This chapter details the auditing and assurance services related to the acquisition and expenditure cycle, emphasizing the process of identifying risks, implementing internal controls, and performing audit procedures to ensure the accuracy and completeness of financial records concerning purchases and expenses.
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hello and welcome to chapter 8 auditing
and Assurance services in this chapter
we are going to discuss the acquisition
and expenditure
cycle so show those numbers to the
Auditors and I'll throw your out of the
window so this was actually buddy Gates
which was the director of
Worldcom uh of General accounting and
this was what was noted that he said to
an employee asking for an explanation of
a large accounting discrepancy that
related to the expenditure cycle so if
you think these things cannot happen in
business trust me they do so here are
our learning objectives for this chapter
we're going to describe the acquisition
and expenditure cycle typically looking
at some Source documents we're going to
identify significant accounts and the
relevant management assertions that
relate to the acquisition and
expenditure cycle we're going to discuss
the risk of material misstatement in the
acquisition and expenditure cycle and
we're going to identify important
internal control activities that are
present in a properly designed system to
mitigate that risk of material Mist
statement for each relevant assertion in
the acquisition and expenditure cycle
we're going to discuss test of controls
uh to test the operating effectiveness
of internal controls in the acquisition
and expenditure cycle also we're going
to look at substantive procedures in the
acquisition and expenditure cycles and
relate them to the management assertions
about significant account balances at
the end of the period and you are going
to apply your knowledge to perform these
audit procedures in the acquisition and
expenditure cycle and evaluate the
findings of your tests and in the
appendix we're going to discuss the
payroll cycle including risks Source
documents and controls so let's get
started so here is a great flowchart and
you can see start here of the
acquisition and expenditure cycle and
then you see there is a purchase
requisition and then that turns into a
purchase order and then that purchase
order goes to the vendor and then
hopefully we receive the goods and
services with a bill of lading or a
receiving report and then we have the
invoice here and then we have that we
record the invoice and then we have all
of the supporting documentation and this
is where we start to audit right we want
to see the voucher the invoice the
receip receiving report the purchase
order the requisition and the check copy
and so that is how the whole cycle is
done and so the most important part from
an Auditor's perspective is to ensure
that you understand the process and this
would be part of our working
papers so the basic activities that we
test as an auditor is the purchases of
goods and services right so does the
department request the purchase of the
items through a purchase requisition and
you might have some bidding that may be
involved when you have higher dollar
purchases then you have the purchasing
department that prepares the purchase
order and it's approved by the
appropriate person and um it could also
be done through an automatic
replenishment system so when you reach a
certain level let's say an inventory
that you don't have or you have you need
more then you it would automatically do
that for you and then we want to receive
the goods and services and here you know
when they are received we either have
that receiving report then you want to
record whether we are recording an asset
or an expense and lastly you want to pay
the invoice and ensure that your vendors
are happy
too so here we're looking at each of the
accounts and the assertions so we're in
the risk assessment phase here and when
you're talking about accounts payable
you have these assertions that relate to
it completeness cut off existence
presentation and valuation and similarly
with expenses we have completeness cut
off accuracy and classification and keep
and remember keep in mind that these are
Management's assertions and we as
Auditors are testing
those so here we have some issues and as
you can see we have Worldcom Waste
Management Hines
corporation uh and several others and
you see the restatement amount that
related to cost and expenses and so you
could see it could be as 11 billion
dollar or as little as 16 million but
either way it's material and these are
some of the cost and expense Capers that
have happened and then we have here our
internal control activities that we're
talking about and basically we have our
accounts payable and our expenses the
relevant management assertion and what
could go wrong so typically with
accounts payable we have that the
liabilities are not recorded or they're
not recorded in the correct period or
they just don't present the actual
obligation of the company or they're not
recorded in the proper amount or
disclosed in the footnotes whereas with
expenses same thing right not all
expenses are recorded not in the correct
period or with the wrong amount as
well so we have control procedures right
and so there's information processing
control so we want to compare the
purchase order with the bill of lading
and with the company's purchase um order
as well we want to compare the
quantities against the receiving report
and the purchase order order so this is
part of our substantive testing that we
do as Auditors so you want to compare
prices between what's on the invoice and
what was quoted you want to recompute
the vendor's invoices determine when to
pay and then properly prepare the
vouchers so these are all the procedures
that hopefully we see within the
organization obviously separation of
Duties is one of the simpler internal
controls that we can have in an
organization so the authorization of a
