Chapter 14: Accounts Payable and Other Liabilities

Sources of Accrued Liabilities

Accumulate over time (and not a current period transaction) and management must make an accounting estimate at period-end - If management does not make such an estimate, no entry will occur since the related transactions (e.g., interest) may have occurred months ago Examples: Salaries, interest, rent, product warranty liability

Objectives for the Audit Accounts Payable and Purchases

Consider inherent risks, including fraud risks Consider internal control over accounts payables and purchases Substantiate the existence of recorded accounts payable and occurrence of purchases Establish the completeness of accounts payable and purchase transactions Determine that the client has obligations to pay the recorded accounts payable Determine that the valuation of accounts payable is in accordance with GAAP Determine that the presentation and disclosure of accounts payable and purchases are appropriate

Internal control weaknesses/ factors that increase risk of misstatement: Inaccurate recording of purchase/disbursement

Inadequate segregation of duties of recordkeeping & preparing cash disbursements/check signer does not review & cancel supporting docs Ineffective controls for matching invoices w/ receiving docs before disbursements are authorized

Steps in audit of AP: Step 2

Obtain an understanding of internal control over accounts payable.

Primary concern in auditing liabilities

Possibility of understatement or omission (unrecorded) of liabilities - Exaggerates the financial strength of company - Conceals fraud as effectively as overstatement of assets - Accompanied by understatement of expenses and overstatement of net income

Documents present in a voucher system that provides good internal control

Purchase order (PO) - Signed by authorized person Receiving report - Copy of PO w/o quantity => forces count when received -> matched w/ PO by AP dept Vendor's invoice Record liab once all three received Audit all three docs for matching items

Sources of Accounts Payable

Short-term obligations arising from purchase of goods and services in ordinary course of business; examples: - Acquisition of merchandise on credit - Receipt of services such as advertising, repairs Invoices and statements from suppliers usually evidence accounts payable Interest-bearing obligations are not included in accounts payable; they are included as bonds, notes, etc.

Factors Contributing to Risks of Material Misstatements in Liabilities

Subsidiary records not in agreement with general ledger Receiving reports and vouchers used haphazardly Purchase transactions often not recorded until payment is made Many accounts payable long past due

Documents Subject to Search for Unrecorded Liabilities

Unmatched invoices and unbilled receiving reports - If receiving report has been created -> associated liab should probably exist --=> Match receiving reports to invoices around year-end to search for unrecorded liabs Vouchers payable entered in the voucher register subsequent to balance sheet date Invoices received after balance sheet date

Steps in audit of AP: Step 1

Use the understanding of the client and its environment to consider inherent risks, including fraud risks, related to accounts payable.

Internal control weaknesses/ factors that increase risk of misstatement: Late (early) recording of cost of purchases

ie- 'cutoff problems' Ineffective board of directors, audit committee, or internal audit function - 'Tone at the top' not conducive to ethical conduct - Undue pressure to meet earnings target

Steps in audit of AP: Step 3

Assess the risks of material misstatement and design further audit procedures.

Controls against risks of material misstatements in liabilities

Auditors found serially numbered receiving reports are prepared Serially numbered vouchers are prepared Payments made promptly on due dates Immediately recorded in accounting records Independent employee reconciles sub-ledger to general ledger

Internal control weaknesses/ factors that increase risk of misstatement: Misappropriation of purchases

Ineffective controls for matching invoices w/ receiving docs before disbursements are authorized

Internal control weaknesses/ factors that increase risk of misstatement: Duplicate recording of purchases

Ineffective controls for review & cancellation of supporting docs by check signer

Steps in audit of AP: Step 5

Perform further audit procedures—substantive procedures for accounts payable. 1. Obtain or prepare a trial balance of accounts payable as of the balance sheet date and reconcile with the general ledger. 2. Vouch balances payable to selected creditors by inspection of supporting documents. 3. Reconcile liabilities with monthly statements from creditors. 4. Confirm accounts payable by direct correspondence with vendors - Not required unless other audit procs are insufficient to reduce DR to acceptable level --=> Done less often than confirm of AR 5.Perform analytical procedures for accounts payable and related accounts. 6. Search for unrecorded accounts payable. 7. Evaluate proper balance sheet presentation and disclosure of accounts payable.

Steps in audit of AP: Step 4

Perform further audit procedures—tests of controls 1. Examples of tests of controls. - Verify a sample of postings to the accounts payable control account. - Vouch to supporting documents a sample of postings in selected accounts of the accounts payable subsidiary ledger. - Test IT application controls -- IT very common in AP system => Have to ensure its controls are effective 2. If necessary, revise the risks of material misstatement based on the results of tests of controls.

Internal Controls Over the Acquisition (ie 'Supply Chain) Cycle

Segregation of duties--purchases and disbursements Approval of purchase orders Numerical control of purchase orders and receiving reports - that is pre-numbered purchase orders and receiving reports Matching of details of vendors' invoices to purchase orders and receiving documents Approval of vendors' invoices Pre-numbered checks Reconciliation of details of individual disbursements to controlling accounts Reconciliation of vendors' statements to accounts - This is the most likely way to identify duplicate payments Reconciliation of bank accounts Use of budgets and analysis of variances Use of chart of accounts and review of account coding - Look at simple accounting rules e.g. if there is a debit to AP there should be a corresponding credit to Cash

Search for Unrecorded Liabilities

Unrecorded A/P = unrecorded liabs for class & CPA exam Gather evidence on completeness Be alert during reconciliations, confirmations and analytical procedures for unrecorded liabilities Examine transactions recorded subsequent to year-end - Compare cash payments after year-end to a/p trial balance - Examine cash disbursements over specific dollar amounts during subsequent period