Chapter 4

Audit of the Acquisition and Payment

Cycle
 Learning Objectives
4.1 Identify the accounts and the classes of transactions in the cycle
4.2 Describe the business functions and the related documents and
records
4.3 Understand internal control, and design and perform tests of controls
and substantive tests of transactions for the cycle
4.4 Describe the methodology for designing tests of details of balances
and analytical procedures for accounts payable
4.5 Design and perform tests of details of balances for accounts payable,
including tests for unrecorded accounts payables and other liabilities
4.6 Distinguish the reliability of vendors’ invoices, vendors’ statements,
and confirmations of accounts payable as audit evidence
4.7 Recognize the many accounts in the acquisition and payment cycle
4.8 Design and perform audit tests of property, plant, and equipment and
related accounts
4.9 Design and perform audit tests of prepaid expenses, accrued
liabilities, and income and expense accounts
 4.1 Overview of the Cycle
• The acquisition and payment cycle begins with:
– the initiation of a purchase requisition by an authorized employee
who needs the goods or services, and
– it ends with payment on accounts payable.
• The acquisition of goods and services includes the acquisition of such
things as:
– raw materials, equipment, supplies, utilities, repairs and
maintenance, and research and development.
• Accounts and Classes of Transactions in the Acquisition and
Payment Cycle
• There are three classes of transactions included in the cycle:
– Acquisitions of goods and services
– Cash disbursements
– Purchase returns and allowances and purchase discounts
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 ..4.1 Overview of the Cycle

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 ..4.1 Overview of the Cycle
Objective of the audit of the acquisition and
payment cycle
– The objective in the audit of the acquisition and
payment cycle is to evaluate whether the accounts
affected by the acquisitions of goods and services and
the cash disbursements for those acquisitions are fairly
presented in accordance with accounting standards.
– Because transactions in this cycle affect many
accounts in both the balance sheet and the income
statement, errors such as incorrect classification may
significantly affect the fairness of financial statements
– Knowing the nature of account in this cycle is helpful

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…4.1 Overview of the Cycle
Accounts in the Acquisition and Payment Cycle
…4.1 Overview of the Cycle
Classes of Transactions, Accounts, Business Functions, and Related
Documents and Records for the Acquisition and Payment Cycle
…4.1 Overview of the Cycle
..Business Functions in the Cycle and Related Documents and
Records

• There are four business functions in the acquisition

and payment cycle:
– Processing purchase orders
– Receiving goods and services
– Recognizing the liability
– Processing and recording cash disbursements
 …4.1 Overview of the Cycle
..Business Functions in the Cycle and Related Documents and
Records
…There are four business functions
(1) Processing purchase orders
Purchase requisition is the first step in a company's purchasing
process. A purchase requisition is a request from an employee or
department to buy goods or services. After internal review and
approval, it is used to create a purchase order that is sent to a
supplier
– The request can be made by the store supervisor, or user
departments (production etc)
– Reorder points are usually seen to fill the requisition form

Purchase order (PO): is a legal document used to order goods and

services from vendors.
– It2023
Audit II YA AAUSC contains details of the goods/services ordered
– It can be prepared electronically
 …4.1 Overview of the Cycle
Business Functions in the Cycle and Related Documents and
Records

…There are four business functions

(2) Receiving goods and services
– It is a critical function in the cycle since most companies recognize
the acquisition and related liability on their records at this point.
– Adequate control is needed at the time of receiving goods to ensure
that goods received are the same to the ordered one
– A receiving report is prepared as an evidence. It can be in a paper
or electronic format, and must be prepared at the time goods are
received
– A receiving report shows relevant details of goods

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 …4.1 Overview of the Cycle
Business Functions in the Cycle and Related Documents and
Records

…There are four business functions

(3) Recognizing the liability
 Proper recognition of the liability for the receipt of goods and
services requires immediate and accurate recording.
The following documents are commonly used in connection to
processing & recording liability:
– Vendor’s Invoice, Goods Receiving Note (GRN)
– Debit Memo,
– Voucher,
– Acquisitions Transaction File,
– Acquisitions Journal or Listing,
– Accounts Payable Master File,
– Accounts Payable Trial Balance,
– Vendor’s Statement
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 …4.1 Overview of the Cycle
Business Functions in the Cycle and Related Documents and
Records
…There are four business functions
(4) Processing and recording cash disbursements
The following documents are used in connection to processing and
recording cash disbursements:
– Check,
– Cash Disbursements Transaction File,
– Cash Disbursements Journal or Listing

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 4.2 Key Internal Controls
• An effective system of internal control for purchases
will aim to ensure the following ('control objectives'):
– Goods are ordered only as and when needed
– They are ordered at competitive prices, in the required quantities
and are of the required quality
– They are ordered from authorized suppliers
– Goods are received as expected (correct time, type, quantity and
condition)
– They are booked into inventory
– Invoices are checked to goods received notes and orders
– Invoices are entered properly into the payables ledger
– Payments are made properly to suppliers.

