chapter 20 – completing the tests in the acquisition and payment cycle: verification...

©2010 Prentice Hall Business Publishing, ©2010 Prentice Hall Business Publishing, Auditing 13/e,Auditing 13/e, Arens//Elder/Beasley Arens//Elder/Beasley 19 - 1

Completing the Tests in the Acquisition Completing the Tests in the Acquisition and Payment Cycle: Verification of and Payment Cycle: Verification of

Selected AccountsSelected Accounts

Chapter 19Chapter 19

©2010 Prentice Hall Business Publishing, ©2010 Prentice Hall Business Publishing, Auditing 13/e,Auditing 13/e, Arens//Elder/Beasley Arens//Elder/Beasley 19 - 19 - 22

Learning Objective 1Learning Objective 1

Recognize the many accountsRecognize the many accountsin the acquisition andin the acquisition andpayment cycle.payment cycle.


Accounts Associated with the Accounts Associated with the Acquisition and Payment CycleAcquisition and Payment Cycle

Cash Inventory Supplies Property, plant, and equipment Patents, trademarks, and copyrights Prepaid rent Prepaid taxes Prepaid insurance

Assets:



Cost of goods sold Rent expense Property taxes Income tax expense Insurance expense Professional fees Retirement benefits Utilities

Expenses:



Accounts payable Rent payable Accrued professional fees Accrued property taxes Other accrued expenses Income taxes payable

Liabilities:


Identify client businessrisks affectingother accounts

Methodology for Designing Methodology for Designing Tests of Details of BalancesTests of Details of Balances

Set tolerable misstatementand assess inherent

risk for accounts

Assess control risk foraccounts

Phase I

Phase I

Phase I



Design and performtests of controls and

substantive testsof transactions

for the acquisitionand payment cycle

Phase II


Timing

Items to select

Sample size

Audit procedures


Design and performanalytical procedures

for the acquisitionand payment cycle

Design tests of detailsof account balances

to satisfybalance-relatedaudit objectives

Phase III

Phase III



Design and perform audit tests of Design and perform audit tests of property, plant, and equipmentproperty, plant, and equipmentand related accounts.and related accounts.


Classifications of Property, Plant, Classifications of Property, Plant, and Equipment Accountsand Equipment Accounts

Land and land improvements Buildings and building improvements Manufacturing equipment Furniture and fixtures Autos and trucks Leasehold improvements Construction-in-process for property,

plant, and equipment


Manufacturing EquipmentManufacturing Equipmentand Related Accountsand Related Accounts

Manufacturing Equipment

AccumulatedDepreciated

Beginningbalance

Beginningbalance

DepreciationExpense

Gain or Losson Disposals

Current perioddepreciationEnding balance

DisposalsDisposals

AcquisitionsEndingbalance


Auditing Manufacturing Equipment Auditing Manufacturing Equipment and Related Accountsand Related Accounts

Perform analytical procedures

Current year acquisitions Current year disposals Ending balance in the asset account Depreciation expense Ending balance in accumulated depreciation

Plus verify:


Analytical Procedures for Analytical Procedures for Manufacturing EquipmentManufacturing Equipment

Compare accumulateddepreciation divided by grossmanufacturing equipment costwith previous years

Misstatement inaccumulated depreciation

Analytical procedure

Compare depreciation expensedivided by gross manufacturingequipment cost with previousyears

Misstatement indepreciation expense andaccumulated depreciation

Possible misstatement


Analytical Procedures for Analytical Procedures for Manufacturing EquipmentManufacturing Equipment


Compare monthly or annualrepairs and maintenance,supplies expense, small toolsexpense, and similar accountswith previous years

Expensing accounts thatshould be capitalized


Compare gross manufacturingcost divided by some measureof production with previousyears

Idle equipment orequipment that wasdisposed of but notwritten off


Verify Current Year AcquisitionsVerify Current Year Acquisitions

The correct recording of current year additionsis important because of the long-term effectthe assets have on the financial statements.

Because of the importance of current periodacquisitions, seven of the eight balance-relatedaudit objectives are used as a frame of reference.


Balance-Related Audit Balance-Related Audit ObjectivesObjectives

Current acquisitions agreewith the master file.

Detail tie-in:

1. Foot the acquisition schedule.2. Trace the individual acquisitions to the master file.3. Trace the total to the general ledger.



Current acquisitions as listed exist.Existence:

1. Examine vendors’ invoices andreceiving reports

2. Physically examine assets.



Existing acquisitions are recorded.Completeness:

1. Examine vendors’ invoices of closelyrelated accounts to uncover items thatshould be manufacturing equipment.

2. Review lease and rental agreements.



Current year acquisitions as listedare accurate.

Accuracy:

1. Examine vendors’ invoices.



Current year acquisitions as listedare correctly classified.

Classification:

1. Examine vendors’ invoices inmanufacturing equipment account.

2. Examine vendors’ invoices of closelyrelated accounts.

3. Examine rent and lease expensefor capitalizable leases.


Current year acquisitions are recordedin the correct period.


Cutoff:

1. Review transactions near the balancesheet date for correct period.


The client has rights to current yearacquisitions.

