Ch. 18-20 LN.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? Chapter 20 AUDIT OF PAYROLL & PERSONNEL CYCLE CHAPTER 20 LEARNING OBJECTIVES 20-1 Identify the accounts and transactions in the payroll and personnel cycle. 20-2 Describe the business functions and the related documents and records in the payroll and personnel cycle. 20-3 Understand internal control and design and perform tests of controls and substantive tests of transactions for the payroll and personnel cycle. 20-4 Design and perform substantive analytical procedures and tests of details of accounts in the payroll and personnel cycle. ACCOUNTS AND TRANSACTIONS IN THE PAYROLL AND PERSONNEL CYCLE The payroll and personnel cycle involves the employment and payment of all employees. The main differences between the payroll and personnel cycle and other cycles include: – There is only one class of transactions for payroll. – Transactions are generally far more significant than related balance sheet accounts – Internal controls over payroll are effective for almost all companies, even small ones. Typical accounts in the payroll and personnel cycle are shown in Figure 20-1. BUSINESS FUNCTIONS IN THE CYCLE AND RELATED DOCUMENTS AND RECORDS The Payroll And Personnel Cycle begins with hiring employees and ends with paying them for the services they performed. It includes payments to the government and other institutions for withheld and accrued payroll taxes and benefits. The Business Functions include, Human Resources: This department is an independent source for hiring qualified personnel and a source for verification of wage information, including deletions from payroll and changes in wages and deductions. – BUSINESS FUNCTIONS IN THE CYCLE AND RELATED DOCUMENTS AND RECORDS Timekeeping and Payroll Preparation: These functions are important in the audit of payroll because they directly affect payroll expense. The following documents are involved in timekeeping and payroll: – Time Record: Document indicating the time the hourly employee started and stopped working. – Job Time Ticket: Form indicating which jobs employees worked on during a given time period. BUSINESS FUNCTIONS IN THE CYCLE AND RELATED DOCUMENTS AND RECORDS Payment of Payroll: The approval and distribution of payroll must be carefully controlled to prevent theft. To increase control, payroll disbursements are usually processed separately from other disbursements. Payroll Bank Account Reconciliation: An imprest payroll account is a separate payroll account in which a small balance is maintained and the exact amount of payroll is transferred immediately before distribution of payroll. Preparation of Payroll Tax Returns and Payment of Taxes: Federal and state laws require timely preparation and payment of payroll BUSINESS FUNCTIONS IN THE CYCLE AND RELATED DOCUMENTS AND RECORDS UNDERSTANDING THE ENTITY & ITS ENVIRONMENT The importance of payroll. Nature of compensation. Importance of various compensation packages. ENTITY – LEVEL CONTROLS Control Environment: – Integrity & Ethical Values Tone at the Top – Human Resources & Hiring Effective hiring controls – Risk Assessment: Payroll frauds – Monitoring: Correction of previous control deficiencies Consideration of internal audit reports INHERENT RISK Volume of Transactions Valuation of Compensation Packages Payroll Fraud – Fictitious Employees – Padding Labor Hours IR is lowest for completeness but higher for existence, valuation, and presentation and disclosure. PAYROLL CYCLE Payroll Responsibilities – Management’s Responsibility Proper authorization of the payroll Appropriate calculation of the payroll Safeguarding of assets associated with the payment of payroll Proper distribution of the payroll Proper accounting for the payroll transactions PAYROLL CYCLE – ORGANIZATIONAL STRUCTURE – Human Resources provides an authorized list of employees and associated pay rates, deductions, and exemptions. – Timekeeping is an accounting function that oversees the employees’ recording of hours on time cards (using the time clock) and that receives and reconciles the job time tickets from Manufacturing. – Payroll is an accounting function responsible for calculating the payroll (i.e., preparing the payroll register) based on PAYROLL CYCLE – ORGANIZATIONAL STRUCTURE – Cost Accounting is an accounting function that accumulates direct materials, direct labor, and overhead costs on job order cost sheets to determine the costs of production. – Accounts Payable prepares the payment voucher based on the payroll register prepared by Payroll. – Cash Disbursements signs and deposits a check based on the payment voucher into a separate payroll account, prepares individual employee paychecks, and distributes PAYROLL CYCLE – KEY CONTROL ACTIVITIES Human Resources has no functional responsibility other than authorization of employees, pay rates, and deductions. Supervisors approve (authorize) work performed (executed) by employees. The Timekeeping reconciliation of the clock cards and job time tickets ensures that employees are present and working. Payroll accounting calculates pay only. It does not authorize transactions or handle (take custody of) assets. Cash Disbursements signs the check but does not authorize, prepare, or account for the transaction. Paychecks are distributed by Cash Disbursements, usually by the paymaster. This individual has no other functions relative to payroll. Unclaimed paychecks are safeguarded by the CFO. A separate payroll bank account allows for ease in reconciling PAYROLL FLOWCHART FUNCTIONS AND RELATED CONTROLS Human Resources – Hiring employees Personnel Authorization Form Update Personnel