of recorded acquisition transactions.

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) Tests of details of certain individual accounts can be reduced if the auditor believes that internal controls are adequate to provide reasonable assurance of correct classification in the acquisitions journal.

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.

21 Important Differences Compared to other Cycles
Acquisitions and Payments Cycle transactions: Larger number of transactions Significant judgment Wide range of dollar amount Transactions in this cycle more commonly require significant judgment. The dollar amounts of individual transactions in the cycle cover a wide range as a result auditors commonly segregate large and unusual items and test them on a 100% basis.

22 Learning Objective 4 Describe the methodology for designing tests of details of balances for accounts payable using the audit risk model.

23 Methodology for Designing Tests of Balances for Accounts Payable
Identify client business risks affecting accounts payable Phase I Set tolerable misstatement and assess inherent risk for accounts payable Phase I Efforts to streamline the purchasing of goods and services include greater emphasis on just-in-time inventories and use of technology and e-commerce to transact business are changing all aspects of the acquisition and payment cycle for many companies. Like accounts receivable, a large number of transactions can affect accounts payable. For this reason, auditors typically set the tolerable misstatement for accounts payable relatively high. Assess control risk for the acquisition and payment cycle Phase I

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 In order to assess control risk, auditors must have a thorough understanding of how these controls relate to accounts payable. After assessing control risk, the auditor designs and performs tests of controls and substantive tests of transactions for acquisitions and cash disbursements.

25 Methodology for Designing Tests of Balances for Accounts Payable
Design and perform analytical procedures for accounts payable balance Phase III Design tests of details of accounts payable balance to satisfy balance- related audit objectives Audit procedures Phase III The use of analytical procedures is as important in the acquisition and payment cycle as it is in every other cycle. Sample size Items to select Timing

26 Learning Objective 5 Design and perform analytical procedures for accounts payable.

27 Analytical Procedures for the Acquisition and Payment Cycle
Possible misstatement Compare acquisition- related expense account balances with prior years Misstatement of accounts payable and expenses Review list of accounts payable for unusual, nonvendor, and interest- bearing payables Classification misstatement for nontrade liabilities

28 Analytical Procedures for the Acquisition and Payment Cycle
Possible misstatement Compare individual accounts payable with previous years 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

29 Learning Objective 6 Design and perform tests of details of balances for accounts payable, including out-of-period liability tests.

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 Because of the emphasis on understatements in liability accounts, out-of-period liability tests are important for accounts payable. The extent of tests to uncover unrecorded accounts payable depend heavily on assess control risk and the materiality of the potential balance in the account.

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 Sending confirmations to active vendors for which a balance has not been included in the accounts payable list is a useful means of searching for omitted amounts. This type of confirmation is commonly called a zero balance confirmation.

32 Cutoff Tests Relationship of cutoff to physical
observation of inventory Inventory in transit FOB destination FOB origin Accounts payable cutoff tests are done to determine whether transactions recorded a few days before and after the balance sheet date are included in the correct period.

33 Learning Objective 7 Distinguish the reliability of vendors’ invoices, vendors’ statements, and confirmations of accounts payable as audit evidence.

34 Reliability of Evidence
Distinction between vendors’ invoices and vendors’ statements Difference between vendors’ statements and confirmations Auditors should distinguish between vendors’ invoices and vendors’ statements in verifying the amount due to a vendor. Auditors get highly reliable evidence about individual transactions when they examine vendor’s invoices and related supporting documents such as receiving reports and purchase orders. The most important distinction between a vendor’s statement and a confirmation of accounts payable is the source of information. A response to a confirmation is normally sent directly to the CPA’s office by the vendor.

35 Accounts Payable Confirmation

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.

37 Types of Audit Tests for the Acquisition and Payment Cycle
Cash in Bank Accounts Payable Acquisition Expenses Payments Expenses Audited by TOC, STOT, and AP Audited by TOC, STOT, and AP Ending balance Ending balance Audited by AP and TDB Audited by AP and TDB TOC + STOT + AP + TDB = Sufficient appropriate evidence per GAAS

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

39 End of Chapter 18

What are the classes of transactions in the acquisition and payment cycles?

What are the five major phases of the acquisition and payment process?

Which of the following accounts is not included in the acquisitions class of transactions?

Which of the following functions does not relate to the acquisitions and payment cycle?