Identify the accounts and the classes

of transactions in the
acquisition and payment cycle.
 ACCOUNTS AND CLASSES OF TRANSACTIONS IN THE
ACQUISITION AND PAYMENT CYCLE
There are three classes of transactions in the acquisition and
payment cycle:
1. Acquisitions of goods and services
2. Cash disbursements
3. Purchase returns and allowances and purchase
discounts
BUSINESS FUNCTIONS IN THE CYCLE AND RELATED
DOCUMENTS AND RECORDS

There are four business functions involved in the

acquisitions and payment cycle:
1. Processing Purchase Orders—Includes a purchase
requisition which is used to request authorization for
goods or services and a purchase order which is used
for the order after it has been authorized.
2. Receiving Goods and Services—Includes a receiving
report which is prepared at the time the goods are
received. Blank
 BUSINESS FUNCTIONS IN THE CYCLE AND
RELATED DOCUMENTS AND RECORDS(CONT.)
3. Recognizing the Liability—Proper recognition requires
prompt and accurate recording. Documents that may be
involved:
• Vendor’s Invoice—Document from the vendor that shows the amount
owed for an acquisition
• Debit Memo—Also from the vendor; indicates a reduction in the
amount owed
• Voucher—A formal means of recording and controlling acquisitions
• Acquisitions Transaction File—Computer-generated file including all
acquisitions transactions. Vendor name, date, amount, account
classification, description and quantity of goods and services
purchased
 BUSINESS FUNCTIONS IN THE CYCLE AND
RELATED DOCUMENTS AND RECORDS(CONT.)
3. Recognizing the Liability (cont.) Documents involved:
• Acquisitions Journal or Listing—Often referred to as the purchases
journal; includes vendor name, date, amount, and account
classification
• Accounts Payable Master File—Records acquisitions, cash
disbursements, and acquisition returns and allowances for each
vendor
• Accounts Payable Trial Balance—A listing of the amount owed each
vendor at a point in time
• Vendor’s Statement—A document prepared monthly by the vendor
that indicates the beginning balance, acquisitions, returns and
allowances, payments to the vendor, and ending balance
 BUSINESS FUNCTIONS IN THE CYCLE AND
RELATED DOCUMENTS AND RECORDS(CONT.)
4. Processing and Recording Cash Disbursements—The
payment for goods and services represent a significant
activity for all entities. Documents that auditors examine
associated with this activity:
• Check—Document used to pay for an acquisition; may be paper or
an electronic funds transfer (EFT)
• Cash Disbursements Transaction File—A computer-generated file
that includes all cash disbursement transactions processed during
a period
• Cash Disbursements Journal or Listing—Includes all disbursement
transactions for a period
Understand internal control, and
design and perform tests of
controls and substantive tests of
transactions for the acquisition
and payment cycle.
IMPORTANCE OF ACQUISITION AND PAYMENT CYCLE

The most time-consuming accounts to verify by tests of

details of balances are accounts receivable, inventory, fixed
assets, accounts payable, and expense accounts. Four of these
are directly related to the acquisition and payment cycle.
• If the auditor can reduce the tests of details of the account
balances by using tests of controls and substantive tests of
transactions for acquisitions and cash disbursements, the time
saved can be dramatic.
 Understand Internal control for acquisition
and cash disbursement cycle

Assess planned control risk for acquisition

and cash disbursement cycle

Determine extend test of control

*PCAOB

Design TOC, ST of T for acquisition and cash disbursement cycle to

meet transaction related objectives
Audit procedures, sample size, items to select, and timin
 INTERNAL CONTROL

Understand Internal Control: The auditor gains an understanding

of internal control for the acquisition and payment cycle as part of
performing risk assessment procedures.
Assess Planned Control Risk: Key internal controls for the business
functions in this cycle are:
• Authorization of purchases
• Separation of asset custody from other functions
• Timely recording and independent review of transactions
• Authorization of payments
 Internal control: Authorization of purchases

Proper authorization for acquisitions ensures that the goods and services
acquired are for authorized company purposes (no excessive or unnecessary
items).
Different levels of authorization for different types of acquisitions or dollar
amounts.:
▪ Fixed assets in excess of a specified dollar limit require approval by the
board of directors.
▪ Items acquired relatively infrequently, such as insurance policies and long-
term service contracts, are approved by certain officers.
▪ Supplies and services costing less than a designated amount are approved
by supervisors and department heads;
▪ Some types of raw materials and supplies are reordered automatically when
they fall below a predetermined level, often by direct communication with
vendors’ computers.
 Internal control: Separation of asset custody from other functions

