Acquisition and Expenditure Cycle

1
Chapter 8

• Acquisition and Expenditure Cycle
• Show those numbers to the damn auditors and I'll
  throw you out the _at__at_ window.----(Buddy Yates,
  director of WorldCom, Inc. general accounting, to
  an employee asking for an explanation of a large
  accounting discrepancy).

2
Presentation Outline

• The Expenditure Cycle
• Expenditure Cycle Risk, Control Procedures, and
  Testing
• Audit Evidence in Management Reports and Data
  Files
• Other Accounts in Cycle

3
I. The Expenditure Cycle

• Requisitioning in Stores
• Order Processing in Purchasing
• Receiving
• Delivery Acknowledgement in Stores
• Invoice Verification in Purchasing
• Accounts Payable Prepares the Voucher Package
• Cash Disbursements
• General Ledger
• Internal Audit

4
A. Requisitioning in Stores

• Requests for purchases originate outside the
  purchasing department.
• Purchase requisitions arise in stores or other
  departments.
• Requisitions should be approved in the
  originating department.
• Purchasing has access to the requisition thru the
  purchase database.

5
B. Order Processing in Purchasing

• Purchase requisitions may be overridden due to a
  lack of funds, improper authorization by the
  requesting department, etc.
• Purchasing selects a vendor using an approved
  vendor list or a bidding process.
• Accounts payable, the requesting department, and
  receiving all have access to the purchase order
  through the purchase database.

6
C. Receiving

• Receiving accesses the purchase order and matches
  it with the vendor delivery.
• Receiving only accepts deliveries for which there
  is an existing purchase order.
• Blind counts are often used to force counters to
  actually count the items received.
• A receiving supervisor later verifies the
  quantity against the purchase order.
• Stores has access to this report thru the
  purchase database.

7
D. Delivery Acknowledgement in Stores

• The stores department acknowledges receipt of the
  delivery on the receiving report in the purchase
  database.
• Purchasing and accounts payable have access to
  the acknowledged report thru the purchase
  database.

8
E. Invoice Verification in Purchasing

• Purchasing uses the purchase database to compare
  the purchase order, acknowledged receiving
  report, and vendor invoice for any discrepancies.
• Purchasing authorizes the invoice for payment
  once they are satisfied that the invoice is
  correct per the order and what was received.

9
F. Accounts Payable Prepares the Voucher Package

• The purchase requisition, purchase order,
  acknowledged receiving report, and approved
  vendor invoice provide the support for the
  preparation of a voucher.
• The voucher serves to summarize the purchase for
  entry on the records as a liability.

10
G. Cash Disbursements

• Cash disbursements received the voucher package
  and check for signing.
• Cash disbursements maintains a check register and
  forwards a journal entry to general ledger.

11
H. General Ledger

• General ledger receives the journal entry from
  accounts payable (Debit Accounts payable and
  Credit Cash) and compares it to the control
  total for cash disbursements.
• The journal entry is then posted into the general
  ledger.

12
I. Internal Audit

• An independent reconciliation of the bank account
  is performed by internal audit.

13
II. Expenditure Cycle Risk, Control Procedures,
and Testing

• Inherent Risks
• Cost and Expense Capers Exhibit 8.2
• Expenditure Control Procedures
• Assertions of Classes of Transactions and Events
  for the Period Acquisition and Expenditure Cycle
  Exhibit 8.4
• Direction of Tests Exhibit 8.3
• The Completeness Assertion
• Purchase Cutoffs

14
A. Inherent Risks

• Unrecorded liabilities may arise when invoice
  verification has not been completed for what
  should be a liability.
• Noncancelable purchase agreements drop in
  market prices below agree contractual price
  should result in loss recognition.
• Capitalizing expenses expenditures with no
  future value may be capitalized when they should
  be expensed.

15
B. Cost and Expense Capers Exhibit 8.1 on p.
293
16
C. Expenditure Control Procedures

• Information processing controls
• Compare quantities against receiving report and
  purchase order
• Compare prices against purchase order (i.e.,
  quoted price)
• Mathematically verify vendor's invoice
• Determine when to pay invoice and prepare VOUCHER
• Segregation of duties
• AUTHORIZATION of the purchase is done by the
  purchasing department.
• Custody of the inventory item(s) is held by the
  receiving department and, ultimately, the
  requesting department.
• Transactions are recorded by general accounting
  (control account) and accounts payable department
  (subsidiary accounts) or vouchers payable
• Physical controls
• Prepare a receiving report upon initial receipt
  of inventory
• Count and verify inventory quantities upon
  delivery to the inventory warehouse
• Restrict access to inventories by keeping them in
  a secured location
• Performance reviews
• Compare purchases data to data from previous
  years or expected purchases data

17
D. Assertions of Classes of Transactions and
Events for the Period Acquisition and
Expenditure Cycle Exhibit 8.4 on p. 299
18
E. Direction of Tests Exhibit 8.3 on p. 298
19
F. The Completeness Assertion

• Search for Unrecorded Liabilities
• Inquire of client about their procedures
• Scan open purchase order file
• Examine all UNMATCHED VENDOR STATEMENTS/INVOICES
• Examine all UNMATCHED RECEIVING REPORTS occurring
  near year-end
• Confirm A/P with NORMAL SUPPLIERS (even those
  with zero balances)
• Review CASH DISBURSEMENTS occurring after year-end

20
G. Purchase Cutoffs

• Verify CUT-OFFs for purchases
• Examine Receiving Reports and Vendor Sales
  Invoices occurring around year-end to ensure
  inventory received is included in the appropriate
  period.

