AP-13:    Audit Program for the Income StatementCompany            Balance Sheet Date       

 

          The company has the following general ledger account groupings classified in the following captions in the income statement.

 GeneralLedger Number1  

AccountDescription   Income Statement Component  

             

             

             

             

             

             

             

             

             

             

             

             

Audit Program for the Income Statement

Company             Balance Sheet Date       

Audit Objectives

Audit Procedures for Consideration

N/APerformed by

Workpaper Index

  FINANCIAL STATEMENT ASSERTIONS

E/O     Existence or occurrence.               V/A          Valuation or allocation.C          Completeness.                              P/D          Presentation

   

and disclosure.R/O     Rights and obligations.

 AUDIT OBJECTIVES

   

      A.     Revenue is for valid transactions in the ordinary course of business that are recorded correctly as to account, amount, and period, and uncollectible amounts, returns, or allowances are adequately provided for (assertions E/O, R/O, V/A, and P/D).

   

      B.     Recorded revenue includes billings at the correct amount for products shipped or services provided (assertion C).

   

      C.     Costs of products or services are valid, complete, and recorded correctly as to account, amount, and period (assertions E/O, C, R/O, V/A, and P/D).

   

      D.     Expenses are valid, complete, and recorded correctly as to account, amount, and period (assertions E/O, C, R/O, V/A, and P/D).

   

      E.     Revenues, cost of products or services, expenses, and extraordinary, unusual, or infrequent items are properly described and disclosed in the income statement (assertion P/D).

   

  IDENTIFICATION CODES

The letters preceding each of the above audit objectives, i.e., A, B, etc., serve as identification codes. These codes are presented in the left column labeled “Audit Objectives” when a procedure accomplishes an objective. If the alpha code appears in a bracket, e.g., [A], [B], etc., the audit procedure only secondarily accomplishes the objective. If an asterisk precedes a procedure, it is a preliminary step or a follow up step that does not accomplish an objective.

   

 BASIC AUDIT PROCEDURES

   

*      1.     Inquire of management or review documentation obtained previously (see CX-3) on the nature of the client’s business and industry and the factors that affect operations. Inquire about any major changes during the period. Obtain an understanding of the client’s revenue recognition policies and determine that they are in

   

accordance with GAAP. Inquire of management about, and evaluate, changes in revenue recognition policies and significant, unusual, and complex transactions occurring at or near year end.

  Practical Considerations:

¯     It is important that the auditor understand the business and how it makes money. Discussion with the owner/manager may provide insight on how management views its approach to making a bottom-line profit. The auditor’s understanding normally should include:

¯¯     The types of products and services sold.

¯¯     Whether the client’s business is seasonal or cyclical.

   

  ¯¯     The client’s and the industry’s marketing and sales policies.

¯¯     Whether the client’s compensation arrangements depend on recording of revenue (for example, whether sales commissions are based on invoiced or collected amounts, frequency for paying sales commissions, etc.).

¯¯     Client policies related to sales returns, discounts, extension of credit, delivery, and payment terms.

¯¯     What personnel are involved in processes affecting revenues (such as order entry, extension of credit, and shipping).

   

 ¯     The auditor’s understanding of the company’s business related to revenue recognition should include understanding how controls over revenue transactions may be overridden and what the client’s motivation to misstate revenue may be.

   

 ¯     If the client has entered into unusual or complex sales transactions (for example, bill and hold transactions or other unusual contractual terms), the auditor should consider performing additional procedures.

   

 ¯     Other conditions that may indicate improper revenue recognition practices and require special consideration in a small business engagement include:

   

 ¯¯     Sales recorded for products shipped in advance of the scheduled shipping date without the customer’s consent.

   

 ¯¯     Invoicing of products prior to shipment (for example, billing for items still being manufactured).

   

 ¯¯     Sales recorded for shipments made after year end.

   

 ¯¯     Transactions with related parties.

   

 ¯¯     Shipments made on canceled or duplicate orders.

   

 ¯¯     Shipments made to a warehouse or another location without instructions from the customer.

   

 ¯¯     Barter transactions.

