AUDITING

BAC2664 (New), BAC2287(Old)

Topic 8, Lecture 9
Audit of the Acquisition and
Payment Cycle

1
 Audit of Acquisition and Payment
Cycle
• System cycle and internal control
• Objective of audit on purchase and account
payable
• Tests of controls system and internal control
• Test on real transactions
• Substantive tests of transactions and account
payable
• Balance confirmation on creditors and accrued
liabilities
2
 Overview of the purchase cycle
Purchases and cash payments cycle covers the purchase of raw
materials and consumables on credit, payments to creditors,
purchase returns and discount received.

Two classes of transactions (credit purchases and cash payments) are

processed by the accounting system in a different manner.

Internal controls are applied to ensure:

6 Complete processing of transactions;
7 Transactions are processed accurately; and
8 Only valid transactions are processed.

(Refer to transactions and credit purchases cycle diagram)

3
 Purchases cycle
• A purchase begins with the request made by
various dept (a purchase requisition is
generated, approved by the respective HOD).
• Purchase order prepared by purchase dept,
approved and sent to supplier.
• Approved purchase order provides the authority
that goods sent by the supplier can be received.
• Purchas invoices received after goods had been
received.
• Supplier expects payment to be made within
credit period.

4
 Account Balances in the purchase
cycle
Credit purchases:
Debit: purchases (summarized in the PJ)
Credit: purchase ledger control account (summarized in the
purchase ledger)

Payments made to supplier:

Debit: purchase ledger control account (summarized in the cash
book)
Credit: bank account (summarized in the cash book)

The accounts pertinent to the test of details of transactions are

purchases account and bank account. Test of details of balances
are performed on purchases ledger control account and its detailed
counterpart, the purchase ledger.

5
 Purchases Activities, Documents,
Records
Auditor has to understand the flow of purchase
transactions through the accounting system.

To facilitate understanding and identification of

appropriate controls, an auditor has to gain
sufficient knowledge about the activities in
purchase cycle, the documents, the records,
related to processing purchase.

Then, the auditor describes his understanding in

flowcharts.

6
 Purchases Activities, Documents,
Records continued

Activity Document Record

Authorization:
Accepting and Purchase requisition
processing purchase Purchase order
requisition

Approving purchases Approved suppliers

quotation
Receiving of goods Approved purchase
from supplier order
Delivery note
Billing by supplier Receiving report
Purchase invoice 7
 Purchases Activities, Documents,
Records continued

Recording:

Journalizing and Purchase invoice Purchase journal

posting the purchases
Purchase ledger

Summarizing the
General ledger
journal entries,
posting the summary

Custody:
Access to documents,
records, limited to
authorized personnel 8
 Purchase Department
Activity/responsibilities:
1 Accepting and processing purchase requisition (PR).
2 Approving purchases entry.
3 Selecting a supplier.
4 Issuing purchase orders (PO).

Possible errors/irregularities:
8 PO could be issued for fictitious purchase
9 PO does not agree with PR pertaining to the specification and quantity of
items required
10 PO misplaced

Control procedures:
13 Matched particulars of PR to suppliers quotations
14 Matched particulars of PO with PR
15 PO are pre-numbered
16 PR are kept on file together with PO

9
 Stores
Activity/responsibilities:
2 Receiving of goods from supplier delivery note – DN)
3 Checking goods and preparing receiving report

Potential risk:
6 Receiving of damaged goods or wrong specification and quantity
7 Goods received by-pass the checking or approved without
making reference to PO

Control procedures:
10 Numerical sequence of approved receiving report
11 Copy 1, sent to account dept, copy 2 used to update the bin card

10
 Accounts Department
Activity/responsibilities:
2 Billing (invoicing) by supplier
3 Keeping the supporting document (approved PO, DN)
4 Ensure PO, DN sequence

Possible errors/irregularities:
1 goods billed, but not yet received
Amount billed may be incorrect

Control procedures:
11 Account for pre-numbered PO to determine all invoices are for
goods actually received
12 Match invoice with DN and approved PO to determine the validity of
authorized transactions

PO, DN, approved PO, copy 2, are stapled and filed numerically

11
 Accounts Department continued

Activity/responsibilities:
2 Journalizing the PJ, posting, recording the purchases and purchase invoices
into the GL
3 Monitoring the amount owing

Possible errors/irregularities:
6 Purchases are not recorded
7 Purchases recorded to the wrong account
8 Purchases are received twice
9 Purchases recorded in the wrong financial year

Control procedures:
12 Account for pre-numbered invoice
13 Establish proper chart of account
14 Invoices marked ‘POSTED’ or cancelled after posting are done
15 Establish internal verification of pricing, extensions, footings
16 Establish proper cut-off, i.e., all receiving report issued before the year end
are not billed by suppliers in the following year

12
 Cash Payments
Activity Document Records
Authorization:
Approving payment Suppliers remittance
vouchers advice (SRA)
Approved purchase
invoice (API)
Approved payment
vouchers (APV)
Approving cheques
SRA, API, APV
cheques

