Chapter 11 Auditing the Purchasing Process

A purchase transaction usually begins with the preparation of a purchase order.

FALSE

A receiving report is used to document the ordering of goods.

FALSE

The purchase journal is referred to as a check register.

FALSE

Identify the primary functions in the purchases cycle and describe each function.

Functions in the purchasing process include: Requisitioning. Initiation and approval of request for goods and services by authorized individuals consistent with management criteria. Purchasing. Approval of purchase orders and proper execution as to price, quantity, quality, and vendor. Receiving. Receipt of properly authorized goods or services. Invoice Processing. Processing of vendor invoices for goods and services received; also, processing of adjustments for allowances, discounts, and returns. Disbursements. Processing of payment to vendors. Accounts Payable. Recording of all vendor invoices, cash disbursements, and adjustments in individual vendor accounts. General Ledger. Proper accumulation, classification and summarization of purchases, cash disbursements, and payables in the general ledger.

In testing controls over cash disbursements, an auditor most likely would determine that the person who signs the checks also

Is responsible for mailing the checks.

An auditor wishes to perform tests of controls on an entity's cash disbursements procedures. If the control activities leave no audit trail of documentary evidence, the auditor most likely will test the procedures by

Observation and inquiry.

Which of the following procedures would an auditor least likely perform before the balance sheet date?

Observation of merchandise inventory.

If completeness is a concern for accounts payable, auditors will send accounts payable confirmations to

Primarily vendors with small or zero accounts payable balances.

An entity erroneously recorded a large purchase twice. Which of the following internal controls would be most likely to detect this error in a timely and efficient manner?

Reconciling vendors' monthly statements with subsidiary payable ledger accounts.

Substantive procedures to examine the occurrence assertion for accounts payable include

Selecting a sample of vouchers and agreeing them to authorized purchase orders.

Substantive procedures to examine the completeness assertion for accounts payable include

Selecting a sample of vouchers and tracing them to the purchases journal.

A voucher

Serves as the basis for recording a vendor's invoice in the purchases journal.

The mailing of disbursement checks and remittance advices should be controlled by the employee who

Signed the checks last.

To provide assurance that each voucher is submitted and paid only once, an auditor most likely would examine a sample of paid vouchers and determine whether each voucher is

Stamped "paid" by the check signer.

Accounts payable confirmations are used less frequently by auditors than accounts receivable confirmations.

TRUE

After the controls are tested, the auditor sets the achieved level of control risk.

TRUE

Analytical procedures can be used to examine the reasonableness of accounts payable and accrued expenses.

TRUE

Because of the low volume of purchase return transactions, the auditor normally does not test the controls associated with these transactions.

TRUE

Product costs should be matched directly with specific transactions and are recognized upon recognition of revenue.

TRUE

The accounts payable department is responsible for ensuring that all vendor invoices, cash disbursements, and adjustments are recorded in the accounts payable records.

TRUE

The principal business objectives of the purchasing process are acquiring goods and services and paying for those goods and services.

TRUE

Which of the following test(s) of details of transactions can be used as a dual-purpose test in conjunction with tests of controls?

Test a sample of purchase requisitions for proper authorization.

Tests of controls for the occurrence assertion for purchases include all of the following except:

Tracing a sample of vouchers to purchases journal.

The accounts payable department receives the purchase order form to accomplish all of the following except to:

Ensure that the goods had been received by the party requesting the goods.

Operating control over the check signature plate normally should be the responsibility of the

Treasurer.

An auditor performs a test to determine whether all merchandise was received for which the entity was billed. The population for this test consists of all

Vendors' invoices.

An examination of the balance in the accounts payable account is ordinarily not designed to

Verify that accounts payable were properly authorized.

Which of the following procedures would an auditor most likely perform in searching for unrecorded liabilities?

Vouch a sample of cash disbursements recorded just after year-end to receiving reports and vendor invoices.

Assertions about account balances at the period end include

Existence, rights and obligations, and completeness.

Which of the following describes a temporary difference?

A timing difference between the recognition of revenue or expense under GAAP and tax purposes.

Listed below are the major functions of the purchasing process. 1) Purchasing function. 2) General ledger function. 3) Invoice-processing function. 4) Disbursement function. 5) Accounts payable function. 6) Requisition and receiving function. Name four pairs of functions that should be segregated from each other and explain why the segregation is important.

