ACCTG 403W CH 18 Audit of the acquisition and payment cycle: tests of controls, substantive tests of transactions, and AP

out of period liability tests

Because auditors are concerned with understatement of liabilities, the following tests are perform ___, also called search for unrecorded AP.

AP master file

records acquisitions, cash disbursements, and acquisition returns and allowances transactions for each vendor. The master file is updated from the acquisition, returns and allowances, and cash disbursement computer transaction files.

1. Processing purchase orders 2. receiving goods and services 3. recognizing the liability 4. processing and recording cash disbursement

What are the 4 business functions involved in the acquisitions and payment cycle?

completeness and accuracy

(1) Select a random sample of receiving reports and trace them to related​ vendors' invoices and acquisitions journal​ entries, comparing the​ vendor's name, type of material and quantity​ acquired, and total amount of the acquisition.​ What does this test for?

cash disbursements

Accounts: cash in bank, AP, and purchase discounts Business functions: processing and recording cash disbursements What class of transaction?

Acquisition

Accounts: inventory, PPE, prepaid expenses, leasehold improvements, AP, manufacturing expenses, selling expenses, administrative expenses Business functions: processing purchase orders, receiving goods and services, and recognizing the liability What class of transaction?

accuracy

Acquisitions are accurately recorded.

classification

Acquisitions are correctly classified.

1. authorization of purchases 2. separation of asset custody from other functions 3. timely recording and independent review of transactions 4. authorization of payments

What are the 4 key internal controls for the business functions in acquisition and payment cycle that affect the planned control risk?

Acquisition transaction file

this is computer-generated file that includes all acquisition transactions processed by the accounting system for a period, such as a day, week, or month. The file contains all information entered into the system and includes information for each transaction such as vendor name, date, amount, account classification, and description and quantity of goods and services purchased. The file can also include purchase returns and allowances or there can be a separate file for those transactions.

detail tie in

AP in the AP list agree with related master file, and the total is correctly added and agrees with the general ledger. What balance related audit objective?

accuracy

AP in the AP list are accurate. What balance related audit objective?

classification

AP in the AP list are correctly classified. What balance related audit objective?

existence

AP in the AP list exist. What balance related audit objective?

occurrence completeness accuracy classification

What 4 of the 6 transaction related audit objectives should be examined more closely?

1. acquisitions of goods and services 2. cash disbursements 3. purchase returns and allowances and purchase discounts

What are the 3 classes of transactions in the acquisition and payment cycle?

occurrence and accuracy

(2) Select a random sample of acquisitions journal entries and trace them to related​ vendors' invoices and receiving​ reports, comparing the​ vendor's name, type of material and quantity​ acquired, and total amount of the acquisition. What does this test for?

Out of period liability tests

- examine underlying documentation for subsequent cash disbursements - examine underlying documentation for bills not paid several weeks after year end - trace receiving reports issued before year end to related vendor's invoices - trace vendor's statements that show a balance due to the AP trial balance - send confirmations to vendors with which the client does business - cutoff tests - to determine whether transactions recorded a few days before and after the balance sheet date are included in the correct period - relationship of cutoff to physical observation of inventory - cutoff tests must be coordinated with the physical observation of inventory to determine that both the asset and liability are recorded in the proper period - inventory in transit - determine whether inventory in transit at year end was FOB destination or FOB origin

Accounts in the acquisition and payment cycle

1. cash 2. AP 3. purchase discounts 4. purchase returns and allowances 5. raw material purchases 6. PPE 7. Prepaid expenses 8. Administrative expense (control account) 9. Selling expense (control account) 10. manufacturing expense (control account)

vendor's invoice vendors' statement

A ___ states the amount of goods shipped, the price, and other details. It is the vendor's bill. A ____ contains the individual open items and the ending balance due in the account.

4. determine that purchases were properly recorded.

An auditor traced a sample of purchase orders and the related receiving reports to the acquisitions journal and cash disbursements journal. The purpose of this substantive test of transactions most likely was to 1. identify unusually large purchases that should be investigated further. 2. verify that cash disbursements were for goods actually received. 3. test whether payments were for goods actually ordered. 4. determine that purchases were properly recorded.

completeness

Existing AP are included in the AP list. What balance related audit objective?

completeness

Existing acquisitions are recorded.

C. The use of a voucher system improves control over the recording of purchases by facilitating the recording in numerical order at the earliest possible​ date, which is the point at which the invoice is received.

