copyright © 2007 pearson education canada 1 chapter 18: completing the tests in the acquisition and...

Copyright © 2007 Pearson Education Canada

1

Chapter 18: Completing the Tests in the Acquisition and Payment Cycle:

Verification of Selected Accounts


18-2

Chapter 18 objectives

Identify the process to be followed in the audit of manufacturing asset acquisitions

Discuss the difficulties in auditing intangible assets

Explain the importance of and the audit processes for prepaid expenses

List typical accrued liabilities Explain how property taxes are audited Discuss the role of analytical review in the audit

of income and expense accounts


18-3

Methodology for designing tests of details for the audit of manufacturing asset

acquisitions Set materiality and assess audit risk and inherent risk

for manufacturing asset acquisitions Assess control risk for manufacturing asset acquisitions Design and perform tests of controls for manufacturing

asset acquisitions Design and perform analytical procedures for

manufacturing asset acquisitions Design tests of details for manufacturing asset

acquisitions (audit procedures, sample size, items to select, timing)


18-4

The nature of manufacturing assets

Manufacturing assets are capital assets that normally have expected lives of more than one year, are used in the business, and are not acquired for resale

The assets are used as a part of the operation of the client’s business

Operational use and normal life of greater than one year distinguishes these assets from inventory, prepaid expenses, or investments


18-5

Tracking manufacturing assets

Large organizations will normally have a capital asset master file, where each asset is described and tracked. This master file is also the source of information for calculating and recording amortization.

Small organizations may have a manual listing of such assets, or may simply track a balance forward from year to year


18-6

Differences between manufacturing assets and current asset accounts

There are usually fewer current period acquisitions

The amount of any given acquisition may be material

The equipment is likely to be kept and maintained in the accounting records for several years


18-7

Audit emphasis for manufacturing asset additions

Emphasis is on auditing current period acquisitions

These are also traced to the capital cost allowance section of the tax working papers

Amortization and accumulated amortization accounts are also verified

Other accounts that are verified in a similar manner include: patents, copyrights, catalogue costs


18-8

Categories of audit tests conducted for manufacturing equipment and related

accounts

Analytical procedures Verification of:

– Current-year acquisitions– Current-year disposals– The ending balance in the asset account– Amortization expense– The ending balance in accumulated

amortization


18-9

Analytical procedures for manufacturing equipment

Analytical procedure Potential misstatement detected

Compare amortization expense divided by gross manufacturing equipment cost with previous years

Misstatement in amortization expense and accumulated amortization

Compare accumulated amortization divided by gross manufacturing equipment cost with previous years

Misstatement in accumulated amortization


18-10

Analytical procedures for manufacturing equipment (cont’d)

Analytical procedure Potential misstatement detected

Compare monthly or annual repairs and maintenance, supplies expense, small tools expense, and similar accounts with previous years

Expensing amounts that should be capital items

Compare gross manufacturing cost divided by some measure of production with previous years

Idle equipment or equipment that has been disposed of but not written off


18-11

Verification of current year acquisitions

Important because of the long-term effect that assets have on financial statements

Starting point is normally a continuity schedule prepared by the client (showing additions, disposals and amortization)

An important technique is examination of supporting documentation


18-12

Verification of current year disposals

The most important internal control over disposals is the existence of a formal method to inform management and record the results of sale, trade-in, abandonment or theft

The most important audit procedures are those for searching for unrecorded disposals


18-13

Verification of asset balances

The nature of the internal controls over existing assets determines whether it is necessary to verify manufacturing equipment acquired in prior years

Relevant controls include a periodic count and a formal method of informing the accounting department of disposals


18-14

Verification of amortization expense

Recorded amounts are internal allocations rather than exchange transactions with outside parties

Primary audit objectives involve determining whether the client is:– Following a consistent amortization policy

from period to period and whether– Making calculations accurately


18-15

Verification of accumulated amortization

Debits are normally tested as a part of the audit or disposals of assets

Credits are verified as part of the audit of amortization expense


18-16

Practice problem 18-18 (p. 544)

Discuss your responsibilities for auditing opening and closing asset balances

Prepare an audit program for the audit of asset balances


18-17

Auditing intangible assets

Intangible assets include goodwill, copyrights, trademarks, deferred expenses, capitalized charges for brand names, and others

May be extremely difficult to value as they do not have a ready value, and can rapidly drop in value

Audit expertise in the area is required, or the auditor may need to engage an independent expert to value material intangible assets


18-18


Evaluate an audit approach for verifying interest and legal expense

Suggest a better approach


18-19

Audit of prepaid expenses

Prepaid expenses arise from the concept of matching expenses with revenues

These types of accounts are found in almost every audit

Prepaid insurance is used as an example because it is a common expense and the auditor is responsible for reviewing the adequacy of insurance coverage


18-20

Audit of prepaid insurance expense

The auditor considers internal controls in the following categories. Controls over:– The acquisition and recording of insurance,– Insurance coverage and– Charge-off of insurance expense

The organization may have an insurance register or spreadsheet, or it may simply have a file of insurance policies in force


18-21

Prepaid insurance expense: audit tests

Analytical procedures Verification that charges to the insurance

expense arose from credits to prepaid insurance (based upon a schedule of insurance charges and prepaid expenses prepared by the client)


18-22

Typical accrued liabilities

Payroll-related accruals (bonuses, commissions, income taxes, interest, payroll, payroll taxes and pension costs)

Professional fees Rent Warranty costs


18-23

Auditing accrued property taxes

Payments of property taxes have been partially tested by means of the tests of the acquisition and payment cycle

Emphasis in the tests is normally on the ending property tax liability and payments


18-24

Audit of operations

The purpose of audit of operations is to determine whether the income and expense accounts are fairly presented

The auditor needs to be aware of the importance of the income statement to users

Matching and consistent application of accounting principles are evaulated


18-25

Approach to auditing operations

This part of the audit is closely linked to the audit of all of the other transaction cycles

All tests conducted during the audit need to be considered to evaluate their impact upon the audit of operations

Analytical review is an important audit step for the audit of operations, and is often conducted using audit software or spreadsheet software


18-26

Typical analytical procedures for operations

Analytical procedure Possible misstatement

Compare individual expenses with previous years

Overstatement or understatement of a balance in an expense account

Compare individual asset and liability balances with previous years

Overstatement or understatement of a balance sheet account that would also affect an income statement account


18-27

Typical analytical procedures for operations (cont’d)


Compare individual expenses with budgets

Misstatement of expenses and related balance sheet accounts

Compare gross margin percentage with previous years

Misstatement of cost of goods sold and inventory


18-28



Compare inventory turnover ratio with previous years

Misstatement of cost of goods sold and inventory

Compare prepaid insurance and insurance expense with previous years

Misstatement of insurance expense and prepaid insurance


18-29



Compare commission expense divided by sales with previous years

Misstatement of commission expense and accrued commissions

Compare individual manufacturing expenses divided by total manufacturing expenses with previous years

Misstatement of individual manufacturing expenses and related balance sheet accounts


18-30


Review the results of analytical review

Are the explanations reasonable?

copyright © 2007 pearson education canada 1 chapter 18: completing the tests in the acquisition and...

Documents

current asset accountsthere

audit risk

capital assets

capital asset master

audit processes

audit of income

resalethe assets

tests of controls