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Chapter 8

Acquisition and Expenditure Cycle

“Show those numbers to the damn auditors and I'll throw you out the $%*@@ window.”----(Buddy Yates, director of WorldCom, Inc. general accounting, to an

employee asking for an explanation of a large accounting discrepancy).

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Presentation Outline

I. The Expenditure Cycle

II. Expenditure Cycle Risk, Control Procedures, and Testing

III. Audit Evidence in Management Reports and Data Files

IV. Other Accounts in Cycle

8-3I. The Expenditure Cycle

A. Requisitioning in StoresB. Order Processing in Purchasing

C. Receiving D. Delivery Acknowledgement in Stores

E. Invoice Verification in PurchasingF. Accounts Payable Prepares the Voucher

PackageG. Cash Disbursements

H. General LedgerI. Internal Audit

8-4A. Requisitioning in Stores

Requests for purchases originate outside the

purchasing department. Purchase requisitions

arise in stores or other departments.

Requisitions should be approved in the

originating department.Purchasing has access to

the requisition thru the purchase database.

Prepare Requisition

Requisition Processing Purchase

Database

8-5B. Order Processing in Purchasing Purchase requisitions may

be overridden due to a lack of funds, improper

authorization by the requesting department,

etc. Purchasing selects a vendor using an approved

vendor list or a bidding process.

Accounts payable, the requesting department, and receiving all have access to the purchase

order through the purchase database.

Prepare Order

PurchaseRequisition

SelectVendor

OrderProcessing

PurchaseOrder

To Vendor

PurchaseDatabase

RetrievePurchase

Requisition

8-6C. Receiving

Receiving accesses the purchase order and matches it with the vendor delivery. Receiving only accepts deliveries for which there is an existing purchase order.

Blind counts are often used to force counters to actually count the items received.

A receiving supervisor later verifies the quantity against

the purchase order. Stores has access to this

report thru the purchase database.

PurchaseDatabase

Retrieve Purchase

Order

PurchaseOrder

From Vendor

DeliveryMatch toPurchase

Order

OrderProcessing

BlindCount

EnterReceipt

DeliveryTo Stores

8-7D. Delivery Acknowledgement in Stores

The stores department acknowledges receipt of

the delivery on the receiving report in the

purchase database. Purchasing and

accounts payable have access to the

acknowledged report thru the purchase

database.

PurchaseDatabase

Retrieve Receiving

Report

ReceivingReportMatch to

Delivery

From Receiving

Delivery

GoodsReceipt

Processing

8-8E. Invoice Verification in Purchasing

Purchasing uses the purchase database to compare the purchase order, acknowledged

receiving report, and vendor invoice for any discrepancies.

Purchasing authorizes the invoice for payment once they are satisfied that the invoice is correct per the

order and what was received.

From Vendor

Vendor Invoice

InvoiceVerification

PurchaseDatabase

Vendor Invoice

To Accounts Payable

8-9F. Accounts Payable Prepares the Voucher Package

The purchase requisition, purchase order, acknowledged receiving report, and

approved vendor invoice provide the

support for the preparation of a

voucher. The voucher serves to

summarize the purchase for entry on

the records as a liability.

From Purchasing

VendorInvoice

PurchaseDatabase

Retrieve Documents

PurchaseRequisition

PurchaseOrder

ReceivingReport

PrepareVoucher

VoucherProcessing

AccountsPayable

orVoucherRegister

VoucherCheck

Voucher JournalVoucher

To Cash Disbursements

To General Ledger

8-10G. Cash Disbursements

Cash disbursements received the

voucher package and

check for signing.Cash

disbursements maintains a

check register and forwards a journal entry to general ledger.

From Accounts Payable

Voucher

VoucherCheck

SignChecks

VoucherVoucherCheck

Cancel Voucher

after Signing Check

PostCheckRegister

VoucherCheck

ControlTotal

Forward to Payee

To General Ledger

8-11H. General Ledger

General ledger receives the journal entry from accounts

payable (Debit – Accounts payable and Credit – Cash) and compares it to the control total for cash disbursements.

