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CIS Final - lecturee notes
Intermediate Accounting 2 (Virgen Milagrosa University Foundation)
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Chapter 12:
Business Ethics, Fraud and Fraud
Detection
ETHICAL ISSUES IN BUSINESS
Ethics: Principles of conduct used in making
choices and behavior in situations involving
right and wrong.
Business ethics involves two questions:
-How do managers decide on what is right in
conducting business?
-Once managers have recognized what is right,
how to they achieve it?
● Firm has conflicting responsibilities to
employees , shareholders, customers
and the public.
● Decisions have consequences that
benefit or harm each group.
● Seeking a balance is the manager’s
ethical responsibility.
● Benefits of decisions must outweigh
risks and be fairly distributed to those
who share the risk. Decisions should be
implemented to minimize and avoid all
unnecessary risks.
EQUITY
•Executive Salaries
•Comparable Worth
•Product Pricing
HONESTY
•Employee and Management Conflicts of
Interest
•Security of Organization Data and Records
•Misleading Advertising
•Questionable Business Practices in Foreign
Countries
•Accurate Reporting of Shareholder Interest
RIGHTS
•Corporate due process
•Employee Health Screening
•Employee Privacy
•Sexual Harassment
•Diversity
•Equal Employment Opportunity
•Whistleblowing
EXERCISE OF CORPORATE POWER
•Political Action Committees
•Workplace Safety
•Product Safety
•Environmental Issues
•Corporate Political Contributions
MAKING ETHICAL DECISIONS
PROPORTIONALITY
The benefit from a decision must outweigh the
risk
JUSTICE
The benefit of the decision should be
distributed fairly to those who share the risk
MINIMIZE RISK
Even if judged acceptable by the principles,
the decision should be implemented so as t
minimize all of the risks and avoid any
unnecessary risks.
COMPUTER ETHICS
• The analysis of the nature and social impact
of computer
technology and the corresponding formulation
and
justification of policies for the ethical use of
such technology.
Three levels of computer ethics:
Pop computer ethics
Para computer ethics
Theoretical computer ethics
COMPUTER ETHICS
A New Problem or Just a New Twist on an Old
Problem?
Although computer programs are a new type of
asset, many believe that they should not be
considered as different from other forms of
property.
Some argue that all pertinent ethical issues
have already been examined in some other
domain.
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PRIVACY
● People prefer to be in full control of what
and how much information about
themselves is available to others, and to
whom it is available. (Issue of Privacy)
● The creation and maintenance of huge,
shared databases makes it necessary to
protect people from the potential misuse
of data. (Issue of ownership in the
personal information industry)
SECURITY
Computer security is an attempt to avoid such
undesirable events as a loss of
confidentiality or data integrity.
OWNERSHIP OF PROPERTY
Laws designed to preserve real property rights
have been extended to cover what is referred
to as intellectual property – SOFTWARE.
EQUITY IN ACCESS
The economic status of the individual or the
affluence of an organization will determine the
ability to obtain information technology.
ENVIRONMENTAL ISSUES
Computers with high-speed printers allow for
the production of printed documents faster than
ever before.
● Intent
● Justifiable reliance
● Injury or loss
EMPLOYEE FRAUD
Employee fraud generally designed to convert
cash or other assets to the employee's
personal benefit.
-Can usually be prevented or detected if an
effective system of internal controls is in place.
- Involves (1) theft of asset, (2) conversion of
asset to cash and (3) concealment of crime.
MANAGEMENT FRAUD
Management fraud often escapes detection
until damage or loss has occurred.
Three characteristics:
-Perpetrated at levels of management above
the one to which internal controls
structures generally relate.
-Frequently involves using the financial
statements to create false image of
corporate financial health
-If fraud involves asset misappropriation,
shrouded in maze of complex business
transactions, often involving third parties.
FRAUD TRIANGLE
FRAUD & ACCOUNTANTS
The lack of ethical standards is fundamental to
the occurrence of business fraud.
No major aspect of the independent auditor’s
role has caused more difficulty for the public
accounting profession than the responsibility
for the detection of fraud during an audit.
