Audit of The Acquisition and Payment Cycle: Tests of Controls, Substantive Tests of Transactions and Accounts Payable

Audit of the Acquisition
and Payment Cycle: Tests

of Controls, Substantive
Tests of Transactions and
Accounts Payable.
Chapter 19
2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 19 - 1

Learning Objective 1
Identify the accounts and the

classes of transactions in the
acquisition and payment cycle.

Transactions in the Acquisition
and Payment Cycle
1. Acquisitions of goods and services
2. Cash disbursements
3. Purchase returns and allowances
and purchase discounts

Accounts in the Acquisition
and Payment Cycle
Raw Material
Cash in Bank Accounts Payable Purchases
Cash Acquisitions
disbursements of goods and
services
Purchase Returns Property, Plant
and Allowances Purchase and Equipment
returns and
allowances
Purchase
Purchase discounts Prepaid
Discounts Expenses

Accounts in the Acquisition
and Payment Cycle
Manufacturing Expense Control Account
Subsidiary accounts
Repair and maintenance
Taxes, Supplies
Freight in, Utilities
Accounts Payable Selling Expense Control Account

Acquisitions Subsidiary accounts
of goods and Commissions
services Travel, delivery expenses
Repairs, Advertising
Administrative Expense Control Account

Subsidiary accounts
Supplies, Officers travel
Legal fees
Auditing fees, Taxes
Describe the business functions

and the related documents and
records in the acquisition and
payment cycle.

Classes of Transactions
and Accounts
Inventory
Property, plant, and equipment
Prepaid expenses
Leasehold improvements
Accounts payable
Manufacturing expenses
Selling and administrative expenses

Classes of Transactions
and Accounts
Cash in bank (from cash disbursements)

Accounts payable
Purchase discounts

Business Functions in the Cycle
Processing purchase orders
Receiving goods and services
Recognizing the liability
Processing and recording cash disbursements

Related Documents and Reports
Processing purchase orders
Purchase requisition
Purchase order
Receiving goods and services
Receiving report

Recognizing the liability
Acquisitions transaction file
Acquisitions journal or listing
Vendors invoice Debit memo
Voucher A/P master file
A/P trial balance Vendors statement

Processing and recording cash disbursements
Check
Cash disbursements transaction file
Cash disbursements journal or listing

Describe how e-commerce

affects the acquisition of
goods and service.

How E-Commerce Affects the
Acquisition and Payment Cycle
Internet-based technologies
allow for electronic linkages
between suppliers and customers.
Suppliers Customers
EDI EDI
Purchase Customer
orders orders

How E-Commerce Affects the
Information about products is available over
the Internet.
Some companies use extranets which allow

companies to communicate and conduct
business in a secure setting.
Other companies use business-to-business

auctions hosted on the Internet to
negotiate purchases.

Understand internal control, and

design and perform tests of
controls and substantive tests
of transactions for the acquisition
and payment cycle.

Methodology for Designing Tests
of Balances: Accounts Receivable
Understand internal Assess planned control
control acquisitions risk acquisitions and
and cash disbursements. cash disbursements.
Determine extent of testing controls.
Design tests of controls and substantive tests of

transactions for acquisitions and cash disbursements
to meet transaction-related audit objectives.
Audit Sample Items to

Timing
procedures size select

Understand Internal Control
The auditor gains an understanding of internal

control for the acquisition and payment cycle
by studying the clients flowcharts, preparing
internal control questionnaires, and performing
walk-through tests for acquisitions and cash
disbursements.

Assess Planned Control Risk
Authorization of purchases
Separation of asset custody from

other functions
Timely recording and independent

review of transactions
Authorization of payments

Evaluate Cost-Benefit of Testing
Controls
The auditor identifies the key internal controls

and weaknesses and assesses control risk.
The auditor decides whether substantive tests

will be reduced sufficiently to justify the cost
of performing tests of controls.

Controls and Substantive Tests of
Transactions for Acquisitions
Recorded acquisitions are for goods and services
received, consistent with the best interests of the
client (existence).
Existing acquisitions are recorded (completeness).
Acquisitions are accurately recorded (accuracy).
Acquisitions are correctly classified (classification).

Attributes Sampling
Because of the importance of tests of controls

and substantive tests of transactions for
acquisitions and cash disbursements,
the use of attributes sampling is
common in this audit area.

Describe the methodology for

designing tests of details of
balances for accounts payable
using the audit risk model.

of Details of Balances for A/R
Phase I
Identify client business risks affecting accounts

payable.
Set tolerable misstatement and assess inherent

risk for accounts payable.
Assess control risk for accounts payable.