   

 ¯¯     Significant sales or volume of sales near year end.

   

 ¯¯     Longer-than-expected payment terms or installment receivables.

   

 ¯¯     Altered dates on contracts or shipping documents.

   

 ¯¯     Unusual volume of sales to distributors or resellers.

   

 ¯¯     Sales recorded based on letters of intent or purchase orders.

   

 ¯¯     Shipments to freight companies pending return to the seller because the customer has canceled or requires modifications prior to delivery.

   

 ¯¯     Shipments of only a portion of the product when the portion not delivered is a significant part of the product.

   

 ¯¯     A change in the company’s revenue recognition policy.

   

 ¯¯     The existence of side agreements.

   

           The additional procedures section of this audit program includes common procedures for auditing revenue recognition in small businesses.

   

 ¯     Information obtained from discussions regarding the business and economic effects on the business of current situations can also be helpful as the auditor evaluates the reasonableness of revenues and expenses and explanations of differences.

   

 ¯     The auditor should determine at the start of the audit any major changes that have been made in the production and sales areas that would affect the normal relationships. For example, significant changes in employee benefits might affect salaries and employee compensation and have an effect on the procedures the auditor will perform for the payroll area.

   

 ¯     The AICPA Audit Guide, Auditing Revenue in Certain Industries, provides general accounting and auditing guidance related to revenue recognition as well as specific guidance on auditing revenue transactions in the computer software and high-technology manufacturing industries. The Audit Guide can be ordered by calling (888) 777-7077 or online at www.cpa2biz.com.

   

A, B      2.     Perform an analytical test of sales by obtaining for the workpapers a schedule summarizing sales by major product line and geographic location for the year compared to prior year amounts, budgets, or other expectations. Analyze this schedule and critically evaluate and document explanations for significant differences that are unusual in amount or nature.

   

  Practical Considerations:

¯     Analytical tests involve comparisons of recorded amounts to the auditor’s expectations. Examples of sources of information for the auditor to consider in developing such expectations may include:

   

  ¯¯     Prior year financial information.

¯¯     Budgets or amounts extrapolated from interim figures.

¯¯     Relationships of financial amounts within the period.

¯¯     Industry statistics, such as gross margins.

¯¯     Relationships of financial amounts to nonfinancial data.

   

 ¯     If desired, this schedule can be combined with the schedule described in basic procedure 3.

   

 ¯     The auditor should attempt to design efficient predictive tests of sales or revenue to reduce or avoid substantive tests of details of sales transactions. This can be a very effective method of auditing sales, and its feasibility should be assessed at the start of the audit. In designing predictive tests, it is necessary to determine the key factor associated with the sales or revenue during the period. (This information can be obtained from prior period workpapers or discussions with the client.)

   

 ¯     The auditor should be aware that the predictive tests performed or other analytical procedures applied will be valid only if the supporting data or information used for the test is relevant and reliable. Caution should be exercised so that the auditor has confidence about the validity of this information. The supporting information is more apt to be reliable if it is obtained from an independent source, e.g., a trade association or an operating department not responsible for the amount being audited; if it was developed from a variety of sources and under a reliable system with adequate controls; or if it was subjected to audit testing in the current or prior year.

   

 ¯     This step is extremely important because sales or revenue is usually a key measure for evaluating the reasonableness of cost of sales and major expenses.

   

 ¯     If the auditor identifies significant differences between the predictive test and the recorded amount, the business reasons for the differences should be identified. It is important that the explanations be based on sound business reasons corroborated with other evidential matter, and not merely on management’s rationalizations. If an explanation for the difference cannot be obtained, the auditor should perform sufficient other audit procedures to determine whether the difference should be considered a likely misstatement.

   

 ¯     When an analytical procedure is used as the principal substantive test of a significant financial statement assertion, SAS No. 56, Analytical Procedures, as amended by SAS No. 96, Audit Documentation, requires the auditor to document (1) the expectation and the factors considered in its development (unless readily determinable from the work performed), (2) the results of the comparison between the expectation and recorded amounts, and (3) any additional procedures performed in response to significant

   

unexpected differences and the results of those procedures. SAS No. 96 is effective for audits of financial statements for periods beginning on or after May 15, 2002, with early application permitted.