1 should be separated from 6 - An individual who performs both of these duties can easily make fictitious purchases and steal cash. 2 should be separate from 5 - The segregation of these duties makes it difficult to cover up defalcation of the company's records. 3 should be separated from 5 - This segregation prevents an individual from overpaying for goods received and stealing cash. 4 should be separated from 5 - Unauthorized transactions can be made by an individual with control over both of these functions. This can lead to unauthorized checks being written and the individual stealing cash.

Identify whether the following tests are substantive analytical procedures, tests of details of transactions, or tests of details of account balances: 1) Test a sample of purchase requisitions for proper authorization. 2) Test transactions around year-end to determine if they are recorded in the proper period. 3) Review results of confirmation of selected accounts payable. 4) Compare payables turnover to previous years' data. 5) Obtain selected vendors' statements and reconcile to vendor accounts. 6) Compare purchase returns and allowances as a percentage of revenue or cost of sales to industry data.

1) Tests of details of transactions. 2) Tests of details of transactions. 3) Tests of details of account balances. 4) Substantive analytical procedures. 5) Tests of details of account balances. 6) Substantive analytical procedures.

There are several important disclosure items to consider when auditing the purchasing process. Discuss what they are and why they are important.

1. Payables by type. This allows the user to determine how much of the payables relate to the normal trade or business compared to other payables (i.e. employees). 2. Short and long-term payables. Accounts found in a classified balance sheet. 3. Long-term purchase contracts, including any unusual purchase commitments. This requirement is to inform the users of what the agreement entails and can help them make decisions about the company. 4. Related-party transactions. These transactions must be identified separately on the financial statements, since they are not made at arms-length and are considered differently by potential users of the financial statements. 5. Dependence on a single vendor or a small number of vendors. This is to inform the users how much exposure the company would have if a significant vendor were to become unavailable for some reason. 6. Costs by reportable segment of the business. This would allow the users to evaluate separate segments of the entity individually.

Match the test of controls described below to the appropriate assertion it is used to test.

1. Review entity's competitive bidding procedures Cutoff 5 2. Review the cash disbursements journal for reasonableness of account distribution Accuracy 6 3. Test a sample of vouchers for the presence of authorized purchase order and receiving report Authorization 1 4. Trace a sample of receiving reports to their respective vendor invoices and vouchers Occurrence 3 5. Compare the dates on the receiving reports with the dates of the relevant vouchers Completeness 4 6. Review monthly bank reconciliations Classification 2

Describe three categories of expenses outlined in FASB Concept Statement No. 5.

1. The first type of expense is a product cost. These costs can be directly matched to specific transactions or events and are recognized upon recognition of revenue. 2. The second type of expense is a period cost. These are expenses recognized during the period in which cash is spent or liabilities are incurred for goods and services to be used up within a short amount of time. 3. The last type of expense includes those that are allocated systematically and rationally to the period during which the related assets are expected to provide benefits.

Which of the following describes a permanent difference?

A fundamental difference in what constitutes revenue or expense for GAAP and tax purposes.

An entity's procurement system ends with the assumption of a liability and the eventual payment of the liability. Which of the following best describes the auditor's primary concern with respect to liabilities resulting from the procurement system?

Accounts payable are not materially understated.

The audit procedures used to verify accrued liabilities differ from those employed for the verification of accounts payable because

Accrued liabilities usually pertain to services of a continuing nature, while accounts payable are the result of completed transactions.

Which of the following audit procedures is least likely to detect an unrecorded liability?

Analysis and recomputation of depreciation expense.

The auditor can often obtain sufficient appropriate evidence in the audit of a tax provision without the use of a specialist. However, several situations may indicate a need for the auditor to involve a tax specialist. Identify three of these situations.

Answers should include three of the following: 1. Multiple locations with significant foreign operations and related foreign tax credits/deductions. 2. Business combinations and/or subsidiary dispositions. 3. Material uncertain income tax positions with a governmental authority. 4. Significant changes in ownership, business operations, or tax status. 5. Significant deferred tax assets for which the future realization of the recorded value is in question.

The authority to accept incoming goods in receiving should be based on a(an)

Approved purchase order.

Which of the following questions would most likely be included in an internal control questionnaire concerning the completeness assertion for purchases?

Are purchase orders, receiving reports, and vouchers prenumbered and periodically accounted for?

Which type of confirmation is used more frequently by auditors―accounts receivable confirmations or accounts payable confirmations? Why?