13
 Cash Payments continued

Recording:
Journalizing, posting Approved payment Cash book
the payments vouchers Purchase ledger

Summarizing journal
entries, posting the General ledger
summary

Custody:
Access to documents,
records limited to
authorized personnel
14
 Accounts Department
Activity/responsibilities:
2 Approving payments vouchers (PV)
3 Issue PV in sequence, in order to ensure
completeness of the payment made to
suppliers
4 Approval for payment given after the officer is
satisfied with the supporting documents that
were attached together with the PV
5 Cashier before signing the cheques, needs to
ensure the validity, accuracy of the payment.
15
 Cashier
Activity/responsibilities:
2 Approve cheques

Irregularities:
5 Payment made for unauthorized payments

Control procedures:
1 Supporting documents are marked “PAID’ or
cancelled at the time cheques are signed

16
 Accounts Department
Activity/responsibilities:
2 journalizing, posting the payments, by using
particulars from the PV
3 Update the cash book and purchase ledger
4 Keep the PV by serial number
5 Summarizing the journal entries and posting
the summary for the month from the PJ, cash
payments from cash book, to the GL

17
 Subsequent Accountability
Activity Record

Agreeing GL balance with GL, PL, Creditors reconciliation

creditors balances in PL statement

Agreeing creditors balances in PL PL, statement of account,

with statement of accounts creditors reconciliation statement

Preparing bank reconciliation Cash book, bank statement, bank

statement reconciliation statement

18
 Accounts Department
Activity/responsibilities:
2 Agreeing GL balances with creditors balances
in PL
3 Determine accuracy of recording on monthly
basis by verifying agreement of the total
balances in the PL with the PL control account
in the GL

Possible errors
1 Errors in recording are highlighted in the
creditors reconciliation statement
19
 Accounts Department
Activity:
2 Agreeing creditors balances in PL with
statement of accounts
3 Check and confirm entries made in the
accounts
4 Highlight the age of the debts

20
 Accounts Department
Activity:
2 Preparing bank reconciliation statement
3 Prepare bank reconciliation every month for the following
reasons:
(a) the differences between the balances as per bank statement
and cash book are valid ones
(b) the differences in balances are not a result of errors made by
the book-keeper or the bank
(c) ensure that no payments have been passed through the bank
account which has not been entered in the cash book
(d) irregular items, such as statute barred unrepresented cheques,
will be shown in the bank statement, thus ensuring their reversal
in the accounting records

21
 Internal Control Questionnaire for
Purchases
Does the System Ensure That No Invoice Can Be
Passed for Payment Without Proof of Receipt of
Goods or Services?
2 Are receiving report used?
3 Are invoices and receiving report sent directly to
accounting dept and promptly recorded in the PJ?
4 Is the PL functions independent of purchasing, stores,
cashier, GL functions?
5 Are invoices compared to Po and receiving report by
different people who cross referenced and initial?
(alternatively, are the signed receiving report and PO
attached to the purchase invoice?)

22
 Internal Control Questionnaire for
Purchases continued

Does the System Prevent Invoices Being Passed for Payment

Without Proper Approval?
2 Is the numerical continuity of pre-numbered purchase requisitions
and PO checked?
3 Are PO approvals required?
4 Is purchasing independent of stores, receiving, PL, cashier, and
inventory record keeping functions?
5 Are quotations obtained from suppliers?
6 Is the PJ balanced monthly and agreed to the GL?

Does the System Ensure That Invoicing Errors Do Not Escape

Attention?
• Are prices and calculations independently checked?
• Are documents cancelled to prevent re-use?
• Are unmatched documents investigated regularly?

23
 Internal Control Questionnaire for
Cash Payments
Does the System Ensure That Payments Cannot Be
Made If Not Properly and Independently
Authorized?
2 Do cheques require two signatures independent of
purchasing, receiving, PL, invoice approvals and
cheque preparation functions?
3 Are cheque signatories authorized by the BOD?
4 Is advance signing of blank cheques prohibited?
5 Are cheques mailed out directly and supporting
documents cancelled at the time when cheques are
signed?
6 Are altered or corrected cheques prohibited?
24
 Internal Control Questionnaire for
Cash Payments continued

Does the System Ensure That Payments Cannot Be

Made for Goods and Services Not Received?
2 Does signatories examine supporting documents
accompanying cheques and review for propriety and
completeness?
3 Are cheques prepared independent of payment
voucher approval?
4 Are calculations, additions, discounts, freight, terms
and quantities checked?
5 Are cheques payable to ‘bearer’ or ‘cash’ prohibited?
6 Is there evidence of cross check between details on
PO and goods received?
25
 Evaluation of Internal Control:
Purchases
Audit objectives:
The audit of purchases should be sufficiently comprehensive to determine whether:
3 Purchases are properly charged to the company; and
4 Purchases have been correctly recorded in the books.