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 …4.2 Key Internal Controls
•

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 …4.2 Key Internal Controls
•

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 .4.2 Key Internal Controls
Key controls in the acquisition and payment cycle:
1. Authorization of purchases
2.Separation of the custody of the received goods from other
functions,
3. Timely recording and independent review of transactions, and
4. Authorization of payments to vendors.
1. Authorization of purchases
• Proper authorization for acquisitions is needed to ensures that:
– Goods and services acquired are for authorized company
purposes, and
– To avoid the acquisition of excessive or unnecessary items.

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 .4.2 Key Internal Controls
• For effective internal control, the purchasing department should be
separate from those who authorize the acquisition or receive the
goods.
• All purchase orders should be pre-numbered

2.Separation of the custody of the received goods from other

functions
• To prevent theft and misuse, the goods should be physically controlled
from the time of their receipt until their use or disposal.
• The personnel in the receiving department should be independent of the
storeroom personnel and the accounting department.
• Finally, the accounting records should transfer responsibility for the
goods each time they are moved,
– from receiving to storage,
– from storage to manufacturing, etc.
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 .4.2 Key Internal Controls
3. Timely recording and independent review of transactions
 Some companies, record liability for acquisitions on the basis of the
receipt of goods and services. There are also companies that defer
(delay) the recording of liability until the vendor’s invoice is received
 It is the responsibility of the accounts payable department:
– to record the liability after checking relevant documents such as
purchase orders, receiving reports and invoices
 Independent review of the recording of liability will reduce the risk of
misstatement
• Separation of duty is also necessary in the accounts payable
department (personnel who record acquisitions do not have access to
cash, marketable securities, and other assets)

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 .4.2 Key Internal Controls
4. Authorization of payments to vendors.
• The most important controls over cash disbursements include:
– The signing of checks by authorized person
– Separation of responsibilities for signing checks and
performing the accounts payable function
– Careful examination of supporting documents by the check
signer at the time the check is signed
– Checks should be pre-numbered
– Physical control is necessary for blank, voided, and signed
checks
– There should be a method of canceling supporting
documents to prevent their reuse as support for another
check at a later time (stamping “paid by check No…….” on
it)..
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 4.3 Tests of Controls & Substantive Tests of
Methodology for Designing Controls and Substantive Tests of
Transactions
Transactions for Acquisition and Payment cycle
Transactions
Knowledge of the nature of the cycle is important to design the methodology.
How the audit in this cycle differ from other cycle? Where is the focus
area?
– Tests of details of balance take too much time for Accounts receivable,
inventory, fixed assets, accounts payable, and expense accounts
– Except AR, the remaining four accounts are part of the audit of
acquisition and payment transactions
What is the implication of this fact to the audit procedure?
– It implies the need to save/minimize time spent for tests of details of
balance by performing extensive tests of controls and substantive
tests of transactions in the payment and acquisition cycle.
 Tests of controls and substantive tests of transactions receive
considerable attention in this cycle
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..4.3 Tests of Controls & Substantive Tests of
Transactions
..Methodology for Designing Controls and Substantive Tests of
Transactions for Acquisition and Payment cycle
– Understand internal control
– Assess planned control risk
– Determine extent of tests of controls
– Design tests of controls and substantive tests of
transactions for acquisitions
– Design tests of controls and substantive tests of
transactions for cash disbursements
– Sampling for tests of controls and substantive tests of
transactions
..4.3 Tests of Controls & Substantive Tests of Transactions
..Methodology for Designing Controls and Substantive Tests of
Transactions for Acquisition and Payment cycle
..4.3 Tests of Controls & Substantive Tests of Transactions
..Methodology for Designing Controls and Substantive Tests of
Transactions for Acquisition and Payment cycle
1.Understand internal control for acquisitions & cash disbursement
– Auditors obtain understanding of internal control for this cycle by
looking at the flowchart, preparing internal control
questionnaires and by performing walkthrough
2.Assess planned control risk for Acquisitions & cash disbursement
– Assessment of control risk requires examining key controls in the
cycle (Note: key controls are mentioned under topic 4.2).
3. Determine Extent of Testing of Controls
– After auditors identify the key controls and deficiencies, they assesses
control risk
– If assessment shows controls are effective, they will decide whether
to perform more tests of control to reduce substantive tests.
4.Designing Tests of Controls and Substantive Tests of Transactions for
acquisitions & cash disbursements to meet transaction related audit (using
four columns: as in the other cycle)
Links Ch4 Methodology for designing Tests of control and substantive t
ests of transactions.docx
 ..4.3 Tests of Controls & Substantive Tests of Transactions
..Methodology for Designing Controls and Substantive Tests of
Transactions for Acquisition and Payment cycle
• Four transaction related objectives deserve considerable attention in
this cycle: Occurrence, Completeness, Accuracy, and Classification
1. Occurrence -Recorded Acquisitions are for Goods and Services
Received, Consistent with the Best Interests of the Client.
• Audit procedure:
– Auditors will check if there are controls for improper transactions
– Indicators of weak control for improper transaction:
 Unintentional recording of transactions not occurred (duplicate
transactions)
 Acquisition of unauthorized personal items by employees
 Fraudulent expense that benefit individuals is recorded as business
expense
 Fraudulent asset that benefit individuals is recorded as business
asset
– If controls are not adequate to prevent the recording of such transactions,
auditors
Audit II YA AAUSC 2023 will perform more extensive examination of supporting
documentation
 ..4.3 Tests of Controls & Substantive Tests of Transactions
..Methodology for Designing Controls and Substantive Tests of
Transactions for Acquisition and Payment cycle
2. Existing Acquisitions Are Recorded
Completeness: Completeness is another important objective for
acquisition and payment cycle since failure to record the acquisition of
goods and services received understates accounts payable and may
result in an overstatement of net income and owners’ equity.
Audit procedure:
• Performing tests of details of balances to determine whether
unrecorded transactions exist is difficult
• For this reason, auditors rely on tests of controls and substantive tests
of transactions