Auditors typically use confirmations for accounts receivable rather than accounts payable because of the reliability of other evidence. To test accounts payable, the auditor can examine vendor invoices and vendor statements. These documents originate from sources outside of the entity being audited and are therefore considered very reliable. Documentation for accounts receivable is normally generated within the entity, so confirmations provide a more reliable way of testing these accounts.

Accounts payable confirmations are used to test

Both the existence and completeness audit assertions.

An entity's internal control requires that for every check request there be an approved voucher, supported by a prenumbered purchase order and a prenumbered receiving report. To determine whether checks are being issued for unauthorized expenditures, an auditor most likely would select items for testing from the population of all

Canceled checks.

When searching for unrecorded liabilities at year-end, the population identified for sampling would be

Cash disbursements recorded in the period subsequent to year-end.

The cash disbursements journal is also called the

Check register.

As an in-charge auditor, you are reviewing a summary of control weaknesses in cash disbursement procedures. Which one of the following weaknesses, standing alone, should cause you the least concern?

Checks are signed by only one person.

Which of the following procedures would an auditor most likely perform in searching for unrecorded payables?

Compare cash payments occurring after the balance sheet date with the accounts payable trial balance.

If payables turnover has increased significantly since the prior year, this is an indication that which of the following assertions for accounts payable might be violated?

Completeness.

In auditing accounts payable, an auditor's procedures most likely would focus primarily on management's assertion of

Completeness.

Which of the following control activities is not usually performed in the accounts payable department?

Controlling the mailing of the check and remittance advice.

Tests designed to detect purchases made before the end of the year that have been recorded in the subsequent year most likely would provide assurance about management's assertion of

Cutoff.

An auditor traced a sample of purchase orders and the related receiving reports to the purchases journal and the cash disbursements journal. The purpose of this substantive procedure most likely was to

Determine that purchases were properly recorded.

The occurrence assertion for accounts payable includes

Determining whether all accounts payable actually are liabilities.

The cutoff assertion for accounts payable includes

Determining whether all accounts payable are recorded in the proper period.

Which of the following is the most effective control activity to detect vouchers prepared for the payment of goods that were not received?

Matching of purchase order, receiving report, and vendor invoice for each voucher in the accounts payable department.

An auditor compares information on canceled checks with information contained in the cash disbursements journal. The objective of this test is to determine that

No discrepancies exist between the data on the checks and the data in the journal.

Listed below are six assertions regarding the financial presentations made in the purchasing process. For each, give an example of how an auditor could use one of the typical documents in the purchasing process to test the assertion. Occurrence Completeness Authorization Accuracy Cutoff Classification

Occurrence - The receiving report provides evidence regarding the occurrence assertion. This document records the receipt of goods. The auditor can test vouchers for the presence of an authorized receiving report to ensure that goods were actually received. Completeness - The auditor can use the entity's vouchers and vendor invoices to test for completeness. In this case, the auditor will start with these documents and trace them to the purchases journal. This will provide assurance that all purchased items have been recorded. Authorization - One example of a document used to test authorization is the purchase requisition form. This form is used to request goods or services for an authorized individual. The auditor can check that all purchase requisitions have been properly approved by reviewing these documents for authorization. This can be an important step in testing controls. Accuracy - To test accuracy, an auditor can recalculate the amounts listed on the vendor invoice. This will help ensure that the proper amounts were paid and recorded in the journals. Cutoff - The dates on the receiving reports and the dates on the vouchers can be compared with the dates in the purchases journal to test that the purchase transactions were recorded in the proper period. Classification - The purchases journal is used to test for proper classification through an auditor's review of the journal. The journal provides details about each of the transactions made and to which accounts the transactions were posted.

Assertions about classes of transactions and events for the period under audit include

Occurrence, completeness, and cutoff.

In assessing control risk for purchases, an auditor vouches a sample of entries in the voucher register to the supporting documents. Which assertion would this test of controls most likely support?

Occurrence.

Which of the following procedures relating to the examination of accounts payable could the auditor delegate entirely to the entity's employees?

Prepare a schedule of accounts payable.

Budd, the purchasing agent for Lake Hardware Wholesalers, has a relative who owns a retail hardware store. Budd arranged for hardware to be delivered by manufacturers to the retail store on a C.O.D. basis, thereby enabling his relative to buy at Lake's wholesale prices. Budd was probably able to accomplish this because of Lake's poor internal control over

Purchase orders.

