Audit Practice II - Week 10

Audit Practice and Procedures II - Week Ten

• Topic: Auditing the Capital Acquisition and Repayment, Cash Balances
• Objective: Evaluate whether accounts affected by acquisitions of goods and services, and cash disbursements for those acquisitions, are fairly presented according to accounting standards.
• Transaction Classes: Acquisitions of goods and services, cash disbursements, purchase returns and allowances, and purchase discounts.

Recap of Last Class

• No specific information on the previous class is available.

Accounts and Classes of Transactions in the Acquisition and Payment Cycle

• Objective: Determine if the accounts affected by acquisitions are fairly presented according to accounting standards.
• Transaction Classes: Acquisitions of goods and services, cash disbursements, purchase returns and allowances, and purchase discounts.

Business Functions in the Cycle and Related Documents and Records

• The acquisition and payment cycle starts with an authorized employee's purchase requisition and ends with payment on accounts payable.
• Key documents include purchase requisitions, purchase orders, receiving reports, vendor's invoices, debit memos, vouchers, acquisition transaction files, journals, master files, trial balances, vendor statements, checks, electronic payments, and disbursement journals.

Table 18-1: Classes of Transactions, Accounts, Business Functions, and Related Documents and Records for the Acquisition and Payment Cycle

• Details of accounts, business functions, and documents used in Acquisitions and Cash Disbursements.

Documents Included in Acquisitions

• Purchase requisition, purchase order, receiving report, vendor's invoice, debit memo, voucher, acquisitions transaction file, acquisition journal or listing, accounts payable master file, accounts payable trial balance, vendor's statement, check or electronic payment, cash disbursement transaction file, cash disbursement journal or listing.

Business Function - Processing Purchase Orders

• Purchase requisition, employee requests for goods/services.
• Purchase order, formal document to vendor for goods/services, indicating quantity, items, and prices required.
• Often electronically transmitted.

Receiving Goods and Services

• Critical step for recognizing acquisition and related liability on company records.
• Receiving report (paper or electronic) documents goods received: description, quantity, date received, and other data.

Business Function - Recognizing the Liability

• Vendor's invoice, document from vendor stating amount owed.

• Includes description, quantity, billing date, prices, total amount.

• Debit memo, document reducing amount owed to vendor (due to returned goods or allowance).

• Similar form to a vendor's invoice but supports reductions, rather than increases, in accounts payable.

Voucher

• Standard accounting document for recording acquisitions.
• Includes a cover sheet to organize documents like purchase orders, and vendor invoices.
• Sequentially numbered.

Acquisitions Transaction File

• Computer-generated file containing all acquisition transactions recorded over a designated period (e.g., day, week, month.)
• Includes vendor names, dates, amounts, account classifications, description of goods or services.

Acquisitions Journal or Listing

• Generated from the acquisitions transaction file.
• Includes vendor name, date, amount, and account classification for each transaction.
• Includes information on cash or accounts payable transactions.

Accounts Payable Master File

• Lists acquisitions, cash disbursements, and returns and allowances for each vendor.
• Updated from acquisition, returns, and allowances, and cash disbursement computer files.
• Vendor-specific records of beginning balance, transactions, and ending balance in accounts payable.

Accounts Payable Trial Balance

• Provides a summary of amounts owed to each vendor (or for each invoice) at a specific point in time.
• Derived directly from the Accounts Payable master file

Vendor's Statement

• Vendor-prepared document detailing beginning balance, acquisitions, returns/allowances, payment to vendor, and ending balance.
• Important difference from confirmation: it's prepared before the auditor examines it.

Business Function: Processing and Recording Cash Disbursements

• Check: used for cash payments. Computer-generated and documented in a multi-copy format.
• Cash Disbursements Transaction File: Computer file to record all cash disbursement transactions by date, week, or month.
• Cash Disbursements Journal or Listing: Period report of cash disbursement transactions recorded in the transactions file.

Methodology for Designing Tests of Controls and Substantive Tests of Transactions

• Tests of controls and substantive tests of transactions for acquisition and payment cycle are categorized into tests of acquisitions and payment.
• The cycle's accounts (receivables, inventory, fixed assets, payables, and expenses) are frequently time-consuming to verify directly by substantive tests of detail. Effective internal controls for the acquisition and payment process may allow the auditor to reduce substantive testing.

Methodology for Designing Tests of Details of Balances for Accounts Payable

• Understand client business risks affecting accounts payable.
• Set performance materiality.
• Assess control risks for the acquisition and payment cycle.
• Design and perform tests of controls, substantive tests of transactions for the acquisition and payment cycle.
• Design and perform analytical procedures for accounts payable.
• Design tests of details of accounts payable to meet balance-related objectives.

Out-of-Period Liability Tests

• Auditors emphasis on understatements in accounts payable.
• Focus on unrecorded amounts in liability transactions.
• These tests use the same procedures as tests for accuracy.

Difference Between Vendor Statements and Confirmations

• Vendor Statement provided by the vendor and is in the client's possession when the auditor reviews it—the vendor can alter these statements.
• Confirmation: independent third party confirmation of accounts.

Audit of Property, Plant, and Equipment

• Property/plant/equipment are assets with a useful life of more than one year, used in the operating business, and not for resale.

Table 19-1: Accounts Typically Associated with the Acquisition and Payment Cycle

• Listing of assets, income, and expenses that are usually included in accounts payable transactions.

Auditors Verify Equipment Differently from Current Asset Accounts

• Less current period equipment acquisitions, especially large equipment used in manufacturing.
• Larger acquisition amount.
• Typically kept in accounting records for years.

Perform analytical procedures to verify current year acquisitions, current disposals, ending balances of asset and accumulated depreciation accounts.

Table 19-3: Analytical Procedures for Equipment

• Analytical procedures for equipment, including comparing depreciation expense, accumulated depreciation, and other related expense accounts over time.

Verify Current Year Acquisitions

• Companies must record current additions to assets accurately as these assets have long-term effects on financial statements and balances.
• Errors in asset recording affect the balance sheet and income statement.
• Disposal recording must be accurate as well.

Verify Current Year Disposals

• Company internal controls should formalize methods for reporting sales, trade-ins, abandonment, and theft of equipment to management. Failure to record disposals leads to overstatement of equipment cost and thus underestimated net book value until asset is fully depreciated.

Verify Ending Balance in Asset Account

• Confirm all recorded equipment physically exists and all equipment is recorded correctly.

Verify Depreciation Expense

• Depreciation expense involves internal calculations and may need more significant tests for accuracy than other expense types.
• Accuracy of a client's depreciation policy needs to be confirmed.

Verify Ending Balance in Accumulated Depreciation

• Accumulated Depreciation balance in the master file should agree with the balance on the general ledger.
• Test the accuracy of accumulated depreciation in the master file versus total accumulated depreciation on the general ledger.

See Chapter 19

• Contains information on the audit of prepaid expenses, accrued liabilities, and income/expense accounts.

In this quiz, you'll explore the auditing of capital acquisition and repayment as well as cash balances. Focus on evaluating accounts related to acquisitions of goods and services, cash disbursements, and ensuring compliance with accounting standards. Test your knowledge on transaction classes such as purchase returns and allowances.