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 ..4.3 Tests of Controls & Substantive Tests of Transactions
..Methodology for Designing Controls and Substantive Tests of
Transactions for Acquisition and Payment cycle
3. Accuracy -Acquisitions are Accurately Recorded
• If acquisitions are not accurately recorded, financial statement will be
misstated
• Tests performed for accuracy objective will reduce the time spent for
tests of details
Audit procedure:
• The auditor should evaluate whether control systems for accuracy are
adequate/not
• If the auditor believes that acquisitions are recorded accurately, it is
acceptable to check few documents during the test of details of
balances
• If perpetual records are maintained correctly, the auditors tests of
Audit II details of inventory can reduce
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 ..4.3 Tests of Controls & Substantive Tests of Transactions
..Methodology for Designing Controls and Substantive Tests of
Transactions for Acquisition and Payment cycle
4. Classification- Acquisitions are Correctly Classified
– If acquisition are not properly classified (eg. If fixed assets are
recorded as expense or vise versa), the financial statement will be
misstated.
Audit procedure
• the auditor should check the whether internal controls are adequate to
provide reasonable assurance of correct classification in the
acquisitions journal.
• The two areas most affected by improper classification are current
period acquisitions of fixed assets, and expense accounts, such as
repairs and maintenance, utilities, and advertising.

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 ..4.3 Tests of Controls & Substantive Tests of Transactions
..Methodology for Designing Controls and Substantive Tests of
Transactions for Acquisition and Payment cycle
• Design Tests of Controls and Substantive Tests of Transactions
for Cash Disbursements
– Normally, tests for acquisitions and cash disbursements are performed at
the same time

Attributes Sampling for Tests of Controls and Substantive Tests of Transactions

• Because of the importance of tests of controls and substantive tests of
transactions for acquisitions and cash disbursements, the use of attributes
sampling is common.

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 ..4.3 Tests of Controls & Substantive Tests of Transactions
..Methodology for Designing Controls and Substantive Tests of
Transactions for Acquisition and Payment cycle
…..Design Tests of Controls and Substantive Tests of Transactions for Cash
Disbursements
Unique features of this cycle
1. It involves larger number of accounts including both income statement
and balance sheet accounts. This makes classification misstatement
to be high, some of which are likely to affect income (eg.
misclassification between repair and maintenance expenses and fixed
assets.
• This makes auditors to reduce the tolerable exception rate, especially
for the classification attribute.
2. It is more common in this cycle for transactions to require significant
judgment, such as for leases and construction costs.
More judgment usually affects accuracy; as a result, auditors often
reduce the tolerable exception rate for the accuracy attribute.
3. The dollar amounts of individual transactions in the cycle cover a wide
range. As a result, large and unusual items segregated and tested
Audit II on a 100
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 4.4 Tests of Details of Balances of Accounts payable
Methodology for Designing Tests of Details of Balances for Accounts
Payable
• Accounts payable account is a critical account in the audit of the
acquisition and payment cycle since all acquisition and payment cycle
transactions flow through it
• Accounts payable should be distinguished from accrued liabilities and
interest bearing obligations.
• A liability is an account payable only if:
– the total amount of the obligation is known and owed at the balance
sheet date.
• If the obligation includes the payment of interest, it should be recorded
as a note payable, contract payable, mortgage payable, or bond
payable.
• Accounts payable tend to be material for most companies, and auditors
almost always perform some tests of details of balances
• As in other cycles, the methodology for designing tests of details
Audit II YA AAUSC 2023

of balances for accounts payable involves three phases

4.4 Tests of Details of Balances of Accounts payable
..Methodology for Designing Tests of Details of Balances for Accounts
Payable
 ..4.4 Tests of Details of Balances of Accounts payable

…The methodology for designing tests of details for accounts payable

include:
Phase I-1Identify significant risks and assess the risk of material
misstatement for accounts payable
– New systems designed and implemented with the intention of improving
efficiency, organizations (eg, e-commerece, just in time inventory system
and so forth) may have their own risk of misstating accounts payable
balances.
– Thus auditors are required to understand how such systems affect the
balance shown as accounts payable.

