THE NATIONAL TEACHERS COLLEGE

QUIAPO, MANILA

SUBJECT: AUDITING PROBLEMS

INSTRUCTOR: MR. ERNESTO NOGOY JR.

Nature of the Expenditure Cycle

It involves the activities associated with the acquisition and payment of goods and services. The major
classes of transactions for a trading concern are acquisition, cash disbursement and payroll while in a
manufacturing firm production cycle transaction and inventory warehousing transaction are included in the
expenditure cycle in addition to that of in a trading concern.

Expenditure cycle affects financial statement accounts. It impacts all current assets, except marketable securities
and accounts receivable, all plant and intangible assets and many current liabilities.

Accounts affected by the expenditure cycle:

 Purchases
 Trade Accounts and note payable
 Purchase return and allowances
 Cash in bank (Credits for cash disbursements)
 Purchase discounts
 Inventories
 Manufacturing and operating expenses requiring payments

Documents used in the expenditure cycle:

 Purchase requisition
 Purchase order
 Receiving report
 Vendor’s invoice
 Debit memo
 Voucher
 Check
 Vendor’s statement

Accounting records involved in the expenditure cycle:

 Purchase journal
 Cash disbursement Journal
 Accounts payable subsidiary ledger

Expenditure Cycle Control Objectives:

 All transactions are authorized.

 All recorded transactions are valid.
  All valid, authorized transactions are recorded.
 All transactions are accurately recorded.
 Assets are safeguarded from loss or theft.

Materiality

Transactions in the expenditure cycle often affect more financial statement accounts than other cycles
combined. The auditor often seeks a low level of risk of material misstatements in the financial statements due
to expenditure cycle transactions. The allocation of materiality to accounts affected by this cycle will vary
according to the likelihood of misstatements in the account and the probable cost of verifying the account. For
example, misstatements are more likely to exist in inventories than plant assets, and it usually costs more to audit
inventories than plant assets.

Inherent and Control Risks

The auditor must remember inherent limitations of internal control, including the possibility of management
override, collusion, errors due to fatigue or misunderstandings, and failure to adapt the control structure to
changed conditions (e.g., rapid growth).

Audit Strategy

Use of either the lower assessed level of control risk approach or primarily substantive approach, or a
combination of the two, may be appropriate for auditing the expenditure cycle. For example, the lower assessed
level of control risk approach is more efficient for a situation involving a high volume of transactions.

Various Common Documents and Records

Purchase requisition– written request by an employee to the purchasing department

Receiving report– a report prepared on the receipts of goods showing the kinds and quantities of goods received
from vendors

Voucher– a form indicating the vendor, amount due, and payment date for purchases received. Usually
considered an authorization for recording and paying a liability.

Purchases transactions files– computer file containing data for approved vouchers for purchases that have been
received. Used to update the A/P, inventory, and general ledger master file.

Functions

The following functions should be assigned to different individuals or departments:

1 Requisitioning goods and services - Capital expenditures and lease contracts require specific approvals.
Purchase requisition forms should be signed by a supervisor who has budgetary responsibility for the expenditure
category. This represents the start of the transaction trail in support of the existence or occurrence assertion for
purchase transactions.

2 Preparing purchase orders - Purchase orders should be prenumbered and signed by an authorized purchasing
agent. Copies are distributed internally to the receiving department, the vouchers payable department, and the
originating department. Quantity ordered is wiped out on the receiving department copy.

3 Receiving the goods A prenumbered receiving report should be prepared for each order received. The receiving
report supports the existence or occurrence assertion for purchase transactions.
4 Storing goods received for inventory - Obtaining initials on a copy of the receiving report provides evidence
for the existence or occurrence assertion.

5 Preparing the payment voucher - The controls over this function and the assertions to which they relate include:
establishing the agreement of the details of vendors’ invoices with receiving reports and purchase orders and
determining the mathematical accuracy of vendors’ invoices. Copies of contracts may be required when the
voucher relates to leased assets or long-term suppliers of services or goods. In a computerized system,
programmed edit checks are made for valid vendor numbers and reasonableness of amounts.

