Completing the Tests in the
Acquisition and Payment
Cycle: Verification of
Selected Accounts
Chapter 20
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Learning Objective 1
Recognize the many accounts
in the acquisition and
payment cycle.
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Accounts Associated with the
Acquisition and Payment Cycle
 Cash
 Inventory
 Supplies
 Property, plant, and equipment
 Patents, trademarks, and copyrights
 Prepaid rent
 Prepaid taxes
 Prepaid insurance
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Accounts Associated with the
Acquisition and Payment Cycle
 Cost of goods sold
 Rent expense
 Property taxes
 Income tax expense
 Insurance expense
 Professional fees
 Retirement benefits
 Utilities
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Accounts Associated with the
Acquisition and Payment Cycle
 Accounts payable
 Rent payable
 Accrued professional fees
 Accrued property taxes
 Other accrued expenses
 Income taxes payable
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Methodology for Designing Tests
of Details of Balances for A/P
Phase I
Identify client business risks affecting other
accounts.
Set tolerable misstatement and assess inherent
risk for accounts.
Assess control risk for accounts.
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Methodology for Designing Tests
of Details of Balances for A/P
Phase II
Design and perform tests of controls and
substantive tests of transactions for the
acquisition and payment cycle.
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Methodology for Designing Tests
of Details of Balances for A/P
Phase III
Design and perform analytical procedures for the
acquisition and payment cycle.
Design tests of details of account balances to
satisfy balance-related audit objectives.
Audit
Sample
procedures size
Items to
select
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Timing
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Learning Objective 2
Design and perform audit tests of
property, plant, and equipment
and related accounts.
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Classifications of Property, Plant,
and Equipment Accounts
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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
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Manufacturing Equipment and
Related Accounts
Manufacturing
Equipment
Beginning
Disposals
balance
Acquisitions
Ending
balance
Accumulated
Depreciated
Disposals Beginning
balance
Current period
depreciation
Ending balance
Gain or Loss
on Disposals
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Depreciation
Expense
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Auditing Manufacturing
Equipment and Related Accounts
Analytical procedures
• Current year acquisitions
• Current year disposals
• Ending balance in the asset account
• Depreciation expense
• Ending balance in accumulated depreciation
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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.
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Analytical Procedures for
Manufacturing Equipment
Analytical Procedure
Possible Misstatement
Compare monthly or annual
repairs and maintenance,
supplies expense, small tools
expense, and similar accounts
with previous years.
Expensing amounts 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.
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Verifying Current Year
Acquisitions
The proper 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 nine balance-related
audit objectives are used as a frame of reference.
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Major 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.
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Major Balance-Related Audit
Objectives
Existence
Current acquisitions as listed exist.
1. Examine vendors’ invoices and
receiving reports
2. Physically examine assets.
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Major Balance-Related Audit
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.
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Major Balance-Related Audit
Objectives
Accuracy
Current year acquisitions as
listed are accurate.
1. Examine vendors’ invoices.
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Major Balance-Related Audit
Objectives
Classification
Current year acquisitions as listed are properly
classified.
Examine:
1. Vendors’ invoices in mfg. equipment account.
2. Vendors’ invoices of closely related accounts.
3. Rent and lease expense for capitalizable leases.
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Major Balance-Related Audit
Objectives
Cutoff
Current year acquisitions are recorded
in the proper period.
1. Review transactions near the balance
sheet date for proper period.
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Major Balance-Related Audit
Objectives
Rights
The client has rights to
current year acquisitions.
1. Examine vendors’ invoices.
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Verifying 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.
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Verifying Ending Balance
of Asset Accounts
1. All equipment owned is recorded.
2. All recorded equipment physically
exists on the balance sheet date.
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Verifying Depreciation Expense
The most important objective is accuracy.
Consistent depreciation policy
Correct calculations
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Verifying 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.
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Learning Objective 3
Design and perform audit tests
of prepaid expenses.
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Audit of Prepaid Expenses
• Prepaid rent
• Organization costs
• Prepaid taxes
• Patents
• Prepaid insurance
• Trademarks
• Deferred charges
• Copyrights
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Prepaid Insurance and Related
Accounts
Prepaid Insurance
Beginning
balance
Insurance Expense
Current period
insurance
expense
Acquisitions
Ending
balance
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Internal Controls
1. Acquisition and recording of insurance
2. Insurance register
3. Insurance expense
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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.
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Audit Tests
Compare the computed prepaid insurance
balance for the current year on a policy-by-policy
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.
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Balance-Related Audit Objectives
Existence and
completeness
Rights
Insurance policies
in the prepaid
insurance schedule
exist and existing
policies are listed.
The client has rights
to all insurance
policies in the
prepaid insurance
schedule.
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Balance-Related Audit Objectives
Accuracy and detail
tie-in
Classification
Prepaid amounts are
accurate and the total
is correctly added
and agrees with
the general ledger.
Insurance expense is
properly classified.
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Balance-Related Audit Objectives
Cutoff
Presentation and
disclosure
Insurance transactions
are recorded in the
proper period.
Prepaid insurance is
properly presented
and disclosed.
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Learning Objective 4
Design and perform audit tests
of accrued liabilities.
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Audit of Accrued Liabilities
• Accrued income taxes
• Accrued interest
• Accrued pension costs
• Accrued professional fees
• Accrued rent
• Accrued warranty costs
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Accrued Property Taxes and
Related Accounts
Accrued
Property Taxes
Property Tax
Expense
Payments
Beginning
(property taxes) balance
Current period
property tax
expense
Ending
balance
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Learning Objective 5
Design and perform audit tests of
income and expense accounts.
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Approach to Auditing Income
and Expense Accounts
Analytical procedures
Tests of controls and substantive tests
of transactions
Tests of details of account balances
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Analytical Procedures for Income
and Expense Accounts
Analytical procedure
Possible misstatement
Overstatement or
Compare individuals expenses understatement of a
with previous years.
balance in an expense
account.
Overstatement or
Compare individual asset and understatement of a
liability balances with previous balance sheet account that
years.
would also affect an income
statement account.
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Analytical Procedures for Income
and Expense Accounts
Analytical procedure
Possible misstatement
Compare individual expenses
with budgets.
Misstatement of expenses
and related balance
sheet accounts.
Compare gross margin
percentage with previous
years.
Misstatement of cost of
goods sold and inventory.
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Analytical Procedures for Income
and Expense Accounts
Analytical procedure
Possible misstatement
Compare inventory turnover
rate with previous years.
Misstatement of cost of
goods sold and inventory.
Compare prepaid insurance
expense with previous years.
Misstatement of insurance
expense and prepaid
insurance.
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Analytical Procedures for Income
and Expense Accounts
Analytical procedure
Possible misstatement
Compare commission expense
Misstatement of cost of
divided by sales with
goods sold and inventory.
previous years.
Compare individual
manufacturing expenses
divided by total manufacturing
expenses with previous years.
Misstatement of individual
manufacturing expenses
and related balance
sheet accounts.
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Tests of Controls and Substantive
Test of Transactions
Understanding internal control and the
related tests of controls and substantive
tests of transactions to determine the
appropriate assessed control risk are
the most important means of verifying
many of the income statement accounts
in each of the transaction cycles.
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Tests of Details of Account
Balances – Expense Analysis
Expense account analysis
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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.
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End of Chapter 20
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