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Auditing the Expenditure Cycle

Transaction and Account Balances

1. Transactions and account balances involve in expenditures cycle are thoseinvolve in expenditures cycle are those related to providing goods and services for operational acti ities incl ding thefor operational activities, including the payment of its payable.

2. However in this chapter the discuss will be focused on the transactions related to purchase of inventory, it can be raw material or merchandise inventory.y

Transaction and Account BalancesCredit DebitCredit DebitAccount Payable

Debit• Merchandise Inventory• Raw material inventory

Credit• Cash• Purchase discounts• Raw material inventory

• Purchases• Prepaid expenses

Pl t t

• Purchase discounts• Purchase returns

• Plant assets• Other assets• Various expensesp

Purchase Payment

Audit Objectives

Assertion Category

Transaction or Balance

Specific Audit Objectives

Existence or Transaction Recorded purchases represent goods Existence or Occurrence

Transaction Recorded purchases represent goods, services, and productive assets received during the period.Recorded cash disbursement transactions Recorded cash disbursement transactions were made during the period to suppliers and creditors.

B l R d d t bl t th Balance Recorded accounts payable represent the amounts the entity owes at the balance sheet date.

C l t T ti All h d h di b t Completeness Transaction All purchases and cash disbursements made during the period were recorded.

Balance Accounts payable include all amounts owed to suppliers of goods and services at the balance sheet date.

Audit ObjectivesAssertion Category

Transac-tion or

Balance


BalanceRights and Obligations

Transaction

The entity is liable for the payables resulting from the recorded purchase transactions.

Balance Accounts payable are obligations of the entity at theobligations of the entity at the balance sheet date.

Valuation or Allocations

Transac-tion

All purchase transactions and cash disbursements are valuedAllocations tion cash disbursements are valued using GAAP and correctly journalized, summarized, and posted.

Audit ObjectivesAssertion Category

Transac-tion or

Balance


Balance Accounts payable are stated at the correct amount owed.Related expense balances are in conformity with GAAPGAAP.

Presentation and Di l

Transaction The details of purchases and cash disbursements support their presentation in the financial

i l di h i l ifi i d l d Disclosure statements including their classification and related disclosures.

Balance Accounts payable and related expenses are properly identified and classified in the financial statements.Adequate disclosures have been made pertaining to commitments contingent liabilities and to commitments, contingent liabilities, and collateralized and related party payables.

Materiality and Inherent Risks

1. Materiality is depend on the level of control risks and inherent risks.co o s s a d e e s s

2. Inherent risksP t d t t ta. Pressures to understate expenses to increase profitability targets or industry normsnorms.

b. Pressures to understate payables to increase liquidityincrease liquidity.

c. The high volume of transactions, it cause increasing risk of material misstatement,increasing risk of material misstatement, except otherwise supported by reliable ICS

Materiality and Inherent Risks

d. Unauthorized purchases and cash disbursements may be made.y

e. Purchase assets may be misappropriated.f. There may be duplicate payment of vendor’s y p p y

invoices.g. Contentious accounting issues may arise

concerning such matters as whether a cost should be capitalized or expensed (e.g. the treatment of repairs and maintenance costs ortreatment of repairs and maintenance costs or the classification of a lease as an operating or capital lease).capital lease).

Analytical Procedures• Analytical procedures are commonly

cost effective. • If the company is growing it is common

to expect purchase, inventory, andto expect purchase, inventory, and accounts payable to grow at consistent ratesrates.

• The auditor’s knowledge of the volume or purchases combined with prioror purchases, combined with prior experience is useful in estimating c rrent ear’s pa ablescurrent year’s payables.

Analytical Procedures

Ratio Formula Audit Significance

Account Average Prior experience in accountsAccount payable turn days

Average Accounts Payable : P h

Prior experience in accounts payable turn days combined with knowledge of current

h b f l iPurchases x 365

purchases can be useful in estimating current payables. A shortening of the period may indicate completeness problems.