21
III. Audit Evidence in Management Reports and
Data Files

• Open Purchase Orders
• Unmatched Receiving Reports
• Unmatched Vendor Invoices
• Accounts (Vouchers) Payable Trial Balance
• Purchases Journal
• Fixed Asset Reports

22
A. Open Purchase Orders

• Purchase orders are open from the time they are
  issued until goods are received.
• Auditors can find evidence of losses on purchase
  commitments in this file (i.e., market prices are
  below price in purchase order).

23
B. Unmatched Receiving Reports

• Auditors can inspect unmatched receiving report
  file to determine whether the company has
  material unrecorded liabilities on the financial
  statement date.

24
C. Unmatched Vendor Invoices

• Auditors can inspect unmatched vendor invoice
  file and compare it to the unmatched receiving
  report file to determine whether the company has
  material unrecorded liabilities on the financial
  statement date.

25
D. Accounts (Vouchers) Payable Trial Balance

• The trial balance is a list of payable amounts by
  vendor, and the sum should agree with the
  accounts payable control account.
• Some organizations have a trial balance of
  individual unpaid vouchers rather than vendor
  names.
• Search for unrecorded liabilities should
  emphasize small and zero balances, especially for
  regular vendors.

26
E. Purchases Journal

• Purchases can be scanned for purchasing patterns
  indicating error or fraud
• Purchase with unapproved vendors
• Purchases to multiple companies at the same
  address
• Duplicate payments
• Vendors whose address matches an employee

27
F. Fixed Asset Reports

• Information for depreciation calculation (cost,
  useful life, method salvage) can be used for the
  audit of depreciation on a sample basis or by
  computer applications to recompute all
  depreciation.

28
IV. Other Accounts in Cycle

• Accrued Liabilities v. Accounts Payable
• Auditing Accrued Liabilities and Prepaid Expenses
• Account Analysis for Prepaid Expenses Exhibit
  8.5
• Auditing Property Plant and Equipment
• Sample PPE and Depreciation Document Exhibit
  8.6

29
A. Accrued Liabilities v. Accounts Payable

• Major differences between ACCRUED Liabilities and
  ACCOUNTS PAYABLE
• Examples include INTEREST, PROPERTY TAXES, WAGES,
  and INCOME TAXES PAYABLE
• These payables are not normally INVOICED or
  EVIDENCED by the RECEIPT OF GOODS
• These differences may make it more difficult to
  detect UNRECORDED ACCRUALS

30
B. Auditing Accrued Liabilities and Prepaid
Expenses

• Agree balances to PRIOR YEAR WORKPAPERS
• Verify PAYMENTS
• Examine UNDERLYING AGREEMENTS
• RECALCULATE amounts
• Agree EXPENSE ACCOUNTS to trial balance
• Search for UNRECORDED ACCRUALS
• Review CASH DISBURSEMENTS at year-end
• Look for expected accruals at other stages of the
  audit (BONDS, NOTES, employees paid on 15th,
  etc.)
• ANALYTICAL PROCEDURES

31
C. Account Analysis for Prepaid Expenses
Exhibit 8.5
32
D. AUDITING PROPERTY, PLANT, AND EQUIPMENT

• GENERAL APPROACH
• Small number of transactions
• Relatively high dollar transactions
• Authorization of Transactions (Board of
  Directors) takes on added importance.
• Less concern for ACCESS to ASSETS
• More concerned with UNRECORDED DISPOSALS

33
D. AUDITING PROPERTY, PLANT, AND EQUIPMENT
(Continued)

• Agree balances to prior year documentation
• PURCHASES OF PPE
• VOUCH to INVOICE or COST RECORDS
• Inspect TITLE
• VOUCH to BOARD MINUTES
• EXPENDITURES SUBSEQUENT TO ACQUISITION
• VOUCH to INVOICE and WORK DESCRIPTIONS
• Consider propriety of classification (EXPENSE or
  CAPITALIZE)

34
D. AUDITING PROPERTY, PLANT, AND EQUIPMENT
(Continued)

• DISPOSAL OF PPE
• VOUCH from PPE to BOD MINUTES (AUTHORIZATION)
• Vouch to cash receipts journal and validated
  deposit slip
• Recalculate gain/loss
• TRACE from BD MINUTES to PPE for disposals
  (COMPLETENESS)
• Look for unrecorded disposals
• Agree balances to PRIOR YEAR WORKPAPERS
• Examine insurance policies, property tax records,
  etc.
• PHYSICALLY INSPECT or CONFIRM fixed assets
• Both existing and newly-acquired items
• Confirm assets LEASED to others under capital
  leases

35
D. AUDITING PROPERTY, PLANT, AND EQUIPMENT
(Continued)

• DEPRECIATION EXPENSE
• Recalculate using USEFUL LIFE, SALVAGE VALUE,
  COST, and METHOD (VA)
• Evaluate REASONABLENESS of USEFUL LIFE, SALVAGE
  VALUE, etc.
• Is depreciation consistent with COMPANY POLICY
  (half year conventions)?
• LEASE AGREEMENTS
• Verify proper treatment (Capitalized or
  Operating)
• Ensure disclosure in footnotes is appropriate

36
E. Sample PPE and Depreciation Documentation
Exhibit 8.6 on p. 304
37
Summary

• Segregation of Duties in Expenditure Cycle
• Risk and Testing in Expenditure Cycle
• Searching for Unrecorded Liabilities
• Audit of Property, Plant Equipment