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15 - 1 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Completing the Tests in the Acquisition and Payment Cycle:

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Presentation on theme: "15 - 1 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Completing the Tests in the Acquisition and Payment Cycle:"— Presentation transcript:

1 15 - 1 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Completing the Tests in the Acquisition and Payment Cycle: Verification of Selected Accounts Chapter 15

2 15 - 2 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Learning Objective 1 Recognize the many accounts in the acquisition and payment cycle.

3 15 - 3 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Assets Cash Inventory Supplies Property, plant, and equipment Patents, trademarks, and copyrights Prepaid rent Prepaid taxes Prepaid insurance Accounts Associated with Acquisition and Payment Cycle Transactions

4 15 - 4 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Accounts Associated with Acquisition and Payment Cycle Transactions Cost of goods sold Rent expense Property taxes Income tax expense Insurance expense Professional fees Retirement benefits Utilities Expenses

5 15 - 5 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Accounts Associated with Acquisition and Payment Cycle Transactions Accounts payable Rent payable Accrued professional fees Accrued property taxes Other accrued expenses Income taxes payable Liabilities

6 15 - 6 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Learning Objective 2 Design and perform audit tests of property, plant, and equipment related accounts.

7 15 - 7 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Auditing Manufacturing Equipment and Related Accounts Analytical procedures Current year disposals Ending balance in the asset account Depreciation expense Ending balance in accumulated depreciation Current year acquisitions

8 15 - 8 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Analytical Procedures for Manufacturing Equipment Analytical ProcedurePossible Misstatement Compare depreciationMisstatement in expense divided by grossdepreciation expense manufacturing equipmentand accumulated cost with previous years.depreciation Compare accumulatedMisstatement in depreciation divided by grossaccumulated manufacturing equipmentdepreciation cost with previous years.

9 15 - 9 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Analytical Procedures for Manufacturing Equipment Analytical ProcedurePossible Misstatement Compare monthly or annualExpensing amounts repairs and maintenance,that should be supplies expense, small toolscapitalized expense, and similar accounts with previous years. Compare gross manufacturingIdle equipment or cost divided by some measureequipment that has of production with previousbeen disposed of, but years.not written off.

10 15 - 10 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Verifying Current Year Acquisitions The proper recording of current year additions is important because of the long-term effect the assets have on the financial statements. Because of the importance of current period acquisitions, seven of the nine balance-related audit objectives are used as a frame of reference.

11 15 - 11 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Major Balance-Related Audit Objectives Existing acquisitions are recorded. Completeness 1. Examine vendors’ invoices of closely related accounts to uncover items that should be manufacturing equipment. 2. Review lease and rental agreements.

12 15 - 12 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Current year acquisitions as listed are accurate. Major Balance-Related Audit Objectives Accuracy 1. Examine vendors’ invoices.

13 15 - 13 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Current year acquisitions as listed are properly classified. Major Balance-Related Audit Objectives Classification Examine: 1. Vendors’ invoices in mfg. equipment account. 2. Vendors’ invoices of closely related accounts. 3. Rent and lease expense for capitalizable leases.

14 15 - 14 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Verifying Current Year Disposals Review whether newly acquired assets replace existing assets. Analyze gains and losses on disposal. Review documents for indications of deletion of equipment. Make inquiries about the possibility of the disposal of assets.

15 15 - 15 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Verifying Ending Balance of Asset Accounts 1. All equipment owned is recorded. 2.All recorded equipment physically exists on the balance sheet date.

16 15 - 16 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Verifying Depreciation Expense The most important objective is accuracy. Consistent depreciation policy Correct calculations

17 15 - 17 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Verifying Ending Balance in Accumulated Depreciation 1. Accumulated depreciation as stated in the property master file agrees with the general ledger. 2. Accumulated depreciation in the master file is accurate.

18 15 - 18 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Learning Objective 3 Design and perform audit tests of prepaid expenses.

19 15 - 19 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Audit of Prepaid Expenses Prepaid rent Organization cost Prepaid taxes Patents Prepaid insurance Trademarks Deferred charges Copyrights

20 15 - 20 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Prepaid Insurance Internal Controls 1. Controls over the acquisition and recording of insurance 2. Controls over the insurance register 3. Controls over the charge-off of insurance expense

21 15 - 21 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Prepaid Insurance Audit Tests Compare total prepaid insurance and insurance expense with previous years. Compute the ratio of prepaid insurance to insurance expense and compare it with previous years. Compare the individual insurance policy coverage on the schedule of insurance obtained with the preceding year’s schedule.

22 15 - 22 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Prepaid Insurance Audit Tests Compare the computed prepaid insurance balance for the current year on a policy-by-policy basis with that of the preceding year. Review the insurance coverage listed on the prepaid insurance schedule with an appropriate client official or insurance broker.

23 15 - 23 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Learning Objective 4 Design and perform audit tests of accrued liabilities.

24 15 - 24 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Audit of Accrued Liabilities Accrued income taxes Accrued interest Accrued pension costs Accrued professional fees Accrued rent Accrued warranty costs

25 15 - 25 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Accrued Property Taxes and Related Accounts Accrued Property Taxes Property Tax Expense Beginning balance PaymentsCurrent period (property taxes) property tax expense Ending balance

26 15 - 26 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Learning Objective 5 Design and perform audit tests of income and expense accounts.

27 15 - 27 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Approach to Auditing Income and Expense Accounts Analytical procedures Tests of controls and substantive tests of transactions Tests of details of account balances

28 15 - 28 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Analytical Procedures for Income and Expense Accounts Analytical ProcedurePossible Misstatement Compare individualOverstatement or expenses with previousunderstatement of a year.balance in an expense sheet.

29 15 - 29 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Analytical Procedures for Income and Expense Accounts Analytical ProcedurePossible Misstatement Compare individual assetOverstatement or and liability balances withunderstatement of a previous years.balance sheet account that would also affect an income statement account

30 15 - 30 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Analytical Procedures for Income and Expense Accounts Analytical ProcedurePossible Misstatement Compare individualMisstatement of expenses with budgets.expenses and related balance sheet accounts Compare gross marginMisstatement of cost percentage with previousof goods sold and years.inventory

31 15 - 31 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Analytical Procedures for Income and Expense Accounts Analytical ProcedurePossible Misstatement Compare inventoryMisstatement of cost turnover ratio withof goods sold and previous years.inventory Compare prepaid insuranceMisstatement of expense with previousinsurance expense years.and prepaid insurance

32 15 - 32 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Analytical Procedures for Income and Expense Accounts Analytical ProcedurePossible Misstatement Compare commissionMisstatement of expense divided by salescommission expense, with previous years.accrued commissions Compare individualMisstatement of manufacturing expensesindividual mfg. divided by total mfg.expenses and related expenses with previous years.balance sheet accounts

33 15 - 33 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Tests of Controls and Substantive Test of Transactions Understanding internal control and the related tests of controls and substantive tests of transactions to determine the appropriate assessed control risk are the most important means of verifying many of the income statement accounts in each of the transaction cycles.

34 15 - 34 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Tests of Details of Account Balances: Expense Analysis Expense account analysis is the examination of underlying documentation of individual transactions and amounts making up the detail of the total of an expense account.

35 15 - 35 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Tests of Details of Account Balances: Allocation Several expense accounts result from the allocation of accounting data rather than discrete transactions. These include depreciation, depletion, and the amortization of copyrights and catalog cost. The allocation of manufacturing overhead between inventory and cost of goods sold is an example of a different type of allocation that affects expenses.

36 15 - 36 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley End of Chapter 15

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