Module 6 - Expenses/liabilities of Payment cycle

Question 1

What are the three classes of transactions within the acquisitions and payment cycles?

Answer 1

1. Acquisition of goods and services (materials, labor)
2. Cash disbursements
3. Purchase returns and allowances and discounts

_{*Focuses on the expenses related to operation of business}

Question 2

10 typical accounts involved in the acquisitions and payment cycle:

Answer 2

Question 3

What are the four business functions involved in recording the three classes of transactions (acquisition and payment cycle)?

Answer 3

1) Processing purchase orders

​2) Receiving goods/services

3) Recognizing the liability

4) Processing and recording cash disbursements

Question 4

What are the documents included in these business functions:

Processing purchase orders

Answer 4

1) Processing purchase orders

• Purchase requisition: Internal document made when needs arise
• Purchase order: Internal purchasing dept. authorizes purchase to vendor

Question 5

What are the documents included in these business functions:

• Receiving goods/services

Answer 5

2) Receiving goods/services

Receiving report: Made by receiving department (internal); compares items received to info on bill of lading

(description of goods, quantity, etc.)

Question 6

Describe these documents related to Recording the liability:

• Vendor’s invoice
• Debit Memo
• Acquisitions Transaction File

Answer 6

Vendor’s invoice: From the vendor (external); description of goods and amounts owed; usually initiates recording process

Debit memo: From the vendor (external); description of returned items; supports reductions to A/P

Acquisitions Transaction File: Log of all acquisition transactions for a given period

Question 7

Describe these documents related to Recording the liability:

• Acquisitions journal
• Vendor’s statement

Answer 7

Acquisitions journal: Generated from transaction file; gives vendor names, account classification, dates, and amounts

Vendor’s statement: Monthly statement that comes from vendor that contains balance details; provides a lot of audit evidence

Question 8

Describe these documents related to Recording the liability:

• Accounts Payable Master File
• Accounts Payable Trial Balance

Answer 8

Accounts Payable master file: contains info by vendor of all invoices, cash disbursements, and returns/allowances

Accounts Payable trial Balance: Generated from amster file; Listing of amounts owed to each vendor

Question 9

What documents can be obtained as evidence for this business function:

Processing and Recording Cash Disbursements

Answer 9

Check/Wire Transfers

Cash disbursement files: Detailed accounting record of transactions related to cash

Cash disbursement journal: Summarized accounting record of cash transactions for a time period

Question 10

What are the steps to desigings tests of controls and tests of transactions for the acquisition and payment cycle?

_{**discussed further do not strictly memorize}

Answer 10

1. Understand internal controls
2. Assess Planned Control Risk
3. Determine extent of testing controls
4. Design tests for acquistions
5. Design tests for cash disbursements

Question 11

How can the auditor gain a better understanding of internal controls related to the acquisitions and payment cycle?

Answer 11

• Study Client flowcharts
• Internal control questionnaire
• Perform walk-through of processes

Question 12

Controls that affect Planned Control Risk of Acquistions/Payment cycle:

Answer 12

Autorization of purchase: Require requisitions and authorizations for significant/unusual purchases

Separation of asset custody from other functions: Separate duties related to requistions, payment, and receiving

Timely recording and independent review of transactions: Controls to ensure expenses/liabilities recorded in appropriate period

Autorization of Payments

Question 13

What are some controls specific to the authorization of payments?

Answer 13

3-way match: Company reconciles the purchase order, receiving report, and vendor invoice for agreement before sending to authorization

Vendor master-list: Company maintains list of vendors that payments may be made to; requires authorization to edit list

Checks are signed by individual with proper authority

Question 14

What factors do auditors consider when deciding the extent of testing controls?

Answer 14

Auditor identifies key control deficiencies to assess control risk; low control risk = more testing for effectiveness

If testing supports control risk, increase detection risk and reduce required substantive testing

Question 15

What audit objectives should auditors focus on when designing tests of controls and tests of transactions for the acquisition/payment cycle?

Answer 15

Completeness; Existing acquisition are recorded; failure to record can result in overstatement of net income

Posting and summarization; Amounts included/summarized in master files

Accuracy: Acquisitions recorded at right amount

Classification; Acquistions correctly classified

Timing; Acquisitions recorded on correct date

Question 16

What is phase 1 for designing tests of balances for the acquisition/payment cycle?

Answer 16

• Identify client business risks affecting accounts payable
• Set performance materiality and assess inherent risk for accounts payable
• Assess control risk for the acquisition/payment cycle

Question 17

Phase 2 and phase 3 for designing tests of details of balance for the acquisition/payment cycle:

Answer 17

Phase 2

• Design and perform tests of controls/substantive tests of trans. (discussed previously)

Phase 3

• Design and perform analytical procedures
• Design tests of D.O.B. of acconts payable to satisfy balance related audit objectives

Question 18

What analytical procedures may be performed in the acquisition and payment cycle?

Answer 18

• Compare individual A/P with previous years; provides evidence of misstatement/unrecorded in A/P
• Review lists of A/P for unusual, large, interest bearing payables; Classification evidence
• Calculate ratios, such as accounts payable divided by current liabilities; tests for unrecorded/nonexistent accounts

_{A/P does not benefit from extensive analytical procedures; used mainly to guide testing}

Question 19

What is this test of D.O.B. for the acquisitions/payment cycle:

Out-of-period liability tests (Search for unrecorded liabilities)

Answer 19

Tests to uncover unrecorded A/P (Completeness) by:

• Examine underlying docs. for subsequent cash disbursement after year-end;
• Examine underlying docs for bills not paid several weeks after year-end; look for liabilities that are still present
• Trace receiving reports received before year-end to related vendor’s invoice
• Check vendor’s statements for possible A/P
• Send confirmations to vendors

Question 20

How can these tests of D.O.B. help uncover unrecorded liabilities:

• Check vendor’s invoice/receiving report for details of timing of liability
• Check receiving repors issued before year-end to related invoices

Answer 20

• Check vendor’s invoice/receiving report for details of timing of liability; companies ofter do not include liabilities if paid after year-end even though they should
• Check receiving repors issued before year-end to related invoices; All items received before year-end should be a liability; trace documentation to ensure it should be included

Question 21

What are this test for D.O.B. of the acquisition cycle:

Cutoff test

Answer 21

Tests to ensure transactions recorded days before or after year-end are included in correct period.

• Relationship between physical observation of inventory; inventory must be recorded alongside liability
• Auditor should check vendor’s invoices for shipping details (FOB destination, FOB origin)