The purchasing department should be separate from those who

authorize the acquisition or receive the goods. All purchase orders
should be prenumbered
Receiving department initiate a receiving report as evidence of the
receipt and examination of goods. One copy is normally sent to the raw
materials storeroom and another to the accounts payable department
for their information needs.
To prevent theft and misuse, the goods should be physically
controlled from the time of their receipt until their use or disposal.
The personnel in the receiving department should be independent of
the storeroom personnel and the accounting department.
Finally, the accounting records should transfer responsibility for the
goods each time they are moved, from receiving to storage, from storage
to manufacturing, etc.
 Internal control: Timely recording and independent review of
transactions
• Accounts payable department typically has responsibility for verifying
the appropriateness of acquisitions. This is done by comparing the
details on the purchase order, the receiving report, and the vendor’s
invoice to determine that the descriptions, prices, quantities, terms,
and freight on the vendor’s invoice are correct.
• In some cases, computer software matches documents and verifies
invoice accuracy automatically. The accounts payable department
should also account for all receiving reports to assure that the
completeness objective is satisfied.
• An important control in the accounts payable and information
technology departments is the requirement that personnel who record
acquisitions do not have access to cash, marketable securities, and
other assets.
 Internal control: Authorization of payments

• The most important controls over cash disbursements include:

1. The signing of checks by an individual with proper authority
2. Separation of responsibilities for signing checks and performing the accounts
payable function
3. Careful examination of supporting documents by the check signer at the time the
check is signed
The checks should be prenumbered.
Provide physical control over blank, voided, and signed checks.
Policy for canceling supporting documents to prevent their reuse as support for
another check at a later time.
If electronic payments: Restrictions should be in place that allow only authorized
individuals to issue an electronic payment, and those individuals should be separate
from the accounts payable function
• PA = Purchase requisition
• PO = Purchase order
• RR = Receiving report
• VI = Vendor invoice
• A/P = Accounts payable
• T/b = Trial balance
• GL = General ledger
Transaction-Related Key Existing Control Test of Control Substantive Test of Transactions
Audit Objective
Occurrence:
-PR, PO, RR and VI are -Examine -Review the acquisition
Recorded attached to voucher documents in journal, GL and A/P master file
-Acquisition are for large or unusual
acquisitions approved at proper
voucher package for
existence. transactions
are for goods level -Examine indication
-Computer accepts of approval -Examine underlying
and services entry of purchased -Attempt to input documents for reasonless and
received, only from authorized transaction with authenticity (VI, RR, PO and
vendor in the vendor valid and invalid PP).
consistent master file vendor
with interest -Documents are -Examine indication -Examine vendor master file for
canceled to prevent of cancelation unusual vendors
of the client reuse. -Examine indication
on internal
-VI, RR, PO and PR are -Trace inventory acquisition to
verification
internally verified inventory master file

-Examine fixed asset acquired

 Transaction-Related Key Existing Control Test of Control Substantive Test of Transactions
Audit Objective
Completeness
-PO are prenumbered -Account for -Trace a file of receiving report to
Existing and accounted for
sequence of PO acquisition journal
acquisition
-Trace a file of vendor’s invoice
transactions -RR are prenumbered
-Account for to the acquisition journal
and accounted for
are recorded sequence of RR

-Vouchers are
-Account for
prenumbered and
sequence of
accounted for
vouchers
Transaction-Related Key Existing Control Test of Control Substantive Test of Transactions
Audit Objective
Accuracy
Calculation and amount -Examine
are internally verified
indication of
Recorded internal Compare recorded transaction in
verification the acquisition journal with VI,
transactions -Batch total ae
RR and other supporting
compared with
are accurate computer summary
Examine file of documentation
batch totals for
report
initial of data Recompute the clerical accuracy
control clerk; on the VI, including discounts
compare total to and freight
summary report
-Acquisition are
Examine indication
approved for prices
of approval
and discounts
 Transaction-Related Key Existing Control Test of Control Substantive Test of Transactions
Audit Objective
Posting and
Summarizatio
n

-A/P master file -Examine

Acquisition contents are indication of
transaction internally internal
are correctly verified verification
Test clerical accuracy
included in by footing the journal
the A/P and
-A/P master file -Examine and tracing posting to
or trial balance initial s on general ledger and
inventory are compared general ledger
master files with general
A/P and inventory
account
and are ledger balances indicating
master files
correctly comparison.
 Transaction-Related Key Existing Control Test of Control Substantive Test of Transactions
Audit Objective
Classification

-An adequate -Examine

Acquisition chart of account procedures
transaction used manual and
are correctly chart of Compare
classified . -Account account
classifications are classification with
internally -Examination chart of accounts by
verified on internal referring to VI’s.
verification
Transaction-Related Key Existing Control Test of Control Substantive Test of Transactions
Audit Objective
Timing