purchase is usually done by the
purchasing department but then the
custody of the items is usually handled
by the receiving department transactions
are recorded by accounting or accounts
payable department uh or and then you
reconcile the liabilities to the
customer statement and then bids are
usually received by some independent
person outside of the purchasing
decision then we have physical controls
so in these physical controls what we
have is we might prepare the receiving
report once we get the receipt of the
inventory then you want to count and
verify those quantities upon delivery to
the inventory warehouse and obviously
restrict access then we also have
performance reviews as a type of control
procedure so you want to compare the
purchasing data from previous years to
what we expected for this year and you
want to review the bids to ensure that
documentation exists regarding the
selection of the
vendor so here we have some internal
control activities um within the
expenditure and acquisition cycle so
here we have the account that we're
talking about accounts payable the
relevant management assertion such as
completion and what could go wrong are
the liabilities are not recorded but we
added now the internal control activity
so in this case we would have the
receiving reports that should be
prenumbered and used in order and all
receiving reports uh are completed by
the end of the period should be be
accounted for in that period for cut off
payables are recorded in the first weeks
of the period should be compared to
those receiving reports um and invoices
for that recording period when we're
talking about existence we want to make
sure that the voucher packages for
payments to vendors should include your
purchase orders and your receiving
reports and the vendor should be part of
that Master approved vendor list and a
three-way match should be performed
where you're looking at the purchase
order the receiving report and the
invoice then for presentation you want
to make sure that the chart of accounts
is used for classifying those purchase
transactions and for the valuation
assertion you want to make sure that the
prices on the vendor invoices are agreed
to that price list and test for
mathematical accuracy now when we're
looking at the expenses we're still
looking at completeness but we should
also use the prenumbered vouchers
receiving report reports and purchase
orders and checks in that numerical
sequence when we're looking at cut off
compare the actual expenses with the
budgeted amount for accuracy we're going
to match the invoices or work orders for
the proper cost or of the items or the
services performed and for
classification we're looking to make
sure that the expenses are recorded in
the proper
account so now we have a test of
internal controls so in this column here
is what the auditor would do so in order
to test the internal control and
remember these are attribute testing
right when we test internal controls
we're looking for something so in this
case when we're looking at accounts
payable for the completeness assertion
we're verifying the sequence of those
prenumbered receiving reports we're
inspecting evidence that there was some
management review or that something
happened with the
unmatched receiving reports when we're
looking at cut off we're tracing those
receiving reports and invoices ensuring
that it was recorded in the proper
period for the Existence assertion on
accounts receivable we are vouching a
sample of payments to vendors for that
three-way match and that's like proba
and that's where RPA here robotic
process automation can help us in the audit
audit
process then when we're looking at
presentation we're looking to see if
there's a chart of accounts for and then
when we're looking at the relevant uh
assertion valuation we're looking to
make sure that there is a price list and
that mathematical accuracy was
performed and then when we're looking at
the expenses we're doing something very
similar as well for completion for for
completeness we are looking at the
numerical sequence uh we are also
examining evidence to make sure that we
compare budget to actual and that any
unusual amounts are addressed and then
we're looking when we're looking at
accuracy we're trying to inspect
evidence between you know the expenses
and the invoices and for classification
we're looking at the journal entries to
ensure that they were recorded
properly and then we have several other
additional uh tests of internal controls
so for example we can look for the
segregation of Duties we can trace
receiving reports to the purchase
journals we can also scan purchase
journals uh and purchase orders for like
the numerical sequence we can do this
same thing with cash
dispersements we can examine evidence
that the managers reviewed the analyses
and followed up on it and maybe look at
the actual versus budget as
well and then when we're looking at
accuracy we want to make sure that we
examine the contracts for authorization
possibly observe the client receiving
the quantities showing evidence of that
documentation looking at the vendor
statements and you know making sure that
there's a recalculation of the price uh
look for approval for that payment look
for manager review of the journal
entries and maybe review the reconciling
items so as you can see from an
Auditor's perspective we are keeping
busy and trying to check the internal
controls and then perform additional
tests of internal controls so we're
looking again more as inspection of
evidence and making sure that the
accounts are recorded correctly in the
account CL classification that's the
name of the game so then we have
direction of the tests so you can go
either way as you can see from the
direction of the arrows so you can go
from the vendor invoices to the purchase
journals or from the vendor invoices to
the receiving report but that is our
three-way match right so that's
basically what we're trying to do when
we're testing substantively testing uh
re for
