1. Auditing the Purchasing Process
Chapter Eleven
Auditing the Purchasing Process

2. Expense and Liability Recognition (IASB)
Expenses are decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or incurrences of liabilities that result in decreases in equity, other than those relating to distributions to equity participants
A liability is a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits

3. Overview of the Purchasing Process
A purchase transaction usually begins with a purchase requisition generated by the user department. The purchasing department prepares a purchase order that is sent to the vendor. When the goods are received or the services rendered, a liability is recorded. Finally, the entity pays the vendor.
Purchase requisition
Purchase order
Receiving report and liability recorded
Vendor

4. Types of Transactions and Financial Statement Accounts Affected
There are three types of transactions:
Purchase of goods and services for cash or credit.
Payment of the liabilities arising from such purchases.
Return of goods to suppliers for cash or credit.

5. Types of Transactions and Financial Statement Accounts Affected

6. Flowchart of the Purchasing Process – EarthWear Clothiers
Department
Requesting
Purchasing IT
Approved
purchase requisition
received
Accounts payable master file
Purchase requisition
Purchase order file
Purchase order program
Input
Vendor
Error corrections
Error report
Purchase order (4 part)
A/P
Receiving
PO #2
Filed
Numer-ically
Purchasing

7. Flowchart of the Purchasing Process – EarthWear Clothiers
Department
Receiving
Accounts Payable (A/P)
PO #1
PO #3
Compare invoice to PO and RR
Review account distribution
Receiving report
Goods received, counted, and inspected
Vendor invoice
Voucher packet
Enter vendor,
quantity, and PO #
Receiving report (RR)
To IT
Input
Error correction
From IT
Daily receiving log

8. Flowchart of the Purchasing Process – EarthWear Clothiers
Department IT
Purchase
order file
A/P master
file
General
ledger file
Open PO report
Accounts
payable update
A/P expense distribution report
Monthly reports
Input from A/P
Weekly
Monthly
A/P reporting
Voucher register
Daily
Cash disbursements journal
A/P listing
Error report
Report
to A/P
Cash disbursement report
Daily
General ledger

9. Flowchart of the Purchasing Process – EarthWear Clothiers
Department
Accounts Payable (A/P) IT
Cashier
Cash disbursement report
A/P master
file
Cheques
Review documents and authorize payment
Cash disbursement program
Review cheques and mail to vendors
Cash disbursement report
Cheques
Cheques
Input
To Vendors

10. Types of Documents and Records
Purchasing documents and records . . .
Purchase Requisition – request to purchase goods or services.
Purchase Order – includes description, quality, and quantity or goods or services being purchased.
Receiving Report – records the receipt of goods.
Vendor Invoice – the bill from the vendor.
Voucher – serves as the basis for recording a vendor’s invoice.
Voucher Register – used to record vouchers for goods and services.
Accounts Payable Subsidiary Ledger – includes amount owed to individual vendors.
Vendor Statement – represents the purchase activity with vendor.
Bank Giros and Cheques – pays for goods or services.
Cash Disbursements Journal – contains columns to record credits to cash and debits to accounts payable and cash discounts.

11. The Major Functions

12. Key Functions and Duties

13. The Key Segregation of Duties

14. Inherent Risk Assessment
Industry-Related Factors
1. Is the supply of raw materials adequate ?
2. How volatile are raw material prices ?

15. Inherent Risk Assessment
Misstatements Detected in Prior Audits
Generally, the purchasing process is not difficult to audit and does not present contentious accounting issues. However, the auditor’s experience in past audits must be considered when assessing inherent risk.

16. Control Risk Assessment
Major steps in setting the control risk in the purchasing process.
Understanding and documenting the purchasing process based on a reliance strategy.
Planning and performing tests of controls of purchase transactions.
Setting and documenting the control risk for the purchasing process.

17. Control Risk Assessment
Information Systems and Communication
For each major class of transactions in the purchasing process, the auditor must obtain the following information:
How purchase, cash disbursements and purchase return transactions are initiated.
The accounting records, supporting documents and accounts involved in processing purchases, cash disbursements and purchase returns.
The flow of each type of transaction from initiation to inclusion in the financial statements, including computer processing.
The process used to estimate accrued liabilities.

18. Control Risk Assessment
After testing controls, the auditor sets the level of control risk. When tests of controls support the planned level of control risk, no modifications are necessary to detection risk. The auditor may proceed with the substantive procedures as planned.
When test do not support the planned control risk, the auditor lowers the level of detection risk leading to more substantive procedures.

19. Control Activities and Tests of Controls – Purchase Transactions
Assertions about Classes of Transactions and Events for the Period under Audit

20. Control Activities and Tests of Controls – Purchase Transactions

21. Occurrence of Cash Disbursement Transactions
Control Activities and Tests of Controls – Cash Disbursement Transactions
Occurrence of Cash Disbursement Transactions
The auditor is concerned with a misstatement caused by a cash disbursement being recorded in the client’s record when no payment was made. The primary control activities to prevent such misstatements include proper segregation of duties, independent reconciliation and review of vendor statements, and monthly bank reconciliations.

22. Completeness of Cash Disbursement Transactions
Control Activities and Tests of Controls – Cash Disbursement Transactions
Completeness of Cash Disbursement Transactions
The major audit concern is that a cash disbursement is made but not recorded in the records. The auditor should examine and test the client’s procedures for reviewing vendor payments lists and reconcile the daily cash disbursements with posting to the accounts payable subsidiary records.