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 ..4.4 Tests of Details of Balances of Accounts payable

...The methodology for designing tests of details for accounts payable

include:
• Phase I-2 Set tolerable misstatement and assess inherent risk for
Accounts Payable accounts
– Like accounts receivable, a large number of transactions can affect
accounts payable.
– Accounts payable balance is usually large and made up of a large
number of vendor balances and it is relatively expensive to audit the
account.
– For these reasons, auditors typically set high tolerable misstatement for
accounts payable and assess inherent risk as medium or high.
– Completeness and cutoff balance-related audit objectives are the focus
areas of auditors because of the potential for understatements in the
account balance.

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 ..4.4 Tests of Details of Balances of Accounts payable
...The methodology for designing tests of details for accounts payable
include:
Phase I-3 : Assess control risk for the Acquisition and Payment cycle
After auditors set tolerable misstatement and inherent risk for accounts
payable, they assess control risk based on an understanding of internal
control.
Phase II: Design and perform tests of controls and substantive tests of
transactions for the Acquisition and Payment cycle.
– The auditor’s ultimate substantive tests depend on the relative
effectiveness of internal controls related to accounts payable.
– A usual, a four column table is used to summarize key internal controls,
common tests of controls, and common substantive tests of transactions
for each transaction-related audit objective.

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 ..4.4 Tests of Details of Balances of Accounts payable
...The methodology for designing tests of details for accounts payable
include:
• Phase III-1:Substantive Analytical Procedures for the Acquisition and
Payment Cycle
• Like in other cycles, the use of analytical procedure in this cycle is helpful:
– to uncover misstatements in A/Payable and
– to identify areas that require additional investigation.
• Eg. comparing current expenses such as rent, utilities, and other regularly
scheduled bills with prior years is an effective procedure for analyzing
accounts payable when expenses from year to year are expected to be
relatively stable.

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 …4.4 Tests of Details of Balances of Accounts payable
...The methodology for designing tests of details for accounts payable include:
Phase III-1:Substantive Analytical Procedures for the Acquisition and
Payment Cycle

Substantive Analytical Procedure Possible Misstatement

Compare acquisition-related expense Misstatement of accounts payable and

account balances with prior years. expenses.

Review list of accounts payable for unusual, Classification misstatement for nontrade
non vendor, and interest-bearing liabilities.
payables.

Compare individual accounts payable with Unrecorded or nonexistent accounts, or

previous years. misstatements.

Calculate ratios, such as purchases divided Unrecorded or nonexistent accounts, or

by accounts payable, and accounts misstatements.
payable divided by current liabilities.

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 ..4.4 Tests of Details of Balances of Accounts payable
...The methodology for designing tests of details for accounts payable
include:
Phase III-2 Design and Perform Tests of Details of Accounts Payable
Balance
• The overall objective in the audit of accounts payable is to determine
whether the accounts payable balance is fairly stated and properly
disclosed
• Seven balance related objectives are applied in tests of details of
A/Payable balance: Existence, completeness, accuracy, classification,
cutoff, detail tie-in, and rights and obligations.
• Realizable value is not applicable to liabilities; it applies only to assets.
• The rights aspect of the rights and obligations objective is not applicable
for liabilities. For liabilities, the auditor is concerned with the client’s
obligations for the payment of the liability. If the client has no obligation to
pay a liability, it should not be included as a liability.
• There is also a difference in emphasis in audit of assets and liabilities
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 ..4.4 Tests of Details of Balances of Accounts payable

...The methodology for designing tests of details for accounts payable include:
…Phase III-2 Design and Perform Tests of Details of Accounts Payable
Balance

• Difference in emphasis in the audit of liabilities and assets:

– When auditors verify assets, they emphasize overstatements and verify by
confirmation, physical examination, and examination of supporting
documents.
– However, in verifying liability balances, the main focus is on understated or
omitted liabilities.
– The difference in emphasis in auditing assets and liabilities results directly
from the legal liability of CPAs.
– If external users such as investors and creditors, found that earnings and
owners’ equity on audited financial statements were materially overstated, a
lawsuit against the CPA firm fairly likely.
– Remember overstatement of asset and understatement of liability are major
causes for overstatement of earnings and owners’ equity
– However,
Audit II YA AAUSC 2023 this doesn’t mean that understatements in assets and
overstatements in liability are ignored
 ..4.4 Tests of Details of Balances of Accounts payable
... ...The methodology for designing tests of details for accounts payable include:
…Phase III-2 Design and Perform Tests of Details of Accounts Payable
Balance

• Because of the emphasis on understatements in liability accounts, search for

unrecorded accounts payable (out-of-period liability) tests are important
• The following are typical audit procedures:
(1) Examine underlying documentation for subsequent cash
disbursements
 Payments after the balance sheet date are examined to check if they
belongs to the period under audit (auditors check supporting
documents such as vendor invoices)
(2) Examine underlying documentation for invoices not paid several weeks
after the year-end
 Bills not paid on time (several weeks after the year end) are also
examined (this test is also performed to check whether the liability
belongs to the period under audit)
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 ..4.4 Tests of Details of Balances of Accounts payable