Master File – Restricted Access – Periodic Reconciliations – Authorizing payroll changes Personnel Department Authorization Termination Notice Update Personnel Master File Receipt of services – Preparing attendance and timekeeping data Clock Cards – Supervision Job Time Tickets – Supervisor Assignment & Approval FUNCTIONS AND RELATED CONTROLS Recording and paying payroll transactions – Preparing the payroll Timekeeping reconciliation of time tickets and clock cards Payroll uses approved clock cards and approved rates and deductions to calculate the period payroll register Cost Accounting uses time tickets to update job costing Accounts Payable uses payroll register as authorization for payable and check for net pay amount Cost Accounting, Accounts Payable, and Cash Disbursements sends entry information to General Ledger Paying payroll – Paying the payroll Checked signed and distributed by Cash Disbursement. Distribute checks after verifying ID Unclaimed checks should be safeguarded – Filing payroll tax returns METHODOLOGY FOR DESIGNING TESTS OF CONTROLS AND SUBSTANTIVE TESTS OF TRANSACTIONS Understand Internal Control and Assess Control Risk—Payroll and Personnel Cycle: – Internal control for payroll is normally highly structured and well controlled. As a result, control risk is often assessed as low for this cycle. – Key controls should be the basis for assessing control risk. METHODOLOGY FOR DESIGNING TESTS OF CONTROLS AND SUBSTANTIVE TESTS OF TRANSACTIONS Key internal controls for payroll and personnel cycle for assessing control risk: – Adequate Separation of Duties: Payroll function should be kept independent of the human resources department. – Proper Authorization: Human resources should authorize additions and deletions to payroll. – Adequate Documents and Records: What is adequate depends on the specific needs of the company, these needs might include time keeping, incentive arrangements, and job cost assignment. METHODOLOGY FOR DESIGNING TESTS OF CONTROLS AND SUBSTANTIVE TESTS OF TRANSACTIONS Key internal controls for payroll and personnel cycle for assessing control risk: – Physical Control over Assets and Records: Access to unsigned payroll checks, direct deposit information, payment authorization system, and check signature machine should be restricted. – Independent Checks on Performance: A member of management or other responsible employee should review payroll for obvious misstatements. METHODOLOGY FOR DESIGNING TESTS OF CONTROLS AND SUBSTANTIVE TESTS OF TRANSACTIONS Design Tests of Controls and Substantive Tests of Transactions— Payroll and Personnel Cycle: – Tests of controls and substantive tests of transactions are the most important part of testing the Payroll and Personnel Cycle, but even they are not usually tested extensively for these reasons: Employees are likely to complain to management if they are underpaid. All payroll transactions are typically uniform and uncomplicated. METHODOLOGY FOR DESIGNING TESTS OF CONTROLS AND SUBSTANTIVE TESTS OF TRANSACTIONS Additional Considerations: – Payroll Tax Forms and Payments: The auditor should review the preparation of at least one of each type of payroll tax form during the understanding of internal control phase of the audit. – Timely Payment of Payroll Taxes and Other Withholdings: The auditor should also test whether the client has fulfilled its legal obligation in submitting payments for all withholdings on a timely basis. METHODOLOGY FOR DESIGNING TESTS OF CONTROLS AND SUBSTANTIVE TESTS OF TRANSACTIONS Additional Considerations: – Inventory and Payroll Considerations: If payroll affects the valuation of inventory, the auditor often extends payroll audit procedures. Relationship Between Payroll and Inventory Valuation: When payroll is a significant portion of inventory, the improper classification of payroll can materially affect asset valuation for work in process and finished goods. Auditors should emphasize internal control over proper classification of payroll transactions. METHODOLOGY FOR DESIGNING TESTS OF CONTROLS AND SUBSTANTIVE TESTS OF TRANSACTIONS Additional Considerations: – Fraudulent Payroll Considerations: Test for nonexistent employees Test for fraudulent hours Fraudulent expense reports METHODOLOGY FOR DESIGNING SUBSTANTIVE ANALYTICAL PROCEDURES AND TESTS OF DETAILS OF BALANCES METHODOLOGY FOR DESIGNING SUBSTANTIVE ANALYTICAL PROCEDURES AND TESTS OF DETAILS OF BALANCES Design and Perform Tests of Details of Balances for Liability and Expense Accounts: The audit of liability accounts associated with payroll, often termed accrued payroll expenses, is ordinarily straightforward if internal controls are operating effectively. – Two major balance-related audit objectives in testing payroll liabilities: Accruals in the trial balance are stated at the correct amounts (Accuracy). Transactions in the payroll and personnel cycle are recorded in the proper period (Cutoff). METHODOLOGY FOR DESIGNING SUBSTANTIVE ANALYTICAL PROCEDURES AND TESTS OF DETAILS OF BALANCES Design and Perform Tests of Details of Balances for Liability and Expense Accounts: – The major liability accounts in the payroll and personnel cycle: Amounts Withheld from Employees’ Pay Accrued Salaries and Wages Accrued Commissions Accrued Bonuses Accrued Vacation Pay, Sick Pay, or Other Benefits METHODOLOGY FOR DESIGNING SUBSTANTIVE ANALYTICAL PROCEDURES AND TESTS OF DETAILS OF BALANCES Design and Perform Tests of Details of Balances for Liability and Expense Accounts: – The major expense accounts in the payroll and personnel cycle: Officers’ Compensation Commissions Payroll Tax Expense Total Payroll Contract Labor QUESTIONS?