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.
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley
19 - 2
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
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley
19 - 3
Accounts Associated with the
Acquisition and Payment Cycle
Expenses:
 Cost of goods sold
 Rent expense
 Property taxes
 Income tax expense
 Insurance expense
 Professional fees
 Retirement benefits
 Utilities
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley
19 - 4
Accounts Associated with the
Acquisition and Payment Cycle
Liabilities:
 Accounts payable
 Rent payable
 Accrued professional fees
 Accrued property taxes
 Other accrued expenses
 Income taxes payable
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley
19 - 5
Methodology for Designing
Tests of Details of Balances
Identify client business
risks affecting
other accounts
Phase I
Set tolerable misstatement
and assess inherent
Phase I
risk for accounts
Assess control risk for
accounts
Phase I
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley
19 - 6
Methodology for Designing
Tests of Details of Balances
Design and perform
tests of controls and
substantive tests
Phase II
of transactions
for the acquisition
and payment cycle
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley
19 - 7
Methodology for Designing
Tests of Details of Balances
Design and perform
analytical procedures
Phase III
for the acquisition
and payment cycle
Design tests of details
of account balances
to satisfy
balance-related
audit objectives
Audit procedures
Sample size
Items to select
Phase III
Timing
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley
19 - 8
Learning Objective 2
Design and perform audit tests of
property, plant, and equipment
and related accounts.
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley
19 - 9
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
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley
19 - 10
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
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley
Depreciation
Expense
19 - 11
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
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley
19 - 12
Analytical Procedures for
Manufacturing Equipment
Analytical procedure
Possible misstatement
Compare depreciation expense Misstatement in
divided by gross manufacturing depreciation expense and
equipment cost with previous
accumulated depreciation
years
Misstatement in
Compare accumulated
depreciation divided by gross accumulated depreciation
manufacturing equipment cost
with previous years
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley
19 - 13
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 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
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley
19 - 14
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.
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley
19 - 15
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.
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley
19 - 16
Balance-Related Audit
Objectives
Existence:
Current acquisitions as listed exist.
1. Examine vendors’ invoices and
receiving reports
2. Physically examine assets.
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley
19 - 17
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.
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley
19 - 18
Balance-Related Audit
Objectives
Accuracy:
Current year acquisitions as listed
are accurate.
1. Examine vendors’ invoices.
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley
19 - 19
Balance-Related Audit
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.
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley
19 - 20
Balance-Related Audit
Objectives
Cutoff:
Current year acquisitions are recorded
in the correct period.
1. Review transactions near the balance
sheet date for correct period.
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley
19 - 21
Major Balance-Related
Audit Objectives
Rights:
The client has rights to current year
acquisitions.
1. Examine vendors’ invoices.
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley
19 - 22
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
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley
19 - 23
Verify Ending Balance
of Asset Accounts
1. All recorded equipment physically
exists on the balance sheet date.
2. All equipment owned is recorded.
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley
19 - 24
Verify Depreciation Expense
The most important objective is accuracy.
 Consistent depreciation policy
 Correct calculations
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley
19 - 25
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.
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley
19 - 26
Learning Objective 3
Design and perform audit tests
of prepaid expenses.
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley
19 - 27
Audit of Prepaid Expenses
Prepaid rent
 Organization costs
 Prepaid taxes
 Patents
 Prepaid insurance
 Trademarks
 Deferred charges
 Copyrights

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley
19 - 28
Prepaid Insurance and Related
Accounts
Prepaid Insurance
Beginning
balance
Insurance Expense
Current period
insurance
expense
Acquisitions
Ending
balance
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley
19 - 29
Internal Controls
 Acquisition and recording of insurance
 Insurance register
 Insurance expense
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley
19 - 30
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
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley
19 - 31
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.
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley
19 - 32
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.
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley
19 - 33
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.
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley
19 - 34
Learning Objective 4
Design and perform audit tests
of accrued liabilities.
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley
19 - 35
Audit of Accrued Liabilities
 Accrued
payroll
 Accrued payroll taxes
 Accrued officers’ bonuses
 Accrued commissions
 Accrued professional fees
 Accrued rent
 Accrued interest
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley
19 - 36
Accrued Property Taxes
and Related Accounts
Accrued Property Taxes
Payments
Beginning
(property taxes) balance
Property Tax Expense
Current period
property tax
expense
Ending
balance
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley
19 - 37
Learning Objective 5
Design and perform audit tests of
income and expense accounts.
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley
19 - 38
Approach to Auditing Income
and Expense Accounts
 Analytical procedures
 Tests of controls and substantive
tests of transactions
 Tests of details of account balances
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley
19 - 39
Analytical Procedures for Income
and Expense Accounts
Analytical procedure
Possible misstatement
Compare individual expenses
with previous years
Overstatement or
understatement of a
balance in an expense
account
Compare individual asset and Overstatement or
liability balances with previous understatement of a
years
balance sheet account that
will also affect an income
statement account
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley
19 - 40
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
Compare inventory turnover
ratio with previous years
Misstatement of cost of
goods sold and inventory
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley
19 - 41
Analytical Procedures for Income
and Expense Accounts
Analytical procedure
Possible misstatement
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
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley
19 - 42
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.
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley
19 - 43
Tests of Details of Account
Balances – Expense Analysis
Expense account analysis:
 Repairs and maintenance
 Rent and lease
 Legal expense
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley
19 - 44
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.
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley
19 - 45
End of Chapter 19
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley
19 - 46