FRAUD
A fraudulent act must meet the following 5
conditions:
● False representation
● Material fact
FINANCIAL LOSSES FROM FRAUD
ACFE 2010 research study estimated losses to
be 5% of annual revenues. Translates to
approximately $3.5 trillion in fraud losses for
2014. Actual cost of fraud is difficult to quantify:
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● Not all fraud is detected and not all
detected fraud is reported.
● In many cases, incomplete information
is gathered.
Information not properly distributed to
management or law enforcement authorities
and,
Sometimes business organizations take no civil
or criminal action against the perpetrator of
fraud.
Indirect costs of fraud –reduced productivity,
legal costs , increased unemployment and
business disruptions –must also be
considered.
20XX
FINANCIAL LOSSES FROM FRAUD
THE PERPETRATORS OF FRAUDS
THE PERPETRATORS OF FRAUDS
●
●
●
●
influenced by position, gender, age, and
education.
Highest positions in the organization are
beyond the internal control structure and
have the greatest access to assets.
Men, older employees and those with
higher levels of education tend to have
more higher positions and thus more
opportunities to commit fraud.
One reason for segregating duties is to
deny potential perpetrators the
opportunity to commit fraud.
When individuals in critical positions
collude, opportunities to control or gain
access to assets that would otherwise
not exist are created
FRAUDULENT STATEMENTS
● Management fraud that must bring
direct or indirect financial benefit to the
perpetrator.
● Accounts for 7.6% of fraud cases, but
the median loss is significantly higher
than other fraud schemes.
● Underlying problems:
● Lack of auditor independence.
● Lack of director independence.
● Questionable executive compensation
schemes.
● Inappropriate accounting practices
PCAOB created to set standards; inspect
registered accounting firms; conduct
investigations; take disciplinary actions.
Act addresses auditor independence by
creating more separation between a firm’s
attestation and non auditing activities.
Corporate governance and responsibility:
CONCLUSIONS
● Greater access to assets (i.e.
opportunity to commit fraud) is
Requires audit committee independence,
prohibits executive loans and requires
attorneys
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to report evidence of material violations of
security laws or breaches of fiduciary duty.
● Issuer and management disclosure
imposes new corporate disclosure
requirements.
● Imposes a range of criminal penalties
for fraud
CORRUPTION
Involves an executive, manager, or employee
in collusion with an outsider.
Types:
● Bribery involves giving, offering,
soliciting, or receiving things of value to
influence an official in the performance
of his or her lawful duties.
● Illegal gratuity involves giving, offering,
soliciting, or receiving something of
value because an official act has been
taken.
● Conflict of interest occurs when an
employee acts on behalf of a third party
when discharging his or her duties or
has self-interest in the activity being
performed.
● Economic extortion is the use (or threat)
of force (including economic sanctions)
to obtain something of value
ASSET MISAPPROPRIATION
Skimming
involves stealing cash before it is recorded.
Mailroom fraud
occurs when employee opens mail, steals
checks , and destroys remittance advices.
Cash larceny
involves stealing recorded cash.
Lapping:
Clerk uses customer’s check from one account
to cover theft from a different account.
Check tampering
involves forging or changing checks written to
legitimate payees.
Payroll fraud
is the distribution of fraudulent paychecks to
existent or nonexistent employees
Losses from Asset Misappropriation Schemes
DATA COLLECTION AND DATA
PROCESSING
● Data collection
frauds involve entering falsified data into the
system by deleting, altering or creating a
transaction.
● Masquerading
involves gaining remote access by pretending
to bean authorized user.
● Piggybacking
involves latching onto an authorized user in the
system.
● Hacking
involves both schemes motivated by the
challenge of trying to access the system.
Data processing frauds are in two classes:
● Program fraud
includes creating illegal programs or destroying
corrupting or altering computer logic to cause
data to be processed incorrectly.
● Operations fraud
is misuse or theft of computer resources
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AUDITOR’S RESPONSE TO RISK
ASSESSMENT
Judgments about the risk of material
misstatements may affect the audit in regards
to:
● Engagement staffing, extent of
supervision, professional skepticism ,
nature, timing, extent of procedures
performed.
● Risk of material misstatement due to
fraud always exists.
Auditor: may determine currently planned audit
procedures are sufficient to respond to risk
factors.
● may determine to extend audit and
modify planned procedures.