 ¯     Auditors should carefully evaluate changes in revenue recognition policies and significant, unusual, and complex transactions occurring at or near year end. The additional procedures section of this program includes common procedures for auditing revenue recognition in small businesses.

   

C      3.     Obtain or prepare for the workpapers an analysis of sales, cost of sales, and gross profit summarized by product line, department, location, or other meaningful division, in total and by meaningful interim period (monthly, quarterly, etc.). Perform the following procedures:

   

      a.     Test the analysis by selecting a few categories and compare the amounts shown with those recorded in the sales journal. Trace the sales journal balances to the general ledger.

   

      b.     Review the analysis and identify any unusual trends or variations within the period or compared to the prior period.

   

      c.     Determine the average or standard mark-up percentage for goods sold, if such percentage exists. Calculate the gross profit using the normal percentage (with an allowance for spoilage or waste) and compare it to the actual percentage realized during the period. Document the comparison.

   

      d.     Obtain and document sound business reasons for large or unusual differences in interim or total amounts included in the analysis. Relate sales by product line, if available, to inventory categories for possible overstock or obsolete inventory items.

   

  Practical Considerations:

¯     The auditor must be careful to avoid a mechanical approach to explaining significant differences noted in this analysis. Only if meaningful explanations are obtained can this step be effective. Explanations should be evaluated in the light of audit evidence obtained in other related audit areas.

   

 ¯     Comparison of such information can also be made to industry statistics in some cases.

   

 ¯     Other tests of cost of sales can be avoided or reduced if the significant differences identified on this analysis are adequately explained and corroborated.

   

 ¯     Step 3c can be used only if the company uses a standard percentage of mark-up for goods sold. (See the inventory program for other tests.) The effectiveness of this test depends on whether the company has few or many products with different mark-up percentages. If there is no effective way to predict the gross profit percentage, comparisons should be made to the results of prior periods to obtain evidence about the reasonableness of the gross profit percentage realized.

   

 ¯     When an analytical procedure is used as the principal substantive test of a significant financial statement assertion, SAS No. 56, Analytical Procedures, as amended by SAS No. 96, Audit Documentation, requires the auditor to document (1) the expectation and the factors considered in its development (unless readily determinable from the work performed), (2) the results of the comparison between the expectation and recorded amounts, and (3) any additional procedures performed in response to significant unexpected differences and the results of those procedures. SAS No. 96 is effective for audits of financial statements for periods beginning on or after May 15, 2002, with early application permitted.

   

D      4.     For specific selected expense accounts that are sensitive or subject to unusual risk, select specific individual large disbursements and examine the documents supporting such transactions. This should be considered for repairs and maintenance, legal fees, consulting fees, and similar accounts, and any other expenses that should be vouched because the auditor, or his firm, has tax return preparation responsibility.

   

      a.     Explain the nature and reason for any expense amounts that lack the proper support.

   

      b.     Determine that the amounts tested are properly classified and recorded in the correct general ledger account.

   

      c.     Document the items tested.

   

  Practical Considerations:

¯     CX-7a, “Planning Worksheet To Determine Extent of Substantive Tests,” may be used to determine the extent of detail testing needed.

   

 ¯     This procedure is done for legal fees to identify legal counsel engaged by the company. The legal counsel used for litigation should be identified for purposes of obtaining lawyers’ letters. (See Chapter 14.) Space should be provided on the schedule to explain the services described in each bill examined.

   

 ¯     This procedure is done for consulting fees to identify any payments related to environmental remediation liabilities. AP-1 provides specific inquiries for identifying an increased risk for liabilities of this sort.

   

 ¯     Basic procedure 4b is essential in industries that have accounting methods especially sensitive to proper classification of expense amounts, e.g., construction contracting, or where expenses are presented in great detail in the income statement. In some cases, applying this procedure may involve audit sampling. Section 405 explains an efficient sampling approach for tests of classifications of transactions, and CX-7c presents a “Sampling Worksheet for Testing Account Coding and Classifications.” See also the additional procedures section of this audit program.

