Audit of the Acquisition and Payment

Cycle: Tests of Controls, Substantive

Tests of Transactions, and Accounts
Payable.

Chapter 18

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 18 - 1

 Learning Objective 1
Identify the accounts and the
classes of transactions in the
acquisition and payment cycle.

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 Transactions in the Acquisition
and Payment Cycle
1. Acquisitions of goods and services
2. Cash disbursements
3. Purchase returns and allowances
and purchase discounts

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 18 - 3

 Accounts in the Acquisition
and Payment Cycle
Raw Material
Cash in Bank Accounts Payable Purchases
Cash Acquisitions
disbursements of goods and
services
Purchase Returns Property, Plant
and Allowances Purchase and Equipment
returns and
allowances

Purchase
Purchase discounts Prepaid
Discounts Expenses

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 18 - 4

 Accounts in the Acquisition
and Payment Cycle
Manufacturing Expense Control Account
Subsidiary accounts
Repair and maintenance
Taxes, Supplies
Freight in, Utilities

Accounts Payable Selling Expense Control Account

Acquisitions Subsidiary accounts
of goods and Commissions
services Travel, delivery expenses
Repairs, Advertising

Administrative Expense Control Account

Subsidiary accounts
Supplies, Officers’ travel
Legal fees
Auditing fees, Taxes
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 18 - 5
 Learning Objective 2
Describe the business functions
and the related documents and
records in the acquisition and
payment cycle.

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 Classes of Transactions
and Accounts
Acquisitions:
 Inventory
 Property, plant, and equipment
 Prepaid expenses
 Leasehold improvements
 Accounts payable
 Manufacturing expenses
 Selling and administrative expenses
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 18 - 7
 Classes of Transactions
and Accounts
Cash disbursements:
 Cash in bank (from cash disbursements)
 Accounts payable
 Purchase discounts

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 18 - 8

 Business Functions in the Cycle

 Processing purchase orders

 Receiving goods and services

 Recognizing the liability

 Processing and recording cash disbursements

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 18 - 9

 Related Documents
and Reports
Processing purchase orders:
 Purchase requisition
 Purchase order

Receiving goods and services:

 Receiving report

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 18 - 10

 Related Documents
and Reports
Recognizing the liability:
 Vendor’s invoice
 Debit memo
 Voucher
 Acquisitions transaction file

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 18 - 11

 Related Documents
and Reports
Recognizing the liability:
 Acquisitions journal or listing
 Accounts payable master file
 Accounts payable trial balance
 Vendor’s statement

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 18 - 12

 Related Documents
and Reports
Processing and recording cash disbursements:
 Check
 Cash disbursements transaction file
 Cash disbursements journal or listing

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

 Learning Objective 3
Understand internal control, and
design and perform tests of
controls and substantive tests
of transactions for the acquisition
and payment cycle.

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 18 - 14

 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

Design tests of controls and Audit procedures

substantive tests of transactions Sample size
for acquisitions and cash
disbursements to meet Items to select
transaction-related audit objectives Timing
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 Understand Internal Control

 Study the client’s flowcharts

 Review internal control questionnaires

 Perform walk-through tests

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 Assess Planned Control Risk

 Authorization of purchases

 Separation of asset custody from

other functions

 Timely recording and independent

review of transactions

 Authorization of payments

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 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

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 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)

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 18 - 19

 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)

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 18 - 20

 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.

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 Important Differences

 Larger number of transactions

 Significant judgment

 Wide range of dollar amount

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 18 - 22

 Learning Objective 4
Describe the methodology for
designing tests of details of
balances for accounts payable
using the audit risk model.

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

©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
analytical procedures
Phase III
for accounts
payable balance
Design tests of Audit procedures
details of accounts
payable balance to Sample size
Phase III
satisfy balance- Items to select
related audit
objectives Timing
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 18 - 26
 Learning Objective 5
Design and perform analytical
procedures for accounts payable.

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 Analytical Procedures for the
Acquisition and Payment Cycle
Analytical procedure Possible misstatement

Compare acquisition-related Misstatement of accounts

expense account balances payable and expenses
with prior years.

Review list of accounts payable Classification misstatement

for unusual, nonvendor, and for nontrade liabilities
interest-bearing payables

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 18 - 28

 Analytical Procedures for the
Acquisition and Payment Cycle
Analytical procedure Possible misstatement

Compare individual accounts Unrecorded or nonexistent

payable with previous years accounts, or misstatements

Calculate ratios, such as Unrecorded or nonexistent

purchases divided by accounts accounts, or misstatements
payable, and accounts payable
divided by current liabilities

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 18 - 29

 Learning Objective 6
Design and perform tests of
details of balances for accounts
payable, including out-of-period
liability tests.

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 18 - 30

 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

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

 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

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

 Cutoff Tests

 Relationship of cutoff to physical

observation of inventory

 Inventory in transit
 FOB destination
 FOB origin

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 18 - 33

 Learning Objective 7
Distinguish the reliability of
vendors’ invoices, vendors’
statements, and confirmations
of accounts payable as audit
evidence.

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 18 - 34

 Reliability of Evidence

 Distinction between vendors’ invoices

and vendors’ statements

 Difference between vendors’ statements

and confirmations

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 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.

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

 Types of Audit Tests for the
Acquisition and Payment Cycle
Cash in Accounts Acquisition
Bank Payable Expenses
Payments Expenses
Audited by Audited by
TOC, STOT, and AP TOC, STOT, and AP

Ending Ending
balance balance
Audited by Audited
AP and by AP and
TDB TDB

TOC + STOT + AP + TDB

= Sufficient appropriate evidence per GAAS
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 18 - 37
 Types of Audit Tests for the
Acquisition and Payment Cycle
Accounts Acquisition
Payable Assets
Acquisition
of assets
Audited by
TOC, STOT, and AP

Ending
balance
Audited by
AP and
TDB
TOC + STOT + AP + TDB
= Sufficient appropriate evidence per GAAS
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 18 - 38
 End of Chapter 18

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