● may conclude procedures cannot be
modified sufficiently to address risk and
consider withdrawing
AUDITOR’S RESPONSE TO DETECTED
MISSTATEMENTS DUE TO FRAUD
If no material effect: Refer matter to
management and ensure implications to other
aspects of audit
have been addressed.
If effect is material or undeterminable:
● Consider implications for other aspects
of the audit.
● Discuss with senior management and
audit committee.
● Attempt to determine if material effect.
● Suggest client consult with legal
counsel.
● Working papers document criteria used
for assessing fraud risk:
● Where risk factors are identified,
documentation should include.
(1)those risk factors identified and
(2) auditor’s response to them
FRAUD DETECTION TECHNIQUES USING
ACL
Payments to fictitious vendors:
● Sort records of the invoice file by invoice
number and vendor number.
● Filter and verify the validity of vendors
with P.O. boxes.
● Join the employee and vendor files to
look matching addresses and review
them.
● Use the duplicate function to search for
multiple vendors with the same address.
● Create a value around the invoice
threshold amount and sort payment
records in this range by vendor
FRAUD DETECTION TECHNIQUES USING
ACL
Payroll fraud:
● Use expression builder to test for
excessive hours worked.
● Use duplicate function to test for
duplicate payments.
● Use join function to link payroll and
employee files to test for non-existent
employees.
● Lapping Accounts Receivable:
● Use expression builder to locate and
investigate invoices whoseRemittance
Amount is less than the Invoice
Amount.
● Calculate the amounts carried forward
and use the duplicate command to
search for carry-forward amounts that
are the same
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AUDIT OF THE REVENUE CYCLE
Transaction cycle – the sequence of
procedure applied in processing a
particular type of transactions.
● Revenue (Sales and Collection) Cycle
● Acquisition (Purchases and
Disbursements) Cycle
● Payroll Cycle
● Investing Cycle
● Financing Cycle
The Cycle Approach the interrelationship of
accounts in gathering evidences
about assertions in the financial statements.
Organizational Charts
Revenue Processing
“Different entities may have different revenue
processes”
Basic Revenue Transaction Process for
Merchandisers
1. Controlling Customers’ Orders
2. Credit Approval
3. Issuing the Merchandise
4. Product Shipment
5. Customer Billing
6. Adjustments for Sales Return and
Allowances and Doubtful Accounts
7. Collection of Receivables
Issuing the Merchandise
Inventory control
function
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Risk Assessment
I. Inherent Risk
REVENUE
◦ Improper revenue recognition
◦ Decline in sales
Due to economic condition, product
obsolescence, or competition
◦ Restrictions by laws and regulations
◦ Complexity of sales transactions
◦ Unusual sales terms
For returns, warranties, leases, or
recourse obligation
ACCOUNTS RECEIVABLES
◦ Collectability of receivables
◦ Conditions for collection
◦ Pledging of receivables
◦ Insufficient uncollectible accounts
II. Control Risk
◦ Document the understanding of controls
◦ Perform walk-throughs to determine the
implementation of controls
Assessing control risk requires knowledge of
weaknesses in revenue control processes
Audit Revenue Process
a. Risk Assessment
● Understanding the client and its
environment (assessing inherent risk)
● Understanding the client’s internal
control (assessing control risk)
b. Test of Controls
Operating effectiveness of controls
Most relevant assertions:
◦ 1. Existence of Revenue
◦ 2. Existence and Valuation of Accounts
Receivable
c. Substantive Procedures
Obtaining direct evidence about financial
statement assertions
Revenue and Accounts Receivable are the
most significant accounts
III. Preliminary Analytical Procedures
◦ Unusual year-end sales
◦ Inconsistent revenue and receivable growth
rates
◦ Unusual percentage of uncollectible
◦ Inconsistency with industry averages
May indicate heightened risks of fraud
IV. Fraud Risk
Fraud Schemes
●
●
●
●
●
●
●
Recognizing revenue on unshipped goods
Recognizing revenue on consigned
goods
Creation of fictitious invoices
Hidden agreements
Lapping
Understanding uncollectible accounts
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The audit of revenue and receivables is
often an area of significant risk
Fraud Responses
● Overall response such as assignment
of more experienced staff
● Response at the assertion level such as
performing procedures at year-end
rather than at interim date
The auditor shall presume that there are risk
of fraud in revenue recognition especially
about overstatements
V. Designing Further Procedures
◦ Deciding whether to perform test of controls
related to revenue processing
◦ Relying on the result of prior test of controls
◦ Nature, timing and extent of substantive
procedures including the reliance on
analytical substantive procedures
◦ Need for special audit consideration for
significant risks
Initial assessment of control risk at below
maximum will lead
to the performance of test of controls
Test of Controls
I. Procedures
◦ Inquiries of client personnel
◦ Inspection of documents/reports
◦ Observation of application controls
◦ Reperformance of the controls
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CHAPTER 10 :
AUDITING THE CYCLE EXPENDITURE.