expenditures then we move from the risk
assess ment to the audit evidence so
when and this would be our workpapers
right our audit workpapers so we're
going to be searching for unrecorded
liabilities so we're going to ask hey
how does the client identify unrecorded
liabilities we're going to scan the open
purchase order file we are going to
examine any unmatched vendor statements
or invoices on any unmatched receiving
reports we're going to confirm the
accounts payables with suppliers and
we're going to review the cash
dispersements that happen at the end of
the year to provide this audit evidence
that we need to perform our substantive
procedures then we're going to look at
purchase cut offs and when we're looking
at C offs we're examining the receiving
reports and the invoices that happened
around year end to make sure that they
were recorded in the proper
period and then we're going to look at
several other accounts within this cycle
so we might look at prepaid expenses
we're going to look at acred liabilities
maybe other expenses such as repair and
maintenance legal we're going to check
out inventory and property plant and
Equipment as
well and here's an example of an account
analysis for prepaid expenses so you see
we do have the actual uh link here to
the workpapers and you notice that we
have our tick marks right
here and then you see F is for footed so
we're footing everything and you see how
every number has some type of tick mark
so I should be able to pick up this
workp paper and know exactly who
prepared it who reviewed it and the work
that was performed as you can see so
every number should have a tick mark on
it that shows what you've done and here
where you're cross putting it to another
uh workpaper and then you see that we're
looking at the audited balance the
addition the disposals and what we've
done that we've calculated it and where
we've traced that to another workpaper
X10 X11 or X12 and then you can look at
the two to see all of the substantive
procedures that were
performed so for ACR liabilities we may
have a major difference between those
acred liabilities and accounts payable
so we might have some issues with
property taxes wages income taxes and
these types of payables aren't normally
invoice or they really do not have a
receipt of goods so this can make it a
little bit more difficult for us as
Auditors to detect the unrecorded
acrs so when we're auditing the acred
liabilities and the prepaid expenses
accounts we're pretty much agreeing the
balances to Prior year workpapers which
we saw in that schedule verifying
payments examining the agreements
recalculating amounts and agreeing the
expenses to the trial balance looking
for those unrecorded acral by by
reviewing the cash dispersements at the
end of the year and looking for any
expected acrs at other stages in the
audit if we're looking for bonds or for
notes and perform our analytical
procedures to make sure that everything looks
looks
good then for income taxes payable taxes
can be a doozy right they can be a
complex area and usually companies work
within multiple uh tax jurisdictions so
you would probably get we probably get
our tax specialist in our office to help
us with that but we would vouch the
payments and we would look and examine
at everything and make sure that we're
adhering to all of the auditing
estimates then when we're auditing PPN
right property plant and Equipment we're
looking at a general approach right
we're looking for maybe small numbers of
transactions some high dollar amounts or
that the authorizations of those
transactions was actually given and
we're not as concerned for the access to
the assets but we're mostly concerned
that we don't have any unrecorded
disposals and then what we're going to
do with ppne is we're going to take
those balances and agree to them to the
prior year documentation we're going to
look at those purchases vouch them to
the invoices inspect the title and make
sure that we vouch those to the board
minutes then for the expenditures
subsequent to acquisition we're going to
vouch those to the invoices and the work
descriptions and make sure that they are
properly classified as either an expense
or capitalized if it
qualifies and then when we're looking at
the disposal of property plant and
Equipment we're vouching right to the
minutes of the board we're vouching the
cash receipts journal and the validated
depart deposit slip recalculating the
gain or loss make sure that we Trace
that to the board minutes for
completeness and then when we're looking
for unrecorded disposals we're going to
to agree the balance to Prior year work
papers look at the insurance policies
and the property tax records and inspect
or confirm the fixed assets whether they
were existing and newly
Acquired and then we're going to look at
depreciation expense making sure that we
recalculate it with the useful life the
salvage value the cost and pretty much
evaluate it based on the reasonableness
of those estimates and is depreciation
consistent with the company policy then
we're going to take a look at the lease
agreements make sure that they're
treated properly and ensure that the
disclosures are in the foot
notes and here we have again a uh
property plant and equipment and
depreciation schedule and as you can see
at the top we have our uh work paper and
then we have each of the buildings and
you see the the tick marks as well that
we agreed it to the prior documents and
as with the prepaid expenses you see
most most of the numbers here have some
type of tick mark so again I should be
able to pick up this workpaper and know
exactly what the Auditors performed and
how they did their
work and then when we're looking at
auditing cost and expense accounts we're
looking at the analytical procedures
relating the expense to the balance
sheet account and making sure that we do
perform those substantive tests of
transactions and vouch to the details
and one of my favorite topics is fraud
and so when you have to and we all know
that in auditing we have to look an
