Audit Chapter 11 Notes
Audit Chapter 11 Notes ACCT 4150
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This 7 page Class Notes was uploaded by Victoria Andreski on Wednesday April 6, 2016. The Class Notes belongs to ACCT 4150 at Clemson University taught by Nancy Harp in Spring 2016. Since its upload, it has received 17 views. For similar materials see Auditing in Accounting at Clemson University.
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Date Created: 04/06/16
CHAPTER 11—Auditing the Purchasing Process Expense & Liability Recognition • Expenses—outflows or other using up of assets or incurrences of liabilities from delivering or producing goods, rendering services, or carrying out other activities that constitute the entity’s ongoing major/central operations o Using up an asset or incurring a liability o Categories: § Product Costs—COGS; something linked to revenue § Period Costs—something incurred during period where cash is spent or liability incurred (rent, salaries) • Linked w/ time § Systematic Allocation—tries to allocate expense into period you get the benefit (depreciation) • Liabilities—probable future sacrifices of economic benefits arising from present obligations of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events o Future sacrifices o Pay something in the future Purchasing Process • Overview: o Purchase transaction usually starts w/ a purchase requisition generated by the user department o Purchasing department prepares a purchase order that is sent to the vendor o When the goods are received or the services are rendered, a liability is recorded o Then the entity pays the vendor • Types of transactions processed o Purchase transaction § Affectsà AP, inventory, purchases or COGS, various asset & expense accounts o Cash disbursement transaction § Affectsà Cash, AP, cash discounts, various asset & expense accounts o Purchase return transaction § Affectsà purchase returns (us sending stuff back to our suppliers), purchase allowances, AP, various asset & expense accounts • Voucher Packet—Invoice, Purchase Order, Receiving Reportà 3 way match • Documents & Records o Purchase Requisition—request to purchase goods or services § Internal documentà person saying hey I need something & sends to supervisor who will approve it o Purchase Order—includes description, quality, & quantity of goods or services being purchased o Receiving Report—records the receipt of goods o Vendor Invoice—the bill from the vendor rd § Vendor—3 party we’re buying from o Voucher—serves as the basis for recording a vendor’s invoice (list of all the invoices we have to pay) o Voucher Register—used to record vouchers for goods & services o Accounts Payable Subsidiary Ledger—includes amount owed to individual vendors o Vendor Statement—represents the purchase activity w/ vendor o Check—pays for goods or services o Check Register—contains columns to record credits to cash & debit to AP and cash discounts • Major Functions o Requisitioning—initiation & approval of requests for goods & services by authorized individuals consistent w/ management criteria o Purchasing—approval of purchase orders & proper execution as to price, quantity, quality, & vendor o Receiving—receipt of properly authorized goods & services § Count everything you got & inspect quality o Invoice Processing—processing of vendor invoices for goods & services received; processing of adjustments for allowances, discounts, & returns o Disbursements—processing of payment to vendors o Accounts Payable—recording of all vendor invoices, cash disbursements, & adjustments in individual vendor accounts o General Ledger—proper accumulation, classification, & summarization of purchases, cash disbursements, & payables in the general ledger • Inherent Risk Assessment o Industrial-Related Factors § 1) Is the supply of raw materials adequate? § 2) How volatile are raw material prices? o Misstatements Detected in Prior Audits § Auditor’s experience in past audits must be considered when assessing inherent risk • Control Risk Assessment o Major steps in setting the CR § Understand & document the purchasing process based on a reliance strategy • Reliance Strategy—relying on controls operating well to do less substantive testing (testing of dollars) as long as you can rely on good controls § Plan & perform tests of controls on purchase transactions • Controls around segregation of duties § Set & document the CR for the purchasing process • Hopefully you can set CR low if you can rely on controls o Control testing—testing of process o Detection risk—keep it low by doing more substantive testing o Information Systems & Communication § Auditor must obtain the following information: • 1. How purchase, cash disbursements, & purchase return transactions are initiated • 2. The accounting records, supporting documents, & accounts involved in processing purchases, cash disbursements, & purchase returns • 3. The flow of each type of transaction from initiation to inclusion in the financial statements (including computer processing) • 4. The process used to estimate accrued liabilities o After testing controls, the