1. 14 - 1 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Audit of the Acquisition and Payment Cycle: Tests of Controls, Substantive Tests of Transactions, and Accounts Payable Chapter 14

2. 14 - 2 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Learning Objective 1 Identify the accounts and the classes of transactions in the acquisition and payment cycle.

3. 14 - 3 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Transactions in the Acquisition and Payment Cycle 1. Acquisitions of goods and services 2. Cash disbursements 3. Purchase returns and allowances and purchase discounts

4. 14 - 4 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Accounts in the Acquisition and Payment Cycle Cash in Bank Purchase Returns and Allowances Purchase Discounts Raw Material Purchases Property, Plant, and Equipment Prepaid Expenses Accounts Payable CashAcquisitions disbursementsof goods and services Purchase returns and allowances Purchase discounts

5. 14 - 5 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Accounts in the Acquisition and Payment Cycle Accounts Payable Acquisitions of goods and services Manufacturing Expense Control Administrative Expense Control Subsidiary accounts Repair and maint. Taxes Supplies Freight in Utilities Selling Expense Control Subsidiary accounts Commissions Travel expense Delivery expense Repairs Advertising Subsidiary Accounts Supplies Officers’ travel Legal fees Auditing fees Taxes

6. 14 - 6 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Learning Objective 2 Describe the business functions and the related documents and records in the acquisition and payment cycle.

7. 14 - 7 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Classes of Transactions and Accounts Inventory Property, plant, and equipment Prepaid expenses Leasehold improvements Accounts payable Manufacturing expenses Selling and administrative expenses

8. 14 - 8 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Classes of Transactions and Accounts Cash in bank (from cash disbursements) Accounts payable Purchase discounts

9. 14 - 9 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Business Functions in the Cycle Processing purchase orders Receiving goods and services Recognizing the liability Processing and recording cash disbursements

10. 14 - 10 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Documents and Records Purchase requisitionPurchase order Receiving report Processing purchase orders Receiving goods and services

11. 14 - 11 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Documents and Records Acquisitions transaction file Acquisitions journal or listing Vendor’s invoice Voucher A/P trial balance Debit memo A/P master file Vendor’s statement Recognizing the liability

12. 14 - 12 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Documents and Records Cash disbursements transaction file Check Cash disbursements journal or listing Processing and recording cash disbursements

13. 14 - 13 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Learning Objective 3 Describe how e-commerce affects the acquisition of goods and services.

14. 14 - 14 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley How E-Commerce Affects the Acquisition and Payment Cycle Electronic data interchange (EDI) is the electronic exchange of information between companies and their suppliers and consumers. Purchase orders Customer orders Customers EDI Suppliers EDI

15. 14 - 15 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley How E-Commerce Affects the Acquisition and Payment Cycle Some companies use extranets which link the intranets of two or more companies. Other companies use business- to-business auctions hosted on the Internet to negotiate purchases. Information about products is available over the Internet.

16. 14 - 16 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Learning Objective 4 Understand internal control and design and perform tests of controls and substantive tests of transactions for the acquisition and payment cycle.

17. 14 - 17 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Understand Internal Control The auditor gains an understanding of internal control for the acquisition and payment cycle by studying the client’s flowcharts, preparing internal control questionnaires, and performing walk-through tests for acquisitions and cash disbursements.

18. 14 - 18 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Assess Planned Control Risk Authorization of purchases Separation of asset custody from other functions Timely recording and independent review of transactions Authorization of payments

19. 14 - 19 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Evaluate Cost-Benefit of Testing Controls The auditor identifies the key internal controls and weaknesses and assesses control risk. The auditor decides whether substantive tests will be reduced sufficiently to justify the cost of performing tests of controls.

20. 14 - 20 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Controls and Substantive Tests of Transactions for Acquisitions Recorded acquisitions are for goods and services received, consistent with the best interests of the client (existence). Existing acquisitions are recorded (completeness). Acquisitions are accurately recorded (accuracy). Acquisitions are correctly classified (classification).

21. 14 - 21 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Controls and Substantive Tests of Transactions for Acquisitions Acquisition transactions are recorded on the correct dates (timing). Acquisition transactions are properly included in the accounts payable and inventory master files and are properly summarized (posting and summarization).

22. 14 - 22 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Controls and Substantive Tests of Transactions for Cash Disbursements The assumption underlying these controls and audit procedures is separate cash disbursements and acquisitions journals. The acquisitions and cash disbursements tests are typically performed concurrently.

23. 14 - 23 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Learning Objective 5 Describe the methodology for designing tests of details of balances for accounts payable using the audit risk model.

24. 14 - 24 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Identify client risks affecting accounts payable. Methodology for Designing Tests of Details of Balances for A/P Assess control risk and design and perform tests of controls and substantive tests of transactions. Set tolerable misstatement and assess inherent risk.

25. 14 - 25 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Learning Objective 6 Design and perform analytical procedures for accounts payable.

26. 14 - 26 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Analytical Procedures for the Acquisition and Payment Cycle Analytical ProcedurePossible Misstatement Compare acquisition-Misstatement of related expense account accounts payable balances with prior years.and expenses Review list of accountsClassification payable for unusual,misstatement for nonvender, and interest-nontrade liabilities bearing payables.

27. 14 - 27 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Analytical Procedures for the Acquisition and Payment Cycle Analytical ProcedurePossible Misstatement Compare individualUnrecorded or accounts payable withnonexistent accounts, previous years.or misstatements Calculate ratios such asUnrecorded or purchases divided bynonexistent accounts, accounts payable, andor misstatements accounts payable divided by current liabilities.

28. 14 - 28 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Learning Objective 7 Design and perform tests of details of balances for accounts payable, including out-of-period liability tests.

29. 14 - 29 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Out-of-Period Liability Tests Examine underlying documentation for subsequent cash disbursements. Examine underlying documentation for bills not paid several weeks after the year end. Trace receiving reports issued before year-end to related vendors’ invoices.

30. 14 - 30 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Out-of-Period Liability Tests Trace vendors’ statements that show a balance due to the accounts payable trial balance. Send confirmations to vendors with which the client does business.

31. 14 - 31 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Cutoff Tests Relationship of cutoff to physical observation of inventory Inventory in transit

32. 14 - 32 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Learning Objective 8 Distinguish the reliability of vendors’ invoices, vendors’ statements, and confirmations of accounts payable as audit evidence.

33. 14 - 33 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Reliability of Evidence Distinction between vendors’ invoices and vendors’ statements Difference between vendors’ statements and confirmations

34. 14 - 34 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Sample Size Sample sizes for accounts payable tests vary considerably, depending on many factors. Statistical sampling is less commonly used for the audit of accounts payable than for accounts receivable.

35. 14 - 35 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley End of Chapter 14