Phase II
Design and perform tests of controls and

substantive tests of transactions for the
acquisition and payment cycle.

Phase III
Design and perform analytical procedures for

the acquisition and payment cycle.
Design tests of details of accounts payable

balance to satisfy balance-related audit objectives.
Audit Sample Items to

Timing
procedures size select
Design and perform analytical

procedures for accounts payable.

Analytical Procedures for the
Analytical procedure Possible misstatement
Compare acquisition-related
Misstatement of accounts
expense account balances
payable and expenses.
with prior years.
Review list of accounts payable Classification

for unusual, nonvender, and misstatement
interest-bearing payables. for nontrade liabilities.

Analytical Procedures for the
Analytical procedure Possible misstatement
Unrecorded or
Compare individual accounts
nonexistent accounts,
payable with previous years.
or misstatements.
Calculate ratios, such as

Unrecorded or
purchases divided by accounts
nonexistent accounts,
payable, and accounts payable
or misstatements.
divided by current liabilities.

Design and perform tests of

details of balances for accounts
payable, including out-of-period
liability tests.

Out-of-Period Liability Tests
Examine underlying documentation for

subsequent cash disbursements.
Examine underlying documentation for bills not

paid several weeks after the year-end.
Trace receiving reports issued before year-end

to related vendors invoices.

Out-of-Period Liability Tests
Trace vendors statements that show a balance

due to the accounts payable trial balance.
Send confirmations to vendors with which

the client does business.

Cutoff Tests
Relationship of cutoff to physical

observation of inventory
Inventory in transit
FOB destination FOB origin

Distinguish the reliability of

vendors invoices, vendors
statements, and confirmations
of accounts payable as audit
evidence.

Reliability of Evidence
Distinction between vendors

invoices and vendors statements.
Difference between vendors

statements and confirmations.

Sample Size
Sample sizes for accounts payable tests vary

considerably, depending on many factors.
Statistical sampling is less commonly used

for the audit of accounts payable than
for accounts receivable.

Types of Audit Tests for the
Cash in Accounts Acquisition
Bank Payable Expenses
Payments Expenses
Audited by Audited by
TOC, STOT, and AP TOC, STOT, and AP
Ending Ending
balance balance
Audited by AP and TDB
TOC + STOT + AP + TDB

= Sufficient competent evidence per GAAS
Types of Audit Tests for the
Accounts Acquisition
Payable Assets
Acquisition
of assets
Audited by
TOC, STOT, and AP
Ending
balance
Audited by
AP and TDB
TOC + STOT + AP + TDB
= Sufficient competent evidence per GAAS
End of Chapter 19

Audit of The Acquisition and Payment Cycle: Tests of Controls, Substantive Tests of Transactions and Accounts Payable

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Audit of the Acquisition

and Payment Cycle: Tests

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 19 - 1

Identify the accounts and the

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 19 - 2

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 19 - 3

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 19 - 4

Accounts Payable Selling Expense Control Account

Administrative Expense Control Account

Describe the business functions

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 19 - 6

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 19 - 7

Cash in bank (from cash disbursements)

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 19 - 8

Processing purchase orders

Receiving goods and services

Recognizing the liability

Processing and recording cash disbursements

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 19 - 9

Processing purchase orders

Receiving goods and services

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 19 - 10

Acquisitions transaction file

Acquisitions journal or listing

Vendors invoice Debit memo

Voucher A/P master file

A/P trial balance Vendors statement

Processing and recording cash disbursements

Cash disbursements transaction file

Cash disbursements journal or listing

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 19 - 12

Describe how e-commerce

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 19 - 13

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 19 - 14

Some companies use extranets which allow

Other companies use business-to-business

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 19 - 15

Understand internal control, and

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 19 - 16

Determine extent of testing controls.

Design tests of controls and substantive tests of

Audit Sample Items to

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 19 - 17

The auditor gains an understanding of internal

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 19 - 18

Separation of asset custody from

Timely recording and independent

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 19 - 19

The auditor identifies the key internal controls

The auditor decides whether substantive tests

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 19 - 20

Existing acquisitions are recorded (completeness).

Acquisitions are accurately recorded (accuracy).

Acquisitions are correctly classified (classification).

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 19 - 21

Because of the importance of tests of controls

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 19 - 22

Describe the methodology for

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 19 - 23

Identify client business risks affecting accounts

Set tolerable misstatement and assess inherent

Assess control risk for accounts payable.

Design and perform tests of controls and