Which of the following accounts is not affected by cash disbursement transactions?

Purchase returns.

Purchase cutoff procedures should be designed to test whether or not all inventory

Purchased and received before the year-end was recorded before year-end.

With respect to a small company's system of purchasing supplies, an auditor's primary concern should be to obtain satisfaction that supplies ordered and paid for have been

Received, counted, and checked to quantities and amounts on purchase orders and invoices.

For effective internal control, the accounts payable department should compare the information on each vendor's invoice with the

Receiving report and the purchase order.

To determine whether accounts payable are complete, an auditor performs a test to verify that all merchandise received is recorded. The population of documents for this test consists of all

Receiving reports.

A product cost is

Recognized in the period during which related revenue is recognized.

When an auditor selects a sample of items from the vouchers payable register for the last month of the period under audit and traces these items to underlying documents, the auditor is gathering evidence primarily in support of the assertion that

Recorded obligations were valid.

A debit memo

Reduces the amount of accounts payable due to a vendor.

The auditor is most likely to verify accrued commissions payable in conjunction with the

Sales cutoff review.

An internal control questionnaire indicates that an approved receiving report is required to accompany every check request for payment of merchandise. Which of the following procedures provides the greatest assurance that this control is operating effectively?

Select and examine canceled checks and ascertain that the related receiving reports are dated no later than the checks.

Substantive procedures to examine the cutoff assertion for accounts payable include

Selecting a sample of receiving reports around year-end and comparing dates on related vouchers to dates in the purchases journal.

The key inherent risk factors an auditor must consider when auditing the purchasing process are industry factors. Which two are most important and why?

The adequacy of the supply of raw materials is important to consider. If there is a shortage of key materials, it could significantly affect the financial performance of the organization. The stability of the price of raw materials is also important. An increase in the price of materials increases the cost to make the product. If the company cannot raise its prices to match the increase, the company's earnings will suffer.

Identify the types of substantive procedures used by the auditor to test accounts payable and accrued expenses. Provide an example of how the auditor may use each substantive procedure. Identify if any of the substantive procedures can be used as a test of controls or a dual-purpose test.

The auditor uses substantive procedures to detect material misstatements in accounts payable and related accounts. There are two categories of substantive procedures: (1) substantive analytical procedures and (2) tests of details of account balances and disclosures. 1. Substantive analytical procedures are used to examine plausible relationships among accounts payable and related accounts. Example: The auditor might compare payables turnover and days outstanding in accounts payable to previous years' and industry data or purchase returns or amounts owed to individual vendors in the current year's accounts payable listing to amounts owed in prior years. 2. Tests of details focus on transactions, account balances, or disclosures. In the purchasing cycle, tests of details of transactions (also called substantive tests of transactions) focus mainly on the purchases and cash disbursement transactions. Examples: To test the occurrence assertion about a purchase, the auditor can test a sample of vouchers for the presence of an authorized purchase order and receiving report. To test the completeness assertion, the auditor can trace a sample of vouchers to the purchases journal. Tests of details of account balances concentrate on the detailed amounts or estimates that make up the ending balance for accounts payable and accrued expenses. Example: To test the existence assertion about purchases, the auditor can vouch selected amounts from the accounts payable listing and schedules for accruals to voucher packets or other supporting documentation. Tests of details of disclosures are concerned with the presentation and disclosures related to accounts payable and accrued expenses. Example: To test the completeness assertions about accounts payable and accrued expenses, the auditor can complete a financial reporting checklist to ensure that all financial statement disclosures related to accounts payable and accrued expenses have been appropriately disclosed. Tests of details of transactions (substantive tests of transactions) can be used as a test of controls or a dual-purpose test. However, if the tests of controls indicate that the controls are not operating effectively, the auditor may need to test transactions at the date the account balance is tested.

Which of the following is an internal control that would prevent a paid disbursement voucher from being presented for payment a second time?

The official signing the check should compare the check with the voucher and should "cancel" the voucher documents by marking them "paid."

An important primary purpose of the auditor's review of the entity's procurement system should be to determine the effectiveness of the activities to protect against

Unauthorized persons issuing purchase orders.

Unrecorded liabilities are most likely to be found during the review of which of the following documents?

Unpaid bills.

Which of the following is a substantive procedure that an auditor most likely would perform to verify the existence of recorded accounts payable?

Vouching selected entries in the accounts payable subsidiary ledger to purchase orders and receiving reports.