Cost of Cost of Unless the company hasCost of goods sold to accounts payable

Cost of Goods Sold : Accounts Payable

Unless the company has changed its payment policy, these amounts should change by approximately the samepayable Payable by approximately the same percentage from year to year.


Payable as a % of total

Account Payable :

Common-sized balances in accounts payable are useful in

assetsy

Total Assetsp y

comparing with industry data. A significant decline in this ratio

i di t l t may indicate completeness problems.

Current ratio Current A significant increase in the Current ratio Current Assets : Current

A significant increase in the current ratio compared to prior year’s experience may indicate a

Liabilities completeness problem. However, this ratio may also be influenced by changes in asset accountsby changes in asset accounts.


Quick ti

Current M t

A significant increase in th t ti ratio Monetary

Assets : C t

the current ratio compared to prior year’s

i i di t Current Monetary Liabilities

experience may indicate a completeness problem. Ho e er this ratio ma Liabilities However, this ratio may also be influenced by changes in asset changes in asset accounts.

Documents and Records – Payable1. Purchase requisition. Written request for goods

or services by an authorized individual or d t t t th h i d t tdepartment to the purchasing department.

2. Purchase order. Written offer from the purchasing department to a vendor or supplier to purchasedepartment to a vendor or supplier to purchase goods or services specified in the order.

3. Receiving report. Report prepared on the receipt g p p p p pof goods showing the kinds and quantities of goods received from vendors.

4. Vendor invoice. The bill from the vendor stating the items shipped or services rendered, the amount due the payment terms and the dateamount due, the payment terms, and the date billed.

Common Documents and Records5. Voucher. An internal form indicating the vendor, the

amount due, and payment date for purchase received. It is used to authorize recording and paying a liabilityIt is used to authorize recording and paying a liability.

6. Exception reports. Reports with information about transactions identified for further investigation by computer application controls.

7. Voucher summary. Report of total vouchers processed in a batch or during a dayprocessed in a batch or during a day.

8. Voucher register. Formal accounting record of recorded liabilities approved for payment.pp p y

9. Approved vendor master file. Computer file containing pertinent information on vendors and suppliers that have been approved to purchase servicesuppliers that have been approved to purchase service from and make payments to.

Common Documents and Records10. Open purchase order file. Computer file of

purchase orders submitted to vendors for which th d i h t b i dthe goods or services have not been received.

11. Receiving file. Computer file with receiving information on quantities or inventory receivedinformation on quantities or inventory received from vendors.

12. Purchase transactions file 13. Account payable master file14. Suspense files. Computer files that hold p p

transactions that have not been processed because the have rejected by computer application controlsapplication controls.

Functions

1. Initiating purchases, including: placing vendors on an authorized vendor list, requisitioning goods and services, preparing purchases orders.

2. Receipt of goods and services, including: receiving the goods, storing goods received for inventory, returning goods to vendor.

3. Recording liabilities, including: preparing the payment voucher and recording the liability, accountability for recorded transactions.

Control Risk – Purchase TransactionsInitiating Purchases

Potential MisstatementPotential Misstatement• Lack of control over purchases and unrecorded

liabilities, control: prenumbered purchase requisitions and purchase order, and checks numerical sequence.P h f th i d t l• Purchases for unauthorized purposes, control:verification of employee authorization code to enter requisition or purchase order.q p

• Fictitious vendor and bill for services not received, control: compare vendor on purchase order to

t fil d A t l t d tmaster file vendor. Access control to vendor master file.

Control Risk – Purchase TransactionsR i i G d bd S iReceiving Goods abd ServicesPotential Misstatement

G d b i d b t t d d t l• Goods may be received but not recorded, control:checks for goods ordered and not received within a reasonable period of time. p

• Accepting goods that were not ordered or authorized, control, checks validity of purchase order in order to i iti t i i tinitiate receiving report.

Recording LiabilitiesPotential MisstatementPotential Misstatement• Goods or services may be received but not be

recorded appropriately, control, checks the record ofrecorded appropriately, control, checks the record of liabilities for reasonable period of time.

