1. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 18 - 1 Audit of the Acquisition and Payment Cycle: Tests of Controls, Substantive Tests of Transactions, and Accounts Payable. Chapter 18

2. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 18 - 2 Learning Objective 1 Identify the accounts and the classes of transactions in the acquisition and payment cycle.

3. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 18 - 3 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. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 18 - 4 Accounts in the Acquisition and Payment Cycle Cash in Bank Purchase Returns and Allowances Purchase Discounts Cash disbursements Purchase returns and allowances Purchase discounts Acquisitions of goods and services Raw Material Purchases Property, Plant and Equipment Prepaid Expenses Accounts Payable

5. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 18 - 5 Accounts in the Acquisition and Payment Cycle Acquisitions of goods and services Accounts Payable Manufacturing Expense Control Account Subsidiary accounts Repair and maintenance Taxes, Supplies Freight in, Utilities Administrative Expense Control Account Subsidiary accounts Supplies, Officers’ travel Legal fees Auditing fees, Taxes Selling Expense Control Account Subsidiary accounts Commissions Travel, delivery expenses Repairs, Advertising

6. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 18 - 6 Learning Objective 2 Describe the business functions and the related documents and records in the acquisition and payment cycle.

7. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 18 - 7 Classes of Transactions and Accounts  Inventory  Property, plant, and equipment  Prepaid expenses  Leasehold improvements  Accounts payable  Manufacturing expenses  Selling and administrative expenses Acquisitions:

8. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 18 - 8 Classes of Transactions and Accounts  Cash in bank (from cash disbursements)  Accounts payable  Purchase discounts Cash disbursements:

9. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 18 - 9 Business Functions in the Cycle  Processing purchase orders  Receiving goods and services  Recognizing the liability  Processing and recording cash disbursements

10. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 18 - 10 Related Documents and Reports  Purchase requisition  Purchase order  Receiving report Processing purchase orders: Receiving goods and services:

11. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 18 - 11 Related Documents and Reports  Vendor’s invoice  Voucher  Debit memo Recognizing the liability:  Acquisitions transaction file

12. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 18 - 12 Related Documents and Reports  Acquisitions journal or listing  Accounts payable master file  Accounts payable trial balance  Vendor’s statement Recognizing the liability:

13. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 18 - 13 Related Documents and Reports  Cash disbursements transaction file  Check  Cash disbursements journal or listing Processing and recording cash disbursements:

14. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 18 - 14 Learning Objective 3 Understand internal control, and design and perform tests of controls and substantive tests of transactions for the acquisition and payment cycle.

15. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 18 - 15 Methodology for Designing Controls and Substantive Tests Understand internal control – acquisitions and cash disbursements Assess planned control risk – acquisitions and cash disbursements Determine extent of testing controls Audit procedures Sample size Items to select Timing Design tests of controls and substantive tests of transactions for acquisitions and cash disbursements to meet transaction-related audit objectives

16. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 18 - 16 Understand Internal Control  Perform walk-through tests  Study the client’s flowcharts  Review internal control questionnaires

17. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 18 - 17 Assess Planned Control Risk  Authorization of purchases  Separation of asset custody from other functions  Timely recording and independent review of transactions  Authorization of payments

18. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 18 - 18 Determine Extent of Testing of Controls  The auditor identifies the key internal controls and weaknesses and assesses control risk  The auditor performs tests of controls to obtain evidence that controls are operating effectively

19. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 18 - 19 Controls and Substantive Tests of Transactions for Acquisitions  Recorded acquisitions are for goods and services received (occurrence)  Existing acquisitions are recorded (completeness)  Acquisitions are accurately recorded (accuracy)

20. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 18 - 20 Controls and Substantive Tests of Transactions for Acquisitions  Acquisitions are correctly included in the master files (posting and summarization)  Acquisitions are correctly classified (classification)  Acquisitions are recorded on the correct dates (timing)

21. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 18 - 21 Attributes Sampling Because of the importance of tests of controls and substantive tests of transactions for acquisitions and cash disbursements, the use of attributes sampling is common in this audit area.

22. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 18 - 22 Important Differences  Larger number of transactions  Significant judgment  Wide range of dollar amount

23. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 18 - 23 Learning Objective 4 Describe the methodology for designing tests of details of balances for accounts payable using the audit risk model.

24. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 18 - 24 Identify client business risks affecting accounts payable Methodology for Designing Tests of Balances for Accounts Payable Set tolerable misstatement and assess inherent risk for accounts payable Assess control risk for the acquisition and payment cycle Phase I

25. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 18 - 25 Methodology for Designing Tests of Balances for Accounts Payable Design and perform tests of controls and substantive tests of transactions for the acquisition and payment cycle Phase II

26. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 18 - 26 Timing Items to select Sample size Audit procedures Methodology for Designing Tests of Balances for Accounts Payable Design and perform analytical procedures for accounts payable balance Design tests of details of accounts payable balance to satisfy balance- related audit objectives Phase III

27. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 18 - 27 Learning Objective 5 Design and perform analytical procedures for accounts payable.

28. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 18 - 28 Analytical Procedures for the Acquisition and Payment Cycle Review list of accounts payable for unusual, nonvendor, and interest-bearing payables Classification misstatement for nontrade liabilities Analytical procedure Compare acquisition-related expense account balances with prior years. Misstatement of accounts payable and expenses Possible misstatement

29. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 18 - 29 Analytical Procedures for the Acquisition and Payment Cycle Analytical procedure Compare individual accounts payable with previous years Unrecorded or nonexistent accounts, or misstatements Calculate ratios, such as purchases divided by accounts payable, and accounts payable divided by current liabilities Unrecorded or nonexistent accounts, or misstatements Possible misstatement

30. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 18 - 30 Learning Objective 6 Design and perform tests of details of balances for accounts payable, including out-of-period liability tests.

31. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 18 - 31 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

32. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 18 - 32 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

33. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 18 - 33 Cutoff Tests  Relationship of cutoff to physical observation of inventory  Inventory in transit  FOB destination  FOB origin

34. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 18 - 34 Learning Objective 7 Distinguish the reliability of vendors’ invoices, vendors’ statements, and confirmations of accounts payable as audit evidence.

35. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 18 - 35 Reliability of Evidence  Distinction between vendors’ invoices and vendors’ statements  Difference between vendors’ statements and confirmations

36. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 18 - 36 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.

37. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 18 - 37 Types of Audit Tests for the Acquisition and Payment Cycle TOC + STOT + AP + TDB = Sufficient appropriate evidence per GAAS Cash in Bank Accounts Payable Acquisition Expenses PaymentsExpenses Audited by TOC, STOT, and AP Ending balance Ending balance Audited by TOC, STOT, and AP Audited by AP and TDB Audited by AP and TDB

38. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 18 - 38 Types of Audit Tests for the Acquisition and Payment Cycle TOC + STOT + AP + TDB = Sufficient appropriate evidence per GAAS Accounts Payable Acquisition Assets Acquisition of assets Ending balance Audited by TOC, STOT, and AP Audited by AP and TDB

39. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 18 - 39 End of Chapter 18