ch 16 and 18.pptx

Chapter 18 AUDIT OF THE ACQUISITION AND PAYMENT CYCLE: TESTS OF CONTROLS, SUBSTANTIVE TESTS OF TRANSACTIONS, AND ACCOUNTS PAYABLE LEARNING OBJECTIVES 18-1 Identify the accounts and the classes of transactions in the acquisition and payment cycle. 18-2 Describe the business functions and the related...

Chapter 18 AUDIT OF THE ACQUISITION AND PAYMENT CYCLE: TESTS OF CONTROLS, SUBSTANTIVE TESTS OF TRANSACTIONS, AND ACCOUNTS PAYABLE LEARNING OBJECTIVES 18-1 Identify the accounts and the classes of transactions in the acquisition and payment cycle. 18-2 Describe the business functions and the related documents and records in the acquisition and payment cycle. 18-3 Understand internal control, and design and perform tests of controls and substantive tests of transactions for the acquisition and payment cycle. 18-4 Describe the methodology for designing tests of details of balances for accounts payable using the audit risk model. 18-5 Design and perform substantive analytical procedures for accounts payable. 18-6 Design and perform tests of details of balances for accounts payable, including out-of-period liability tests. ACCOUNTS AND CLASSES OF TRANSACTIONS IN THE ACQUISITION AND PAYMENT CYCLE There are three classes of transactions in the acquisition and payment cycle: – Acquisitions of goods and services – Cash disbursements – Purchase returns and allowances and purchase discounts UNDERSTANDING THE ENTITY & ITS ENVIRONMENT Size and importance of accounts payable and purchases. Complexity and limitations of purchasing process. Likelihood of consignment sales. Accounts payable turnover per industry. INHERENT RISKS Generally understated, – Understate expenses/liabilities – Working capital requirements – Invoices received after year end (Cutoff) High volume of transactions Employee fraud – Purchasing kickbacks – Unauthorized purchases or payments – Misappropriation of purchased materials ENTITY – LEVEL CONTROLS Control Environment: Integrity & Ethical Values – Tone at the top can impact likelihood of employee fraud. Competence and Commitment – Important responsibilities for purchasing goods, and receiving and storing goods. – Accounting personnel – Audit committee/BOD Organizational Structure & Assignment of Authority and Responsibility – Separation of duties – Understanding of control responsibilities ENTITY – LEVEL CONTROLS Risk Assessment: – Employee fraud – Dependencies on suppliers Monitoring: – Correction of previous control deficiencies – Feedback from and correspondence with suppliers – Consideration of internal audit reports MANAGEMENT RESPONSIBILITIES – CONTROLS Management is responsible for establishing the controls over the purchases-payables cash disbursements cycle to ensure the following: – Proper authorization of the purchase – Ordering the proper quality and quantity of goods on a timely basis – Acceptance only of goods that have been ordered – Receipt of proper terms and prices from the vendor – Payment only for those goods and services that were ordered, received, and properly invoiced – Payment on a timely basis (e.g., to take ACQUISITION TRANSACTIONS: CONTROL ACTIVITIES Authorized Vendor List Prenumbered & Controlled Documents – Purchase Requisition (Proper authorization) – Purchase Order (Only for approved PRs) – Receiving Report (No quantity information) – Voucher (Voucher packet: PR, PO, RR, VI) Open Purchase Orders Open Receiving Reports CASH DISBURSEMENT TRANSACTIONS: CONTROL ACTIVITIES Payments made by Check – Prenumbered & Controlled – Never made out to Cash or left blank Agree Check with Voucher Packet Deface Supporting Documents Check Authorization (Signatures) Control of Check Mailing Independent Bank Reconciliation PURCHASE ADJUSTMENTS: CONTROL ACTIVITIES Vendor Authorization Company Approval & Shipping Documentation Debit Memo (Agree with approval and shipping documents) Open Purchase Adjustments OTHER CONTROL ACTIVITIES Independent Reconciliation of Vendor Statements & Accounts Payable Management Review of Purchases for Reasonableness Independent Reconciliation of Bank Statements Disclosure Committee BUSINESS FUNCTIONS IN THE CYCLE AND RELATED DOCUMENTS AND RECORDS There are four business functions involved in the acquisitions and payment cycle: – Processing Purchase Orders—Includes a purchase requisition which is used to request authorization for goods or services and a purchase order which is used for the order after it has been authorized. – Receiving Goods and Services—Includes a receiving report which is prepared at the time the