1. Electronic Presentations in Microsoft ® PowerPoint ® Prepared by Brad MacDonald SIAST © 2009 McGraw-Hill Ryerson Limited

2. Learning Objectives Chapter Overview Purchases, Payables and Payments Process Chapter 12 Tous droits réservés McGraw Hill Ryerson.

3. Learning Objectives Chapter Overview Slide 3 1.Describe the purchases, payables and payments process, including typical transactions, source documents, controls and account balances. 2.Outline control tests for auditing control over purchase of inventory, services, and fixed assets and disbursement of cash. 3.Explain the importance of the completion assertion for the audit of accounts payable liabilities and procedures used to search for unrecorded liabilities. 4.Identify audit considerations for observing the physical inventory count. Learning Objectives Tous droits réservés McGraw Hill Ryerson.

4. Learning Objectives Chapter Overview Slide 4 Understanding the Purchases, Payables and Payments Process Control Risk Assessment Special Note: The Completeness Assertion for Liabilities Special Note: Physical Inventory Observation Chapter Overview Tous droits réservés McGraw Hill Ryerson.

5. Learning Objectives Chapter Overview Learning objective 1 2 3 4 5 Slide 5 Understanding the Purchases, Payables and Payments Process Purchases of goods and services are a major part of cash outflow in most organizations. –High level of management planning and control. Tous droits réservés McGraw Hill Ryerson.

6. Learning Objectives Chapter Overview Learning objective 1 2 3 4 5 Slide 6 Risk Assessment for Purchases Payables and Payments To assess risks in the purchasing-related processes, the auditor considers purchasing and cash payment transactions and accounts payable. –Understanding of business will point auditors towards specific risks. –Existence, ownership, completeness, valuation and disclosure must all be considered. Tous droits réservés McGraw Hill Ryerson.

7. Learning Objectives Chapter Overview Learning objective 1 2 3 4 5 Slide 7 Purchases, Payments, and Payables Process: Typical Activities Exhibit 12-1 shows the activities and transactions, accounts and records in the purchases, payables, and payments processes. The basic activities are: –purchasing goods and services, and –paying the bills. Tous droits réservés McGraw Hill Ryerson.

8. Purchase, Payables and Payment Process Start Here Request for purchases Enter accounts payable Cash disbursement Receive vendor invoice Receive goods and services Tous droits réservés McGraw Hill Ryerson.

9. Learning Objectives Chapter Overview Learning objective 1 2 3 4 5 Slide 9 Authorization Purchases are made by purchasing departments or authorized purchasers. –Purchasing controls such as competitive bids should be in place. Disbursements are authorized by an accounts payable department. –Purchase orders, invoices and receiving reports are matched prior to payment. –Cheques are signed by authorized personnel. Tous droits réservés McGraw Hill Ryerson.

10. Learning Objectives Chapter Overview Learning objective 1 2 3 4 5 Slide 10 Custody A receiving department receives goods purchased and forwards them to the proper departments. Custody of cash is the responsibility of personnel assigned to authorize and sign cheques. Access to blank documents should also be considered as an aspect of custody. Tous droits réservés McGraw Hill Ryerson.

11. Learning Objectives Chapter Overview Learning objective 1 2 3 4 5 Slide 11 Recording Purchases should be recorded once the purchase order, receiving report, and vendor invoice are matched. Disbursements are recorded when the cheques are prepared. Tous droits réservés McGraw Hill Ryerson.

12. Learning Objectives Chapter Overview Learning objective 1 2 3 4 5 Slide 12 Periodic Reconciliation Periodic comparison of existing assets to recorded amounts in various accounts occurs in several ways. –Physical inventory is compared to the accounts. –Bank reconciliations are prepared. –Fixed assets are compared to the accounts. –A trial balance of accounts payable is compared to the control account. Tous droits réservés McGraw Hill Ryerson.

13. Learning Objectives Chapter Overview Learning objective 1 2 3 4 5 Slide 13 Audit Evidence in Management Reports Computer processing of purchase and payment transactions will produce several management reports which may provide audit evidence: Management Report Control PurposePotential Audit Evidence Open purchase orders Completeness of accounts payable Purchase commitments, valuation of inventory unmatched receiving reports Validity of purchases recorded Unaccrued liabilities for purchases Tous droits réservés McGraw Hill Ryerson.

14. Learning Objectives Chapter Overview Learning objective 1 2 3 4 5 Slide 14 Audit Evidence in Management Reports Management Report Control PurposePotential Audit Evidence Unmatched vendor invoices Validity of purchases recorded Unaccrued liabilities for purchases Accounts payable trial balance Proper accounting, cash flow management Existence and completeness of payables Purchases journal Completeness and validity or purchases, inventory or expenses Analysis of inventory changes and expense reasonability Inventory reportsCompleteness, validity and valuation of inventory Analysis of inventory balances, valuation, selection of samples for test counts and valuation tests Tous droits réservés McGraw Hill Ryerson.

