Document

Completing the Tests in the Acquisition and Payment Cycle: Verification of

Selected Accounts

Chapter 19

©2010 Prentice Hall Business Publishing,

Auditing 13/e, Arens//Elder/Beasley 19 - 1

Learning Objective 1

Recognize the many accounts in the acquisition and payment cycle.



Accounts Associated with the

Acquisition and Payment Cycle

Assets:





Cash

Inventory





Supplies

Property, plant, and equipment







Patents, trademarks, and copyrights

Prepaid rent

Prepaid taxes

 Prepaid insurance





Expenses:





Cost of goods sold

Rent expense





Property taxes

Income tax expense







Insurance expense

Professional fees

Retirement benefits

 Utilities





Liabilities:

 Accounts payable

 Rent payable

 Accrued professional fees

 Accrued property taxes





Other accrued expenses

Income taxes payable



Methodology for Designing

Tests of Details of Balances

Identify client business risks affecting other accounts

Phase I

Set tolerable misstatement and assess inherent risk for accounts

Phase I

Assess control risk for accounts

Phase I





Design and perform tests of controls and substantive tests of transactions for the acquisition and payment cycle

Phase II





Design and perform analytical procedures for the acquisition and payment cycle

Phase III

Audit procedures

Design tests of details of account balances to satisfy balance-related audit objectives

Sample size

Items to select

Timing


Auditing 13/e, Arens//Elder/Beasley

Phase III

19 - 8


Design and perform audit tests of property, plant, and equipment and related accounts.



Classifications of Property, Plant, and Equipment Accounts















Land and land improvements

Buildings and building improvements

Manufacturing equipment

Furniture and fixtures

Autos and trucks

Leasehold improvements

Construction-in-process for property, plant, and equipment



Manufacturing Equipment and Related Accounts

Beginning balance

Manufacturing

Equipment

Disposals

Acquisitions

Ending balance

Accumulated

Depreciated

Disposals Beginning balance

Current period depreciation

Ending balance

Gain or Loss on Disposals

Depreciation

Expense



Auditing Manufacturing Equipment and Related Accounts

Perform analytical procedures

Plus verify:

 Current year acquisitions

 Current year disposals

 Ending balance in the asset account

 Depreciation expense

 Ending balance in accumulated depreciation



Analytical Procedures for

Manufacturing Equipment

Analytical procedure Possible misstatement

Compare depreciation expense divided by gross manufacturing equipment cost with previous years

Misstatement in depreciation expense and accumulated depreciation

Compare accumulated depreciation divided by gross manufacturing equipment cost with previous years

Misstatement in accumulated depreciation



Analytical Procedures for

Manufacturing Equipment


Compare monthly or annual repairs and maintenance, supplies expense, small tools expense, and similar accounts with previous years

Expensing accounts that should be capitalized

Compare gross manufacturing cost divided by some measure of production with previous years

Idle equipment or equipment that was disposed of but not written off



Verify Current Year Acquisitions

The correct recording of current year additions is important because of the long-term effect the assets have on the financial statements.

Because of the importance of current period acquisitions, seven of the eight balance-related audit objectives are used as a frame of reference.



Balance-Related Audit

Objectives

Detail tie-in:

Current acquisitions agree with the master file.

1. Foot the acquisition schedule.

2. Trace the individual acquisitions to the master file.

3. Trace the total to the general ledger.




Objectives

Existence:

Current acquisitions as listed exist.

1.

Examine vendors’ invoices and receiving reports

2. Physically examine assets.




Objectives

Completeness:

Existing acquisitions are recorded.

1.

Examine vendors’ invoices of closely related accounts to uncover items that should be manufacturing equipment.

2. Review lease and rental agreements.




Objectives

Accuracy:

Current year acquisitions as listed are accurate.

1. Examine vendors’ invoices.




Objectives

Classification:

Current year acquisitions as listed are correctly classified.

1. Examine vendors’ invoices in manufacturing equipment account.

2. Examine vendors’ invoices of closely related accounts.

3. Examine rent and lease expense for capitalizable leases.




Objectives

Cutoff:

Current year acquisitions are recorded in the correct period.

1. Review transactions near the balance sheet date for correct period.



Major Balance-Related

Audit Objectives

Rights:

The client has rights to current year acquisitions.