goods are received. BUSINESS FUNCTIONS IN THE CYCLE AND RELATED DOCUMENTS AND RECORDS – Recognizing the Liability—Proper recognition requires prompt and accurate recording. Documents that may be involved: Vendor’s Invoice—Document from the vendor that shows the amount owed for an acquisition Debit Memo—Also from the vendor; indicates a reduction in the amount owed Voucher—A formal means of recording and controlling acquisitions Vendor’s Statement—A document prepared monthly by the vendor that indicates the beginning balance, acquisitions, returns and allowances, payments to the vendor, and ending balance BUSINESS FUNCTIONS IN THE CYCLE AND RELATED DOCUMENTS AND RECORDS – Processing and Recording Cash Disbursements—The payment for goods and services represent a significant activity for all entities. Documents that auditors examine associated with this activity: Check—Document used to pay for an acquisition; may be paper or an electronic funds transfer (EFT) METHODOLOGY FOR DESIGNING TESTS OF CONTROLS AND SUBSTANTIVE TESTS OF TRANSACTIONS Understand Internal Control Assess Planned Control Risk: Key internal controls for the business functions in this cycle are: – Authorization of purchases – Separation of asset custody from other functions – Timely recording and independent review of transactions – Authorization of payments SUBSTANTIVE TESTS Initial Procedures – Understanding substance and importance of transactions. Importance of purchasing transactions and accounts payable Availability of supplies and concentration of suppliers – Analyzing the accuracy of account information Trace beginning AP to prior year working papers Scan journals for large or unusual transactions SUBSTANTIVE TESTS Tests of Transactions – Vouching/tracing transactions (Directional Testing) Vouching AP transactions (Credit to RR & Debit to Check) Tracing purchase, cash disbursement, and purchase adjustment transactions – Cutoff tests Purchases (Prenumbered receiving report) Purchase returns (Prenumbered shipping document) Cash disbursements (Prenumbered Check) DESIGN AND PERFORM SUBSTANTIVE ANALYTICAL PROCEDURES The use of analytical procedures is as important in the acquisition and payment cycle as it is in every other cycle, especially for uncovering misstatements in accounts payable. DESIGN AND PERFORM TESTS OF DETAILS OF ACCOUNTS PAYABLE BALANCE The overall objective in the audit of accounts payable is to determine whether the accounts payable balance is fairly stated and properly disclosed. Difference in the emphasis in auditing assets and liabilities: In auditing assets, auditors are concerned about overstatements; for liabilities, auditors are concerned about understatements. SUBSTANTIVE TEST OF BALANCE Accounts Payable Confirmations – Not a required procedure Vendor invoices and statements available – Appropriate when, Detection risk is low Individual vendors with large balances Client is experiencing operating difficulties – Confirmation characteristics, Significant vendors Vendors without monthly statements Small and zero balances Unusual transactions Reconciliation of AP & Vendor Statements DESIGN AND PERFORM TESTS OF DETAILS OF ACCOUNTS PAYABLE BALANCE Out-of-Period Liability Tests: Also called search for unrecorded accounts payable – Examine underlying documentation for subsequent cash disbursements. – Examine underlying documentation for bills not paid several weeks after year-end. – Trace receiving reports issued before yearend to related vendor’s invoices. – Trace vendor’s statements that show a balance due to the accounts payable trial balance. DESIGN AND PERFORM TESTS OF DETAILS OF ACCOUNTS PAYABLE BALANCE Out-of-Period Liability Tests: – Send confirmations to vendors with which the client does business. Relationship of cutoff to physical observation of inventory—Cutoff tests must be coordinated with the physical observation of inventory to determine that both the asset and liability are recorded in the proper period. Inventory in Transit—Determine whether inventory in transit at year-end was FOB destination or FOB origin. QUESTIONS? Completing The Tests In The Sales And Collections Cycle: Accounts Receivable Chapter 16 Chapter 16 Learning Objectives 16-1 Describe the methodology for designing tests of details of balances using the audit risk model. 16-2 Design and perform substantive analytical procedures for accounts in the sales and collection cycle. 16-3 Design and perform tests of details of balances for accounts receivable. 16-4 Obtain and evaluate accounts receivable confirmations. 