   

 ¯     A common form of fraudulent financial reporting in small businesses is to charge fixed asset additions to repairs and maintenance or some other expense account to reduce income taxes. If the auditor has identified risk factors that indicate management may be inclined to understate income for tax reasons through inappropriate means, consideration should be given to testing material repair and maintenance transactions to determine if amounts should be capitalized as fixed assets.

   

 ¯     See additional procedures for expanded testing of expenses if the auditor decides to modify his or her procedures in response to identified fraud risk factors.

   

 ¯     SAS No. 96, Audit Documentation, requires documentation of

   

substantive tests of details involving inspection of documents to include identification of the items tested. The authors believe items tested can be identified by listing the items; by including a detail schedule in the workpapers, such as an expense account detail, on which the items are identified; or by documenting in the workpapers the source and selection criteria. For example:

 ¯¯     For tests of significant items, documentation may describe the auditor’s scope and the source of the items (for example, all disbursements greater than $5,000 from the 20X2 repairs and maintenance expense detail).

   

 ¯¯     For haphazard or random samples, documentation should include the identifying characteristics of the items (for example, the specific invoice numbers, check numbers, etc.).

   

 ¯¯     For systematic samples, documentation may indicate the source, starting point, and sampling interval (for example, a selection of checks from the cash disbursements journal for the period 1/1/X2 to 12/31/X2, starting with check number 2150 and selecting every 100th check thereafter).

   

      SAS No. 96 is effective for audits of financial statements for periods beginning on or after May 15, 2002, with early application permitted.

   

 ¯     Expense vouching undertaken in connection with tax return preparation should be coordinated with the tax staff.

   

D      5.     Review and document the large or unusual differences in specific expense accounts compared to the prior period actual amounts and, if available, the current period budget. From discussions with management and analysis of evidence from other audit areas, obtain and document explanations for the variations noted.

   

  Practical Considerations:

¯     It is important to obtain sound business reasons for significant differences, (not just excuses) and to corroborate those explanations.

   

 ¯     The explanations should be consistent with changes noted and

   

tested in balance sheet areas.

 ¯     When an analytical procedure is used as the principal substantive test of a significant financial statement assertion, SAS No. 56, Analytical Procedures, as amended by SAS No. 96, Audit Documentation, requires the auditor to document (1) the expectation and the factors considered in its development (unless readily determinable from the work performed), (2) the results of the comparison between the expectation and recorded amounts, and (3) any additional procedures performed in response to significant unexpected differences and the results of those procedures. SAS No. 96 is effective for audits of financial statements for periods beginning on or after May 15, 2002, with early application permitted.

   

D      6.     Review the payroll procedures with management and determine the key factors related to payroll (if it is significant). Determine the total employees by type or class from a review of the payroll records. Also identify the normal rate of pay for employees at various levels. Design and document a predictive test of the total compensation expense recorded and compare the results with the salary expense in the general ledger. Document explanations for significant or unusual differences.

   

  Practical Considerations:

¯     This analytical procedure may need to be applied to individual payroll areas if there are different factors in each one.

   

 ¯     Some auditors also prepare or review a reconciliation of payroll expense per the general ledger to payroll as reported on payroll tax returns.

   

 ¯     The effectiveness of a predictive test naturally depends on the reliability of the data used. See the fourth practical consideration following basic procedure 2.

   

 ¯     In most small business audits, payroll can be effectively tested by a well-designed analytic test. In some engagements, however, payroll transactions may need to be tested, and audit sampling may be necessary. Section 405 explains an efficient sampling approach. See also the additional procedures section of this audit program.

   

 ¯     The auditor may find it necessary to test a few individual compensation amounts to supporting documents to obtain satisfaction about the validity of the data used.