... ...The methodology for designing tests of details for accounts payable
include:
…Phase III-2 Design and Perform Tests of Details of Accounts Payable
Balance
• …typical audit procedures:
– (3) Trace receiving reports issued before year-end to related vendors’
invoices
 All merchandise received before the year-end of the accounting
period should be included as accounts payable. Tracing receiving
reports to vendor invoices will help the auditor to identify unrecorded
obligations
– (4) Comparison of balances with Vendors’ Statements with the
Accounts Payable Trial Balance
 Comparing vendors’ statements, with A/payable trial balance helps
to make sure whether the balance is included as an A/payable or not

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 ..4.4 Tests of Details of Balances of Accounts payable

... ...The methodology for designing tests of details for accounts payable
include:
…Phase III-2 Design and Perform Tests of Details of Accounts Payable
Balance
• …typical audit procedures:
– (5) Send confirmations to vendors with which the client does business
 The use of confirmations for Accounts Payable is less common as
compared to Accounts Receivable
 However, it is used occasionally to test for vendors omitted from the
accounts payable list, omitted transactions, and misstated account
balances.
 A confirmation commonly called a zero balance confirmation, in
which confirmation is send to active vendors for which a balance
has not been included in the A/ payable list, is considered as a
useful means of searching for omitted amounts.

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 ..4.4 Tests of Details of Balances of Accounts payable

... ...The methodology for designing tests of details for accounts payable
include:
…Phase III-2 Design and Perform Tests of Details of Accounts Payable
Balance
• …typical audit procedures:
– (6) Cut-off tests
– These tests are done to determine whether transactions recorded a few
days before and after the balance sheet date are included in the correct
period.
Two aspects of cut-off that require attention:
1. Relating cutoff to physical observation of inventory and
2. The determination of the amount of inventory in transit.

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 ..4.4 Tests of Details of Balances of Accounts payable

... ...The methodology for designing tests of details for accounts payable
include:
…Phase III-2 Design and Perform Tests of Details of Accounts Payable
Balance
• …typical audit procedures:
– …(6) Cut-off tests

6.1. Relating cutoff to physical observation of inventory and

– Check if all inventories are counted,
– Record and document the last receiving report number of
inventory included in the physical count.
– Test the accounting records for cutoff (usually done subsequent
to the physical count date)
– Trace the previously documented receiving report numbers to
the accounts payable records to verify that they are correctly
included or excluded.
Eg if the last receiving report is 550, numbers beyond this number
should be included in the accounts payable of the next period
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 ..4.4 Tests of Details of Balances of Accounts payable
... ...The methodology for designing tests of details for accounts payable
include:
…Phase III-2 Design and Perform Tests of Details of Accounts Payable
Balance
• …typical audit procedures:
– …(6) Cut-off tests

6.2 The determination of the amount of inventory in transit.

For goods in transit, terms of shipment is considered.
– For goods on transit on FOB destination point, since title passes up on
receipt of goods (eg. after year end/in new period)
 Purchase and A/payable are not recorded,
 Items are not included in inventory
– For goods on transit on FOB origin (shipping point), if shipment occurs
on or before balance sheet date, title passes at shipping point
 Record the purchase and A/payable and
 Include the item on inventory
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… ..4.4 Tests of Details of Balances of Accounts
payable
Reliability of Evidence
• Auditors need to understand the relative reliability of
the three primary types of evidence ordinarily used
for verifying accounts payable:
– Vendors’ invoices
– Vendors’ statements
– Confirmations
• Auditors should distinguish:
– Between vendors’ invoices and vendors’ statements in
verifying the amount due to a vendor
– Between a vendor’s statement and a confirmation of
accounts payable in verifying account balances. The
primary difference is the source of the information.
 … ..4.4 Tests of Details of Balances of Accounts
payable
…Reliability of Evidence
• Comparison between:
– Vendors’ invoices and vendors’ statements
 Vendor invoice- more informative to verify individual
transaction
 Vendor statement- more reliable to verify A/P ending balance
since it shows the ending balance
– Vendor’s statement and a confirmation of accounts payable
 Both came from independent source (the vendor), and also
provide the same information
 But A/payable confirmation is sent directly to the auditor by the
vendor. This makes it more reliable than vendor statement.
(The client can’t alter it)

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 … ..4.4 Tests of Details of Balances of Accounts payable
…Reliability of Evidence
• Vendor confirmation is not common due to the availability of invoices and
vendor statement (since both are evidences from independent source)
Vendor confirmations are sent:
– When the client’s internal controls are deficient,
– When statements are not available,
– When the auditor questions the client’s integrity,
• Because of the emphasis on understatements of liability accounts, the
accounts confirmed should include large, active, zero balance accounts
and a representative sample of all others.
Time to send confirmation
– Normally confirmation is sent short after the balance sheet date
– If assessed control risk is low, it is possible to send on interim period
as a test of effectiveness of internal control.
– If confirmation shows, internal control is ineffective, other methods are
Audit II YA AAUSC 2023
designed to test accounts payable balance
 … ..4.4 Tests of Details of Balances of Accounts payable
…Reliability of Evidence
• .. Vendor confirmation