Explain how its use can improve an​ organization's internal controls. A. The use of a voucher system improves control over the bank statement by preventing the use of unauthorized checks. B. The use of a voucher system improves control over cash disbursements by providing a reconciliation of recorded cash disbursements with cash disbursements on the bank statement for a test period. C. The use of a voucher system improves control over the recording of purchases by facilitating the recording in numerical order at the earliest possible​ date, which is the point at which the invoice is received. D. The use of a voucher system improves control over the recording of purchases by providing detailed information of vendor​ prices, discount rates and payment policies.

vendor's invoice vendor's statement

Ideally, the ___ should be used as evidence in auditing acquisition transactions. A ___ is not as meaningful as ___ to verify individual transactions because a statement includes only the total amount of the transactions and not the details making up the shipment.

C. Compare acquisition-related expense account balances with prior years F. Calculate the ratio of purchases to AP< and compare with prior year

Identify two types of substantive analytical procedures an auditor may perform in testing purchases. A. Examine indication of approval. B. Examine indication of internal verification. C. Compare​ acquisition-related expense account balances with prior years. D. Trace from a file of​ vendors' invoices to the acquisitions journal. E. Account for a sequence of purchase orders. F. Calculate the ratio of purchases to accounts​ payable, and compare with prior year.

D. Without​ prenumbering, unauthorized and unrecorded checks may be more easily issued without detection until after they have cleared the bank.

If an audit client does not have prenumbered​ checks, what type of misstatement has a greater chance of​ occurring? A. Without​ prenumbering, the accounting staff may not record the checks in the proper order. B. Without​ prenumbering, there is no way to determine whether the checks have cleared the bank. C. Without​ prenumbering, the expense recognition may be recorded in the wrong accounting period. D. Without​ prenumbering, unauthorized and unrecorded checks may be more easily issued without detection until after they have cleared the bank.

Determine extent of tests of controls

If the auditor intends to rely on controls to support a preliminary control risk assessment below maximum, the auditor performs tests of controls to obtain evidence that controls are operating effectively.

Attributes sampling for tests of controls and substantive tests of transactions

Important differences in acquisition and payment cycle: - a larger number of accounts involved in this cycle, including both income statement and balance sheet accounts - more common for transactions to require significant judgement, such as for leases and construction costs - dollar amounts of individual transactions in the cycle cover a wide range

2. Occurrence

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? 1.Completeness 2. Occurrence 3.Rights and obligations 4.Valuation and allocation

3. completeness.

In auditing accounts​ payable, an​ auditor's procedures most likely will focus primarily on​ management's assertion of 1. valuation and allocation. 2. realizable value. 3. completeness. 4. existence.

A. It is important that the cutoff of accounts payable be coordinated with that of the physical inventory to determine that they are established at the same point in time. If these cutoffs are not​ consistent, goods may be counted in the physical inventory for which no liability in accounts payable has been​ recorded, or vice versa. Such a situation would result in an understatement of accounts payable and cost of goods sold or an overstatement of these two​ accounts, respectively.

In testing the cutoff of accounts payable at the balance sheet​ date, explain why it is important that auditors coordinate their tests with the physical observation of inventory. A. It is important that the cutoff of accounts payable be coordinated with that of the physical inventory to determine that they are established at the same point in time. If these cutoffs are not​ consistent, goods may be counted in the physical inventory for which no liability in accounts payable has been​ recorded, or vice versa. Such a situation would result in an understatement of accounts payable and cost of goods sold or an overstatement of these two​ accounts, respectively. B. It is important that the cutoff of accounts payable be coordinated with that of the physical inventory to determine that they are established at different points in time. If these cutoffs are the​ same, goods may be counted in the physical inventory more than once and the liability in accounts payable would be duplicated as well. Such a situation would result in an overstatement of accounts payable and cost of goods sold. C. It is important that the cutoff of accounts payable be coordinated with that of the physical inventory to ensure that all inventory in storage is priced correctly. D. It is important that the cutoff of accounts payable be coordinated with that of the physical inventory to maximize the efficiency of the audit and keep audit fees to a minimum.

understate

In verifying AP< the auditor assumes that the client is more likely to ___ AP, and therefore concentrates on the vendors with whom the client deals actively, especially if that vendor's balance appears to be lower than normal at the confirmation date.

overstate

In verifying AR, the auditor assumes that the client is more likely to ___ account balances, and therefore concentrates more on the larger dollar balances and is not as concerned with zero balances.

