CHAPTER 14

Accounts Payable and Other Liabilities

TOPIC LIST
 Accounts Payable  Other Liabilities
 Sources and Nature of AP  Amounts Withheld form Employees’ Pay
 The Auditors’ Objectives in AP  Sales Tax Payable
 Internal Control over AP  Unclaimed Wages
 Audit Documentation of AP  Customers’ Deposits
 Accrued Liabilities
 Audit of AP
 Balance Sheet Presentation
 Time of Examination
ACCOUNTS
PAYAPLE
SOURCES AND NATURE OF AP
 The term accounts payable is used to describe short-term obligations arising from the purchase
of goods and services in the ordinary course of business.
 Invoices and statements from suppliers usually support accounts payable arising from the
purchase of goods or services and most other liabilities.
THE AUDITORS’ OBJECTIVES
IN AP
 Understand the Inherent Risks of the client relating to AP and other liabilities.
 Understanding of internal controls over AP and other liabilities.
 Assess the risk of material misstatement.
 Existence
 Obligation
 Occurrence
 Completeness
 Cut-off
 Valuation
 Accuracy
 Presentation and disclosure
TIME TO DISCUSSION
1. How an understatement of liabilities relate to overstatement of companies earnings (Net
Income)?
2. Finding understatement in liabilities is more difficult in finding overstatement of liabilities,
discuss why?
INTERNAL CONTROL OVER AP
 In thinking about internal control over accounts payable, it is important to recognize that the
accounts payable of one company are the accounts receivable of other companies.
 Discussions of internal control applicable to accounts payable may logically be extended to the
entire purchase or acquisition cycle.
PURCHASE OR ACQUISITION
CYCLE
Beneficiary –
Material
requisition

Stores –
Payment –
Purchases
Sign Checks
Requisition

Payables – Purchasing –
Payment Purchase
Vouchers Order

Receiving -
Receiving
Report
AUDIT OF AP
UNDERSTAND THE CLIENT
AND ITS ENVIRONMENT
 After obtaining an understanding of the client and its environment, the auditors have to
identify and assess inherent risks of account payable.
 Risks can be payment of unauthorized payables and failure to capture all account payables for
financial reporting purpose.
 If any of inherent risks identified related to fraud, the auditor will understand the programs and
controls established by management to control risk.
UNDERSTAND THE IC OVER
AP
 In obtaining understanding of IC auditors may use:
 Written description
 Flowcharts
 Questionnaire

 Typical questions are the following:

