CH 18 Audit of The Acquisition and Payment Cycle PDF
CH 18 Audit of The Acquisition and Payment Cycle PDF
Chapter 18
Audit of The Acquisition and Payment Cycle: Test of Controls,
Substantive Tests of Transactions, and Accounts Payable
The request for goods or services by the client’s personnel is the starting point for the
cycle. Common documents are:
The receipt by the company of goods or services from the vendor is a critical point in the
cycle because it is when most companies first recognize the acquisition and related
liability on their records.
Receiving report is a paper or electronic document prepared at the time goods are
received.
The proper recognition of the liability for the receipt of goods and services requires
prompt and accurate recording. The initial recording affects the financial statements and
the actual cash disbursement.
Vendor’s invoice is a document received from the vendor and shows the amount
owed for an acquisition. It indicates the description and quantity of goods and
services received, price (including freight), cash discount terms, date of the
billing, and total amount.
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.
Voucher is commonly used by organizations to establish a formal means of
recording and controlling acquisitions, primarily by enabling each acquisition
transaction to be sequentially numbered.
Acquisitions Transaction File A computer-generated file that includes all
acquisition transactions processed by the accounting system for a period, such as a
day, week, or month. It contains all information entered into the system and
includes information for each transaction, such as vendor name, date, amount,
account classification or classifications, and description and quantity of goods and
services purchased.
Acquisitions journal or listing, often referred to as the purchases journal, is
generated from the acquisitions transaction file and typically includes the vendor
name, date, amount, and account classification or classifications for each
transaction, such as repair and maintenance, inventory, or utilities. It also
identifies whether the acquisition was for cash or accounts payable.
Accounts payable master file records acquisitions, cash disbursements, and
acquisition returns and allowances transactions for each vendor. The master file is
updated from the acquisition, returns and allowances, and cash disbursement
computer transaction files. The total of the individual account balances in the
master file equals the total balance of accounts payable in the general ledger.
Accounts payable trial balance includes the amount owed to each vendor or for
each invoice or voucher at a point in time. It is prepared directly from the
accounts payable master file.
Vendor’s statement is a document prepared monthly by the vendor and indicates
the beginning balance, acquisitions, returns and allowances, payments to the
vendor, and ending balance.
Check
- a listing or report generated from the cash disbursements transaction file that
includes all transactions for any time period included in the accounts payable
master file and general ledger.
The most time-consuming accounts to verify by substantive tests of details of balances are
accounts receivable, inventory, fixed assets, accounts payable, and expense accounts.
Tests of controls and substantive tests of transactions for the acquisition and payment
cycle are divided into two broad areas:
1. Tests of acquisitions, which concern three of the four business functions discussed
earlier in this chapter: processing purchase orders, receiving goods and services,
and recognizing the liability
2. Tests of payments, which concern the fourth function, processing, and recording
cash disbursements
The auditor gains an understanding of internal control for the acquisition and payment
cycle as part of performing risk assessment procedures by studying the client’s flowcharts,
reviewing internal control questionnaires, and performing walkthrough tests for
acquisition and cash disbursement transactions.
Authorization of Purchases
o Proper authorization for acquisitions ensures that the goods and services
acquired are for authorized company purposes, and it avoids the acquisition
of excessive or unnecessary items.
o For effective internal control, the purchasing department should be
separate from those who authorize the acquisition or receive the goods. All
purchase orders should be prenumbered to permit easier accounting for all
outstanding purchases orders and should be designed to minimize the
likelihood of unintentional omissions on the form when goods are ordered.
Authorization of Payments
- The most important controls over cash disbursements include:
• The signing of checks by an individual with proper authority
• Separation of responsibilities for signing checks and performing the
accounts payable function
• Careful examination of supporting documents by the check signer at the
time the check is signed
- The checks should be prenumbered and printed on special paper; provide physical
control over blank, voided, and signed checks; a method of canceling supporting
documents to prevent their reuse as support for another check at a later time.
When auditors intend 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.
Four of the six transaction-related audit objectives for acquisitions deserve special
attention and are therefore examined more closely.
1. Recorded Acquisitions Are for Goods and Services Received, Consistent with the
Best Interests of the Client (Occurrence)
2. Existing Acquisitions Are Recorded (Completeness)
3. Acquisitions Are Accurately Recorded (Accuracy)
4. Acquisitions Are Correctly Classified (Classification)
Auditors typically perform the acquisitions and cash disbursements tests at the
same time. For a transaction selected for examination from the acquisitions
journal, the vendor’s invoice, receiving report, and other acquisition
documentation are examined at the same time as the related cancelled check.
Thus, the verification is done efficiently without reducing the effectiveness of the
tests.
Accounts payable are unpaid obligations for goods and services received in the ordinary
course of business.
Accounts payable should be distinguished from accrued liabilities and interest bearing
obligations. A liability is an account payable only if the total amount of the obligation is
known and owed at the balance sheet date. If the obligation includes the payment of
interest, it should be recorded as a note payable, contract payable, mortgage payable, or
bond payable.