Processing purchase orders

Includes a purchase requisition which is used to request authorization for goods or services and a purchase order which is used for the order after it has been authorized.

Receiving goods and services

Includes a receiving report which is prepared at the time the goods are received

2. Assess planned control risk

Key internal controls for the business functions in this cycle are: - authorization of purchases - separation of asset custody from other functions - timely recording and independent review of transactions - authorization of payments

Design tests of controls and substantive tests of transactions for acquisitions and cash disbursements

Key internal controls, common tests of controls, and common substantive tests of transactions for each transaction-related audit objective

Recognizing the liability

Proper recognitions requires prompt and accurate recording. Documents that may be involved: 1. vendor's invoice - document from the vendor that shows the amount owed for an acquisition 2. debt memo - also from the vendor; indicates a reduction in the amount owed 3. voucher - a formal means of recording and controlling acquisitions 4. acquisitions transaction file - computer generated file including all acquisitions transactions 5. Acquisitions journal or listing - often referred to as the purchases journal; includes vendor name, date, amount, and account classification 6. accounts payable master file - records acquisitions, cash disbursements, and acquisition returns and allowances for each vendor 7. accounts payable trial balance - a listing of the amount owed each vendor at a point in time 8. Vendor's statement - document prepared monthly by the vendor that indicates the beginning balance, acquisitions, returns and allowances, payments to the vendor, and ending balance

occurrence

Recorded acquisitions are for goods and services received, consistent with the best interests of the client.

Unrecorded or non-existent accounts, or misstatements

Substantive analytical procedure: Calculate ratios, such as purchases divided by AP, and AP divided by current liabilities. Possible misstatement?

misstatement of AP and expenses

Substantive analytical procedure: Compare acquisition-related expense account balances with prior years. Possible misstatement?

Unrecorded or non-existent accounts, or misstatements

Substantive analytical procedure: Compare individual accounts payable with previous year. Possible misstatement?

Classification misstatement for nontrade liabilities

Substantive analytical procedure: Review list of AP for unusual, nonvendor, and interest bearing payables. Possible misstatement?

vendor's statement statement

The ___ can be used to verify the correct balance in AP for an individual vendor. The ___ contains the ending balance and the individual transactions required to reconcile the AP listings and determine the propriety of the balances shown for individual vendors.

1. Understand internal control

The auditor gains an understanding of internal control for the acquisition and payment cycle as part of performing risk assessment procedures.

4. approved purchase order.

The authority to accept incoming goods in receiving should be based on​ a(n) 1. ​vendor's invoice. 2. purchase requisition. 3. bill of lading. 4. approved purchase order.

Obligations

The company has an obligation to pay the liabilities included in AP. What balance related audit objective?

AR, inventory, fixed assets, AP, and expense accounts acquisition and payment

The most time consuming accounts to verify by tests of details of balances are __,__,__,__,and __. Four of these are directly related to the ___ and ___ cycle. - If the auditor can reduce the tests of details of the account balances by using tests of controls and substantive tests of transactions for acquisitions and cash disbursements, the time saved can be dramatic.

Processing and recording cash disbursements

The payment for goods and services represent a significant activity for all entities. Documents that auditors examine associated with this activity: 1. check - document used to pay for an acquisition; may be paper or an electronic funds transfer (EFT) 2. Cash disbursements transaction file - a computer generated file that includes all cash disbursement transaction processed during a period 3. cash disbursements journal or listing - includes all disbursement transactions for a period

B. title to the goods and services passes and a liability that should be included in the financial statements is established.

The point at which goods and services are received is ordinarily when A. a purchase order is completed. It is at this point that the company first recognizes the acquisition and related liability on their records. B. title to the goods and services passes and a liability that should be included in the financial statements is established. C. a purchase requisition is issued. Once a requisition is issued a liability and an intent to pay is established. D. payment is made and the purchase and related liability are guaranteed.

analytical procedures

The use of ___ is as important in the acquisition and payment cycle as it is in every other cycle, especially for uncovering misstatements in AP.

cutoff

Transactions in the acquisition and payment cycle are recorded in the proper period. What balance related audit objective?

A. The auditor can compensate for poor control over checks by reconciling recorded cash disbursements with cash disbursements on the bank statement for a test period.