Causes of difference between Vendor statement / confirmations and

client’s record
– Inventory in transit,
– Checks mailed by the client but not received by the vendor at the
statement date, and
– Delays in processing accounting records.
• Documents needed for reconciliation include:
– Receiving reports, vendors’ invoices, and cancelled checks

Sample size: Sample sizes for accounts payable tests vary considerably,
depending on such factors as:
 The materiality of accounts payable,
 the number of accounts outstanding,
 2023
Audit II YA AAUSC assessed control risk, and the
 results of the prior year.
 Types of Other Accounts in the Acquisition and
Payment Cycle
• There are many accounts associated with the
acquisition and payment cycle which include:
– Property, plant, and equipment
– Prepaid expenses
– Other liabilities
– Income and expense accounts

Audit II YA AAUSC 2023

 Accounts Typically Associated with Acquisition and
Payment Cycle Transactions

Assets Expenses Liabilities

Cash Cost of goods sold Accounts payable

Inventory Rent expense Rent payable

Supplies Property taxes Accrued professional fees

Property, plant, and equipment Income tax expense Accrued property taxes

Patents, trademarks, and copyrights Insurance expense Other accrued expenses

Prepaid rent Professional fees Income taxes payable

Retirement benefits Blank

Prepaid taxes

Prepaid insurance Utilities Blank

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 4.5 Tests of Details of Property, Plant and Equipment
Equipment and Related Accounts

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 …4.5 Tests of Details of Property, Plant and Equipment

Property, plant and equipment (PPE) are assets that have expected
lives of more than one year, are used in the business, and are not
acquired for resale
Classifications of Property, Plant, and Equipment
Accounts
Land and land improvements Autos and trucks

Buildings and building improvements Leasehold improvements

Equipment Construction-in-process for

Furniture, computers, and fixtures property, plant, and equipment

The Key assertions for PPE are:

Existence, Valuation, Completeness & Rights
Audit II YA AAUSC 2023
 …4.5 Tests of Details of Property, Plant and Equipment
Audit of Property, Plant, and Equipment(PPE)
• The primary accounting record for property, plant, and equipment
accounts is generally a fixed asset master file
• How the audit of PPE differs from the audit of current asset
accounts?
• There are three reasons for difference:
– There are usually fewer current period acquisitions
– The amount of any given acquisition is often material
– They are likely to be kept and maintained in the accounting
records for several years
• Because of these differences, the audit of PPE emphasizes the
verification of current period acquisitions rather than the balance in
the account carried forward from the preceding year.
• Depreciation expense and accumulated depreciation accounts are
Audit II YAalso
AAUSCverified
2023 as part of the audit of PPE
 …4.5 Tests of Details of Property, Plant and Equipment
Audit of Property, Plant, and Equipment(PPE)
• Sources of evidence
 Non Current asset register
 Purchase invoice (additions)
 Sales invoice/disposal forms
 Bank statement & cash book
 Physical count of assets
 Ownership documents including title deeds & registration documents
 Depreciation policy and rates
 Capital expenditure budgets/asset replacement plan
• PPE items must exist, be completely recorded, be valued appropriately, and
must be owned and controlled by the entity
• The auditor needs to obtain sufficient appropriate evidence over:
 Existing assets (assets purchased in previous period)
 Additions & disposals,
 Revaluations,
 Depreciations
 Related disclosures (Notes to PPE, dep. Policies, useful/economic lives,
revaluations.)
Audit II YA AAUSC 2023s
 …4.5 Tests of Details of Property, Plant and Equipment
..Audit of Property, Plant, and Equipment(PPE)
Audit tests:
• In the audit of PPE and related accounts, it is helpful to
separate the tests into the following categories:
– (1) Perform substantive analytical procedures
– (2) Verify current year acquisitions
– (3) Verify current year disposals
– (4) Verify the ending balance in the asset account
– (5) Verify depreciation expense
– (6) Verify the ending balance in accumulated depreciation
– (7) Verify the ending balance is properly classified and
disclosures are adequate
Audit II YA AAUSC 2023
 ..4.5 Tests of Details of Property, Plant and Equipment
1. Substantive Analytical Procedures for Equipment
Most of the analytical procedures assess the likelihood of material
misstatements in depreciation expense and accumulated depreciation

Substantive Analytical Procedure Possible Misstatement

Compare depreciation expense Misstatement in depreciation
divided by gross equipment cost expense and accumulated
with previous years. depreciation
Compare accumulated depreciation Misstatement in
divided by gross equipment cost accumulated depreciation.
with previous years.
Compare monthly or annual repairs Expensing amounts that should
and maintenance, supplies be capitalized.
expense, small tools expense, and
similar accounts with previous
years.
Compare gross manufacturing cost Idle equipment or equipment that
divided by some measure of was disposed of but not written
production with previous years. off.