Major Balance-RelatedMajor Balance-RelatedAudit ObjectivesAudit Objectives

Rights:

1. Examine vendors’ invoices.


Verify Current Year DisposalsVerify Current Year Disposals

Review whether newly acquired assetsreplace existing assets

Analyze gains and losses on disposal

Review documents for indications ofdeletion of equipment

Make inquiries about the possibility ofthe disposal of assets


Verify Ending BalanceVerify Ending Balanceof Asset Accountsof Asset Accounts

2. All equipment owned is recorded.

1. All recorded equipment physicallyexists on the balance sheet date.


Verify Depreciation ExpenseVerify Depreciation Expense

The most important objective is accuracy.

Consistent depreciation policy

Correct calculations


Verify Ending Balance in Verify Ending Balance in Accumulated DepreciationAccumulated Depreciation

1. Accumulated depreciation as statedin the property master file agreeswith the general ledger.

2. Accumulated depreciation in themaster file is accurate.



Design and perform audit testsDesign and perform audit testsof prepaid expenses.of prepaid expenses.


Audit of Prepaid ExpensesAudit of Prepaid Expenses

Prepaid rent Organization costs Prepaid taxes Patents Prepaid insurance Trademarks Deferred charges Copyrights


Prepaid Insurance and Related Prepaid Insurance and Related AccountsAccounts

Prepaid InsuranceBeginning balance

Acquisitions

Ending balance

Current period insurance expense

Insurance Expense


Internal ControlsInternal Controls

Acquisition and recording of insurance

Insurance register

Insurance expense


Audit TestsAudit Tests

Compare total prepaid insurance andinsurance expense with previous years

Compute the ratio of prepaid insuranceto insurance expense and compareit with previous years

Compare the individual insurance policycoverage on the schedule of insuranceobtained with the preceding year’s schedule


Audit TestsAudit Tests

Compare the computed prepaid insurancebalance for the current year on a policy-by-policy basis with that of the preceding year.

Review the insurance coverage listed onthe prepaid insurance schedule with anappropriate client official or insurance broker.


Balance-related Audit Balance-related Audit ObjectivesObjectives

Existence and completeness:Insurance policies in the prepaid insuranceschedule exist and existing policies are listed.

Rights:The client has rights to all insurance policiesin the prepaid insurance schedule.


Balance-related Audit Balance-related Audit ObjectivesObjectives

Accuracy and detail tie-in:Prepaid amounts are accurate and the totalis correctly added and agrees with thegeneral ledger.

Classification:Insurance expense is properly classified.

Cutoff:Insurance transactions are recorded in theproper period.



Design and perform audit testsDesign and perform audit testsof accrued liabilities.of accrued liabilities.


Audit of Accrued LiabilitiesAudit of Accrued Liabilities

Accrued payroll Accrued payroll taxes Accrued officers’ bonuses Accrued commissions Accrued professional fees Accrued rent Accrued interest


Accrued Property TaxesAccrued Property Taxesand Related Accountsand Related Accounts

Accrued Property TaxesBeginning balance

Current period property tax expense

Ending balance

Property Tax ExpensePayments(property taxes)



Design and perform audit tests ofDesign and perform audit tests ofincome and expense accounts.income and expense accounts.


Approach to Auditing IncomeApproach to Auditing Incomeand Expense Accountsand Expense Accounts Analytical procedures

Tests of controls and substantivetests of transactions

Tests of details of account balances


Analytical Procedures for Income Analytical Procedures for Income and Expense Accountsand Expense Accounts

Compare individual asset andliability balances with previousyears

Overstatement orunderstatement of abalance sheet account thatwill also affect an incomestatement account


Compare individual expenseswith previous years

Overstatement orunderstatement of abalance in an expenseaccount





Compare individual expenseswith budgets

Misstatement of expensesand related balancesheet accounts


Compare gross marginpercentage with previousyears

Misstatement of cost ofgoods sold and inventory

Compare inventory turnoverratio with previous years

Misstatement of cost ofgoods sold and inventory




Compare prepaid insuranceexpense with previous years

Misstatement of insuranceexpense and prepaidinsurance


Compare commission expensedivided by sales withprevious years

Misstatement ofcommission expense andaccrued commissions

Compare individualmanufacturing expensesdivided by total manufacturingexpenses with previous years

Misstatement of individualmanufacturing expensesand related balancesheet accounts


Tests of Controls and SubstantiveTests of Controls and SubstantiveTest of TransactionsTest of Transactions

Both tests of controls and substantivetests of transactions have the effect ofsimultaneously verifying balance sheet and income statement accounts.


Tests of Details of Account Tests of Details of Account Balances – Expense AnalysisBalances – Expense Analysis

Expense account analysis:

Repairs and maintenance

Rent and lease

Legal expense


Tests of Details of Account Tests of Details of Account Balances – AllocationBalances – Allocation

Several expense accounts result from the allocationof accounting data rather than discrete transactions.

These include depreciation, depletion, and theamortization of copyrights and catalog cost.

The allocation of manufacturing overhead betweeninventory and cost of goods sold is an example ofa different type of allocation that affects expenses.

©2010 Prentice Hall Business Publishing, ©2010 Prentice Hall Business Publishing, Auditing 13/e,Auditing 13/e, Arens//Elder/Beasley Arens//Elder/Beasley 19 - 46

End of Chapter 19End of Chapter 19

chapter 20 – completing the tests in the acquisition and payment cycle: verification...

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