EXPENDITURE CYCLE ACTIVITIES AND
TECHNOLOGIES
This section examines alternative
information technologies used to
support expenditure cycle activities.
EXPENDITURE CYCLE
ACTIVITIES AND TECHNOLOGIES
01 . Purchases And Cash Disbursement
Procedures Using BAtCH Processing
Technology
❖
❖
❖
❖
VENDORS
ACCOUNTS PAYABLE
RECEIVING
DATA PROCESSING
● PURCHASING DEPARTMENT
Upon receipt of the purchase requisition, the
purchasing department
● PREPARES AFIVE
Part purchase order
ALTERNATIVE APPROACHES
AUTHORIZING AND ORDERING
INVENTORIES
This Approach Characterizes
The Era Of Data Ownership In Which Files
Were Designed Exclusively For The Use Of A
Single user.
ALTERNATIVE 1
PO are sent for review
and signing before
sending to v e n d o r s and internal users.
02 . Reengineering the purchases/ cash
disbursement system
A Modern System That Employs Real- Time
Processing And Uses Direct Access Files Or
Database
ALTERNATIVE 2
Distributing the PO directly to
vendors and internal users
03 . Overview of payroll procedures
A Modern Payroll System
That Uses Real Time Processing
And Database Technology
ALTERNATIVE 3
uses EDI; no physical documents produced .
the entire ordering process is automate
PURCHASES AND CASH DISBURSEMENT
PROCEDURES USING BATCH
PROCESSING TECHNOLOGY
THIS TYPE OF SYSTEM IS AN EXAMPLE OF
AN EARLY LEGACY SYSTEM.
STEP 2
creation of open purchase order
transfer of corresponding records
● purchasing
● accounts payable
● data processing
Receiving department - when the goods arrive
from vendors, the receiving clerk prepares a
receiving report.
DATA PROCESSING DEPARTMENT
STEP 1
● Monitoring of the inventory
● Records creation of open requisition
file
● Preparation of purchase order
Step 3
Updates the inventory subsidiary file
Update the general ledger
Closing of corresponding records
● open voucher file
● data processing
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accounts payable - when the AP c l e r k
receives the invoice, the clerk's reconciles the
documents that were placed in the AP pending
file and prepare a voucher.
STEP 4
● vali d at e s the v o u c h e r r e c o r d s
● prepare for posting in the ledger
●
Data processing department- each day, the
System scan items that are due and checks
are printed for these items.
REENGINEERING THE PURCHASE/ CASH
DISBURSEMENT SYSTEM
● shows how reengineering the process
can produce considerable savings.
MAILING TO VENDORS. EDI VENDORS
RECEIVE PAYMENT ELECTRONICALLY.
2. THE PAYMENTS ARE RECORDED IN THE
CHECK REGISTER FILE.
3. ITEMS PAID ARE TRANSFERRED FROM
THE OPEN ACCOUNTS PAYABLE FILE TO
THE CLOSED ACCOUNT PAYABLE FILE.
4.THE GENERAL LEDGER ACCOUNTS
PAYABLE AND CASH ACCOUNTS ARE
UPDATED.
5.REPORTS DETAILING THESE
TRANSACTIONS ARE TRANSMITTED VIA
TERMINAL TO THE ACCOUNTS PAYABLE
AND CASH DISBURSEMENTS
DEPARTMENTS FOR THE MANAGEMENT'S
REVIEW AND FILING.