Control Risk – Purchase Transactions• Liabilities may be recorded for goods or services not

received or may be recorded at an incorrect amount, control matching information inside the voucher withcontrol, matching information inside the voucher with the underlying supporting documents, such as purchase orders and receiving report.

• Payment invoice twice, control, stamp paid to the paid invoice, and review prior payment before decide t th hto pay the voucher.

• Recording in the wrong accounting period, control,comparing the date in the invoice with the date ofcomparing the date in the invoice with the date of recording the invoice.

• Mathematical error may be made in processing the vouchers, control, checks the mathematical accuracy of the vouchers and supporting documents.

Control Risk – Purchase Transactions• Purchase may be incorrectly posted or summarized,

control, compare sum of the subsidiary ledger accounts with the general ledger control accountaccounts with the general ledger control account.

• Purchase may be posted to the wrong accounts, control, compares account distribution on thecontrol, compares account distribution on the voucher with the account distribution on purchase requisition or purchase order.

• Purchase may be recorded for goods or services not received, they may be posted to the wrong account, or in the wrong amount, control independent reviewor in the wrong amount, control independent review to all purchases charged to the responsibility center as well as reviewing vendors, amount, and accounts h d ti l b icharged on timely basis.

Documents and Records

1. Check2 Check summary2. Check summary3. Cash disbursements transaction file.

Information on payments by check toInformation on payments by check to vendors and others. Used for posting to the accounts payable and general ledgerthe accounts payable and general ledger master files.

4 C h di b t j l h k4. Cash disbursements journal or check register. Formal accounting record of h k i d t d d thcheck issued to vendors and others.

Control Risk – Cash Disbursement

• A check may not be recorded, control, computer accounts for prenumbered checkcomputer accounts for prenumbered check series, compare total on check summary to total vouchers submitted for payment, control access to blank check and signature plates.

• A check may not be recorded promptly, control, prints report of checks due but not yet paid, compare beginning cash less cash disbursement with ending cash balance as welldisbursement with ending cash balance, as well as, beginning payable less disbursement with ending payableending payable.


• A check may be issued for unauthorized purchases control compare checks withpurchases, control, compare checks with its supporting documents, such as authorized purchase order receivingauthorized purchase order, receiving report, and voucher. Also limit test on large disbursement and these checklarge disbursement, and these check must be manually signed.A voucher may be paid twice control• A voucher may be paid twice, control, stamp paid to paid voucher package.


• A check may be issued for wrong amount, control, independent check matching thecontrol, independent check matching the check with related voucher package.

• A check may be altered after signed, control, y g , ,put certain sign in the beginning and ending part of the amount of check which written in word, i.e. by putting sign # and word only#

• Error in recording check, control, independent h k i h k h d h kcheck comparing check, voucher, and check

register.

Purchase Adjusments ‐ Documents

• Purchase return authorization, it is a form showing the description, quantity, and othershowing the description, quantity, and other data pertaining to the goods that the vendor has authorized to return.

• Shipping report, it is a report prepared on the shipment of goods to vendor showing the kinds and quantities of goods shipped.

• Debit memo, it is a form stating the particulars f d bit t t bl i l di thof a debit to account payable, including the

specific items returned, prices, and amount creditedcredited.

Substantive Tests of Payable

Initial Procedures1 Obtain understanding of business and industry and1. Obtain understanding of business and industry and

determine:a. The significance of purchases and account g p

payable to the entity.b. Key economic drivers that influence the entity’s

purchases and resultant account payables.c. Standard trade terms in the industry, including

seasonal datingseasonal dating.d. The extent of concentration of activity with the

suppliers and related purchase commitmentssuppliers and related purchase commitments.