If tests of controls and related substantive tests of transactions show that controls are
operating effectively, and if analytical procedures results are satisfactory, the auditor is
likely to reduce tests of details of balances for accounts payable.
The auditor needs to understand the nature of changes to these systems to identify
whether client business risks and related management controls affect the likelihood of
material misstatements in accounts payable.
The balance of accounts payable is often large and made up of a large number of vendor
balances and it is relatively expensive to audit the account.
- auditors typically set performance materiality for accounts payable relatively high.
- auditors often assess inherent risk as medium or high.
- Concerned about the completeness and cutoff balance-related audit objectives
potential for understatements in the account balance.
Assess Control Risk and Design and Perform Tests of Controls and Substantive Tests of
Transactions (Phases I and II)
The auditor’s ultimate substantive tests depend on the relative effectiveness of internal
controls related to accounts payable. Therefore, auditors must have a thorough
understanding of how these controls relate to accounts payable.
The effects of the client’s internal controls on accounts payable tests can be illustrated by
two examples:
1. Assume that the client has highly effective internal controls over recording and
paying for acquisitions. The receipt of goods is promptly documented by
prenumbered receiving reports; prenumbered vouchers are promptly and
efficiently prepared and recorded in the acquisition transactions file and the
accounts payable master file. Cash disbursements are made promptly when due
and immediately recorded in the cash disbursements transactions file and the
accounts payable master file. Individual accounts payable balances in the master
file are reconciled monthly with vendors’ statements, and the computer
automatically reconciles the master file total to the general ledger. Under these
circumstances, the verification of accounts payable should require little audit
effort once the auditor concludes that internal controls are operating effectively.
2. Assume that receiving reports are not used, the client defers recording acquisitions
until cash disbursements are made, and because of cash shortages, bills are often
paid several months after their due date. When an auditor faces such a situation,
there is a high likelihood of an understatement of accounts payable therefore,
extensive tests of details of accounts payable are necessary to determine whether
accounts payable is correctly stated on the balance sheet date.
Auditors should compare current year expense totals with prior years to uncover
misstatements of accounts payable as well as in the expense accounts. Because of double-
entry accounting, a misstatement of an expense account usually also results in an equal
misstatement of accounts payable.
Design and Perform Tests of Details of Accounts Payable Balance (Phase III)
The extent of tests to uncover unrecorded accounts payable, often called the search for
unrecorded accounts payable, depends heavily on assessed control risk and the materiality
of the potential balance in the account.
b. Examine Underlying Documentation for Bills Not Paid Several Weeks After the Year-
End*#
- This procedure differs in that it is done for unpaid obligations near the end of the
audit rather than for obligations that have already been paid.
d. Trace Vendors’ Statements That Show a Balance Due to the Accounts Payable Trial
Balance*
- If the client maintains a file of vendors’ statements, auditors can trace any
statement that has a balance due at the balance sheet date to the listing to make
sure it is included as an account payable.
f. Cutoff Tests
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.
o Relationship of Cutoff to Physical Observation of Inventory
In determining that the accounts payable cutoff is correct, it is
essential that the cutoff tests be coordinated with the physical
observation of inventory.
The cutoff information for acquisitions should be obtained during the
physical observation of inventory. At that time, the auditor should
review the procedures in the receiving department to determine
that all inventory received was counted, and the auditor should
record in the audit documentation the last receiving report number
of inventory included in the physical count.
Subsequent to the physical count date, the auditor should then test
the accounting records for cutoff. The auditor should trace the
previously documented receiving report numbers to the accounts
payable records to verify that they are correctly included or
excluded.
o Inventory in Transit
In accounts payable, auditors must distinguish between acquisitions
of inventory that are on an FOB destination basis and those that are
made FOB origin. For FOB destination, title passes to the buyer when
the inventory is received, so only inventory received on or before
the balance sheet date should be included in inventory and accounts
payable at year-end. When an acquisition is FOB origin, the company
must record the inventory and related accounts payable in the
current period if shipment occurred on or before the balance sheet
date.
Reliability of Evidence
Better for veryfying correct balance The vendor’s statement is superior for verifying
accounts payable because it includes the ending balance. The auditor can compare
existing vendors’ invoices with the client’s list and still not uncover missing ones, which is
the primary concern in accounts payable.
A vendor’s statement has been prepared by the vendor (an independent third party) but is
in the hands of the client at the time the auditor examines it. This provides the client with
an opportunity to alter a vendor’s statement or to withhold certain statements from the
auditor only used when internal control is really bad
Sample Size
Sample sizes for accounts payable tests vary considerably, depending on such factors as
the materiality of accounts payable, the number of accounts outstanding, assessed control
risk, and the results of the prior year. When a client’s internal controls are deficient,
which is not uncommon for accounts payable, almost all population items must be
verified. In other situations, minimal testing may suffice.