The journal entry is then posted into the

general ledger.

From Cash Disbursements

ControlTotal

From Accounts Payable

JournalVoucher

ComparePost

GeneralLedger

ProcessingGeneralLedger

ControlTotal

JournalVoucher

8-12I. Internal Audit

An independent reconciliation of the bank account is

performed by internal audit.

BankReconciliation

BankStatement

CancelledChecks

From Bank

BankReconciliation

CheckRegister

BankStatement

CancelledChecks

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II. Expenditure Cycle Risk, Control Procedures, and Testing

A. Inherent RisksB. Cost and Expense Capers – Exhibit 8.2

C. Expenditure Control Procedures D. Assertions of Classes of Transactions and

Events for the Period: Acquisition and Expenditure Cycle – Exhibit 8.4

E. Direction of Tests – Exhibit 8.3F. The Completeness Assertion

G. Purchase Cutoffs

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A. Inherent Risks

Unrecorded liabilities – may arise when invoice verification has not been completed for what should be

a liability.Noncancelable purchase agreements – drop in market

prices below agree contractual price should result in loss recognition.

Capitalizing expenses – expenditures with no future value may be capitalized when they should be

expensed.

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B. Cost and Expense Capers – Exhibit 8.1 on p. 293

8-16C. Expenditure Control Procedures

• Information processing controls – Compare quantities against receiving report and purchase order– Compare prices against purchase order (i.e., quoted price)– Mathematically verify vendor's invoice– Determine when to pay invoice and prepare VOUCHER

• Segregation of duties– AUTHORIZATION of the purchase is done by the purchasing department.– Custody of the inventory item(s) is held by the receiving department and, ultimately, the

requesting department.– Transactions are recorded by general accounting (control account) and accounts payable

department (subsidiary accounts) or vouchers payable

• Physical controls– Prepare a receiving report upon initial receipt of inventory– Count and verify inventory quantities upon delivery to the inventory warehouse– Restrict access to inventories by keeping them in a secured location

• Performance reviews– Compare purchases data to data from previous years or expected purchases data

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D. Assertions of Classes of Transactions and Events for the Period: Acquisition and Expenditure Cycle – Exhibit 8.4 on p. 299

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E. Direction of Tests – Exhibit 8.3 on p. 298

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F. The Completeness Assertion

• Search for Unrecorded Liabilities– Inquire of client about their procedures– Scan open purchase order file– Examine all UNMATCHED VENDOR

STATEMENTS/INVOICES– Examine all UNMATCHED RECEIVING REPORTS

occurring near year-end– Confirm A/P with NORMAL SUPPLIERS (even those

with zero balances)– Review CASH DISBURSEMENTS occurring after

year-end

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G. Purchase Cutoffs

• Verify CUT-OFFs for purchases – Examine Receiving Reports and Vendor Sales

Invoices occurring around year-end to ensure inventory received is included in the appropriate period.

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III. Audit Evidence in Management Reports and Data Files

A. Open Purchase Orders

B. Unmatched Receiving Reports

C. Unmatched Vendor Invoices

D. Accounts (Vouchers) Payable Trial Balance

E. Purchases Journal

F. Fixed Asset Reports

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A. Open Purchase Orders

Purchase orders are open from the time they are issued until goods are received.

Auditors can find evidence of losses on purchase commitments in this file (i.e.,

market prices are below price in purchase order).

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B. Unmatched Receiving Reports

Auditors can inspect unmatched receiving report file to determine whether the

company has material unrecorded liabilities on the financial statement date.

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C. Unmatched Vendor Invoices

Auditors can inspect unmatched vendor invoice file and compare it to the unmatched receiving report file to

determine whether the company has material unrecorded liabilities on the

financial statement date.

