copyright © 2003 mcgraw-hill ryerson limited chapte r 1010 1 acquisition and expenditure cycle...

Copyright © 2003 McGraw-Hill Ryerson Limited

Chapter10

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Acquisition and Acquisition and Expenditure CycleExpenditure Cycle

Including Audit of Accounts Payable and Inventory Existence

Copyright © 2003 McGraw-Hill Ryerson Limited 2Chapter 10

Acquisition and Expenditure Acquisition and Expenditure Cycle: Typical ActivitiesCycle: 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.

Acquisition and Acquisition and Expenditure CycleExpenditure Cycle

Start Here

Request for purchases

Enter accounts payable

Cash disbursement

Receive vendor invoice

Receive goods and services

3Chapter 10 Copyright © 2003 McGraw-Hill Ryerson Limited


Acquisition Cycle:Acquisition Cycle:Typical ActivitiesTypical 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


Audit Evidence in Audit Evidence in Management ReportsManagement 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.


Audit evidence in management Audit evidence in management reportsreports

– 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


Control Risk AssessmentControl 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)


General Control ConsiderationsGeneral 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


Detail Test of Controls Audit Detail Test of Controls Audit ProceduresProcedures

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.


Detail Test of Controls for Detail Test of Controls for Inventory RecordsInventory 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.


Summary: Summary: Control Risk AssessmentControl 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.


Audit Cases: Audit Cases: Substantive Audit ProceduresSubstantive 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.


Substantive ProceduresSubstantive 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 Objective Control Test of Controls

Audit of Balance

Audit Approach


Audit Casettes: Audit Casettes: Substantive Audit ProceduresSubstantive 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.



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.



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.


Special Note: Special Note: The Completeness AssertionThe 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.


Search for Unrecorded LiabilitiesSearch 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.


Special Note:Special Note:Physical Inventory ObservationPhysical 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.


Auditor’s Observation of InventoryAuditor’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.


Special Note:Special Note:Physical Inventory ObservationPhysical 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.


Special Note: Special Note: Physical Inventory ObservationPhysical 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.


Special Note: Special Note: Physical Inventory ObservationPhysical 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.


Appendix 10AAppendix 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


Appendix 10BAppendix 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


EDI Systems and Accounts EDI Systems and Accounts Payable Audits - Appendix 10CPayable Audits - Appendix 10C

Partnership with suppliers

Elimination of statements of account

Billing of accounts payable

Audit approach

Confirmation

copyright © 2003 mcgraw-hill ryerson limited chapte r 1010 1 acquisition and expenditure cycle...

Documents

audit of accounts payable

acquisition cycle

procedures slide

purchase goods

various accounts

expenditure cycle

inventory existence

manufacturing slide