Audit procedures:

For 1-3 months:

9 Cast total column of PJ from which items are individually posted
10 Check posting from PJ to GL
11 Check posting from PJ to creditor control account in GL

For, say 30 items or 10%:

Vouch PJ with purchase invoices noting:
15 Invoices are original and not duplicates
16 dates are correct
17 Suppliers and clients name on invoice are correct
18 Evidence of independent checking with supplier quotation for price
19 Evidence of independent comparison with PO and receiving report for specification and quantity
20 Evidence of independent check of extension and casts
21 Approval were given by correct person
22 Nature of expense and account charged (revenue and capital)
23 Invoices stamped “PAID” or cancelled at time cheques paying the invoices were signed

26
 Evaluation of Internal Control:
Purchases continued

Select 30 items, say 10% of creditors account, by ensuring

all ledgers are available for the selection:
2 Scrutinize and enquire into any old or unusual items
3 Cast each account selected

Examine system of reconciliations of creditors ledger

balances with creditors statement of accounts, ensure
that:
6 Statements of accounts are obtained regularly from the
suppliers
7 All statements obtained are reconciled with the
creditors ledger
8 Reconciling items are being followed up.
27
 Evaluation of Internal Control:
Cheque Payments
Audit objectives:
The audit of cheque payments should be sufficiently comprehensive to
determine whether:
3 Cheque payment ought to have been made
4 Cheque payment have been received by the payee, or
5 Cheque payment have been correctly recorded in the books.

Audit procedures:
Control of cheque books:
9 Vouch cheque books received/purchased from bank with bank
notifications (note serial number)
10 Verify that cheque books issued have been properly recorded in
register
11 At all time of audit, count un-issued cheque books and agree with
register

28
 Evaluation of Internal Control:
Cheque Payments continued

Control of payment vouchers:

2 Vouch payment voucher books purchased with printers invoices
(note serial number)
3 Verify that payment voucher books issued have been properly
recorded in register
4 At the time of audit, count un-issued payment voucher books and
agree with the register

For 1-3 months:

7 Account the numerical sequence of payments vouchers
8 List any missing payment vouchers.
9 Cast creditors payment column of cash payments journal from
which item are individually posted:
(a) check posting the total for both columns from cash receipts
journal to GL
(b) Check posting the total for creditors payments from cash
payment journal to creditors control account

29
 Evaluation of Internal Control:
Cheque Payments continued

For 1-3 months vouch payments made to creditors noting:

2 Proof of payments, i.e., official receipts. (list ant missing receipts. Discuss
with independent responsible official)
3 Indication that goods or services charged for have been received and
approved, and have been checked with order
4 Authorization for payment by the correct person (as listed in the permanent
file)
5 Payment vouchers have been stamped “PAID” or cancelled

Select 30 items, say 10% payment vouchers:

8 Trace payment vouchers to cash payment journal
9 Check posting to creditors ledger

For 1-3 months:

12 Check cheque payments with bank statements, noting that cheques are
debited without undue delay
13 Cheque payments side of bank statement and find out why unticked
payments are not entered on credit side of cash book.

30
 Substantive Tests: Verification of
Trade Creditors
Audit of trade creditors is to ensure that
creditors are not understated and all
trade creditors are accounted for in the
financial statements.
Audit procedures must ensure:
3 Unrecorded liabilities are identified
4 Make sure accounting policies being
applied by the client are consistent with
those applied in the previous years
31
 Audit of Creditors Balances
Management Audit Substantive
Assertions Objectives of Audit
Test of Details Procedures
of Balances

Existence 4 Obtain list of

Existence balances
5 Agree figures in
GL, check
individual
balance are
made up of
specific and 32
recent invoices
Audit of Creditors Balances continued
Completeness Completeness 1 Ensure all year
end transactions
in respect of
creditors are
accounted for
2 Creditors for that
accounting period
have actually
been recorded
3 Ensure
supporting
documents are
sequential order
4 Determine how
client deal with
cancelled
documents 33
Audit of Creditors Balances continued
Valuation and Accuracy 1 Review all creditors
balances, check or
Allocation
test the addition of
the list
2 Examine supporting
documents
3 Review
reconciliation by
checking to
suppliers statements
4 Review prior year
list to ensure no
omissions
5 Investigate debit
balances. Consider
their recoverability

34
Audit of Creditors Balances continued
Classification Creditors figures are
classified properly
according to chart
of accounts

Obtain and trace

Cut-off creditors cut-off
information
( number,
amounts, PO) into
PJ and PL

Figures of creditors
Detail tie-in balances in PL tie
with creditors
figures in GL
35
Audit of Creditors Balances continued
Send positive
Rights and Ownership confirmation letters
Obligations

1 Ensure comparative
Presentation Presentation figures agree with last
year’s FS
and Disclosure and disclosure 2 Consider whether
significant debit
balances should be re-
classified as debtors

36
 References
• Text – Chapter 11
• Lecture Notes
• Tutorial Questions
• Past Exam Questions
• ACCA, MIA, MICPA, Articles from
Journals and Magazines

37