   

 ¯     When an analytical procedure is used as the principal substantive test of a significant financial statement assertion, SAS No. 56, Analytical Procedures, as amended by SAS No. 96, Audit Documentation, requires the auditor to document (1) the expectation and the factors considered in its development (unless readily determinable from the work performed), (2) the results of the comparison between the expectation and recorded amounts, and (3) any additional procedures performed in response to significant unexpected differences and the results of those procedures. SAS No. 96 is effective for audits of financial statements for periods beginning on or after May 15, 2002, with early application permitted.

   

E      7.     Scan the accounting records for large and unusual transactions and review evidence obtained in other audit areas to determine any matters that should be disclosed in the financial statements. Cross-reference work done in balance sheet areas to the related revenue and expense accounts. It is important to relate information from balance sheet audit areas to disclosure requirements for the income statement. Typical areas of concern are property and equipment, inventory, liabilities (leases), and income taxes.

   

  Practical Considerations:

¯     When scanning for large and unusual transactions, auditors should pay particular attention to nonstandard journal entries, especially those made at or near the end of the reporting period.

   

 ¯     Auditors should consider the business purpose of significant or unusual transactions.

   

 ¯     The additional general procedures at AP-1 provide guidance when the auditor considers it necessary to perform additional procedures to review for unusual items.

   

*      8.     Consider the need to apply one or more additional procedures. The decision to apply additional procedures should be based on a consideration of whether information obtained or misstatements detected by performing substantive tests or from

   

other sources during the audit alter your judgment about the need to obtain a further understanding of control activities, the assessed level of risk of material misstatements (whether caused by error or fraud), and on an evaluation of whether the basic procedures have been sufficient to achieve the audit objectives. Attach audit program sheets to document additional procedures.

  Practical Considerations:

¯     Certain common additional procedures relating to the following topics are illustrated following this program:

¯¯     Completeness of sales.

¯¯     Revenue recognition.

¯¯     Sales cutoff.

¯¯     Bill and hold transactions.

¯¯     Sales returns.

¯¯     Cash disbursements.

¯¯     Additional procedures in response to fraud risk assessment related to accounts payable and cash disbursements.

¯¯     Payroll transactions.

¯¯     Additional procedures in response to fraud risk assessment related to payroll expense.

   

 ¯     Practitioners may refer to PPC’s Guide to Fraud Investigations for more extensive fraud detection procedures if it is suspected that the financial statements are materially misstated due to fraud.

   

*      9.     Consider whether procedures performed are adequate to respond to identified fraud risk factors. If fraud risk factors or other conditions are identified that require an additional audit response, consider those risk factors or conditions and the auditor’s response in connection with the performance of Step 11 AP-1b.

   

  Practical Consideration:

¯     Specific responses to identified fraud risk factors are addressed

   

in individual audit programs. In connection with evaluation and other completion procedures in AP-1b, the auditor considers the need to perform additional procedures based on the results of procedures performed in the individual audit programs and the cumulative knowledge gained from performing those procedures.

*      10.     Consider whether the results of audit procedures indicate reportable conditions in internal control and, if so, add to the memo of points for the communication of reportable conditions. (See section 1504 for examples of reportable conditions, and see CX-18 for a worksheet that can be used to document the points as they are encountered during the audit.)

   

  CONCLUSION

We have performed procedures sufficient to achieve the audit objectives for the income statement, and the results of these procedures are adequately documented in the accompanying workpapers. (If you are unable to conclude on any objective, prepare a memo documenting your reason.)

     

     

     

     

 

   

Additional Audit Procedures for the Income Statement

Instructions:    Additional procedures will occasionally be necessary on some small business engagements. The following listing, although not all-inclusive, represents common additional procedures and their related objectives.

     

 Completeness of Sales

   

B Perform a test of sales completeness by applying the following    

procedures: 

     a.     Select a sample of original shipping documents. Document the items selected.

   

      b.     Trace the information on the documents to the related sales invoices. Determine that details are appropriately reflected on the invoice.

   

      c.     Determine that the total amount of sales reported on the invoice is properly computed and approved.

   

      d.     Trace the amounts on sales invoices to proper recording in the sales journal or general ledger, as appropriate.

   

      e.     Determine that proper accounting treatment has been applied to these sales transactions.

   

 Practical Considerations:

   

 ¯     The test is designed to test the completeness of sales transactions.