DATA P R O C E S S I N G
the following task are performed automatically:
1. The inventory file is searched for the items
that have fallen to their reorder point.
2. a record is entered in the purchase
requisition file for each item to be replenished.
3. requisitions are then consolidated according
to the vendor number.
4. vendor mailing information is retrieved from
the valid vendor file.
5. purchase orders are prepared and sent to
the vendor. alternatively, these may be
transmitted Using edi technology.
6. a record of each transactions is a d d e d to
the o p e n
p u rc h a s e order file.
7.. a t transaction listing of p u rc h a s e order
s is sent
to the purchasing department for review.
DATA PROCESSING
THE FOLLOWING PROCEDURES ARE
PERFORMED:
1. CHECKS ARE PRINTED, SIGNED AND
DISTRIBUTED TO THE MAILROOM FOR
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REENGINEERED PAYROLL SYSTEM
FEATURES
PERSONNEL
THE PERSONNEL DEPARTMENT MAKES
CHANGES TO THE EMPLOYEE FILE IN
REAL TIME VIA TERMINALS
COST ACCOUNTING
THE COST ACCOUNTING DEPARTMENT
ENTERS JOB COST DATA TO CREATE THE
LABOR USAGE FILE
TIMEKEEPING
UPON RECEIPT OF THE APPROVED
TIMECARDS FROM THE SUPERVISOR AT
THE END OF THE WEEK, THE TIME
KEEPING DEPARTMENT CREATES THE
CURRENT ATTENDANCE FILE.
DATA PROCESSING
THE FOLLOWING PROCEDURES ARE
PERFORMED IN A BATCH PROCESS:
1 . LABOR COST ARE DISTRIBUTED TO
VARIOUS WORK-IN-PROCESS, OVERHEAD,
AND EXPENSE ACCOUNTS.
2. AN ONLINE LABOR DISTRIBUTION
SUMMARY FILE IS CREATED. COPIES OF
THE FILE GO TO THE COST ACCOUNTING
AND GENERAL LEDGER DEPARTMENTS.
3. AN ONLINE PAYROLL REGISTER IS
CREATED FROM THE ATTENDANCE FILE
AND THE EMPLOYEE FILE.
4. THE EMPLOYEE RECORDS FILE IS
UPDATED.
5. PAYROLL CHECKS ARE PREPARED AND
SIGNED. THEY ARE SENT TO THE
TREASURER FOR REVIEW AND
RECONCILIATION WITH THE PAYROLL
REGISTER. THE PAYCHECKS ARE THEN
DISTRIBUTED TO THE EMPLOYEES.
6. THE DISBURSEMENT VOUCHER FILE IS
UPDATED AND A CHECK IS PREPARED
FOR THE FUNDS TRANSFER TO THE
PAYROLL IMPREST ACCOUNT. THE CHECK
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AND A HARD COPY OF THE
DISBURSEMENT VOUCHER GO TO CASH
DISBURSEMENT. ONE COPY OF THE
VOUCHER GOES TO THE GENERAL
LEDGER DEPARTMENT, AND THE FINAL
COPY GOES TO ACCOUNTS PAYABLE.
7. AT THE END OF THE PROCESSING, THE
SYSTEM RETRIEVES THE LABOR
DISTRIBUTION SUMMARY FILE AND THE
DISBURSEMENT VOUCHER FILE AND
UPDATES THE GENERAL LEDGER FILE.
EXPENDITURE CYCLE AUDIT
OBJECTIVES, CONTROLS, AND TEST OF
CONTROLS
RELATIONSHIP BETWEEN MANAGEMENT
ASSERTIONS AND EXPENDITURE CYCLE
AUDIT OBJECTIVES
EXISTENCE AND OCCURRENCE
- VERIFY THAT THE ACCOUNTS
PAYABLE BALANCE REPRESENTS
AMOUNTS ACTUALLY OWED BY THE
ORGANIZATION AT THE BALANCE SHEET
DATE.
COMPLETENESS
- VERIFY THAT THE FINANCIAL
STATEMENTS REFLECT ALL WAGES
FOR SERVICES PERFORMED
DURING THE PERIOD COVERED.
ACCURACY
- VERIFY THAT PAYROLL AMOUNTS
ARE BASED ON CORRECT PAY
RATES AND HOURS WORKED AND
ARE ACCURATELY COMPUTED.
