Chapter 13: Audit of the Acquisition and Payment Cycle

What does the acquisition and payment cycle invole

the decisions and processes for obtaining the goods and services for operating a business. 

What are the relevant assertions for the acquisition and payment cycle

the relevant assertions are completeness and cutoff of payables, provisions and accrued liabilities

What areas must the auditor have knowledge of to determine IR factors

Supply chain, contractual agreements, agreements with supplies and retailers involving credits and rebates, physically moving inventory, purchasing process, cashflow management, operating cycle and other internal procedures.

External environment will also be considered and AP

PAP in planning for ACQ and PMT cycle

Accuracy concerns with Accrued liabilities and provisions

that they are all calcualted correctly

Completeness concerns with Accrued liabilities and provisions

That they are all included

Allocation concerns with Accrued liabilities and provisions

For adjustments to balances

Cutoff concerns with Accrued liabilities and provisions

as related to purchase transactions

Significant Risks that can create potentially high Inherent risk circumstances

The client has complex arrangements with vendors (such as chargebacks and allowances)

The client has integrated supply chain management

The client has numerous routine and nonroutine related-party transactions

The client has significant accruals and provisions that require considerable judgement

what are the common types of fraud risks with ACQ and PMT cycle

misappropriation of assets.

Typical fraud for ACQ and PMT

the perpetrator to issue payments to fictitious vendors and deposit the cheque in a fictitious account. 

Prevention of fictitious vendors and deposit the cheque in a fictitious account.

allowing payments to be made only to approved vendors and by having authorized personnel carefully scrutinize documentation supporting the acquisitions before payments are made.

Key controls for each of the business functions

Authorization of purchases 

Processing vendor database changes

Timely recording and independent review of transactions

Authorization of payments

the signing of cheques and individuals with proper authority 

Separation of responsibilities for approving the payments and performing the accounts payable function 

Careful examination of the supporting documents by the cheque signer at the time the cheque is signed 

Use of a password (preferably two different passwords by two people) before electronic payments are released 

Tests of acquisitions:

processing purchase orders, vendor database changes, receiving goods and services, recognizing the liability)

Tests of payment:

processing and recording cash distribsements 

audit objective for Occurence

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

audit objective from completeness

Existing acquisitions are recorded

Analytical procedures for ACQ and PMT Cycle

Inspect list of accounts payable for unusual, non vendor and interest-bearing payables

Compare individual accounts payable with pervious years.

Potential misstatements for Substantive analytical procedures for ACQ and PMT Cycle pertaining to classification

Classification misstatement doe non trade liabilities

Potential misstatements for Substantive analytical procedures for ACQ and PMT Cycle pertaining to Completeness

Unrecorded or nonexistent accounts payable or misstatements.

search for unrecorded accounts payable

Test to uncover unrecorded accounts payable

Vendor’s statement

is superior for verifying accounts payable because it includes the ending balance. 

vendor’s invoice

is superior for verifying transactions because the auditor is verifying individual transactions and the invoices show the details of the acquisitions. 

Typical audit procedures to support the search for unrecorded liabilities?

Inspection of underlying documentation for subsequent cash disbursements

Inspect underlying documentation for bills not paid several weeks after the 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 accounts payable trial balance

Send confirmations to client’s vendors

Payables and Accrued Liabilities: Cutoff Assertions purpose:

determine whether transactions recorded a few days before and after the balance sheet date are included in the correct period.

What is essential to the cutoff test for Payables and Accrued Liabilities

be coordinated with physical observation of inventory.

FOB destination

shipping contract in which title to the goods passes to the buyer when the goods are received. 

FOB origin

shipping contract in which title to the goods passes to the buyer at the time that the goods are shipped.

Other Substantive Procedures: Accruals and Provisions

Inquire of management to determine which accruals exist

Determine the policy for establishing the accrual

Inspect the related documentation (such as subsequent payroll journals for accrued wages, payroll taxes, and bonuses)

Reclaualte the accrual

Assess the reasonableness of assumptions (if applicable)

Primary accounting record for PPE

PPE database, with supporting purchases, disposal, and amortization transactions. Totals of the database must agree to totals in the GL 

PPE significant risks

Miss-recordings between assets and repair & maintenance

Errors in class or amortization rate (acucracy)

Errors or manipulation of estimates of remaining life

Economic events that increase uncertainty around estimating the remaining useful live and salvage value

Valuation

Fraud risks

What controls are Individually material transactions subject to

capital budget, authorization

Other controls auditors should be concerned about pertaining to PPE

Use of database for individual PPE

Adequate physical controls over moveable assets

ID numbers to each PPe

Periodic physical counts of PPE and their reconciliation

What is focus of PPE audits

acquisition, current year amortization and disposals.

Test of Details of transactions: Current-Year acquisitions

Proper recording of current-year additions is important because of the long-term effect the assets have on the FS.

The audit procedures for current-year acquisitions are

Inspect supporting documentation for asset costs

Inspect large reports and maintenance documentation

Search for trade-ins

Physically inspect the assets or repair

Reassess risks based on findings

Tests of Details of Transactions: Current-Year Disposals

Recording disposals relies heavily on internal controls, which need to be in place.

The audit procedures for current year disposals are

Inquire about the nature of the disposals

Recalculate gains and losses

Trace postings to the correct accounts

Physically inspect the plant location

Inspect related accounts for potential unrecorded disposals

While inspecting asset acquisition, search for trade-ins

Tests of Details of Transactions: Amortization Expense

determining whether the client is following a consistent amortization policy from period to period and whether the client’s calculations are accurate.

Most important assertions for Amortization Expense

(Accuracy, classifacation and valuation) and allocation

Accuracy test for Amortization Expense

recomputing amortizing expenses for selected assets.

Tests of Details of Transactions: Verifying Opening Balance

If the auditor audited the opening balance and the client has a PPE database that agrees with the opening balance, the auditor would normally only check that the opening balance agrees with the ending balance of the proper year’s audit for each PPE account.

Tests of Details of Transactions: Verifying Closing balances

test if accuracy needs to be completed:

Reconcile opening to the closing balance

Agree subsidiary totals to the closing balance

Tests of Details of Transactions Existence PPE

Auditor will often verify existence when conducting a tour a tour of the operations.

Tests of Details of Transactions Valuation PPE

The auditor considers the entity’s environment, cost of recent additions, and replacement cost of comparable equipment to determine fi there is a potential impairment 

Impairments exist when

the carrying amount of the long-lived asset exceeds its FV.

Tests of Details of Transactions Rights and Obligations PPE

 PPE may be used as collateral for loans, or purchased with debt, so the auditor must read legal and lease agreements.

Tests of Details of Transactions Presentation PPE

PPE details must be clearly shown on the FS.