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Acquisition and
Expenditure Cycle
Including Audit of Accounts Payable
and Inventory Existence
Copyright © 2003 McGraw-Hill Ryerson Limited
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Acquisition and Expenditure
Cycle: Typical Activities
Exhibit 10-1 shows the activities and
transactions, accounts and records in the
acquisition and expenditure cycle.
– Purchase goods and services.
– Pay the bills.
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Start Here
Request for
purchases
Cash disbursement
Acquisition and
Expenditure Cycle
Enter accounts
payable
Receive
goods and
services
Receive vendor
invoice
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Acquisition Cycle:
Typical Activities
– Authorization - Purchase requisition, order and
payment
• Assembly of payment voucher, paid stamp
• Authorized cheque signatories
– Custody - Receipt of goods, and supporting
documents and records
– Recording - Record in accounts payable and cash
accounts
– Periodic Reconciliation - Periodic comparison of
existing assets to recorded amounts in various
accounts
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Audit Evidence in
Management Reports
Computer processing of acquisition and
payment transactions include
– Open purchase orders - Contain purchase
orders for goods ordered, but not yet received.
– Unmatched receiving reports - Reports for
goods received for which the vendor invoice
has not yet been received or matched.
– Unmatched vendor invoices - Invoices
received for goods not yet received or
matched.
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Audit evidence in management
reports
– Accounts payable trial balance - A list of
balances owed to specific vendors
– Purchases journal - A detailed list of all
purchase for the period
– Inventory reports (trial balance) - A detailed
list of all inventory items
– Fixed asset reports - A detailed list of all fixed
assets
– Cash disbursements report - A detailed list of
all cash disbursements
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Control Risk Assessment
Control risk assessment governs the nature,
timing, and extent of substantive audit
procedures.
– Accounts included in acquisition and expenditure:
• inventory
• capital assets
• amortization expense
• accumulated amortization
• accounts and notes payable
• cash
• expense categories (administrative, selling, and
manufacturing)
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General Control Considerations
Ensure proper segregation of
responsibilities for authorization, custody,
recording, and reconciliation.
– Persons who have custody of assets and
cash disbursements authority should not do
accounting.
Controls should provide evidence for detail
control checking activities.
– Signatures, initials, physical security, policies
and procedures
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Detail Test of Controls Audit
Procedures
Tests of controls should address all of the
control objectives.
– Cut-off is important to valuation of inventory.
– Tests include identification of population and
expression of the action to be taken.
• Note dual direction of testing for
completeness and validity requires
selection of sample from appropriate
population.
– See Exhibit 10-5.
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Detail Test of Controls for
Inventory Records
Auditors need to determine whether they
can rely on the accuracy of perpetual
records.
– Tests over accuracy involve tests of the
additions (purchases) and reductions (issues)
of the item balances.
– A dual direction test of audit samples should
be performed.
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Summary:
Control Risk Assessment
The purpose of testing controls is to
determine nature, extent, and timing of
substantive procedures.
– Good controls – low control risk
• Smaller sample sizes, earlier timing for
substantive tests.
– Poor controls – high control risk
• Larger samples, more work at year end.
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Audit Cases:
Substantive Audit Procedures
The audit of account balances consists of
procedural efforts to detect errors,
irregularities, and frauds that may exist in
the balances, thus making them misleading
in financial statements.
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Substantive Procedures
Specific examples of test of controls and
substantive procedures are in the form of
casettes (mini-case studies).
– Each casette has the following parts:
Paper Trail
Method
Amount
Audit Approach
Audit Objective
Control
Test of Controls
Audit of Balance
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Audit Casettes:
Substantive Audit Procedures
10.1 Printing (Copying) Money
– Improper expenditures for company services
charged to motion picture production costs.
10.2 Real Cash Paid to Phony Doctors
– Cash disbursements fraud to determine
whether employee medical benefits “existed”
in the sense of being valid claims paid to
valid doctors.
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Audit Casettes:
Substantive Audit Procedures
10.3 Receiving the Missing Oil
– Fuel oil supplies inventory and fuel expenses
inflated because of short shipments.
10.4 Go For The Gold
– Fixed assets in the form of mining properties
were overstated through a series of “flip”
transactions involving related parties.
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Audit Casettes:
Substantive Audit Procedures
10.5 Retread Tires
– Inventory and income overstated by
substitution of retread tires for inventory at
new tire prices.
10.6 Amortize “The Drum” Slowly
– Net asset values (unamortized cost of films)
was overstated by taking too little
amortization expense.
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Special Note:
The Completeness Assertion
When considering assertions and obtaining
evidence about accounts payable and other
liabilities, auditors must put emphasis on the
completeness and obligations assertions.
– Emphasis because companies tend to be
less concerned about recording expenses
and liabilities.
– Auditors cannot rely entirely on the
management assertion of completeness.
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Search for Unrecorded Liabilities
The search for unrecorded liabilities is
designed to yield audit evidence of liabilities
that were not recorded in the reporting
period.
– Objective is to search all the places where
evidence of liabilities might exist.
– See list of procedures in text.
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Special Note:
Physical Inventory Observation
The auditing procedures for inventory and
related sales accounts frequently are
extensive in an audit engagement.
– A material error or irregularity in inventory has
a pervasive effect on the financial statement.
– Auditing standards require that the auditor
observe the inventory taking and make test
counts. They seldom take or count the entire
inventory.
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Auditor’s Observation of Inventory
First task is to review client’s inventorytaking instructions.
– This is a test of controls.
– If count procedures are sound, auditor can
rely on count to produce good results.
Auditor will also perform test counts.
– Testing of counts will be a dual-direction test.
– The physical observation procedures are
designed to audit for existence,
completeness, and valuation.
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Special Note:
Physical Inventory Observation
Physical inventory not on year-end date:
– The inventory on the count date is reconciled
to the year-end inventory and auditing
procedures are performed on inventory
additions and issues for the intervening period.
Cycle inventory counting:
– Company does not take a complete count on a
single date, but rather in cycles or uses
statistical counting plan. Accuracy of perpetual
records must be determined.
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Special Note:
Physical Inventory Observation
Auditors not present at client’s inventory
count:
– The auditor must review the client’s plans for
the completed count.
– Some test counts of current inventory should
be made and traced to current records to
determine reliability of perpetual records.
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Special Note:
Physical Inventory Observation
Inventories located off the client’s premises:
– Determine the amount and location of the
inventory off the client’s premises.
– If amounts are material and controls are not
strong, the auditor may wish to visit locations
and conduct on-site tests counts.
– If amounts are not material and control risk is
low, direct confirmation with the custodian
may be sufficient competent evidence.
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Appendix 10A
Internal Control Questionnaires:
– Purchasing and Accounts Payable
– Cash Disbursements Processing
– Acquisition and Expenditure Computer
Controls
– Inventory Transaction Processing
– Fixed Asset and Related Transactions
Processing
– Selected Computer Questionnaire Items:
General and Application Controls
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Appendix 10B
Substantive Audit Programs:
– Audit Program for Inventory and Cost of
Goods Sold
– Audit Program for Capital Assets and Related
Accounts
– Audit Program for Accounts Payable
– Audit Program for Prepaid, Deferred, and
Accrued Expenses
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EDI Systems and Accounts
Payable Audits - Appendix 10C
Partnership with suppliers
Elimination of statements of account
Billing of accounts payable
Audit approach
Confirmation
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