Acquisition and Expenditure Cycle

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Chapter 8

• Acquisition and Expenditure Cycle
• Show those numbers to the damn auditors and I'll
  throw you out the _at__at_ 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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Learning Objectives

• Identify significant inherent risks in the
  acquisition and expenditure cycle.
• Describe the acquisition and expenditure cycle,
  including typical source documents and controls.
• Give examples of tests of controls over purchases
  of inventory and services.
• Explain the importance of the completeness
  assertion for the audit of accounts payable
  liabilities, and list some procedures for a
  search for unrecorded liabilities.

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Learning Objectives (cont.)

• Discuss audit procedures for other accounts
  affected by the acquisition and expenditure
  cycle.
• Specify some ways fraud can be found in accounts
  payable and cash disbursements.
• Describe some common errors and frauds in the
  acquisition and expenditure cycle, and design
  some audit and investigation procedures for
  detecting them.

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Acquisition and Expenditure Cycle

• Concerned with transactions involving
• The purchase of merchandise and materials
  necessary for the continued operations of
  business and
• The subsequent payment for such purchases.

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Inherent Risks

• Unrecorded liabilities
• Noncancelable purchase agreements
• Capitalizing expenses

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Acquisition and Expenditure Cycle Typical
Activities

• Department requesting purchase of item(s)
  prepares a PURCHASE REQUISITION
• Purchase is approved by preparation of a PURCHASE
  ORDER
• After vendor approval, goods are received by
  company and evidenced by preparing a RECEIVING
  REPORT
• Vendor bills company for goods using a VENDOR'S
  INVOICE

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EXHIBIT8.2 ACQUISITION AND EXPENDITURE CYCLE
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Control Procedures

• Information processing controls
• Compare quantities against receiving report and
  purchase order
• Compare prices against quoted price or catalog
  listing
• Mathematically verify vendor's invoice
• Determine when to pay invoice and prepare VOUCHER
• Segregation of duties
• AUTHORIZATION of the purchase 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)
• 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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Audit Evidence in Management Reports and Data
Files

• Open purchase orders
• Unmatched receiving reports
• Unmatched vendor invoices
• Accounts payable trial balance
• Purchases journal
• Inventory reports

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EXHIBIT 8.4
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The Completeness Assertion

• Search for Unrecorded Liabilities
• Scan open purchase order file
• Examine all UNMATCHED VENDOR STATEMENTS/INVOICES
• Examine all UNMATCHED RECEIVING REPORTS occurring
  near year-end
• TRACE from unpaid VOUCHERS in A/P
• Confirm A/P with NORMAL SUPPLIERS (even those
  with zero balances)
• Review CASH DISBURSEMENTS occurring after year-end

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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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Other Accounts in Cycle

• Accrued Expenses
• Prepaid Expenses
• Expenses
• Inventory
• Property Plant and Equipment

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Accrued Payables

• Major differences between ACCRUED PAYABLES 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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Auditing Accrued Payables and Prepaid Expenses

• Agree balances to PRIOR YEAR WORKPAPERS
• Verify PAYMENTS
• Examine UNDERLYING AGREEMENTS
• RECALCULATE amounts
• 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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Auditing Property, Plant, and Equipment

• GENERAL APPROACH
• Use TEST OF TRANSACTION 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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Auditing Property, Plant, and Equipment

• 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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Auditing Property, Plant, and Equipment

• 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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Auditing Property, Plant, and Equipment

• 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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Exhibit 8.6
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Auditing Expense Accounts

• Analytical procedures (e.g. sales commissions)
• Agree to related balance sheet account
  (depreciation)
• Substantive tests of transactions (e.g. payroll)
• Vouch detail (e.g. legal expense)

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Fraud Signs

• Photocopies of invoices
• Invoices in numerical order
• Round numbers
• Slightly below threshold

• P.O. Boxes
• No listed phone
• Vendor and Employee addresses the same
• Multiple vendors at same location