6 Recording the liability - In computerized systems, the purchases transactions file is used to update the A/P,
inventory, and G/L master files. In any type of system, an accounting supervisor should check the timeliness of
recording by comparing the dates of voucher register entries with dates on the copies of the vouchers.

Computer-Assisted Tests of Controls

Tests of effectiveness must be done for any controls that lead to a control risk assessment below the
maximum. For general controls over changes to programs and master files, the auditor makes inquiries and
inspects documentation. Application controls tests involve the use of test data to find out whether results
produced by the client’s program for unpaid vouchers are as expected. Generalized audit software may be used
to perform sequence checks and print list of purchase orders, receiving reports, or vouchers with missing
numbers.

Control Activities–Cash Disbursement Transactions

Common Documents and Records

Cash disbursements transaction file–information on payments by check to vendors and others. Used for
posting to the A/P and general ledger master files. There are two cash disbursement functions:

1. Paying the liability

In a computerized system, the vouchers payable department submits batches of vouchers due for
payment to EDP or enters the data on vouchers via terminals. Checks and a check summary are produced.
Payment data are entered into a cash disbursements transaction file. Checks should be physically matched with
supporting vouchers. Various controls over the preparation and signing of checks and related audit objectives
include:

–Independent checks of the agreement of the total of the issued checks with a batch total of the vouchers
processed for payment.

–Authorized check signers should ascertain that each check is accompanied by a properly approved unpaid
voucher and that the name of the payee and check amount agree with the voucher.

–The check signer should control the mailing of the checks.

–Prenumbered checks should be used.

–A voucher and supporting documents should be stamped or canceled to avoid double payments.

2. Recording Cash Disbursements

The cash disbursements file created when checks are prepared is used to update the accounts payable
master file and general ledger accounts in computerized systems.
Audit of Acquisition
1. Evaluation of Internal Control over acquisition
 Segregation of duties--purchases and disbursements
 Approval of purchase orders
 Numerical control of purchase orders and receiving reports
 Matching of details of vendors’ invoices to purchase orders and receiving documents
 Approval of vendors’ invoices
 Pre-numbered checks
 Reconciliation of details of individual disbursements to controlling accounts
 Reconciliation of vendors’ statements to accounts
 Reconciliation of bank accounts
 Use of budgets and analysis of variances
 Use of chart of accounts and review of account coding

For the purchase flowchart.

2. Test of Controls: Acquisition

The following presents the controls that an entity should have to ensure the propriety of each assertion and
the test an auditor may perform to determine the effectiveness of the controls of the acquisition transactions.
a. Existence. Recorded acquisitions are for items that were acquired.
b. Completeness. Acquisitions that occurred are recorded.
c. Rights and obligations. Recorded acquisitions are the entity’s purchases and liabilities.
d. Valuation or Allocation. Acquisitions are recorded for the proper amount
e. Presentation and disclosure. Acquisition are recorded to result in the presentation and disclosure in
accordance with PAS/PFRS

3. Audit program for test of controls: Acquisitions Transactions

4. Substantive Test of Transactions: Acquisition

Discussion of Audit Procedures

a. Examine the underlying documents for authenticity and reasonableness. Scan voucher register for large or
unusual items. Inspect acquired property, plant and equipment. Trace inventory purchased to perpetual
records. Scan voucher register for duplicate payments.
b. Trace a sequence of receiving reports to entries in the voucher register. Test cut off. Account for a sequence
of entries in the voucher register.
c. Trace form invoice to perpetual inventory records. Examine vendor’s invoices to determine that goods were
purchased.
d. Recompute invoices and compare invoice price to purchase order.
e. Check accuracy of accounts an invoice by reference to chart of accounts.

Audit of Cash Disbursements

For cash disbursement processing.