1. Examine vendors’ invoices.



Verify Current Year Disposals

 Review whether newly acquired assets replace existing assets

 Analyze gains and losses on disposal

 Review documents for indications of deletion of equipment

 Make inquiries about the possibility of the disposal of assets



Verify Ending Balance of Asset Accounts

1. All recorded equipment physically exists on the balance sheet date.

2. All equipment owned is recorded.



Verify Depreciation Expense

The most important objective is accuracy.

 Consistent depreciation policy

 Correct calculations



Verify Ending Balance in

Accumulated Depreciation

1. Accumulated depreciation as stated in the property master file agrees with the general ledger.

2. Accumulated depreciation in the master file is accurate.




Design and perform audit tests of prepaid expenses.



Audit of Prepaid Expenses

 Prepaid rent

 Organization costs

 Prepaid taxes

 Patents

 Prepaid insurance

 Trademarks

 Deferred charges

 Copyrights



Prepaid Insurance and Related

Accounts

Insurance Expense Prepaid Insurance


Current period insurance expense

Acquisitions

Ending balance



Internal Controls

 Acquisition and recording of insurance

 Insurance register

 Insurance expense



Audit Tests

 Compare total prepaid insurance and insurance expense with previous years

 Compute the ratio of prepaid insurance to insurance expense and compare it with previous years

 Compare the individual insurance policy coverage on the schedule of insurance obtained with the preceding year’s schedule



Audit Tests

 Compare the computed prepaid insurance balance for the current year on a policy-bypolicy basis with that of the preceding year.

 Review the insurance coverage listed on the prepaid insurance schedule with an appropriate client official or insurance broker.



Balance-related Audit

Objectives

Existence and completeness:

Insurance policies in the prepaid insurance schedule exist and existing policies are listed.

Rights:

The client has rights to all insurance policies in the prepaid insurance schedule.



Balance-related Audit

Objectives

Accuracy and detail tie-in:

Prepaid amounts are accurate and the total is correctly added and agrees with the general ledger.

Classification:

Insurance expense is properly classified.

Cutoff:

Insurance transactions are recorded in the proper period.




Design and perform audit tests of accrued liabilities.



Audit of Accrued Liabilities

 Accrued payroll

 Accrued payroll taxes



Accrued officers’ bonuses

 Accrued commissions

 Accrued professional fees

 Accrued rent

 Accrued interest



Accrued Property Taxes and Related Accounts

Accrued Property Taxes

Payments

(property taxes)


Property Tax Expense

Current period property tax expense

Ending balance




Design and perform audit tests of income and expense accounts.



Approach to Auditing Income and Expense Accounts

 Analytical procedures

 Tests of controls and substantive tests of transactions

 Tests of details of account balances



Analytical Procedures for Income and Expense Accounts


Compare individual expenses with previous years

Overstatement or understatement of a balance in an expense account

Compare individual asset and liability balances with previous years

Overstatement or understatement of a balance sheet account that will also affect an income statement account




Analytical procedure

Compare individual expenses with budgets

Compare gross margin percentage with previous years

Compare inventory turnover ratio with previous years

Possible misstatement

Misstatement of expenses and related balance sheet accounts

Misstatement of cost of goods sold and inventory

Misstatement of cost of goods sold and inventory





Compare prepaid insurance expense with previous years

Misstatement of insurance expense and prepaid insurance

Compare commission expense divided by sales with previous years

Compare individual manufacturing expenses divided by total manufacturing expenses with previous years

Misstatement of commission expense and accrued commissions

Misstatement of individual manufacturing expenses and related balance sheet accounts



Tests of Controls and Substantive

Test of Transactions

Both tests of controls and substantive tests of transactions have the effect of simultaneously verifying balance sheet and income statement accounts.



Tests of Details of Account

Balances – Expense Analysis

Expense account analysis:

 Repairs and maintenance

 Rent and lease

 Legal expense



Tests of Details of Account

Balances – Allocation

Several expense accounts result from the allocation of accounting data rather than discrete transactions.

These include depreciation, depletion, and the amortization of copyrights and catalog cost.

The allocation of manufacturing overhead between inventory and cost of goods sold is an example of a different type of allocation that affects expenses.



End of Chapter 19



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