 Is an A/P trail balance prepared monthly and reconciled to the general ledger?
 Are monthly statements from vendors reconciled with A/P ledger?
ASSESS THE ROMM
 Based on their understanding of the client and it’s environment, including internal control over
Account payable.
 The auditors develop their planned assessed levels of the risks of material misstatement for the
assertions about AP.
 The auditors’ assessment of control risk, along with their assessment of inherent risk will be
used to plan the nature, timing, and extend of substantive procedures.
TESTS OF CONTROLS
 Test of controls is direct toward testing the effectiveness of controls used by
the client.
 Determine whether the auditors can justify their planned assessed levels of
control risk for the assertions about Account payable.
 For example:
 Verify a sample of postings
 Vouch to supporting Documents
 Test IT application controls
TESTS OF CONTROLS
 Completion of the audit procedures mentioned in the previous slide enables the auditors to
perform a final assessment of the risk of material misstatement for each of the major financial
statement assertions about accounts payable.
 The auditors use the reassessment of control risk to determine whether it is necessary to
modify their planned substantive procedures.
SUBSTANTIVE
PROCEDURES.
1. OBTAIN OR PREPARE A TB OF AP AS OF
THE BSH DATE AND RECONCILE WITH THE
GL.
 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.
 If the schedule of individual items does not agree in total with the control account, the cause of
the discrepancy should be investigated.
 Agreement of the control account and the list of individual account balances is not absolute
proof of the total indebtedness; invoices received near the close of the period may not be
reflected in either the control account or the subsidiary records.
2. VOUCH BALANCES PAYABLE TO
SELECTED CREDITORS BY INSPECTION
OF SUPPORTING DOCUMENTS.
 The vouching of selected creditors’ balances to supporting vouchers, invoices, purchase
orders, and receiving reports is a substantive procedure that addresses the existence and
valuation of accounts payable.
3. RECONCILE LIABILITIES
WITH MONTHLY STATEMENTS
FROM CREDITORS.
 If the auditors find that the client’s staff regularly performs this reconciliation, they may limit
their review of vendors’ statements to determining that the reconciliation work has been
satisfactory.
 If the client’s staff has not reconciled vendors’ statements and accounts payable, the auditors
may do so on a selected basis.
4. CONFIRM ACCOUNTS
PAYABLE BY DIRECT
CORRESPONDENCE WITH
VENDORS.
 Although confirmation of accounts payable is a widely used procedure, it is generally
considered less necessary than is the confirmation of accounts receivable. One reason is that
for accounts payable the auditors will find in the client’s possession externally created
evidence such as vendors’ invoices and statements that substantiate the accounts payable
5. PERFORM ANALYTICAL PROCEDURES
FOR AP AND RELATED ACCOUNTS.
 To gain assurance as to the overall reasonableness of accounts payable, the auditor may
compute ratios such as purchases divided by accounts payable and accounts payable divided
by total current liabilities. These ratios are compared with ratios for prior years to disclose
trends that warrant investigation.
 The auditors may test purchase discounts by computing the ratio of cash discounts earned to
total purchases during the period and comparing this ratio from period to period. Any
significant decrease in the ratio might indicate a change in terms of purchases, failure to take
discounts, or fraudulent manipulation.
6. SEARCH FOR UNRECORDED
AP.
 Throughout the audit, the auditors should be alert for any unrecorded payables. For example,
during—reconciliation, confirmation, and analytical procedures—may disclose unrecorded
liabilities. In addition to normal trade payables that may be unrecorded, other examples
include unrecorded liabilities related to customers’ deposits recorded as credits to accounts
receivable, unbilled contractor or architect fees for a building under construction at the audit
date, and unpaid attorney or insurance broker fees.
 In addition to the prior audit steps, the auditors will
 Examine transactions that were recorded following year-end, e.g. cash disbursements that are made by
the client during the subsequent period
7. PERFORM PROCEDURES TO
IDENTIFY AP TO RELATED
PARTIES.
 Payables to a corporation’s officers, directors, stockholders, or affiliates require particular
attention by the auditors since they are not the result of arm’s-length bargaining by parties of
opposing interests.
 The independent auditors should search for such payables. All material payables to related
parties must be disclosed in the fi nancial statements.
8. EVALUATE PROPER BALANCE SHEET
PRESENTATION AND DISCLOSURE OF AP.
 Proper balance sheet presentation of accounts payable requires that any material amounts
payable to related parties (directors, principal stockholders, officers, and employees) be listed
separately from amounts payable to trade creditors.
 Debit balances of substantial amount sometimes occur in accounts payable because of such
events as duplicate payments made in error, return of merchandise to vendors after payment
has been made, and advances to suppliers. If these debit balances are material, a
reclassification entry should be made in the audit working papers so that the debit balances
will appear as assets in the balance sheet rather than being offset against other accounts
payable with credit balances.
 Accounts payable secured by pledged assets should be disclosed in the balance sheet and
cross-referenced to the pledged assets.
OTHER
LIABILITIES
OTHER LIABILITIES
 Notes payable are discussed in the next chapter. In addition to the accounts payable, other
items classified as current liabilities include:
 1. Amounts withheld from employees’ pay.
 2. Sales taxes payable.
 3. Unclaimed wages.
 4. Customers’ deposits.
 5. Accrued liabilities.
BALANCE SHEET
PRESENTATION
 Accrued expenses—interest, taxes, rent, and wages—are included in the current liability
section of the balance sheet and sometimes combined into one figure.
 Income taxes payable, however, may be sufficiently material to be listed as a separate item.
 Deferred credits to revenue for such items as rent or interest collected in advance that will be
included in earnings in the succeeding period are customarily included in current liabilities.
Deposits on contracts and similar advances from customers also are accorded the status of
current liabilities
TIME OF EXAMINATION
 The nature and amount of trade accounts payable may change greatly within a few weeks’
time; consequently, the auditors’ verification of these rapidly changing liabilities is most
effective when performed immediately after the balance sheet date
THANK YOU