1. Internal Control for Cash Disbursements transactions

Using a questionnaire, an entity can evaluate the internal control over the cash disbursement transaction. The
auditor is concerned with a misstatement caused by a cash disbursement being recorded in the client’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, and monthly
bank reconciliations.

2. Test of control: Cash Disbursements Transactions

a. Existence. Recorded acquisitions are for items that were acquired.

b. Completeness. Acquisitions that occurred are recorded.
c. Rights and obligations. Recorded acquisitions are the entity’s purchases and liabilities.
d. Valuation or Allocation. Acquisitions are recorded for the proper amount
e. Presentation and disclosure. Acquisition are recorded to result in the presentation and disclosure in
accordance with PAS/PFRS

3. Audit Program for test of controls

Typical audit procedures employed by the auditor in testing disbursement for the period under consideration
include the following:

a. Prove the arithmetical accuracy of the cash disbursements record and trace postings to the general ledger
b. Compare paid bank checks with the cash disbursements
c. Account for all checks.
d. Reconcile recorded disbursements with the bank statement.
e. Examine supporting documents.
f. Review cash disbursement records for unusual items.

4. Substantive tests of transactions: Cash Disbursements

Discussion of audit procedures

1. Examining documents underlying cash disbursements.

2. Reconciling cash disbursements per books to cash disbursements per bank
3. Preparing or testing reconciliation

Additional Notes for Test of Details of Transactions and Balances- A/P.

Tests of Details of Transactions
We consider four substantive tests of A/P transactions. The extent of use of each test varies based on
acceptable levels of detection risk. The four tests are:

1. Vouch Recorded Payables to Supporting Documentation

In this test, credit entries to A/P are vouched to supporting documents in the client’s files such as
vouchers, vendor invoices, and purchase orders. Debits are vouched to documentation of cash disbursements
transactions, such as paid checks.
2. Perform Purchases Cutoff Test
This test involves ascertaining that purchases transactions occurring near the balance sheet date are
recorded in the proper period. This is accomplished by tracing dated receiving reports to voucher register entries
and vouching recorded entries to supporting documentation. The test usually covers a period of 5 to 10 business
days before and after the balance sheet date. The E or O and completeness assertions are the ones addressed
by this test.

Do not forget to accord due consideration to goods in transit at the balance sheet date. Goods shipped
FOB shipping point must be included in the inventory and A/P of the buyer. Goods shipped FOB destination
point should remain in the inventory of the seller and be left out of the buyer’s inventory and A/P (until receipt
by the buyer).

3. Perform Cash Disbursements Test

Evidence for the cash disbursements cutoff test may be obtained by personal observation and review of
internal documentation. Tracing of the evidence for the last checks written to the accounting records is necessary.
The auditor should also trace canceled checks dated within a period of several days before and after the balance
sheet date to the dates the checks were recorded.

4. Perform Search for Unrecorded Payables

A review of subsequent payments consists of examining the documentation for checks issued or vouchers
paid after the balance sheet date. If evidence purports to show payment for an obligation that existed at the
balance sheet date, it should be traced to the A/P listing to ascertain whether it was included. This is an important
test for finding out whether payables have been understated or left out.

Other auditing procedures that may indicate unrecorded payables include: (1) checking unmatched
purchase orders; (2) inquiring of accounting and purchasing personnel about unrecorded A/P; and (3) reviewing
capital budgets, work orders, and construction contracts.

Tests of Details of Balances

1. Confirm A/P
Confirmation of A/P is optional because a confirmation offers no assurance that unrecorded payables will
be uncovered and external evidence such as invoices and vendor monthly statements should be available to
substantiate the balances. Confirmation of A/P is recommended when detection risk is low or a firm is having
trouble in meeting its obligations. The positive form of confirmation should be used if this test is used. The test
provides evidence for all A/P assertions.

2. Reconcile Unconfirmed Payables to Vendor Statements

In many cases, vendors provide monthly statements that are available in client files. In such cases,
amounts owed to vendors per the client’s listing of payables can be reconciled to those statements.