   

 ¯     See section 405 for a discussion of an efficient sampling approach for this type of test.

   

 ¯     The auditor should not provide detailed documentation regarding the tracing of the invoice amount to the general ledger if complicated tie-ins are necessary to determine that amounts are properly recorded. This documentation is unnecessary and inefficient.

   

     

 Revenue Recognition

   

A      a.     If the company had sales for which the earnings process was not complete, consider whether revenue was appropriately deferred.

   

 Practical Considerations:

   

  ¯     Generally, the earnings process is not complete unless all of the    

following criteria are met:

¯¯     evidence of the final understanding between the parties to the exchange transaction exists,

¯¯     delivery has occurred or services have been performed,

¯¯     the sales price is fixed or determinable, and

¯¯     collectibility is reasonably assured. 

¯     Some situations when the earnings process would not be considered complete include sale and delivery of a piece of machinery that has not been installed when installation is the seller’s responsibility; sale of a piece of machinery that as part of the original contract requires customization; sale but not delivery of goods sold FOB receiving point; or sale of goods subject to customer cancellation or termination clauses.

   

      b.     If the auditor, based on his or her understanding of the client’s business or consideration of fraud risk factors, decides to modify procedures related to revenue recognition, consider confirming additional information with customers in conjunction with accounts receivable confirmation procedures (see AP-3).

   

  Practical Considerations:

¯     Examples of information to confirm include relevant contract terms such as acceptance criteria, delivery and payment terms, the absence of future or continuing client obligations, the right to return product, guaranteed resale amounts, and cancellation and refund provisions. The auditor should also consider confirming that the client and customer do not have any side agreements in addition to stated contract terms.

   

  ¯     Practitioners may refer to PPC’s Guide to Fraud Investigations for more extensive fraud detection procedures if it is suspected that the financial statements are materially misstated due to fraud.

¯     See also the additional procedures related to bill and hold transactions.

   

     

 Sales Cutoff

   

A If the auditor, based on his or her understanding of the client’s business or consideration of fraud risk factors, decides to perform additional procedures related to sales cutoff, perform the following procedures:

   

      a.     Analyze the ratio of sales in the last month or week of the period to total sales for the period.

   

      b.     Compare revenues recorded daily for the periods shortly before and after year end for unusual fluctuations.

   

      c.     Compare sales credits for returns subsequent to year end with monthly sales credits during the year to determine if there is an unusual increase that may indicate contingent sales or special concessions to customers.

   

      d.     Compare monthly cash receipts during the year to cash receipts subsequent to year end to determine if receipts subsequent to year end are unusually low compared to the collection history during the months under audit.

   

      e.     Vouch large or unusual sales made at year end to original source documents.

   

  Practical Considerations:

¯     These procedures are generally designed to detect an overstatement of revenue.

   

 ¯     The following factors may influence the scope of sales cutoff testing:

   

 ¯¯     Large quantities of inventory awaiting shipment noted by the auditor during the physical inventory observation.

   

 ¯¯     Significant quantities of in-transit inventory at year end.

   

 ¯¯     Unusual increase in sales the last few days of the year followed by an unusual decrease in sales subsequent to year end.

   

 ¯¯     Numerous shipping locations.

   

 ¯¯     Transactions in which revenue is recognized before title passes to the buyer.

   

     

 Bill and Hold Transactions

   

A If the company is holding inventory that has been billed to customers, perform the following procedures:

   

      a.     Determine that the transaction meets the following criteria:

   

      (1)     Risks of ownership have passed to the buyer.

   

      (2)     The customer has a fixed commitment to purchase the goods.

   

      (3)     The customer (not the client) requested the transaction be on a bill and hold basis and the customer has a substantial business purpose for doing so.

   

      (4)     There is a fixed schedule for delivering the goods and the delivery date is reasonable.

   

      (5)     The client has no specific performance requirements such that the earnings process is not complete.

   

      (6)     The goods are separated from the client’s regular inventory and cannot be used to fill other orders.

   

      (7)     The inventory is complete and ready for shipment.