RIGHTS AND OBLIGATIONS
- ESTABLISH THAT THE ACCOUNTS
PAYABLE AND ACCRUED PAYROLL
RECORDED AT THE BALANCE
SHEET DATE ARE LEGAL
OBLIGATIONS OF THE
ORGANIZATIONS.
VALUATION OR ALLOCATION
- VERIFY THAT ACCOUNTS PAYABLE
ARE STATED AT CORRECT
AMOUNTS OWED.
ACCURACY
- ENSURE THAT ACCOUNTS PAYABLE,
ACCRUED PAYROLL, AND
EXPENSES REPORTED FOR THE
PERIOD ARE PROPERLY DESCRIBED
AND CLASSIFIED IN THE FINANCIAL
STATEMENTS.
INPUT CONTROL
- DESIGNED TO ENSURE THAT
TRANSACTIONS ARE VALID, ACCURATE,
AND COMPLETE.
DATA VALIDATION CONTROLS
- INTENDED TO DETECT TRANSCRIPTION
ERRORS IN TRANSACTION DATA
BEFORE THEY ARE PROCESSED.
TESTING VALIDATION CONTROLS
- DATA ENTRY ERRORS THAT SLIP
THROUGH EDIT PROGRAMS
UNDETECTED CAN CAUSE RECORDED
ACCOUNTS PAYABLE AND EXPENSE
AMOUNTS TO BE MATERIALLY
MISSTATED.
BATCH CONTROLS
- USED TO MANAGE HIGH VOLUMES OF
TRANSACTION DATA THROUGH A
SYSTEM.
TESTING BATCH CONTROLS
- PROVIDE THE AUDITOR WITH
EVIDENCE RELATING TO THE
ASSERTIONS OF COMPLETENESS AND
ACCURACY.
PURCHASES AUTHORIZATION CONTROLS
- ACTUALLY OCCURS IN THE REVENUE
CYCLE WHEN GOODS ARE SOLD TO
CUSTOMERS.
TESTING PURCHASES AUTHORIZATION
CONTROLS
- CONTROLS CAN CAUSE UNNECESSARY
AND INCORRECT ORDERS TO BE
PLACED WITH VENDORS.
EMPLOYEE AUTHORIZATION
- USED TO EFFECT CHANGES IN HOURLY
PAY RATES, PAYROLL DEDUCTIONS,
AND JOB CLASSIFICATION.
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TESTING EMPLOYEE AUTHORIZATION
PROCEDURES
- IDENTIFY CURRENT EMPLOYEES,
COMMUNICATE THEIR STATUS
COMPLETELY AND CORRECTLY THE
PAYROLL FUNCTION, AND MONITOR
ADHERENCE TO EMPLOYEE
AUTHORIZATION PROCEDURES.
Process controls
• Process controls include computerized
procedures for updating files and restricting
access to data. Depending on the level of
computer technology in place, process controls
may also include physical controls associated
with manual activities. We begin by examining
three control techniques related to file
updating. Access and physical controls are
examined later
File update controls
Run-to-run controls use batch control data
discussed in the previous section to monitor
the batch as it moves
from one programmed procedure (run) to
another.
● Sequence Check Control
In systems that use sequential master files
(mostly legacy systems), the order of the
transaction records in the batch is
critical to correct and complete processing.
● Liability Validation Control
An important control in purchases/accounts
payable systems is the validation of the liability
prior to
making payment.
● Valid Vendor File
The valid vendor file is similar to the authorized
employee file discussed earlier.
● Testing File Update Controls
Failure of file update controls to function
properly can result in transactions
(1) not being processed (liabilities are not
recognized and recorded),
(2) being processed incorrectly (i.e., payments
are approved for unauthorized recipients), or
(3) being posted to the wrong supplier’s
account..
Access controls
• Access controls prevent and detect
unauthorized and illegal access to the firm’s
assets. Inventories and cash are the physical
assets of the expenditure cycle. Traditional
techniques used to limit access to these assets
include:
● Warehouse security, such as fences,
alarms, and guards.
● Moving assets promptly from the
receiving dock to the warehouse.
● Paying employees by check rather than
cash.
