S10.1 - Auditing Payables

Question 1

What is the typical reporting bias for expenses and liabilities?

Answer 1

Understate these items (expenses)
Liabilities are understated because expenses are understated
Completeness is the typical assertion tied to understatement

Question 2

What are the three types of transactions that are processed through the purchasing process

Answer 2

• Purchase transaction
• Cash disbursement to transaction (pay the liability resulting from the purchase of goods)
• Purchase return transactions

Question 3

Which accounts are affected by “Purchase Transactions”
(4)

Answer 3

• A/P
• Inventory
• Purchase or COGS
• Various assets and expenses accounts

Question 4

Which accounts are affected by “Cash Disbursement to Transaction”

Answer 4

• Cash
• A/P
• Cash Discounts
• Various assets and expenses accounts

Question 5

Which accounts are affected by “Purchase Return Transactions”

Answer 5

• Purchase returns
• Purchase allowances
• A/P
• Various assets and expenses accounts

Question 6

Why might Cash on Delivery (COD) be a red flag?

Answer 6

This suggests a potential risk factor in business transactions. If a client insists on COD rather than other payment methods (like upfront payments or credit terms), it might indicate cash flow issues or a lack of financial stability on their end.

Question 7

TYPE OF DOCS AND RECORDS
What is a purchase requisition?

Answer 7

The request to purchase goods or services.
Usually comes internally

Question 8

TYPE OF DOCS AND RECORDS
What is a purchase order?

Answer 8

It’s the order that contains the descriptions, quantity, and quality of the goods/services being purchased.

It also contains who approved of the purchase, and the authorization of it.

The purchasing agent tries to get his best price.

Question 9

TYPE OF DOCS AND RECORDS
What is a receiving report?

Answer 9

Document that records the receipt of goods.

Usually a copy of the purchase order, with the quantities omitted

Along with bill of lading, the report tracks everything that is coming in.
It triggers liabilities (FOB s.p or dest.)

Question 10

TYPE OF DOCS AND RECORDS
What is the vendor’s invoice?

Answer 10

The bill from the vendor
Includes description and quantities, price including freight, ToT including cash discounts, and the date

Question 11

TYPE OF DOCS AND RECORDS
What is the purpose of the voucher?

Answer 11

Serves as the basis for recording the vendor’s invoice.

Frequently used by entities to control payment for acquired goods/services

Often used to show that the invoice has been acknowledged (approval/signatures)

GPT: A voucher is the full paper trail + approval checklist used to authorize payment.
It’s like: “Yeah this expense checks out — cut the check.”

Question 12

TYPE OF DOCS AND RECORDS
What is the voucher register / purchase journal

Answer 12

Used to record vouchers for goods and services

Question 13

TYPE OF DOCS AND RECORDS
What is the A/P subsidiary ledger?

Answer 13

Includes the amounts owed to individual vendors

For purchase journal: Transactions with amounts owed to vendor

For voucher register: Lists the unpaid vouchers

Question 14

TYPE OF DOCS AND RECORDS
What is the vendor statement?

Answer 14

It represents the purchase activity with the vendor.

Issued to customer as a reminder (external source of evidence, very useful)

Question 15

TYPE OF DOCS AND RECORDS
What are cheques or EFT?

Answer 15

They are the disbursement made to pay for goods/services

Must have its own controls (e.g. segregation of duties)

Question 16

TYPE OF DOCS AND RECORDS
What are the cash disbursement journal / cheque register?

Answer 16

Journal that contains columns to record credits to cash and debits to accounts payable and cash discounts.

We make use of the journal for current year but also search for post-year end (due to prospective liabilities)

Question 17

MAJOR FUNCTIONS OF PURCHASING PROCESS
Requisitioning

Answer 17

Initiation and approval of requests for goods and services by authorized individuals consistent with management criteria.

Question 18

MAJOR FUNCTIONS OF PURCHASING PROCESS
Purchasing

Answer 18

Approval of purchase orders and proper execution as to price, quantity, quality, and vendor.

Question 19

MAJOR FUNCTIONS OF PURCHASING PROCESS
Receiving

Answer 19

Receipt of properly authorized goods and services.

Question 20

MAJOR FUNCTIONS OF PURCHASING PROCESS
Invoice processing

Answer 20

Processing of vendor invoices for goods and services received; also, processing of adjustment for allowances, discounts, and returns.

Question 21

MAJOR FUNCTIONS OF PURCHASING PROCESS
Disbursements

Answer 21

Processing of payment to vendors.

Question 22

MAJOR FUNCTIONS OF PURCHASING PROCESS
Accounts Payable

Answer 22

Recording of all vendor invoices, cash disbursements, and adjustments in individual vendor accounts.

Question 23

MAJOR FUNCTIONS OF PURCHASING PROCESS
General Ledger

Answer 23

Proper accumulation, classification, and summarization of purchases, cash disbursements, and payables in the general ledger.

Question 24

INHERENT RISK ASSESSMENT
What are the 2 industry related factors of risk for auditing payables?

Answer 24

1. Is the supply of raw materials adequate
2. How volatile are raw material prices

Higher purchasing volume = Higher inherent risk

Question 25

INHERENT RISK ASSESSMENT Is it generally hard for the purchasing process to be audited?

Answer 25

No, however, the auditor must ensure he considers the experience in past audit engagements when assessing inherent risk (Misstatements detected in prior audits)

Question 26

What are the 3 major steps in setting control risk for the purchasing process

Answer 26

1. Understand and document the purchasing process based on a reliance strategy. 2. Plan and perform tests of controls on purchase transactions. 3. Set and document the control risk for the purchasing process.