auditor sets the achieved level of CR § When tests of controls support the planned level of CR, no modifications are necessary to DR & auditor may proceed w/ the substantive procedures as planned § When tests do NOT support the planned CR, the auditor lowers the level of DR leading to more substantive procedures • Assertions—PURCHASES o Occurrence—all purchases & cash disbursements have been recorded & have occurred & pertain to the entity § Observe & evaluate proper segregation of duties § Test a sample of vouchers for the presence of an authorized purchase order & receiving report § Examine paid vouchers & supporting documents for indication of cancellation § Think about errors—if they didn’t occur, it’s a fictitious purchase o Completeness—all purchases & cash disbursements that should have been recorded have been recorded § Is anything missing? Are they all there? § Review procedures for accounting for numerical sequence of purchase orders, receiving reports, & vouchers § Trace a sample of receiving reports to their vendor invoices & vouchers § Trace a sample of vouchers to the purchases journal § Pull samples from outside population (outside GL)—start from receiving or shipping documents § Purchases that are missing; books will be understated in terms of what you bought (assets & liabilities) • Trace a sample of receiving reports & compare to vouchers o Authorization—all purchase & cash disbursements are properly authorized § Are purchases authorized & approved? § Examine purchase requisitions or purchase orders for proper approval § Review client’s competitive bidding process § Based on dollars o Accuracy—amounts relating to recorded purchase & cash disbursements have been recorded appropriately & properly accumulated from journals & ledgers § Are the numbers being put in accurately? On invoices, double check the quantity billed to receiving report & check prices on vendor invoice to purchase order § Recomputed the mathematical accuracy of vendor invoice § Agree information in the sample of vouchers for product, quantity, & price § Examine reconciliation of vouchers to daily accounts payable report o Cutoff—purchase & cash disbursements have been recorded in the correct accounting period § Compare the dates on receiving reports w/ the dates on the relevant vouchers § Compare the dates of vouchers w/ the dates they were recorded in the purchases journal § If it was received on 12/31, it must be recorded as a liability on 12/31 o Classification—purchase & cash disbursements have been recorded in the proper account § Review purchases journal & GL for reasonableness § Examine a sample of vouchers for proper classification • Assertions—CASH DISBURSEMENTS o Occurrence § Auditor is concerned w/ a misstatement caused by a cash disbursement being recorded in the client’s record when no payment was made § Primary control procedures to prevent misstatements: • Segregation of duties • Independent reconciliation & review of vendor statements • Monthly bank reconciliations § When a disbursement was recorded but no payment was made § Wrote a check but it was lost or stolen—never comes out of bank account § Segregation of duties—people who can handle checks shouldn’t be allowed to approve vouchers o Completeness § Major audit concern is that a cash disbursement is made but not recorded in the records § Auditor should account for the numerical sequence of checks & reconcile the daily cash disbursements w/ posting to the AP subsidiary records § You actually did disburse cash but didn’t record in records (not in GL) • Cash is too high • Make sure numerical sequence of checks is accounted for o Authorization § Proper segregation of duties reduces the likelihood that unauthorized cash disbursements are made § Individual who approves a purchase should not have direct access to the cash disbursement o Accuracy § Concern is that the payment amount is recorded incorrectly § To detect, client personnel should reconcile the total of checks issued each day w/ the daily cash disbursements report • Make sure a $1,000 check isn’t accidently recorded as a $100 check o Cutoff § Auditor’s tests of controls include reviewing the reconciliation of checks w/ postings to the cash disbursements journal & AP subsidiary records § Auditor also tests cash disbursements before and after year-end to ensure that transactions are recorded in the proper period o Classification § Auditor is concerned that a cash disbursement may be charged to the wrong GL account § The use of a chart of accounts & independent approval & review of the account code on the voucher should provide adequate control • Purchase Return Transactions o Substantive analytical procedures are used to test the reasonableness of the amount § CR is high, DR is low o Magnitude & # of purchase return transactions are not material § Auditor typically doesn’t test controls related to purchase returns • Assessed Level of CR & Substantive Procedures o If the results of the tests of controls support the achieved level of CR, the auditor conducts substantive procedures at the planned level o If the results do NOT support the achieved