16-5 Design audit procedures for the audit of accounts receivable, using an evidence-planning worksheet as a guide. OBJECTIVE 16-1 DESCRIBE THE METHODOLOGY FOR DESIGNING TESTS OF DETAILS OF BALANCES USING THE AUDIT RISK MODEL. Methodology For Designing Tests Of Details Of Balances Identify Significant Risks and Assess the Risk of Material Misstatement for Accounts Receivable (Phase I): Tests are based on the auditor’s risk assessment. As part of the assessment of risk of material misstatement, the auditor determines whether any of the risks are a significant risk. For most audits, revenue recognition is considered a significant risk. Methodology For Designing Tests Of Details Of Balances Set Performance Materiality for Accounts Receivable (Phase I): The auditor makes a preliminary judgment about materiality for the entire financial statement, then allocates the amount to each significant balance sheet account. Accounts receivable is typically one of the most material accounts for companies that sell on credit. Even when the ending balance in accounts receivable is small, the transactions occurring throughout the year in the sales and collection cycle are almost certain to be highly significant. Methodology For Designing Tests Of Details Of Balances Assess Control Risk for the Sales and Collection Cycle (Phase I): Internal controls over sales and cash receipts and related accounts receivable are reasonably effective for most companies because they want to maintain good relations with customers. Auditors are especially concerned with three aspects of internal controls: 1. Controls that prevent or detect embezzlement 2. Controls over cutoff 3. Controls related to the allowance for uncollectible accounts Methodology For Designing Tests Of Details Of Balances Design and Perform Tests of Controls and Substantive Tests of Transactions (Phase II): – Chapters 14 covered designing audit procedures for tests of controls and substantive tests of transactions. – Auditors use results of substantive tests of transactions to determine the extent to which planned detection risk is satisfied for each accounts receivable balance-related audit objective. OBJECTIVE 16-2 DESIGN AND PERFORM SUBSTANTIVE ANALYTICAL PROCEDURES FOR ACCOUNTS IN THE SALES AND COLLECTION CYCLE. Design And Perform Substantive Analytical Procedures (Phase III) Most substantive analytical procedures performed during the detailed testing phase are done after the balance sheet date but before tests of details of balances. Auditors perform both planning and substantive analytical procedures for the entire sales and collection cycle, not just accounts receivable. – This is necessary because of the close relationship between these income statement and balance sheet accounts. OBJECTIVE 16-3 DESIGN AND PERFORM TESTS OF DETAILS OF BALANCES FOR ACCOUNTS RECEIVABLE. Designing Tests Of Details Of Balances Recorded Accounts Receivable Exist: Confirmation of customer’s balances is the most important test of details of balances for determining existence. Existing Accounts Receivable Are Included: It is difficult to test for account balances omitted from the aged trial balance except by relying on the self-balancing nature of the accounts receivable master file. Accounts Receivable Are Accurate: Confirmation is the most common test for the accuracy of accounts receivable. Accounts Receivable Are Properly Classified: Normally classification of accounts receivable is relatively easy, by reviewing the aged trial balance for material receivables from affiliates, officers, directors, or other related parties. Auditors should also verify whether any of the accounts or notes receivable are noncurrent and should be classified as such. Designing Tests Of Details Of Balances Accounts Receivable Is Stated at Realizable Value: – Accounting standards require that companies state accounts receivable at the amount that will ultimately be collected, the realizable value. – The realizable value is equal to the gross accounts receivable less the allowance for uncollectible accounts. – The allowance for uncollectible accounts is an estimate and it is necessary for auditors to determine if the client’s allowance is reasonable. Designing Tests Of Details Of Balances The Client Has Rights to Accounts Receivable: Normally, this is not a problem. - The auditor must determine if any of the receivables are pledged, assigned, factored, or sold. Accounts Receivable Presentation and Disclosure: Tests of the presentation and disclosure-related audit objectives are generally done as part of the completion phase of the audit. - Some tests may be done with tests of balance-related audit objectives. For example, the auditor must evaluate whether the client has separated material amounts requiring separate disclosure, such as related party receivables. OBJECTIVE 16-4 OBTAIN AND EVALUATE ACCOUNTS RECEIVABLE CONFIRMATIONS. Confirmation Of Accounts Receivable Auditing Standards Requirements: Auditors should use external confirmations for accounts receivable UNLESS: 1. The overall accounts receivable balance is immaterial. 