Controlling access to accounting records is no
less important. An individual with unrestricted
access to data can manipulate the physical
assets of the firm and cause financial
statements to be materially misstated.
Physical controls
Purchases System Control
• Segregation of Inventory control from
warehouse.
• Segregation of the general ledger and
accounts payable from cash disbursements.
• Supervision of the receiving department.
• Inspection of assets
• Theft of assets
• Reconciliation of supporting documents.
• The purchase order
• The receiving report
• The supplier’s invoice
Payroll System Controls
• Verification of timecards
• Supervision
• Paymaster
• Payroll Imprest account
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Output controls
• Accounts Payable Change Report
• This document is a summary report
that shows the overall change to accounts
payable.
• Transaction Logs
• Every transaction successfully
processed by the system should be recorded
on a transaction log, which serves as a journal.
Understanding data
• Transaction Listing
• The system should produce a (hard
copy) transaction listing of all successful
transactions.
Testing the accuracy and completeness
assertions
• The audit procedures described provide
evidence relating to management assertions of
accuracy and completeness. Auditors often
precede substantive tests of details with an
analytical review of account balances.
Analytical procedures can identify relationships
between accounts and risks
• Log of Automatic Transactions
• Some transactions are triggered
internally by the system.
• Unique Transaction Identifiers
• Each transaction processed by the
system must be uniquely
identified with a transaction number.
• Error Listing
• A listing of all error records should go
to the appropriate user to
support error correction and resubmission.
SUBSTANTIVE TEST OF EXPENDITURE
CYCLE ACCOUNTS
Expenditure cycle risks and audit concerns
• External auditors are concerned primarily with
the potential for understatement of liabilities
and related expenses. Reported balances
usually consist of items that have been
reviewed, validated, and acknowledged by
management. Attempts to improve financial
statement presentation may involve actions to
suppress the recognition and reporting of valid
liabilities related to the period under review.
Review disbursement vouchers for Unusual
trend and exceptions
• A useful audit procedure for identifying
potential audit risks involves scanning data
files for unusual transactions and account
balances. For example, scanning accounts
payable for excessively large balances may
indicate abnormal dependency on a particular
supplier. However, a high number of vendors
with small balances may indicate the need to
consolidate business activity.
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Reviewing for accurate invoice
prices
• Comparing prices on supplier invoices to
original purchase order prices provides
evidence for testing the management assertion
of accuracy. Significant discrepancies between
expected prices and the prices actually
charged may be due to clerical errors, failure to
review supporting documents before
authorizing payment, or accounts payable
personnel exceeding their authority in dealing
with price discrepancies
Testing the Completeness, existence and
right and obligations assertions
• Searching for Unrecorded Liabilities
• Searching for Unauthorized Disbursement
Vouchers
• Review for Multiple Checks to Vendors
• Auditing Payroll and Related Accounts
EXPENDITURE CYCLE
Chapter 10
● Purchases Processing Procedures
● Cash Disbursements Procedures
Purchases Processing
Manufacturing firms purchase raw materials for
production, and their purchasing decisions are
authorized by the production planning and
control function.
Merchandising firms purchase finished goods
for resale. The inventory control function
provides the purchase authorization for this
type of firm.
❖ Monitor Inventory Records
Firms deplete their inventories by transferring
raw materials into the production process and
by selling finished goods to customers.
When inventories drop to a pre-determined
reorder point, a purchase requisition is
prepared and sent to the prepare purchase
order function to initiate the purchase process.
❖ Prepare Purchase Order
Receives the purchase requisitions that are
sorted by vendor if necessary. Next, a
purchase order (PO) is prepared for each
vendor.
A copy of the PO is sent to the vendor. In
addition, a copy is sent to the set up accounts
payable (AP) function for filing temporarily in
the AP pending file, and a
blind copy is sent to the receive goods
function, where it is held until the inventories
arrive. The last copy is filed in the open/closed
purchase order file.
❖ Receive Goods
At this point, the firm has received no
inventories and incurred no financial obligation.
Hence, there is no basis for making a formal
entry into any accounting record.
❖ Upon completion of the physical count
and inspection, the receiving clerk
prepares a receiving report stating the
quantity and condition of the inventories.