Question 27

CONTROL ACTIVITIES AND TESTS OF CONTROLS - CASH DISBURSEMENT TRANSACTIONS Occurence --> what is the concern? and what are the primary controls (3)

Answer 27

The auditor is concerned with a misstatement caused by a cash disbursement being recorded in the entity’s record when NO PAYMENT was made. The primary control activities to prevent such misstatements include proper: - segregation of duties, - independent reconciliation and review of vendor statements - monthly bank reconciliations.

Question 28

CONTROL ACTIVITIES AND TESTS OF CONTROLS - CASH DISBURSEMENT TRANSACTIONS Completeness major concern + Controls to do (4)

Answer 28

The major audit concern is that a cash disbursement is made but not recorded in the records. Controls: - Same as occurrence: - Segregation of duties - Independent reconciliation and review of vendor statements - Monthly reconciliation + - The auditor should also account for the numerical sequence of checks and reconcile the daily cash disbursements with posting to the accounts payable subsidiary records.

Question 29

CONTROL ACTIVITIES AND TESTS OF CONTROLS - CASH DISBURSEMENT TRANSACTIONS Authorization controls (2)

Answer 29

- Proper segregation of duties reduces the likelihood that unauthorized cash disbursements are made. - The individual who approves a purchase should not have direct access to the cash disbursement.

Question 30

CONTROL ACTIVITIES AND TESTS OF CONTROLS - CASH DISBURSEMENT TRANSACTIONS Accuracy audit concern + Controls

Answer 30

One of the major audit concerns is that the payment amount is recorded incorrectly (wrong amount). To detect such an error, entity personnel should reconcile the total of the cheques and EFTs issued each day with the daily cash disbursements report.

Question 31

CONTROL ACTIVITIES AND TESTS OF CONTROLS - CASH DISBURSEMENT TRANSACTIONS Cutoff test of controls (2)

Answer 31

The auditor tests of controls include: - Reviewing the reconciliation of cash disbursements with postings to the cash disbursements journal and accounts payable subsidiary records. - Also tests cash disbursements before and after year-end to ensure that transactions are recorded in the proper period.

Question 32

CONTROL ACTIVITIES AND TESTS OF CONTROLS - CASH DISBURSEMENT TRANSACTIONS Classification audit concern + Tests of controls (2)

Answer 32

The auditor is concerned that a cash disbursement may be charged to the wrong general ledger account. The use of a chart of accounts, As well as independent approval and review of the account code on the voucher should provide adequate control.

Question 33

CONTROL ACTIVITIES AND TESTS OF CONTROLS What does the auditor do with Purchase Returns?

Answer 33

Generally, the number and magnitude of purchase return transactions are not material. The auditor normally does not test controls relating to purchase returns. Substantive analytical procedures are used to test the reasonableness of the amount.

Question 34

TESTS OF DETAILS OF TRANSACTIONS, ACCOUNT BALANCES, AND DISCLOSURES Regarding completeness, the auditor should conduct a search for unrecorded liabilities that includes the following:

Answer 34

- Inquire management about control activities used to identify unrecorded liabilities and accruals at the end of an accounting period. - Vouch large-dollar items from the purchases journal and cash disbursements journal for a limited time after year-end; examine the date on each receiving report of vendor invoice to determine if the liability relates to the current audit period. - Examine the files of unmatched purchase orders, receiving reports, and vendor invoices for any unrecorded liabilities.

Question 35

TESTS OF DETAILS OF TRANSACTIONS, ACCOUNT BALANCES, AND DISCLOSURES Existence concern + Control

Answer 35

The auditor’s major concern is whether the recorded liabilities are valid obligations of the entity. The auditor should vouch a sample of items on the listing of accounts payable to other supporting documents.

Question 36

TESTS OF DETAILS OF TRANSACTIONS, ACCOUNT BALANCES, AND DISCLOSURES How is the purchase cutoff coordinated?

Answer 36

The auditor attempts to determine if all purchase transactions are recorded in the proper period. On most audits, the purchase cutoff is coordinated with the entity’s physical inventory count. Proper cutoff should also be determined for purchase return transactions.

Question 37

TESTS OF DETAILS OF TRANSACTIONS, ACCOUNT BALANCES, AND DISCLOSURES Rights and obligations

Answer 37

There is little risk associated with this assertion because entities rarely have an incentive to record liabilities that are not obligations of the entity.

Question 38

TESTS OF DETAILS OF TRANSACTIONS, ACCOUNT BALANCES, AND DISCLOSURES Accuracy, Valuation, and Allocation How are A/P recorded (value). On what does it depend.

Answer 38

Accounts payable are recorded at either the gross amount of the invoice or net of cash discount amount. The valuation of accruals depends upon the type and nature of the accrued expense. Most accruals are relatively easy to value.

Question 39

TESTS OF DETAILS OF TRANSACTIONS, ACCOUNT BALANCES, AND DISCLOSURES What are the 3 major classification issues?

Answer 39

- Identifying and reclassifying any material debits contained in accounts payable. - Segregating short-term and long-term payables. - Ensuring that different types of payables are properly classified.

Question 40

TESTS OF DETAILS OF TRANSACTIONS, ACCOUNT BALANCES, AND DISCLOSURE Presentation What are the 2 disclosure items particularly important for accounts payable and accrued expenses

Answer 40

- The auditor must ensure that all related-party purchase transactions have been identified. If material, such related-party purchase transactions should be disclosed. - The other major disclosure issue is purchase commitments. When the entity has entered into a formal long-term purchase contract, adequate disclosure of the terms of the contract should be provided in a footnote.