15. Learning Objectives Chapter Overview Learning objective 1 2 3 4 5 Slide 15 Audit Evidence in Management Reports Management Report Control PurposePotential Audit Evidence Fixed Asset Reports Completeness, validity and valuation of fixed assets, accumulated depreciation and depreciation expense Analysis of changes in fixed assets balances. Selection of sample additions for vouching. Recalculation of depreciation expense Cash disbursements report Expenditure reviews by management for validity, authorization Selection of sample for testing existence, authorization and proper cut-off of payments. Tous droits réservés McGraw Hill Ryerson.

16. Learning Objectives Chapter Overview Learning objective 1 2 3 4 5 Slide 16 Control 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, and expense categories (administrative, selling, and manufacturing). Tous droits réservés McGraw Hill Ryerson.

17. Learning Objectives Chapter Overview Learning objective 1 2 3 4 5 Slide 17 General 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. Tous droits réservés McGraw Hill Ryerson.

18. Learning Objectives Chapter Overview Learning objective 1 2 3 4 5 Slide 18 Detail Test of Controls Audit Procedures 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 12-4 Tous droits réservés McGraw Hill Ryerson.

19. Learning Objectives Chapter Overview Learning objective 1 2 3 4 5 Slide 19 Detail Test of Controls for Inventory 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. –Testing needs to take place from the physical inventory to the accounts, and from the accounts to the physical inventory to cover both completeness and validity. Tous droits réservés McGraw Hill Ryerson.

20. Learning Objectives Chapter Overview Learning objective 1 2 3 4 5 Slide 20 Summary: Control 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. Tous droits réservés McGraw Hill Ryerson.

21. Learning Objectives Chapter Overview Learning objective 1 2 3 4 5 Slide 21 Special Note: The 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. Tous droits réservés McGraw Hill Ryerson.

22. Learning Objectives Chapter Overview Learning objective 1 2 3 4 5 Slide 22 Search 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. Tous droits réservés McGraw Hill Ryerson.

23. Learning Objectives Chapter Overview Learning objective 1 2 3 4 5 Slide 23 Special Note: Physical 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. Tous droits réservés McGraw Hill Ryerson.

24. Learning Objectives Chapter Overview Learning objective 1 2 3 4 5 Slide 24 Auditor’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. Tous droits réservés McGraw Hill Ryerson.

25. Learning Objectives Chapter Overview Learning objective 1 2 3 4 5 Slide 25 Special Notes: Physical 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. Tous droits réservés McGraw Hill Ryerson.

26. Learning Objectives Chapter Overview Learning objective 1 2 3 4 5 Slide 26 Special Notes: Physical 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. Tous droits réservés McGraw Hill Ryerson.

27. Learning Objectives Chapter Overview Learning objective 1 2 3 4 5 Slide 27 Special Note: Physical 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 test counts. –If amounts are not material and control risk is low, direct confirmation with the custodian may be sufficient competent evidence. Tous droits réservés McGraw Hill Ryerson.

28. Learning Objectives Chapter Overview Learning objective 1 2 3 4 5 Slide 28 Inventory Existence and Completeness In addition to the physical count of inventory, the auditor will also need to consider: –whether there are any consignment relationships in effect, –any goods in transit that are the property of the client, and –whether there are any goods on hand which have been sold but not yet delivered. Tous droits réservés McGraw Hill Ryerson.

29. Learning Objectives Chapter Overview Learning objective 1 2 3 4 5 Slide 29 Audit Cases: Substantive 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. Tous droits réservés McGraw Hill Ryerson.

30. Learning Objectives Chapter Overview Learning objective 1 2 3 4 5 Slide 30 Substantive 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 ObjectiveControl Test of Controls Audit of Balance Audit Approach Tous droits réservés McGraw Hill Ryerson.

31. Learning Objectives Chapter Overview Learning objective 1 2 3 4 5 Slide 31 Audit Casettes: Substantive Audit Procedures 12.1 Copying Money –Improper expenditures for company services charged to motion picture production costs. 12.2 Receiving the Missing Oil –Fuel oil supplies inventory and fuel expenses inflated because of short shipments. Tous droits réservés McGraw Hill Ryerson.

32. Learning Objectives Chapter Overview Learning objective 1 2 3 4 5 Slide 32 Audit Casettes: Substantive Audit Procedures 12.3 Retread Tires –Inventory and income overstated by substitution of retread tires for inventory at new tire prices. 12.4 Amortize “The Drum” Slowly –Net asset values (unamortized cost of films) was overstated by taking too little amortization expense. Tous droits réservés McGraw Hill Ryerson.