23. Authorization of Cash Disbursement Transactions
Control Activities and Tests of Controls – Cash Disbursement Transactions
Authorization of Cash Disbursement Transactions
Proper segregation of duties reduces the likelihood that unauthorized cash disbursements are made. The individual who approves a purchase should not have direct access to the cash disbursement.

24. Accuracy of Cash Disbursement Transactions
Control Activities and Tests of Controls – Cash Disbursement Transactions
Accuracy of Cash Disbursement Transactions
One of the major audit concerns is that the payment amount is recorded incorrectly. To detect such an error, client personnel should reconcile the total of electronic cash disbursements transfer and the cheques issued each day with the daily cash disbursements report.

25. Cutoff of Cash Disbursement Transactions
Control Activities and Tests of Controls – Cash Disbursement Transactions
Cutoff of Cash Disbursement Transactions
The auditor’s tests of controls include reviewing the reconciliation of payments transfers with postings to the cash disbursements journal and accounts payable subsidiary records. The auditor also tests cash disbursements before and after year-end to ensure that transactions are recorded in the proper period.

26. Classification of Cash Disbursement Transactions
Control Activities and Tests of Controls – Cash Disbursement Transactions
Classification of Cash Disbursement Transactions
The auditor is concerned that a cash disbursement may be charged to the wrong general ledger account. The use of a chart of accounts, as well as independent approval and review of the account code on the voucher should provide adequate control.

27. Control Activities and Tests of Controls – Purchase Return Transactions
Generally, the number and magnitude of purchase return transactions are not material. The auditor normally does not test controls relating to purchase returns. Substantive testing is used to test the reasonableness of the amount.

28. Relating the Assessed Level of Control Risk to Substantive Procedures
If the results of the tests of controls support the achieved level of control risk, the auditor conducts substantive procedures at the planned level. If the results do not support the achieved level of control risk, the auditor reduces the detection risk, which will increase substantive procedures.

29. Auditing Accounts Payable and Accrued Expenses

30. Auditing Accounts Payable and Accrued Expenses

31. Auditing Accounts Payable and Accrued Expenses
Substantive Analytical Procedures

32. Tests of Details of Transactions, Account Balances and Disclosures
Completeness
Obtain a listing of accounts payable, foot the listing, and agree it to the general ledger control account. Selected vouchers or vendor accounts should be traced to the supporting documents or subsidiary accounts payable records to verify the accuracy of the details.

33. Tests of Details of Transactions, Account Balances and Disclosures
Completeness
The auditor should conduct a test for unrecorded liabilities that include the following procedures:
Ask management about control activities used to identify unrecorded liabilities at the end of the period.
Obtain copies of vendors’ monthly statements and reconcile the amounts to the client’s accounts payable records.
Confirm vendor accounts, including accounts with small or zero balances.
Vouch large-monetary items from the purchases journal and cash disbursements journal for a limited time after year-end.
Examine the files of unmatched purchase orders, receiving reports, and vendor invoices for any unrecorded liabilities.

34. Tests of Details of Transactions, Account Balances and Disclosures
Existence
The auditor’s major concern is whether the recorded liabilities are valid obligations of the entity. The auditor should vouch a sample of items on the listing of accounts payable to other supporting documents.

35. Tests of Details of Transactions, Account Balances, and Disclosures
Cutoff
The auditor attempts to determine if all purchase transactions are recorded in the proper period. On most audits, the purchase cutoff is coordinated with the client’s physical inventory count. Proper cutoff should also be determined for purchase return transactions.

36. Tests of Details of Transactions, Account Balances and Disclosures
Rights and Obligations
There is little risk related to this assertion because clients seldom have an incentive to record liabilities that are not obligations of the entity.

37. Tests of Details of Transactions, Account Balances and Disclosures
Valuation
Accounts payable are recorded at either the gross amount of the invoice or net of cash discount amount. The valuation of accruals depends upon the type and nature of the accrued expense. Most accruals are relatively easy to value.

38. Tests of Details of Transactions, Account Balances and Disclosures
Classification, Presentation and Disclosure
Major classification issues include . . .
Identifying and reclassifying any material debits contained in accounts payable.
Segregating short-term and long-term payables.
Ensuring that different types of payables are properly classified.

39. Tests of Details of Transactions, Account Balances, and Disclosures
Disclosure Items for the Purchasing Process
Payables by type (trade, employees, etc.).
Purchases from and payables to related parties.
Dependence on a single vendor or a small number of vendors.
Short- and long-term payables.
Long-term purchase contracts, including any unusual purchase commitments.
Costs by reportable segment of the business.

40. Tests of Details of Transactions, Account Balances and Disclosures
Other Presentation Disclosure Assertion
The auditor must ensure that all related party transactions have been identified. When the client has entered into formal long-term purchase contracts, adequate disclosure of the terms must be made.

41. Accounts Payable Confirmation
Accounts payable confirmations are used less often than accounts receivable confirmations. The auditor is able to examine externally created source documents relating to accounts payable. When confirmations are used they are usually positive and referred to as blank confirmations. The vendor is asked to supply the balance owed by the client.

42. Evaluating the Audit Findings
All identified misstatements should be aggregated. The aggregated amount of identified misstatement is then compared to tolerable misstatement. If the aggregated amount of misstatements is less than the tolerable misstatement, the auditor has evidence that the account is fairly presented. Conversely, it the aggregated amount exceeds the tolerable, the auditor should conclude that the account is not fairly presented.

43. End of Chapter 11