Audit II YA AAUSC 2023

 …4.5 Tests of Details of Property, Plant and Equipment
..Audit of Property, Plant, and Equipment(PPE)
– ..Tests
– (2) Verify current year acquisitions
 Current year additions must be correctly recorded because the
assets have long-term effects on the FSs.
The following have effect of both B/sheet & income statement:
 Failure to capitalize a fixed asset, or
 the recording of an acquisition at the incorrect amount,
– Effect on b/sheet- until the company disposes of the asset
– Effect on income statement-until the asset is fully depreciated
• The focus of verifying current year acquisition includes:
– Existence, completeness, accuracy, classification, and rights
– Most common audit tests to verify current year additions:
 Examining vendors’ invoices
 Verifying Large and unusual transactions for the entire year as well
as a representative sample of typical additions
Audit II YA AAUSC 2023
 …4.5 Tests of Details of Property, Plant and Equipment
..Audit of Property, Plant, and Equipment(PPE)
– ..Tests
…(2) Verify current year acquisitions
• In testing acquisitions, the auditor must understand the following:
– Accounting standards about capitalization of costs,
– Recording of trade-ins of existing assets
– Client’s policy for capitalization and whether this policy is consistently
applied
– Classification errors such as expensing assets
Auditors frequently examine whether the client has a right to record
equipment as an asset (eg. is it under operating lease contract?).
They examine purchase or lease contracts to determine whether
capitalization of the equipment is appropriate

Audit II YA AAUSC 2023

 …4.5 Tests of Details of Property, Plant and Equipment
..Audit of Property, Plant, and Equipment(PPE)
– ..Tests
– (3) Verify current year disposals

• Transactions involving the disposal of PPE are often misstated when

company internal controls lack a formal method to inform the following to
management:
– about the sale, trade-in, abandonment, or theft of recorded machinery
and equipment.
– Failure to record disposals will overstate the cost of PPE
– (4) Verify the ending balance in the asset account
Ending balance in the PPE is audited to achieve two audit
objectives:
1. Existence: All recorded PPE physically exists on the balance
sheet date
2. Completeness: All PPE owned is recorded
Procedure:
– Examination of actual assets by taking samples of transactions.
Audit II YA–AAUSC
A complete
2023 physical inventory of fixed assets to make sure they all
exist, and the fixed asset records are complete (Rare case)
 …4.5 Tests of Details of Property, Plant and Equipment
..Audit of Property, Plant, and Equipment(PPE)
–..Tests
…..(4) Verify the ending balance in the asset account
– Classification: Auditors have to check that non operating assets are
not included in PPE as such assets have to be reported separately.
– Realizable value: It is also necessary to see that such assets are
written down to their realizable value
– Presentation and Disclosure: Auditors have to make sure that items
requiring disclosures such as leased property are disclosed
separately.
(5) Verify depreciation expense: accuracy is the most important balance-
related audit objective for depreciation expense.

Focus of the audit:

– Checking the use of consistent depreciation policy from period to period,
– Checking accuracy of calculations
– Checking whether depreciation methods are disclosed since it is required by
accounting standards

Procedures: (1) Test of reasonableness through analytical procedures (multiplying

Audit II YA AAUSC 2023
un-depreciated fixed assets by the depreciation rate for the year) is important to
audit depreciation expense (2) Re-computation depreciation expense
 …4.5 Tests of Details of Property, Plant and Equipment
..Audit of Property, Plant, and Equipment(PPE)
– ..Tests
– (6) Verify the ending balance in accumulated depreciation
• The audit of the ending balance in accumulated depreciation emphasizes
in the following two objectives:
1. Detail tie in: Accumulated depreciation stated in the property
master file agrees with the general ledger.
2. Accuracy: Accumulated depreciation in the master file is
accurate.
– (7) Verify the ending balance is properly classified and
disclosures are adequate
– Ending balance should be properly classified as PPE, Non
operating PPE, PPE under finance lease (Right of use
asset)
Audit II YA AAUSC 2023
 4.6 Tests of Details of Other accounts
Audit of Prepaid Expenses
Prepaid expenses, deferred charges, and intangibles are assets that
vary in life from several months to several years which include:
–Prepaid rent Prepaid taxes
–Patents Prepaid insurance
–Trademarks Deferred charges
–Copyrights Goodwill
• Audit procedures:
– Analytical procedures are often sufficient for prepaid expenses,
deferred charges, and intangibles
– Internal controls (eg for Prepaid insurance) are divided in to three
parts:
1. Controls over the acquisition and recording of insurance,
(focus on checking authorization)
2. Controls over the insurance register, (eg, are policies and
expiration dates clearly indicated?)
3.Controls over the charge-off of insurance (to ensure no
Audit II YA AAUSC 2023
overcharging/undercharging of expense).
 ..4.6 Tests of Details of Other accounts
..Audit of Prepaid Expenses

Balance-related audit objectives

– Existence and Completeness: Insurance policies in the prepaid
insurance schedule exist and existing policies are listed
– Rights: The client has rights to all insurance policies in the prepaid
insurance schedule
– Accuracy and Detail Tie-in: Prepaid amounts on the schedule are
accurate; and agrees with the general ledger
– Classification: The insurance expense related to prepaid insurance
is correctly classified
– Cutoff : Insurance transactions are recorded in the correct period
• Realization objective is not applicable