Under the​ circumstances, what audit procedure can the auditor use to compensate for the​ deficiency? A. The auditor can compensate for poor control over checks by reconciling recorded cash disbursements with cash disbursements on the bank statement for a test period. B. The auditor can compensate for poor control over checks by counting the unused checks in the​ company's safe. C. The auditor can compensate for poor control over checks by tracing a check from the receiving report to the acquisitions journal. D. The auditor can compensate for poor control over checks by footing the journals and tracing the posting to the general ledger and account payable and inventory master files.

1. Understand internal control - acquisitions and cash disbursements 2. Assess planned control risk - acquisitions and cash disbursements 3. Determine extent of tests of controls 4. Design tests of controls and substantive tests of transactions for acquisitions and cash disbursements to meet transaction related audit objectives - audit procedures - sample size - items to select - timing

What are the 4 steps behind the methodology for designing tests of controls and substantive tests of transactions for the acquisition and payment cycle?

1. identify significant risks and assess risk of material misstatement for AP 2. set performance materiality 3. assess control risk for the acquisition and payment cycle 4. design and perform tests of controls and substantive tests of transactions for the acquisition and payment cycle (phase II) 5. Design and perform substantive analytical procedures for AP (phase III) 6. Design tests of details of AP to satisfy balance-related audit objectives (phase III) - audit procedures - sample size - items to select - timing

What are the 6 steps in the methodology for designing tests of details of balances for AP?

A. During the physical​ inventory, the auditor should gather cutoff information​ (such as the last several receiving reports and shipping​ documents) to assist in the determination that an accurate cutoff was established.

What can the auditor do during the physical inventory to enhance the likelihood of an accurate​ cutoff? A. During the physical​ inventory, the auditor should gather cutoff information​ (such as the last several receiving reports and shipping​ documents) to assist in the determination that an accurate cutoff was established. B. During the physical​ inventory, the auditor should document the staff that was on hand for the physical inventory to assist in the determination that an accurate cutoff was established. C. During the physical​ inventory, the auditor should gather a current price list to assist in the determination that an accurate cutoff was established. D. During the physical​ inventory, the auditor should photograph inventory that is being valued to assist in the determination that an accurate cutoff was established.

D. A voucher is a document used by an organization to establish a formal means of recording and controlling acquisitions. A voucher register is a journal for recording the vouchers for the acquisition of goods and services.

What is meant by a​ voucher? A. A voucher is a document received from the vendor and shows the amount owed for an acquisition. It indicates the description and quantity of goods and services​ received, price​ (including freight), cash discount​ terms, date of the billing and total amount. B. A voucher is a document prepared monthly by the vendor and indicates the beginning​ balance, acquisitions, returns and​ allowances, payments to the​ vendor, and ending balance. These balances and activities are the​ vendor's representations of the transactions for the​ period, not the​ client's. C. A voucher is a document received from the vendor that indicates a reduction in the amount owed to a vendor because of returned goods or an allowance granted. It supports reductions in accounts payable. D. A voucher is a document used by an organization to establish a formal means of recording and controlling acquisitions. A voucher register is a journal for recording the vouchers for the acquisition of goods and services.

- vendors' statements have been prepared by the vendor, but is in the hands of the client - confirmations are sent by the auditor and responses from the vendor are sent directly to the auditor, and are therefore more reliable

What is the difference between vendors' statements and confirmations?

In auditing assets, auditors are concerned about overstatements. In auditing liabilities, auditors are concerned about understatements.

What is the difference in emphasis in auditing assets and liabilities?

Vendors' invoices and supporting documents provide reliable evidence about individual transactions. The Vendor's statement is superior for verifying AP because it includes the ending balance.

What is the distinction between vendors' invoices and vendors' statements?

To determine whether the AP balance is fairly stated and properly disclosed.

What is the overall objective in the audit of AP?

4. vendors with whom the entity has previously done business.

When using confirmations to provide evidence about the completeness assertion for accounts​ payable, the appropriate population most likely is 1. invoices filed in the​ entity's open invoice file. 2. amounts recorded in the accounts payable subsidiary ledger. 3. payees of checks drawn in the month after​ year-end. 4. vendors with whom the entity has previously done business.