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D. Accounts (Vouchers) Payable Trial Balance

The trial balance is a list of payable amounts by vendor, and the sum should agree with the

accounts payable control account.Some organizations have a trial balance of individual unpaid vouchers rather than vendor

names.Search for unrecorded liabilities should emphasize

small and zero balances, especially for regular vendors.

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E. Purchases Journal

Purchases can be scanned for purchasing patterns indicating error or fraud:

Purchase with unapproved vendorsPurchases to multiple companies at the

same addressDuplicate payments

Vendors whose address matches an employee

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F. Fixed Asset Reports

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

all depreciation.

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IV. Other Accounts in Cycle

A. Accrued Liabilities v. Accounts PayableB. Auditing Accrued Liabilities and Prepaid

ExpensesC. Account Analysis for Prepaid Expenses –

Exhibit 8.5D. Auditing Property Plant and Equipment

E. Sample PP&E and Depreciation Document – Exhibit 8.6

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A. Accrued Liabilities v. Accounts Payable

• Major differences between ACCRUED Liabilities and ACCOUNTS PAYABLE– Examples include INTEREST, PROPERTY TAXES,

WAGES, and INCOME TAXES PAYABLE

– These payables are not normally INVOICED or EVIDENCED by the RECEIPT OF GOODS

• These differences may make it more difficult to detect UNRECORDED ACCRUALS

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B. Auditing Accrued Liabilities and Prepaid Expenses

• Agree balances to PRIOR YEAR WORKPAPERS• Verify PAYMENTS• Examine UNDERLYING AGREEMENTS• RECALCULATE amounts

– Agree EXPENSE ACCOUNTS to trial balance• Search for UNRECORDED ACCRUALS

– Review CASH DISBURSEMENTS at year-end– Look for expected accruals at other stages of the audit

(BONDS, NOTES, employees paid on 15th, etc.)• ANALYTICAL PROCEDURES

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C. Account Analysis for Prepaid Expenses – Exhibit 8.5

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D. AUDITING PROPERTY, PLANT, AND EQUIPMENT

• GENERAL APPROACH– Small number of transactions

• Relatively high dollar transactions

– Authorization of Transactions (Board of Directors) takes on added importance.

– Less concern for ACCESS to ASSETS

– More concerned with UNRECORDED DISPOSALS

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

• Agree balances to prior year documentation

• PURCHASES OF PPE– VOUCH to INVOICE or COST RECORDS

– Inspect TITLE

– VOUCH to BOARD MINUTES

• EXPENDITURES SUBSEQUENT TO ACQUISITION– VOUCH to INVOICE and WORK DESCRIPTIONS

– Consider propriety of classification (EXPENSE or CAPITALIZE)

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

• DISPOSAL OF PPE– VOUCH from PPE to BOD MINUTES (AUTHORIZATION)

– Vouch to cash receipts journal and validated deposit slip

– Recalculate gain/loss

– TRACE from BD MINUTES to PPE for disposals (COMPLETENESS)

• Look for unrecorded disposals– Agree balances to PRIOR YEAR WORKPAPERS

– Examine insurance policies, property tax records, etc.

– PHYSICALLY INSPECT or CONFIRM fixed assets• Both existing and newly-acquired items

• Confirm assets LEASED to others under capital leases

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

• DEPRECIATION EXPENSE– Recalculate using USEFUL LIFE, SALVAGE

VALUE, COST, and METHOD (VA)– Evaluate REASONABLENESS of USEFUL LIFE,

SALVAGE VALUE, etc.– Is depreciation consistent with COMPANY POLICY

(half year conventions)?

• LEASE AGREEMENTS– Verify proper treatment (Capitalized or Operating)– Ensure disclosure in footnotes is appropriate

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E. Sample PP&E and Depreciation Documentation – Exhibit 8.6 on p. 304

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Summary

Segregation of Duties in Expenditure CycleRisk and Testing in Expenditure CycleSearching for Unrecorded LiabilitiesAudit of Property, Plant & Equipment