Audit II YA AAUSC 2023

 …4.6 Tests of Details of Other accounts
….Audit of Prepaid Expenses
• In the audit of prepaid insurance, the auditor obtains a
schedule from the client that lists for each policy in
force:
– Policy information, including policy number, amount of
coverage, and annual premium
– Beginning prepaid insurance balance
– Payment of policy premiums
– Amount charged to insurance expense
– Ending prepaid insurance balance

Audit II YA AAUSC 2023

 …4.6 Tests of Details of Other Accounts
….Audit of Prepaid Expenses
Prepaid Insurance and Related Accounts

Audit II YA AAUSC 2023

 …4.6 Tests of Details of Other Accounts
Audit of Accrued Liabilities
• A third major category of accounts in the acquisition and
payment cycle is accrued liabilities
• Accrued liabilities are the estimated unpaid obligations for
services or benefits that have been received before the
balance sheet date which include:
– Accrued payroll Accrued payroll taxes
– Accrued officers’ bonuses Accrued commissions
– Accrued professional fees Accrued rent
– Accrued interest
Depending on the nature of the account, the verification
of accrued liability may take few time or considerable
time (eg. Computation of interest payable, taxes
payable may involve complex calculation )
Audit II YA AAUSC 2023
 …4.6 Tests of Details of Other Accounts
…Audit of Accrued Liabilities

• A second type of accrual involves estimates where the

amount of the obligation due is uncertain
– Accrued warranty costs and accrued pension costs are
similar accruals
– The verification of accrued expenses varies depending
on the nature of the accrual and the circumstances of
the client

Audit II YA AAUSC 2023

 …4.6 Tests of Details of Other Accounts
…Audit of Accrued Liabilities
• When verifying accrued property taxes, the two most significant
balance-related audit objectives are:
– Completeness- Existing properties for which accrual of taxes is
appropriate are on the accrual schedule
– Accuracy- Accrued property taxes are accurately recorded and the
treatment is consistent from year to year

Audit II YA AAUSC 2023

 …4.6 Tests of Details of Other Accounts
Audit of Income and Expense Accounts
• Main consideration are:
– The matching of periodic income and expense is necessary for a
correct determination of operating results
– The consistent application of accounting principles for different
periods is necessary for comparability
• Approach to auditing income and expense accounts include:
– Substantive analytical procedures
– Tests of controls and substantive tests of transactions
– Tests of details of account balances

Audit II YA AAUSC 2023

 …4.6 Tests of Details of Other Accounts

Audit of Income and Expense Accounts

Substantive Analytical Procedures for Income and
Expense Accounts
Substantive Analytical Procedure Possible Misstatement
Compare individual expenses with Overstatement or understatement of a
previous years. balance in an expense account.

Compare individual asset and liability Overstatement or understatement of a

balances with previous years. balance sheet account that will also
affect an income statement account
(for example, a misstatement of
inventory affects cost of goods sold).

Compare individual expenses with Misstatement of expenses and related

budgets. balance sheet accounts.
Compare gross margin percentage with Misstatement of cost of goods sold and
previous
Audit II YA AAUSC 2023years. inventory.
 …4.6 Tests of Details of Other Accounts
Audit of Income and Expense Accounts
…Substantive Analytical Procedures for Income and
Expense Accounts
Substantive Analytical Procedure Possible Misstatement
Compare inventory turnover ratio with Misstatement of cost of goods sold and
previous years. inventory.

Compare prepaid insurance expense Misstatement of insurance expense

with previous years. and prepaid insurance.
Compare commission expense divided Misstatement of commission expense
by sales with previous years. and accrued commissions.

Compare individual manufacturing Misstatement of individual

expenses divided by total manufacturing expenses and related
manufacturing expenses with previous balance sheet accounts.
years.
Audit II YA AAUSC 2023
 …4.6 Tests of Details of Other Accounts
Audit of Income and Expense Accounts
… Analytical procedures
• Analytical procedures help to uncover misstatements in income and
expense accounts
Tests of controls and substantive tests of transactions
• Tests of controls and substantive tests of transactions have the effect of
simultaneously verifying balance sheet and income statement accounts
– If these tests show control is effective, the possibility of
misstatement in the financial statement is low
Tests of details of account balances
The balances of expense accounts with high possibility of
misstatements (eg. Repairs and maintenance expense) are analyzed
using expense analysis method which focuses on:
 whether the transactions are appropriate,
 properly classified, and
 accurately recorded.
Audit II YA AAUSC 2023
If auditors are satisfied with the analysis, it is an indication for low
misstatement.
 …4.6 Tests of Details of Other Accounts
Audit of Income and Expense Accounts
… Analytical procedures
Tests of details of account balance allocation
– Allocations are important because they determine whether an
expenditure is an asset or a current period expense.
– If the client fails to follow accounting standards or fails to calculate
the allocation correctly, the financial statements can be materially
misstated.
• Focus area
 Adherence to accounting Standards and
 Consistency with the preceding period.

• Audit procedures:

1. Tests for overall reasonableness using analytical procedures and

2. Recalculation of the client’s results.

Audit II YA AAUSC 2023

 End of Chapter 4:

Questions

Audit II YA AAUSC 2023