©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley Completing the Tests in the Acquisition and Payment Cycle: Verification of Selected Accounts Chapter 19

©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley Learning Objective 1 Recognize the many accounts in the acquisition and payment cycle.

©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley Accounts Associated with the Acquisition and Payment Cycle Assets:

©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley Learning Objective 2 Design and perform audit tests of property, plant, and equipment and related accounts.

©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley Classifications of Property, Plant and Equipment

©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley Equipment and Related Accounts Manufacturing Equipment Accumulated Depreciated Beginning balance Beginning balance Depreciation Expense Gain or Loss on Disposals Current period depreciation Ending balance Disposals Acquisitions Ending balance

©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley Auditing Manufacturing Equipment and Related Accounts Perform analytical procedures  Current year acquisitions  Current year disposals  Ending balance in the asset account  Depreciation expense  Ending balance in accumulated depreciation Plus verify:

©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley Analytical Procedures for Manufacturing Equipment

©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley Verify Current Year Acquisitions Current year additions have a long-term effect on the financial statements. Seven of the eight balance-related audit objectives are used as a frame of reference.

©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley Balance-related Audit Objectives Detail tie-in: Current acquisitions agree with the master file. 1.Foot the acquisition schedule. 2.Trace the individual acquisitions to the master file. 3.Trace the total to the general ledger.

©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley Balance-related Audit Objectives Existence: Current acquisitions as listed exist. 1.Examine vendors’ invoices and receiving reports 2.Physically examine assets.

©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley Balance-related Audit Objectives Completeness: Existing acquisitions are recorded. 1.Examine vendors’ invoices of closely relatedaccounts to uncover items that should be manufacturing equipment. 2.Review lease and rental agreements.

©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley Balance-related Audit Objectives Current year acquisitions as listed are accurate. 1. Examine vendors’ invoices. Accuracy:

©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley Balance-related Audit Objectives Classification: Current year acquisitions as listed are correctly classified. 1. Examine vendors’ invoices in manufacturing equipment account. 2. Examine vendors’ invoices of closely related accounts. 3. Examine rent and lease expense for capitalizable leases.

©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley Current year acquisitions are recorded in the correct period. 1.Review transactions near the balance sheet date for correct period. Balance-related Audit Objectives Cutoff:

©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley The client has rights to current year acquisitions. 1. Examine vendors’ invoices. Major Balance-related Audit Objectives Rights:

©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley Verify 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

©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley Verify Ending Balance of Asset Accounts  All recorded equipment physically exists on the balance sheet date  All equipment owned is recorded

©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley Verify Depreciation Expense The most important objective is accuracy.  Consistent depreciation policy  Correct calculations

©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley Verify Ending Balance in Accumulated Depreciation Accumulated depreciation as stated in the property master file agrees with the general ledger. Accumulated depreciation in the master file is accurate.

©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley Learning Objective 3 Design and perform audit tests of prepaid expenses.

©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley Audit of Prepaid Expenses  Prepaid rent  Organization costs  Prepaid taxes  Patents  Prepaid insurance  Trademarks  Deferred charges  Copyrights

©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley Prepaid Insurance and Related Accounts Prepaid Insurance Beginning balance Acquisitions Ending balance Current period insurance expense Insurance Expense

©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley Internal Controls  Acquisition and recording of insurance  Insurance register  Insurance expense

©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley 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

©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley 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.

©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley Balance-related Audit Objectives Existence and completeness: Insurance policies in the prepaid insurance schedule exist and existing policies are listed. Rights: The client has rights to all insurance policies in the prepaid insurance schedule.

©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley Balance-related Audit Objectives Accuracy and detail tie-in: Prepaid amounts are accurate and the total is correctly added and agrees with the general ledger. Classification: Insurance expense is properly classified. Cutoff: Insurance transactions are recorded in the proper period.

©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley Learning Objective 4 Design and perform audit tests of accrued liabilities.

©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley Audit of Accrued Liabilities  Accrued payroll  Accrued payroll taxes  Accrued officers’ bonuses  Accrued commissions  Accrued professional fees  Accrued rent  Accrued interest

©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley Accrued Property Taxes and Related Accounts Accrued Property Taxes Beginning balance Current period property tax expense Ending balance Property Tax Expense Payments (property taxes)

©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley Learning Objective 5 Design and perform audit tests of income and expense accounts.

©2012 Pearson Education, Auditing 14/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

©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley Analytical Procedures for Income and Expense Accounts Compare individual asset and liability balances with previous years Overstatement or understatement of a balance sheet account that will also affect an income statement account Analytical procedure Compare individual expenses with previous years Overstatement or understatement of a balance in an expense account Possible misstatement

©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley Analytical Procedures for Income and Expense Accounts Analytical procedure Compare individual expenses with budgets Misstatement of expenses and related balance sheet accounts Possible misstatement Compare gross margin percentage with previous years Misstatement of cost of goods sold and inventory Compare inventory turnover ratio with previous years Misstatement of cost of goods sold and inventory

©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley Analytical Procedures for Income and Expense Accounts Analytical procedure Compare prepaid insurance expense with previous years Misstatement of insurance expense and prepaid insurance Possible misstatement Compare commission expense divided by sales with previous years Misstatement of commission expense and accrued commissions Compare individual manufacturing expenses divided by total mfg. expenses with previous years Misstatement of individual manufacturing expenses and related balance sheet accounts

©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley Tests of Controls and Substantive Test of Transactions Both tests of controls and substantive tests of transactions have the effect of simultaneously verifying balance sheet and income statement accounts.

©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley Analysis of Legal Expense Expense account analysis:  Repairs and maintenance  Rent and lease  Legal expense

©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley Analysis of Legal Expense Expense account analysis:  Repairs and maintenance  Rent and lease  Legal expense

©2012 Pearson Education, Auditing 14/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.

©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley End of Chapter 19