audit for fraud so if we review for
fraud risk if it tells us that there
could be a potential significant risk
that fraud is occurring within the
acquisition and expenditure cycle then
we have to do several types of searches
and we would do those with cats computer
assisted auditing tools so in this case
what we can do and this is again again
where data mining software such as idea
or altrix can really help us and robotic
process automation can help us where we
can inspect invoices for photoc copies
looking at the vendor invoices that were
submitted in numerical order looking
making sure that vendor invoices that
are always in round numbers to kind of
help us see if there's any fraud we can
scan those invoices to see if there was
a lower uh than a review threshold we
can also look to make sure there's no
boxes or that the invoices do have phone
numbers and that those addresses and
phone numbers match what we have in the
vendor Master file we could also vouch a
sample of vendor invoices to the
approved vendor list and so this is all
types of procedures that we can do to
try to find fraud in accounts
payable and here we have the pcaob
inspections and the of what they're
telling us right that the pcaob is
required to perform detailed inspections
of the audit process employed by each
firm's auditing publicly traded
corporations and a formal inspection
report is issued by the pcaob for each
firm and in a recent inspection report
the pcaob highlighted the importance of
testing uh clients accounting for income
taxes and here you see that and so this
was the report on the 2019 inspection of
grand Thorton by the pcaob
pcaob
and then here we have for property plant
and Equipment based on the same report
that the pcaob is required to do this
and then the firm selected for testing a
control that included the issuer's
review of possible impairment indicators
for property plant and equipment at one
of the issuers subsidiary and the firm
did not evaluate one whether the control
was appropriately designed to identify
the impairment indicators that were
present and two the review procedures
that the control owner performed
including the procedures to identify
items for followup and the procedures to
determine whether those items were
appropriately resolved Additionally the
pcaob noted that in performing its
substantive procedures related to the
issuer's assessment of the possible
impairment of this property plant and
Equipment The Firm did not evaluate the
issuer's determination that there were
no indicators of potential impairment
Beyond inquiry of management and here
you see the auditing standards that
relate to that so the pcob in their
inspections basically is pretty much
saying what Grand Thorton in this case
failed to
perform and then the last piece is the
payroll cycle and so often we um process
this by service organization so our
socker report and then we have the
balance sheet accounts are usually
pretty small so what Auditors typically
do is rely on the test of controls and
the substantive testing of
transactions and there are some risks
associated with the payroll cycle
especially with fraud so ghost employees
where you're paying people that don't
exist or overpaying or padding the time
uh have some classification errors with
incorrect accounting or you forget to
pay third parties such as your payroll
taxes or your insurance so those are the
types of inherent risks and we know
inherent risk is part of our overall
audit risk
model and here we have the typical
activities within a payroll cycle where
we start you know with compensation we
have to make sure that we record keep we
make sure that we have our timekeeping
records our government and payroll taxes
our payroll register make sure we're
recording it properly and that we're
giving out the payroll checks
accordingly so when we're talking about
the payroll cycle we are talking about
Personnel authorization forms right to
authorize all payroll related
transactions and employees should record
their hours using time sheets and then
supervisory Personnel will hopefully
review those time sheets and verify the
distribution of the Hours worked now the
payroll department will process payroll
and then they'll do the payroll register
and the checks then we have the cash
dispersement or the treasurer that will
review that payroll register and compare
it to the payroll checks and the payroll
checks are signed by an authorized party
and then given to the
employees and here we have several
control activities where physical
controls segregation of Duties and
performance reviews so we want to
physically control the payroll checks
and the signature plates we want to make
sure that the checks are distributed by
a person that isn't involved in the
process or recording of payroll we also
want to make sure that the payroll
checks distributed uh to individuals
with it with providing proper
identification and any unclaimed pay
payroll checks are stored in a secure
location obviously with segregation of
Duties we want the Personnel department
and the hiring and employee Department
to authorize those payroll transaction
payroll is recorded by the payroll
department and general accounting and
then the cash dispersements department
or treasure keeps custody of those
payroll checks with performance reviews
we're looking at payroll transaction
data and we're looking at it comparing
prior year or to budgeted and expected
we're also reviewing the payroll
register for reasonableness and making
sure that the payroll bank account is
reconciled as
well and then we have actual management
reports and files within the payroll
cycle right so we have Personnel files
we want to make sure the payroll
register is kept if there's labor cost
analysis any clearing accounts are
reconciled making sure that we adhere to
the government and tax reports and
year-to-date earnings records and
W2s and that concludes our Le pressure
on the acquisition and expenditure cycle
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