Audit_Chapter 14

What are accrued liabilities?

represent obligations payable sometime during the succeeding period for services or privileges received before the balance sheet date represent accounting estimates made by the client of amounts that will subsequently become payable.

How do auditors assess the risk of material misstatement?

Based on their understanding of the client and its environment, including internal control over accounts payable.

How do auditors test for unrecorded liabilities?

In addition to the prior audit steps, when searching for unrecorded accounts payable the auditors will examine transactions that were recorded following year-end. A comparison of cash payments occurring after the balance sheet date with the accounts payable trial balance is generally the most effective means of disclosing unrecorded accounts payable. All liabilities must eventually be paid and will, therefore, be reflected in the accounts at least by the time they are paid.

A/P vs A/R

a recognition that the self-interest of creditors constitutes an effective control in accounting for payables that is not present in the case of accounts receivable.

Test of Controls A/P

a. Verify a sample of postings to the accounts payable control account. b. Vouch to supporting documents a sample of postings in selected accounts of the accounts payable subsidiary ledger. c. Test IT application controls.

What are some controls that the auditors may expect to find in a well-managed accounts payable department?

the monthly balancing of the detailed records of accounts payable (or vouchers) to the general ledger control account. These reconciliations should be preserved as evidence of the performance of this procedure and as an aid in locating any subsequent errors.

Describe the auditors' objectives in the audit of accounts payable

1. Use the understanding of the client and its environment to consider inherent risks, including fraud risks, related to accounts payable. 2. Obtain an understanding of internal control over accounts payable. 3. Assess the risks of material misstatement and design tests of controls and substantive procedures that: a. Substantiate the existence of accounts payable and the client's obligation to pay these liabilities, and establish the occurrence of purchase transactions. b. Establish the completeness of recorded accounts payable. c. Verify the cutoff of purchase transactions. d. Establish the proper valuation of accounts payable and the accuracy of purchase transactions. e. Determine that the presentation and disclosure of information about accounts payable are appropriate.

What is the purpose in preparing a trial balance of A/P?

One purpose of this procedure is to determine that the liability figure appearing in the balance sheet is in agreement with the individual items comprising the detailed records. A second purpose is to provide a starting point for substantive procedures. The auditors will use the list of vouchers or accounts payable to select a representative group of items for careful examination.

What Happens if Any Inherent Risk is Identified as Fraud?

The auditors will make certain that they understand the programs and controls established by management to control the risk. They will also determine that the controls have been implemented. Finally, the auditors will design appropriate responses to these fraud risks and all other risks of material misstatement.

What are other current liabilities?

a. Amounts withheld from employees' pay. b. Sales taxes payable. c. Unclaimed wages. d. Customers' deposits. e. Accrued liabilities.

A/P Working Papers

are a lead schedule for accounts payable, trial balances of the various types of accounts payable at the balance sheet date, and confirmation requests for accounts payable. In addition, the auditors may prepare a listing of unrecorded accounts payable discovered during the course of the audit

Risk Assessment of A/P

arise from business risks faced by management, such as: the risk of payment of unauthorized payables, and the failure to capture all accounts payable for financial reporting purposes.

What are we concerned with related to auditing accounts payable and other liabilities?

the auditors are primarily concerned with the possibility of understatement, or omission, of liabilities. An understatement of liabilities will exaggerate the financial strength of a company and conceal fraud just as effectively as an overstatement of assets. Furthermore, the understatement of liabilities is usually accompanied by the understatement of expenses and an overstatement of net income.

What additional evidence can an auditor obtain in testing the operating effectiveness of various controls?

the auditors may need to obtain additional evidence of the operating effectiveness of various controls. This evidence is obtained by performing tests of controls. In designing these tests, the auditors should decide which ones will result in sufficient reductions in substantive procedures to justify the time spent performing them.

How do auditors become familiar with a client's internal controls over A/P?

1. prepare a flowchart or to use flowcharts prepared by the client. 2. narrative description covering such matters as the independence of the accounts payable department and the receiving department from the purchasing department. 3. questionnaire to obtain a description of accounts payable controls. - Is an accounts payable trial balance prepared monthly and reconciled to the general ledger controlling account? - Are monthly statements from vendors reconciled with accounts payable ledgers or unpaid vouchers? - Are advance payments to vendors recorded as receivables and controlled in a manner that assures that they will be recovered by offset against vendors' invoices? - Are debit memos issued to vendors for discrepancies in invoice prices, quantities, or computations? - Are debit balances in vendors' accounts brought to the attention of the credit and purchasing departments?

How does an auditor design substantive procedures?

The auditors' assessment of control risk, along with their assessment of inherent risk, will be used to plan the nature, timing, and extent of substantive procedures for accounts payable. In designing planned substantive procedures, the auditors will consider potential misstatements that may occur and the weaknesses in control or other factors that make the misstatements more likely

How do auditors evaluate the reasonableness of accounting estimates?

a. Review and test management's process of developing the estimate. b. Review subsequent events or transactions bearing on the estimate. c. Independently develop an estimate of the amount to compare to management's estimate.

