10 Acquisition and Payment Cycle (Ch. 10) PDF

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Acquisition and Payment Cycle (Ch. 10) 1. What Classes of Transactions occur in the Acquisition and Payment Cycle (a.k.a. Purchases-Payables-Payments -- PPP Cycle)? Classes of Transactions in PPP Cycle? ** the opposite of RRR Cycle. (a)

Acquisitions Class (Credit Side, many possible debits therefore need to pay more attention to classification) DR Purchases (periodic) or Inventory (perpetual) or Capital Assets or Expenses or..... CR Accounts Payable

(b)

Cash Disbursements Class (Debit Side DR Accounts Payable CR Cash

*** at the end of the year the accounts payable account will be in a debit net zero balance 2. Business Functions and the related Documents and Reports.

Employee initiates

Purchasing Department

Receiving Department

Accounts Payable (Acc’ting)

Accounting (Cash Disburse.) $$$

 Purchase Requisition (PR) o Employee fills out the materials that they need o Name the product and quantity that is needed  supervisor approval o Authority is restricted to the types of goods applicable to that person’s function  Purchase Order(PO) o Purchasing department formalizes PR and picks better quality or more quantity to receive volume discounts  Separation of duties: one person can have a good relationship with the vendor  improved efficiency  Restricts opportunity for those making PR to issue fraudulent orders (goods for their own use)  Provides evidence that the goods have been received o Kickback: purchasing dept agrees to buy from one vendor, gets a present for submitting business  Not in the past interest of the company  Competing bids to mitigate kick backs  Approved price ranges and vendors list (reputable and want to do business with, there new competitors to consider?)  Receiving Report (RR) o Waiting for the goods to come in, department will fill out the report o List the product and quantity received and the condition o Compare the RR to the PO, if correct then sign off and staple all 3 reports together  Invoice o Accounting clerk matches the invoice to the PR, PO and RR

Code the general entry: DR Exp CR A/P  Requires supervisor review and approval because want correct classification  Voucher system: show what the journal entry is and approvals Deface the invoice and packages

o

o  Cheque o DR A/P CR Cash  cheque signatory will review cheque and invoice package (segregation of duties) 3. Methodology – PPP Cycle 1) 2) 3) 4)

Understand the entity & its environment and its PPP Cycle For each cycle, identify internal controls that exist Assess CR and risk of material misstatement (IR x CR) Evaluate cost benefit of testing controls and following a combined audit approach a. Purely substantive approach vs. combined audit approach 5) If you want to follow a combined approach: Determine the:  Test the Controls  Nature  Substantive Procedures  Timing  Extent of audit procedures 4. Acquisitions Class of Transactions 4.1

“Classification” assertion for this class of transactions is more important than for the sales class of transactions. Why? Because there are many possible debits

4.2

The First “P” - Purchases Class of Transactions – What controls exist?

Assertion Occurrence (Recorded purchases are for goods and services received, consistent with the best interests of the client.)



 

Approval of purchase order. Cancellation of documents once transaction recorded. Approved Vendor’s List is independently examined periodically. New vendors and changes to Approved Vendor’s List are approved. Purchase orders are pre-numbered and accounted for. Receiving reports are pre-numbered and accounted for.

  

Supervisor approval of journal entries Adequate Chart of Accounts Compare balances with budget

    Completeness (All purchases are recorded) Classification (Purchases are recorded in the appropriate accounts)

Internal Control Supporting documents accompany the recording of a purchase (purchase requisition, purchase order, receiving report, and vendor’s invoice).

5. Accounts Payable -- COMPLETENESS is critical. Why  A/R can’t get sued for opportnity loss if there are receivables missing  Understated liabilities is risky for auditors because it attracts legal liabilities o Management likely to understate in order to have a more favorable financial position  AP is a significant factor in evaluating an entity’s short -term solvency



Look for transactions in the next period that should be recorded in this period

6. Cash Disbursements Class of Transactions (3rd P, Payment)  Segregation of duties is important.  Bank reconciliation is important. 7. Auditor’s role

SUBSTANTIVE PROCEDURES Procedures to Obtain Understanding of Internal Control

7.1

Tests of Controls

Substantive Analytical Procedures

Tests of Details of Balances (TODB)

Substantive Analytical Procedures? Very often involves relatively small account balances (e.g. all G&A accounts). Imagine office expenses, telephone expense, photocopier expense -> general and admin accounts Analytical Procedures are often SAAE because the amounts are not significant (e.g. compare to budget) o Not expecting huge errors, risk is low, don’t to TODB If results confirm expectations then this will dictate how much TODB to complete

  

Some account balances are important to analyze separately  

Recall discussion on Analytical Procedures Examples: Legal Expense, R&M Expense, Lease Expense, etc. o GAAP issues, follow up with detail testing along with comparing to budget o Contingencies or legal issues that could arise to another accounting issues

7.2

Tests of Details of Balances (TODB) – Accounts Payable  Search for Unrecorded Liabilities (Completeness)

(a)

Cash Disbursement  Examine cash disbursements after year-end to see if they relate to year-end payables.  Should these have been accrued in 2017 even though paid in 2018  Go through cheque runs each day after year end and look for disbursements greater than $10k

(b)

Vendor Invoice  Examine open/unpaid vendor invoice file after year-end to see if they relate to year-end payables. May need to link back to receiving reports.  See why invoices have not been recorded at year end, should it be recorded or accrued for?

(c)

Receiving Reports  Trace last 5 receiving reports for 2017 issued before year-end to related vendor invoices.  At the most risk for not being reported in the correct period

(d)

Vendor Statement  Reconcile to the accounts payable subledger, provide reliable evidence, have they been altered?  Concerned about the suppliers with high volume transactions, don’t want any understatement

(e)

Confirmation  Unlike receivables, we would send confirmations to vendors that show a low/zero balance at year-end but which could have a bigger balance. What does this mean?  Don’t stratify because are looking for unrecorded liabilities and only need to look for vendors with a low balance and we do a lot of business with  understatement

Example: A large invoice that should have been charged to Rent Expense (account 6040) was unintentionally charged to Repairs and Maintenance Expense (account 6045). (a) (b) (c)

(d)

Class of Transactions? Acquisitions Assertion? Classification Suggest an internal control that would be effective at PREVENTING or DETECTING AND CORRECTING this type of problem.  Preventing: adequate chart of accounts, supervisor approval  Detecting: comparing rent expense to budget, review that there are 12 expenses Suggest substantive audit procedures (SAP or TODB) that should have identified this.  SAP: comparison of actual rent expense to budget or prior year o Predictive tests, 12 months X monthly rent = expected balance  TODB: choose a sample from repairs and trace it to the invoice...