Substantive Tests of Payable

2. Perform initial procedures on the A/P balance and records that will be subjected to further jtesting.a. Trace beginning balance to prior years working

papers.b. Review activities in the GL accounts and

i ti t t i th t l iinvestigate entries that appear unusual in amount or source.

c Obtain listing of A/P at balance sheet date andc. Obtain listing of A/P at balance sheet date and determine that it accurately represents the underlying accounting records by:underlying accounting records by:

Substantive Tests of Payablei. Footing the listing and determining agreement with

(1) the total of unpaid voucher file, subsidiary ledger, or A/P master file, and (2) the GL control g , , ( )account balance.

ii. Testing agreement of vendors and balance on listing with those included in the underlyinglisting with those included in the underlying accounting records.

Analytical Procedures:1. Develop an expectation for A/P using knowledge of

entity’s business activities, normal trade terms, and history of A/P turnoverof A/P turnover.

2. Calculate ratio and analyze the results relative to expectations. Pay attention to indication of

dunderstatement.

Substantive Tests of PayableTests of Details of Transactions1. Vouch sample of recorded transactions to

ti d t C dit A/P t hsupporting documents. Credit A/P to vouchers package (vouchers + vendor invoices + receiving reports + purchase orders + other supportingreports purchase orders other supporting information. Debit A/P to cash disbursements or purchase returns memoranda.

2. Perform purchases cut-off test.a. Select sample of recorded purchase

t ti l d b f d fttransactions several days before and after balance sheet date, and examine the supporting documents and tests the appropriateness ofdocuments and tests the appropriateness of cut-off transactions.

Substantive Tests of Payableb. Observe the numbers of the last receiving

report issued on the last day of the audit period and trace sample of lower and higherand trace sample of lower and higher numbered receiving reports to ensure that purchases were recorded in the proper period.

3. Perform cash disbursements cut-off test.a. Observe the number of check issued and mail

or the last payment of payable, on the last day of accounting period, and trace to the accounting records to verify accuracy of cutoffaccounting records to verify accuracy of cutoff.

b. Trace dates of “paid” checks returned with year-end cut-off bank statements to dates recorded.end cut off bank statements to dates recorded.

Substantive Tests of Payable4. Purchase return cut-off.

a. Review purchase return on the last days of accounting period to ensure accuracy the date of recording.

b. Vouch the last purchased returns in the books of original entry (journal) to vendor’s

th i ti d hi i tauthorization and shipping reports.8. Perform search for unrecorded liabilities.

a. Examine subsequent payments until the end date of fieldwork and trace it to the

bl b l t th b l h tpayable balance at the balance sheet.

Substantive Tests of Payableb. Investigate unmatched purchase documents.c. Inquire accounting and purchasing personnel

b t d d li bilitiabout unrecorded liabilities.d. Review capital budgets, work orders, and

construction contracts for evidence ofconstruction contracts for evidence of unrecorded payables.

Tests Details of Balances1. Confirm account payable.

a. Identify major vendors by reviewing voucher y j y gregister or account payable subsidiary ledger and send confirmation to vendors with large balancebalance.

Substantive Tests of Payableb. Investigate and reconcile the differences.

2. Reconcile unconfirmed payable to monthly t t t i d b li t f dstatements received by client from vendors.

Presentation and DisclosuresCompare presentation with GAAPCompare presentation with GAAP.

a. Identify the proper identification and classification of payableclassification of payable.

b. Determine the existence of debit balance of payable that need to be reclassified.p y

c. Determine the sufficiency of disclosures.d. Inquire about undisclosed commitment and

contingent liabilities.

Substantive Tests of Payablee. Evaluate completeness of presentation and

disclosures.f R d th di l d i d d tlf. Read the disclosures and independently

evaluate the appropriateness of classification and disclosures, as well as theand disclosures, as well as the understandability of classification and disclosures.

Example of ConfirmationTitle and addresseeDear Sir or MadamWill you please send directly to our auditors, Bla & Bla, Certified Public Accountants, and itemized statement of the amount owed to you by us at the close ofof the amount owed to you by us at the close of business on December 31, 20xx? Will you please also supply the following information:

Amount not yet due Rp…..Amount past due RpAmount of purchase commitments Rp…….

Description of any collateral held. Etc……………….Very truly yours etc…… etc…..

Thank You