❖ One copy of the receiving report
accompanies the physical inventories to
either the raw materials storeroom or
finished goods warehouse for
safekeeping.
❖ Another copy is filed in the open/closed
PO file to close out the purchase order.
A third copy of the receiving report is sent to
the AP department, where it is filed in the AP
pending file. A fourth copy of the receiving
report is sent to inventory control for updating
the inventory records.
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Finally, a copy of the receiving report is placed
in the receiving report file.
❖ Update Inventory Records
Depending on the inventory valuation method
in place, the inventory control procedures may
vary somewhat among firms.
Organizations that use a standard cost system
carry their inventories at a predetermined
standard value regardless of the price actually
paid to the vendor.
❖ Set Up Accounts Payable
During the course of this transaction, the set up
AP function has received and temporarily filed
copies of the PO and receiving report. The
organization has received inventories from the
vendor and has incurred (realized) an
obligation to pay for the goods.
Voucher Payable System
Each voucher is recorded in the voucher
register.
The voucher register reflects the AP liability of
the firm. The sum of the unpaid vouchers in the
register is the firm’s total AP balance. The AP
clerk files the cash disbursement voucher,
along with supporting source documents, in the
vouchers payable file. This file is equivalent to
the open AP file discussed earlier and also is
organized by due date.
❖ Post to General Ledger
The general ledger function receives a journal
voucher from the AP department and an
account summary from inventory control. The
general ledger function posts from the journal
voucher to the inventory and AP control
accounts and reconciles the inventory control
account and the inventory subsidiary summary.
The approved journal vouchers are then
posted to the journal voucher file.
The Cash Disbursements Systems
The cash disbursements system
Processes the payment of obligations created
in the purchases system.
Ensure that only valid creditors receive
payment and that amounts paid are timely and
correct. If the system makes payments early,
the firm forgoes interest income that it
★ Identify Liabilities Due
The AP function reviews the open AP file (or
vouchers payable file) for such items and
sends payment approval in the form of a
voucher packet (the voucher and/or supporting
documents) to the cash disbursements
department.
★ Prepare Cash Disbursement
The cash disbursements clerk receives the
voucher packet and reviews the documents for
completeness and clerical accuracy.
The clerk marks the documents in the voucher
packets paid and returns them to the AP clerk.
★ Update AP Record
Upon receipt of the voucher packet, the AP
clerk removes the liability by debiting the AP
subsidiary account or by recording the check
number and payment date in the voucher
register.
★ Post to General Ledger
The general ledger function receives the
journal voucher from cash disbursements and
the account summary from AP. The voucher
shows the total reductions in the firm’s
obligations and cash account as a result of
payments to suppliers.
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Overview of Payroll Activities
Update WIP Account
● After cost accounting allocates labor
costs to the WIP accounts, the charges
are summarized in a labor distribution
summary and forwarded to the general
edger function.
●
Prepare Payroll
● The payroll department receives pay
rate and withholding data from the
personnel department and
hours-worked data from the production
department.
A clerk in payroll then performs the
following tasks.
1. Prepares the payroll register
2. Enters the above information into the
employee payroll records.
3. Prepares employee paychecks.
4. Sends the paychecks to the distribute
paycheck function.
5. Files the time cards, personnel action form,
and and copy of the payroll register.
Prepare Accounts Payable
● The accounts payable (AP) clerk
reviews the payroll register for
correctness and prepares copies of a
cash disbursement voucher for the
amount of the payroll. The clerk records
the voucher in the voucher register and
submits the voucher packet (voucher
and payroll register) to cash
disbursements. A copy of the
disbursement voucher is sent to the
general ledger function.
Prepare Cash Disbursement
● Upon receipt of the voucher packet, the
cash disbursements function prepares a
single check for the entire amount of the
payroll and deposits it in the payroll
imprest account. The employee
paychecks are drawn on this account,
which is used only for payroll. Funds
must be transferred from the general
cash account to this imprest account
before the paychecks can be cashed.
The clerk sends a copy of the check along with
the disbursement voucher and the payroll
register to the AP department, where they are
filed.
Update General Ledger
● Receives the labor distribution summary
from cost accounting, the disbursement
voucher from AP, and the journal
voucher from cash disbursements.
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