15 - 1 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley...

Completing the Tests in theAcquisition and Payment

Cycle: Verificationof Selected Accounts

Chapter 15

Learning Objective 1

Recognize the many accounts in

the acquisition and payment cycle.

AssetsCashInventorySupplies Property, plant, and equipmentPatents, trademarks, and copyrightsPrepaid rentPrepaid taxesPrepaid insurance

Accounts Associated with Acquisition

and Payment Cycle Transactions

Cost of goods soldRent expenseProperty taxesIncome tax expenseInsurance expenseProfessional feesRetirement benefitsUtilities

Expenses

Accounts payableRent payableAccrued professional feesAccrued property taxesOther accrued expensesIncome taxes payable

Liabilities

Design and perform audit

tests of property, plant, and

equipment related accounts.

Auditing Manufacturing Equipment

and Related Accounts

Analytical procedures

Current year disposals

Ending balance in the asset account

Depreciation expense

Ending balance in accumulated depreciation

Current year acquisitions

Analytical Procedures for Manufacturing Equipment

Analytical Procedure Possible MisstatementCompare depreciation Misstatement inexpense divided by gross depreciation expensemanufacturing equipment and accumulatedcost with previous years. depreciation

Compare accumulated Misstatement indepreciation divided by gross accumulatedmanufacturing equipment depreciationcost with previous years.

Analytical Procedures for Manufacturing Equipment

Analytical Procedure Possible MisstatementCompare monthly or annual Expensing amountsrepairs and maintenance, that should besupplies expense, small tools capitalizedexpense, and similar accountswith previous years.Compare gross manufacturing Idle equipment orcost divided by some measure equipment that hasof production with previous been disposed of, butyears. not written off.

Verifying Current Year Acquisitions

The proper recording of current year additionsis important because of the long-term effectthe assets have on the financial statements.

Because of the importance of current periodacquisitions, seven of the nine balance-related

audit objectives are used as a frame of reference.

Major Balance-RelatedAudit Objectives

Existing acquisitions are recorded.

Completeness

1. Examine vendors’ invoices of closely relatedaccounts to uncover items that should bemanufacturing equipment.

2. Review lease and rental agreements.

Current year acquisitions as listed are accurate.

Accuracy

1. Examine vendors’ invoices.

Current year acquisitions as listed are properly classified.

Classification

Examine:1. Vendors’ invoices in mfg. equipment account.2. Vendors’ invoices of closely related accounts.3. Rent and lease expense for capitalizable leases.

Verifying Current Year Disposals

Review whether newly acquired assets replace existing assets.

Analyze gains and losses on disposal.

Review documents for indicationsof deletion of equipment.

Make inquiries about the possibilityof the disposal of assets.

Verifying Ending Balanceof Asset Accounts

1. All equipment owned is recorded.

2. All recorded equipment physically exists on the balance sheet date.

Verifying Depreciation Expense

The most important objective is accuracy.

Consistentdepreciation

policy

Correctcalculations

Verifying Ending Balance in Accumulated Depreciation

1. Accumulated depreciation as statedin the property master file agreeswith the general ledger.

2. Accumulated depreciation in themaster file is accurate.

tests of prepaid expenses.

Audit of Prepaid Expenses

• Prepaid rent• Organization cost• Prepaid taxes• Patents • Prepaid insurance

• Trademarks• Deferred charges• Copyrights

Prepaid InsuranceInternal Controls

1. Controls over the acquisition andrecording of insurance

2. Controls over the insurance register

3. Controls over the charge-off ofinsurance expense

Prepaid InsuranceAudit Tests

Compare total prepaid insurance and insuranceexpense with previous years.

Compute the ratio of prepaid insurance to insuranceexpense and compare it with previous years.

Compare the individual insurance policy coverageon the schedule of insurance obtained with the

preceding year’s schedule.

Prepaid InsuranceAudit Tests

Compare the computed prepaid insurance balancefor the current year on a policy-by-policy basis

with that of the preceding year.

Review the insurance coverage listed on theprepaid insurance schedule with an appropriate

client official or insurance broker.

tests of accrued liabilities.

Audit of Accrued Liabilities

• Accrued income taxes• Accrued interest• Accrued pension costs• Accrued professional fees• Accrued rent• Accrued warranty costs

Accrued Property Taxesand Related Accounts

Accrued Property Taxes

Property Tax Expense

Beginning balance

Payments Current period(property taxes) property tax expense

Ending balance

Design and perform audit tests

of income and expense accounts.

Approach to Auditing Incomeand Expense Accounts

Analytical procedures

Tests of controls and substantivetests of transactions

Tests of details of account balances

Analytical Procedures forIncome and Expense Accounts

Analytical Procedure Possible Misstatement

Compare individual Overstatement orexpenses with previous understatement of ayear. balance in an expense

sheet.

Compare individual asset Overstatement orand liability balances with understatement of aprevious years. balance sheet account

that would also affectan income statementaccount

Compare individual Misstatement ofexpenses with budgets. expenses and related

balance sheetaccounts

Compare gross margin Misstatement of costpercentage with previous of goods sold andyears. inventory

Compare inventory Misstatement of costturnover ratio with of goods sold andprevious years. inventory

Compare prepaid insurance Misstatement ofexpense with previous insurance expenseyears. and prepaid insurance

Compare commission Misstatement ofexpense divided by sales commission expense,with previous years. accrued commissions

Compare individual Misstatement ofmanufacturing expenses individual mfg.divided by total mfg. expenses and relatedexpenses with previous years. balance sheet accounts

Tests of Controls and Substantive

Test of Transactions

Understanding internal control and therelated tests of controls and substantive

tests of transactions to determine theappropriate assessed control risk are

the most important means of verifyingmany of the income statement accounts

in each of the transaction cycles.

Tests of Details of AccountBalances: Expense Analysis

Expense account analysis is the examination

of underlying documentation of individual transactions and

amounts making up the detail of the total of an expense account.

Tests of Details of Account Balances: Allocation

Several expense accounts result from the allocationof accounting data rather than discrete transactions.

These include depreciation, depletion, and theamortization of copyrights and catalog cost.

The allocation of manufacturing overhead betweeninventory and cost of goods sold is an example ofa different type of allocation that affects expenses.

End of Chapter 15

15 - 1 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley...

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