-Procedures -Examine
Acquisition recording procedures
transaction transactions as a manual and
are recorded soon as possible observe
on the correct after the goods whether Compare dates of RR
and services have unrecorded VIs and VI with dates in
date.
been received exist.
the acquisition
Dates are -Examine journal.
internally indication of
verified internal
verification
Tests of details of balances for
accounts payable
METHODOLOGY FOR DESIGNING TESTS OF DETAILS OF
BALANCES FOR ACCOUNTS PAYABLE

Because all acquisition and payment cycle transactions typically

flow through accounts payable, it is critical to any audit.
The methodology for designing tests of details for accounts
payable is summarized in Figure 18-3.
• Identify Significant Risks and Assess the Risk of Material
Misstatement for Accounts Payable (Phase I).
• Set Performance Materiality (Phase I).
• Assess Control Risk and Design and Perform Tests of Controls
and Substantive Tests of Transactions (Phases I and II).
Substantive analytical procedures
for accounts payable.
 DESIGN AND PERFORM SUBSTANTIVE ANALYTICAL
PROCEDURES
Analytical procedures is the study of relationship/data between
various figures. Ratios, horizontal analysis, vertical analysis so
on.
Looking for unusual fluctuations or relationship for further
investigation. Change in A/P versus Inventory. Common one
Analytical procedures are performed at three stages of audit:
1. Beginning of the audit (risk assessment procedures)
2. During (optional as a substantive step) Use judgement.
Extend depends on stability of numbers
3. End of audit (financial Analytical procedures)
 Analytical procedures Possible Misstatement

Compare acquisition-related expense balance with Misstatements of A/P and expenses

prior years

Review list of A/P for unusual , nonvendor, and Classification misstatement for nontrade liabilities
interest bearing payable

Compare individual A/P with previous years Unrecorded or nonexistent accounts, or

misstatement

Calculate ratios, such as purchases divided by A/P Unrecorded or nonexistent account or

and A/P divided by current liabilities misstatement
 Tests of details of balances for
accounts payable, including out-of-
period liability tests.
• The overall objective in the audit of accounts payable is to determine whether the
accounts payable balance is fairly stated and properly disclosed
• Difference in the emphasis in auditing assets and liabilities: In auditing assets,
auditors are concerned about overstatements; for liabilities, auditors are
concerned about understatements
✓ The realizable value objective is not applicable to liabilities. Realizable value applies only
to assets.
✓ The rights aspect of the rights and obligations objective is not applicable to liabilities. For
assets, the auditor is concerned with the client’s rights to the use and disposal of the
assets. For liabilities, the auditor is concerned with the client’s obligations for the
payment of the liability. If the client has no obligation to pay a liability, it should not be
included as a liability.
✓ For liabilities, there is emphasis on the search for understatements rather than for
overstatements
Does not have to foot every page
If control is good, limit procedure
Not an important procedure
Primary concern in understatements for liabilities
• Out-of-Period Liability Tests: Also called search for unrecorded
accounts payable

✓Examine underlying documentation for bills not paid several weeks

after year-end.
✓Trace receiving reports issued before year-end to related vendor’s
invoices.
✓Trace vendor’s statements that show a balance due to the accounts
payable trial balance.
✓Send confirmations to vendors with which the client does business.
No common, nevertheless auditor can use them. Zero balance
confirmation
• Concern in understatement of liability. Check during the search
for unrecorded liabilities
• Knowledge of client business.
• Which is which?
• Cutoff Tests—To determine whether transactions recorded a few
days before and after the balance sheet date are included in the
correct period.
• Relationship of cutoff to physical observation of inventory—Cutoff
tests must be coordinated with the physical observation of inventory
to determine that both the asset and liability are recorded in the
proper period. Example
• Inventory in Transit—Determine whether inventory in transit at
year-end was FOB destination or FOB origin. Example
• Normally not a concern
Example
 Distinguish the reliability of
vendors’ invoices, and
confirmations of accounts payable
as audit evidence.
 RELIABILITY OF EVIDENCE
Distinction Between Vendors’ Invoices and Vendors’ Statements:
Vendors’ invoices and supporting documents provide reliable
evidence about individual transactions .
The vendor’s statement is superior for verifying accounts payable
because it includes the ending balance.
Difference between Vendors’ Statements and Confirmations:
• Vendors’ statements have been prepared by the vendor, but is in
the hands of the client.
• Confirmations (example shown in Figure 18-4) are sent by the
auditor and responses from the vendor are sent directly to the
auditor, and are therefore more reliable.