   

      b.     Confirm the details of bill and hold transactions with the customer. (See CL-41, “Confirmation Request for a Bill and Hold Transaction.”)

   

      c.     Retain copies of all confirmations in the workpapers.

   

 Practical Consideration:

   

 ¯     When determining whether bill and hold transactions meet the criteria in Step a, consideration should be given to the following factors:

   

 ¯¯     The date by which the client expects payment and whether normal billing and credit terms have been modified for this customer.

   

 ¯¯     The client’s past experience with bill and hold transactions (for example, whether the client has a history of reversing bill and hold transactions in subsequent periods).

   

 ¯¯     Whether the customer has an expected risk of loss in the event of a decline in the inventory’s market value.

   

 ¯¯     Whether the client’s custodial risks are insurable and insured.

   

 ¯¯     Whether the related receivable from the customer should be discounted in accordance with APB Opinion No. 21.

   

 ¯¯     Whether extended procedures are necessary to ensure that there are no exceptions to the customer’s commitment to accept and pay for the inventory (i.e., the business reasons for the bill and hold transaction have not resulted in a contingency to the customer’s commitment).

   

     

 Sales Returns

   

A If the entity sells a product and a right of return exists either contractually or from existing practice, determine whether revenue has been recognized in accordance with SFAS No. 48 and the allowance for future returns is reasonable.

   

     

 Cash Disbursements

   

C, D Determine whether the company records expense amounts using a voucher system or as they are actually paid. Based on the method used by the company, select a sample of vouchers or cash disbursements incurred during the year charged to expense categories. Document the items selected and perform the following procedures:

   

      a.     Compare the amount, payee or vendor, date, and description to the vendor’s invoice and canceled checks, if appropriate.

   

      b.     Determine that the transaction was properly authorized.

   

      c.     Determine that the expense is an appropriate transaction for the company.

   

      d.     Trace the expense amount to determine that it was properly classified in the general ledger.

   

      e.     Summarize exceptions and determine the results of the overall test.

   

  Practical Considerations:

¯     The test is not normally essential and may be omitted if adequate evidence is obtained from examination of individual expense amounts and key accounts combined with analytical procedures. It may be necessary for some small business clients, e.g., a contractor or manufacturer where bids or prices are based on costs of production (i.e., to test valuation), or where expenses are presented in great detail in the income statement (i.e., to test classification). If the auditor, based on his or her consideration of fraud risk factors, concludes that procedures should be modified related to accounts payable disbursements, the auditor should consider performing the next additional procedure listed in this program instead of this procedure.

   

 ¯     CX-7a, “Planning Worksheet To Determine Extent of Substantive Tests,” can be used to determine the extent of detail testing needed.

   

 ¯     If audit sampling is deemed necessary, refer to section 405 for a discussion of an efficient sampling approach to this type of test.

   

 ¯     The auditor should not examine the nature of discounts paid and similar items of minimal importance simply because they are associated with the disbursement or expense voucher. The key elements related to the transaction should be tested only for propriety and proper accounting treatment.

   

     

 Additional Procedures in Response to Fraud Risk Assessment Related to Accounts Payable and Cash Disbursements

   

C, D If the auditor, based on his or her consideration of fraud risk factors, decides to modify procedures related to accounts payable or disbursements, the following procedures should be considered:

   

      a.     Review the vendor list for any unusual patterns, such as names that may be similar but not identical to names of approved vendors and vendors that have multiple addresses. Review vendor files for unusual items, such as vendor invoices that appear different from the norm, consecutive vendor invoice numbers, preprinted and not customized forms, different delivery addresses, different telephone numbers, and other unusual patterns.

   

      b.     Examine disbursement records for payments of the following types:

   

      (1)     Payments charged to expense accounts in which it is suspected that fraudulent payments are being hidden.

   

      (2)     Payments for services that do not require delivery of goods or significant documentation to obtain payment (for example, payment of sales commissions, consulting fees, repair and maintenance, etc.).

   

      (3)     Voided checks. Cash may be embezzled by charging an expense account, crediting accounts payable, and voiding the check written to pay the payable and removing it from the mail.