2. The auditor considers confirmations ineffective evidence because response rates will likely be inadequate or unreliable. 3. The auditor’s assessed level of the risk of material misstatement is low and other evidence can be accumulated to provide sufficient evidence. If the auditor decides not to confirm accounts receivable that are material, the justification must be documented in the audit files. Confirmation Of Accounts Receivable Types of Confirmations: Positive Confirmation: A communication addressed to the debtor requesting the recipient to confirm directly whether the balance as stated is correct or incorrect. Negative Confirmation: A communication addressed to the debtor, but requests a response only when the debtor disagrees with the stated amount. Positive confirmations are more reliable, but negative confirmations are less costly. Negative confirmations are acceptable as the sole substantive audit procedure only when all of the following circumstances are present: 1. The auditor has assessed the risk of material misstatement as low. 2. The population of items is made up of a large number of small, homogenous account balances. 3. The auditor expects a low exception rate. 4. The auditor reasonably believes that recipients of negative confirmation requests will give the requests adequate consideration. Confirmation Of Accounts Receivable Verification of Addresses and Maintaining Control: – The auditor should perform procedures to verify the addresses or email addresses used for confirmation. – For confirmations sent by mail, the auditor must maintain control of the confirmations until they are returned from the customer. – The client may assist in preparing the confirmations, but the auditor must be responsible for mailing and the return address should be the auditor’s to ensure that undeliverable confirmations are returned to the auditor, not the client. Confirmation Of Accounts Receivable Follow-Up on Nonresponses: Nonresponses to positive confirmations provide no audit evidence, though nonresponses to negative confirmations provide some evidence of the existence assertion. When positive confirmations are used, auditing standards require followup procedures. Documents and procedures may include: – Subsequent Cash Receipts—Evidence of the receipt of cash for payment subsequent to the confirmation. – Duplicate Sales Invoices—Examining duplicate sales invoices are useful in verifying the actual issuance of an invoice as well as verifying the date. – Shipping Documents—These help to determine that a shipment was made to test cutoff. – Correspondence with the Client—Can be used to discover any disputed balances. Confirmation Of Accounts Receivable Analysis of Differences: The most commonly reported types of differences in confirmations include: – Payment Has Already Been Made—The customer has made payment prior to the confirmation date, but the client has not recorded it. These should be carefully investigated for cutoff misstatements, lapping, or theft of cash. – Goods Have Not Been Received—Typically because the client records the sale on the ship date, but the customer may not have received the goods yet. – The Goods Have Been Returned—The client may have failed to record a credit memo for a sales return. – Clerical Errors and Disputed Amounts—Normally, the auditor will ask the client to reconcile the differences. Confirmation Of Accounts Receivable Drawing Conclusions: When all differences have been resolved, the auditor must reevaluate internal control. The misstatements must be analyzed to determine whether it was consistent or inconsistent with the original assessed level of control risk. If a significant number of misstatements occurred that are inconsistent with the assessment of control risk, it is necessary to revise the assessment and consider the effect of the revision on the audit. OBJECTIVE 16-5 DESIGN AUDIT PROCEDURES FOR THE AUDIT OF ACCOUNTS RECEIVABLE, USING AN EVIDENCE-PLANNING WORKSHEET AS A GUIDE. Questions?