level of CR, the auditor reduces the DR, which will increase substantive procedures • Auditing AP & Accrued Expenses o Assertions about account balances at period end: § Existence—both are valid transactions § Rights & Obligations—both are obligations to the entity § Completeness—both have been recorded • Usually there is an expense w/ it • Expenses hurt bottom line so companies try to avoid recording some of them without getting caught § Valuation & Allocation—both are included in the financial statements at appropriate amounts & any resulting valuation or allocation adjustments are appropriately recorded o Assertions about presentation & disclosure § Occurrence & Rights/Obligations—all disclosed events, transactions, & other matters relating to AP & accrued expenses have occurred & pertain to the entity § Completeness—all disclosures that should have been included in the financial statements have been included § Classification & Understandability—financial information is appropriately presented & described, and disclosures are clearly expressed § Accuracy & Valuation—financial & other information are disclosed fairly & in appropriate amounts • Any footnotes related to these need to be recorded o Substantive Analytical Procedures § Look at ratios—look at last year & industry data § This year vs. last year for accruals—helps to determine if all expenses are recorded • Tests of Details of Transactions, Account Balances, & Disclosures o Accuracy—Recompute the mathematical accuracy of a sample of vendors’ invoices § Pull samples & details § Sample 30 invoices & check math o Completeness—auditor should conduct a search for unrecorded liabilities that includes: § 1) Ask management about control procedures used to identify unrecorded liabilities at the end of the period § 2) Obtain copies of vendors’ monthly statements & reconcile the amounts to the client’s AP records § 3) Confirm vendor accounts, including accounts w/ small or zero balances § 4) Vouch large-dollar items from the purchases journal & cash disbursements journal for a limited time after year-end § 5) Examine the files of unmatched purchase orders, receiving reports, & vendor invoices for any unrecorded liabilities § **Main concern is understatement of payables • Look for missing payablrd & unreported liabilities § Physical documents from 3 parties is good evidence o Existence—auditor’s main concern is whether the recorded liabilities are valid obligations of the entity § Auditor should vouch a sample of items on the listing of AP to other supporting documents o Cutoff—auditor attempts to determine if all purchase transactions are recorded in the proper period § On most audits, the purchase cutoff is coordinated w/ the client’s physical inventory count § Also determined for purchase return transactions o Rights & Obligations—little risk related to this assertion b/c clients seldom have an incentive to record liabilities that are not obligations of the entity o Valuation—AP are recorded at either the gross amount of the invoice or net of cash discount amount § The valuation of accruals depends upon the type & nature of the accrued expense § Most accruals are relatively easy to value § Are they recognized gross or net of the discount? o Major Classification Issues § 1. Identifying & reclassifying an material debits contained in AP • If there are any debits in AP—overpaid or returned items (they owe you money)à should be reclassified as a receivable b/c vendor owes you money § 2. Segregating short-term & long-term payables § 3. Ensuring that different types of payables are properly classified o Disclosure items for the purchasing process (things you would footnote) § Payables by type (trade, officers, employee, etc.) § Short- & long-term payables § Long-term purchase contracts, including any unusual purchase commitments § Purchases from & payable to related parties § Dependence on a single vendor or a small # of vendors § Costs by reportable segment of the business • AP Confirmations o Used less often than accounts receivable confirmations o Auditor is able to examine externally created source documents relating to AP o When confirmations are used, they are usually positive & referred to as blank conformations o Vendor is asked to supply the balance owed by the client o For AR, the invoices come from us o For AP, invoicesrdome from the vendor (external document)—we trust that more b/c they’re 3 party documents § Rarely confirm AP § Make sure confirmations are positive § Blank confirmations (aka zero-balance confirmations)—missing balanceà no dollar amount to check off; must insert amount • Evaluate the audit findings o All identified misstatements should be aggregated (including any consideration for sampling risk) o The likely misstatement is then compared to tolerable misstatement o If the likely misstatement is LESS THAN the tolerable misstatement, the auditor has evidence that the account is fairly presented o If the likely misstatement EXCEEDS the tolerable misstatement, the auditor should conclude that the account is not fairly presented
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