   

      (4)     Checks other than payroll checks made out to employees, or checks with a vendor address or phone number that is the same as an employee’s.

   

      (5)     Checks with a vendor name that is similar in sound or appearance to a legitimate vendor’s name.

   

      (6)     Payments for amounts just below the threshold for approval.

   

      c.     Examine original canceled checks (both front and back) for the following:

   

      (1)     The identity of the endorsees. Compare to the payee, date, and amount and review the signature.

   

      (2)     Discrepancies between related documents, such as the

   

amount or name on the check differing from the invoice or discrepancies between documents, the checks, and the cash disbursements journal.

      (3)     A second endorsement, for example, a check payable to a business that is first endorsed by the business name and then by an individual or then endorsed over to the issuer of the check. (These are typical indications of fictitious payables.)

   

      (4)     Any check that was cashed rather than deposited.

   

      (5)     Checks exhibiting any other unusual patterns.

   

 Practical Considerations:

   

  ¯     Practitioners may refer to PPC’s Guide to Fraud Investigations for more extensive fraud detection procedures if it is suspected the financial statements are materially misstated due to fraud.

¯     Particular attention should be paid to disbursements occurring near year end. The clever fraud perpetrator will concentrate his or her misappropriation at the end of the year to minimize the amount of time the theft remains on the books.

   

     

 Payroll Transactions

   

D Select a sample of payroll transactions during the year. Document the items selected and perform the following procedures:

   

      a.     Trace the gross pay to proper authorization.

   

      b.     Recalculate the gross pay if it is determined on an hourly basis.

   

      c.     Trace the hours used to compute gross pay to time cards or timesheets, as appropriate.

   

      d.     Determine that the gross pay amount is appropriate and properly classified in the general ledger.

   

  Practical Consideration:

¯     This procedure is often inefficient and should be avoided

   

unless effective analytical procedures cannot be designed. If it must be performed, see section   405 for an explanation of an efficient sampling approach.

     

 Additional Procedures in Response to Fraud Risk Assessment Related to Payroll Expense

   

D      a.     If the auditor, based on his or her consideration of fraud risk factors, decides to modify procedures related to payroll expense, the extent of the preceding procedures may be expanded. In addition, the following procedures may also be performed:

   

      (1)     Obtain a list of current and former employees from personnel files and compare to the payroll list suspected of including fictitious employees. Note any discrepancies.

   

      (2)     Look for employees who have no tax withholding forms, insurance elections, or other employee benefit elections or deduction forms.

   

      (3)     Determine whether any social security numbers may be fictitious or are the same for two different people.

   

      (4)     Determine whether two different employees have the same address.

   

      (5)     For suspected fictitious employees, examine canceled payroll checks. If the canceled checks are missing, request copies from the bank.

   

 Practical Consideration:

   

 ¯     If the auditor suspects fictitious employees, the most effective procedures are paymaster procedures (that is, distribute the checks or observe their distribution). However, because the auditor normally performs field work at a date subsequent to year end for small business clients, it may not be practicable to perform paymaster procedures. Practitioners may refer to PPC’s Guide to Fraud Investigations for more extensive fraud detection procedures if it is suspected that the financial statements are materially misstated due to fraud.

   

      b.     If the auditor, based on his or her consideration of fraud risk factors, decides to modify procedures related to payroll expense, the payroll register and payroll check register may be reviewed for:

   

      (1)     Duplicate names or addresses.

   

      (2)     Names of former employees.

   

      (3)     Math errors.

   

      (4)     Unusual pay rates or number of hours worked.

   

      (5)     Factors that might indicate ghost employees.

   

 Practical Consideration:

   

 ¯     If the auditor suspects fictitious employees, the most effective procedures are paymaster procedures (that is, distribute the checks or observe their distribution). However, because the auditor normally performs field work at a date subsequent to year end for small business clients, it may not be practicable to perform paymaster procedures. Practitioners may refer to PPC’s Guide to Fraud Investigations for more extensive fraud detection procedures if it is suspected that the financial statements are materially misstated due to fraud.

   

     

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