What are some potential sources of unrecorded liabilities?

a. Unmatched invoices and unbilled receiving reports. These documents are called work in process in a voucher system. The auditors should review such unprocessed documents at the balance sheet date to ascertain that the client has recorded an account payable where appropriate. b. Vouchers payable entered in the voucher register subsequent to the balance sheet date. Inspection of these records may uncover an item that should have been recorded as of the balance sheet date. c. Invoices received by the client after the balance sheet date. Not all vendors send invoices promptly when goods are shipped or services are rendered. Accordingly, the auditors' review of invoices received by the client in the subsequent period may disclose unrecorded accounts payable as of the balance sheet date. d. Consignments in which the client acts as a consignee. The consignee assumes liability for consigned merchandise when those goods have been sold to third parties. Those sales, especially shortly before the year-end, may not have been set up as a liability to the consignor. While the auditors' overall knowledge about the accounting for such consigned items will dictate the appropriate procedures, those related to the revenue cycle, such as tests of sales transactions around year-end, may reveal such sales.

How are vouchers, shipping documents, invoices, etc used in internal controls over accounts payable?

will prepare and approve the issuance of a purchase requisition that will be sent to the purchasing department. A copy of the purchase requisition will be filed numerically and matched with the subsequently prepared purchase order and finally with a copy of the receiving report. Purchasing Department The purchasing department, upon receiving the purchase requisition, will (1) determine that the item should be ordered and (2) select the appropriate vendor, quality, and price. Then, a serially numbered purchase order is issued to order the goods. Copies of the purchase order should be sent to stores, receiving, and the accounts payable department. Receiving Department The receiving department should be independent of the purchasing department. When goods are received, they should be counted and inspected. Receiving reports should be prepared for all goods received. These documents should be serially numbered and prepared in a sufficient number of copies to permit prompt notification of the receipt of goods to the stores department, the purchasing department, and the accounts payable department. A/P Department Within the accounts (vouchers) payable department, all forms should be stamped with the date received. Vouchers and other documents originating within the department can be controlled through the use of serial numbers. Each step in the verification of an invoice should be evidenced by entering a date and signature on the voucher. Comparison of the quantities listed on the invoice with those shown on the receiving report and purchase order prevents the payment of charges for goods in excess of those ordered and received. Comparison of the prices, discounts, and terms of shipment as shown on the purchase order and on the vendor's invoice provides a safeguard against the payment of excessive prices. Treasurer The separation of the function of invoice verification and approval from the function of cash disbursement is another step that tends to prevent errors and fraud. Before invoices are approved for payment, written evidence must be presented to show that all aspects of the transaction have been verified. The official who signs checks should stamp or perforate the voucher and supporting documents so that they cannot be presented to support payment a second time.3

What are the basic auditing steps for accrued liabilities?

a. Examine any contracts or other documents on hand that provide the basis for the accrual. b. Appraise the accuracy of the detailed accounting records maintained for this category of liability. c. Identify and evaluate the reasonableness of the assumptions made that underlie the computation of the liability. d. Test the computations made by the client in setting up the accrual. e. Determine that accrued liabilities have been treated consistently at the beginning and end of the period. f. Consider the need for accrual of other accrued liabilities not presently considered (that is, test completeness). g. For significant estimates, perform a retrospective analysis of the prior year's estimates for evidence of management bias.

Substantive Procedures A/P

a. Obtain or prepare a trial balance of accounts payable as of the balance sheet date and reconcile with the general ledger. (Valuation & Accuracy) b. . Vouch balances payable to selected creditors by inspection of supporting documents. (EOO) d. Reconcile liabilities with monthly statements from creditors. (EOO) e. Confirm accounts payable by direct correspondence with vendors. (EOO) f. Perform analytical procedures for accounts payable and related accounts. (AV) g. Search for unrecorded accounts payable. (ECT) h. Perform procedures to identify accounts payable to related parties. (Presentation & Disclosure) i. Evaluate proper balance sheet presentation and disclosure of accounts payable.

Work Performed in Verification of A/P

a. Use the understanding of the client and its environment to consider inherent risks, including fraud risks, related to accounts payable. b. Obtain an understanding of internal control over accounts payable. c. Assess the risks of material misstatement and design further audit procedures. d. Perform further audit procedures—tests of controls. d-2. If necessary, revise the risks of material misstatement based on the results of tests of controls. e. Perform further audit procedures—substantive procedures for accounts payable.

How do auditors determine whether controls have been implemented?

a. perform walk through of various purchase transactions b. they will observe and inquire about the segregation of duties for purchases and cash disbursements. c. inspect the various documents and reconciliations that are important to the client's internal control over accounts payable. For example, the reconciliations of monthly statements from vendors to the payables ledger will be inspected. d. Budgets for cash disbursements will be inspected and the auditors will review the evidence of the follow-up on variances from budgeted amounts of disbursements.