4. Reviewing cash disbursements recorded subsequent to the balance sheet date to determine whether the related payables apply to the prior period

Which of the following audit procedures is best for identifying unrecorded trade accounts​ payable? 1. Examining unusual relationships between monthly accounts payable balances and recorded cash payments 2. Investigating payables recorded just prior to and just subsequent to the balance sheet date to determine whether they are supported by receiving reports 3. Reconciling​ vendors' statements to the file of receiving reports to identify items received just prior to the balance sheet date 4. Reviewing cash disbursements recorded subsequent to the balance sheet date to determine whether the related payables apply to the prior period

2. The official signing the check compares the check with the documents and should deface the documents.

Which of the following is an internal control that will prevent paid cash disbursement documents from being presented for payment a second​ time? 1. Unsigned checks are prepared by individuals who are responsible for signing checks. 2. The official signing the check compares the check with the documents and should deface the documents. 3. Cash disbursement documents are approved by at least two responsible management officials. 4. The date on cash disbursement documents must be within a few days of the date that the document is presented for payment.

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

Which of the following questions would be best to include in an internal control questionnaire concerning the completeness assertion for​ purchases? 1. Is an authorized purchase order required before the receiving department can accept a shipment or the vouchers payable department can record a​ voucher? 2. Are purchase requisitions prenumbered and independently matched with vendor​ invoices? 3. Is the unpaid voucher file periodically reconciled with inventory records by an employee who does not have access to purchase​ requisitions? 4. Are purchase​ orders, receiving​ reports, and vouchers prenumbered and periodically accounted​ for?

4. Send out accounts payable confirmations.

Which of the following tests would an auditor be least likely to perform during an audit of accounts​ payable? 1. Trace a sample of vouchers to the purchase journal. 2. Examine open​ vouchers, receiving​ reports, and vendor invoices shortly after the​ year-end. 3. Select cash disbursements made shortly after​ year-end and examine supporting documentation such as receiving reports and vendor invoices. 4. Send out accounts payable confirmations.

1. cutoff assertion.

While auditing a​ client's purchase​ transactions, an auditor selects a sample of vouchers and then compares the dates on the vouchers to the dates on which the corresponding transactions were actually recorded in the​ client's purchase journal. The audit procedure is most likely designed to test the 1. cutoff assertion. 2.completeness assertion. 3.occurrence assertion. 4.accuracy assertion.

AP trial balance

includes the amount owed to each vendor or for each invoice or voucher at a point in time. It is prepared directly from the AP master file.

Vendor's statement

is a document prepared monthly by the vendor that indicates the beginning balance, acquisitions, returns and allowances, payments to the vendor, and ending balance. Except for disputed amounts and timing differences, the client's AP master file should be the same as the vendor's statement.

Vendor's invoice

is a document received from the vendor and shows the amount owed for an acquisition. It indicates the description and quantity of goods and services received, price, cash discount terms, date of billing, and total amount. The vendor's invoice is important because it indicates the amount recorded in the acquisition transaction file.

purchase order

is a document used to order goods and services from vendors. It includes the description, quantity, and related information for goods and services the company intends to purchase and is often used to indicate authorization of the acquisition.

Debit memo

is also a document received from the vendor and indicates a reduction in the amount owed to a vendor because of returned goods or an allowance granted.

Voucher

is commonly used by organizations to establish a formal means of recording and controlling acquisitions, primarily by enabling each acquisition transaction to be sequentially numbered. Vouchers include a cover sheet or folder for containing documents and a package of relevant documents such as the purchase order, copy of the packing slip, receiving report, and vendor's invoice

purchase requisition

is used to request goods and services by an authorized employee

Check

o This document is commonly used to pay for the acquisition when payment is due. o Most companies use computer-prepared checks based on information included in the acquisition transactions file at the time goods and services are received o In most cases, individual checks are recorded in a cash disbursement transaction file o After a check includes the signature of an authorized person, it is an asset o When cashed by the vendor and cleared by the client's bank, it is called a cancelled check At that point it is no longer an asset, but not is a document

Cash disbursements journal or listing

o This is a listing or report generated from the cash disbursements transaction file that includes all transactions for any time period o The same transactions, including all relevant information, are included in the AP master file and general ledger

Cash disbursement transaction file

o This is computer generated file that includes all cash disbursements transactions processed by the accounting system for a period, such as a day, week, or month.

Acquisition journal

often referred to as the purchases journal, is generated from the acquisitions transaction file and typically includes the vendor name, date, amount, and account classification or classifications for each transaction, such as repair and maintenance, inventory, or utilities. It also identifies whether the acquisition was for cash or AP