Completing the Tests in the
Acquisition and Payment
Cycle: Verification
of Selected Accounts
Chapter 15
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Learning Objective 1
Recognize the many accounts in
the acquisition and payment cycle.
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Accounts Associated with Acquisition
and Payment Cycle Transactions
Assets
Cash
Inventory
Supplies
Property, plant, and equipment
Patents, trademarks, and copyrights
Prepaid rent
Prepaid taxes
Prepaid insurance
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Accounts Associated with Acquisition
and Payment Cycle Transactions
Expenses
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 Acquisition
and Payment Cycle Transactions
Liabilities
Accounts payable
Rent payable
Accrued professional fees
Accrued property taxes
Other accrued expenses
Income taxes payable
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Learning Objective 2
Design and perform audit
tests of property, plant, and
equipment related accounts.
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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.
Compare accumulated
depreciation divided by gross
manufacturing equipment
cost with previous years.
Misstatement in
depreciation expense
and accumulated
depreciation
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.
Compare gross manufacturing
cost divided by some measure
of production with previous
years.
Expensing amounts
that should be
capitalized
Idle equipment or
equipment that has
been 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
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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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 cost
• Prepaid taxes
• Patents
• Prepaid insurance
• Trademarks
• Deferred charges
• Copyrights
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Prepaid Insurance
Internal Controls
1. Controls over the acquisition and
recording of insurance
2. Controls over the insurance register
3. Controls over the charge-off of
insurance expense
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Prepaid Insurance
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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Prepaid Insurance
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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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
Beginning balance
Payments
(property taxes)
Current period
property tax expense
Ending balance
Property Tax Expense
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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
Compare individual
expenses with previous
year.
Overstatement or
understatement of a
balance in an expense
sheet.
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Analytical Procedures for
Income and Expense Accounts
Analytical Procedure
Possible Misstatement
Compare individual asset
and liability balances with
previous years.
Overstatement or
understatement of a
balance sheet account
that 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 ratio with
previous years.
Compare prepaid insurance
expense with previous
years.
Misstatement of cost
of goods sold and
inventory
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 divided by sales
with previous years.
Compare individual
manufacturing expenses
divided by total mfg.
expenses with previous years.
Misstatement of
commission expense,
accrued commissions
Misstatement of
individual mfg.
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 is the
examination
of underlying documentation
of individual transactions and
amounts making up the detail of
the total of an expense account.
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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 15
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