Accounts Payable

and Other Liabilities

Chapter 14

McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

14-2

Sources of Accounts Payable

Short-term obligations arising from purchase of

goods and services in ordinary course of

business; examples:

Acquisition of merchandise on credit

Receipt of services such as advertising, repairs

Invoices and statements from suppliers usually

evidence accounts payable

Interest-bearing obligations are not included in

accounts payable; they are included as bonds,

notes, etc.

14-3

Sources of Accrued Liabilities

Accrued liabilities

Sometimes called accrued expenses

Examples: Salaries, interest, rent

Accumulate over time and management must

make accounting estimate at year-end.

• Note that if management does not make such an

estimate, no entry will occur since the related

transactions (e.g., interest) may have occurred

months ago

14-4

Objectives for the Audit

Accounts Payable and

Purchases

1. Use the understanding of the client and its environment to consider inherent risk, including fraud risks, related to accounts payable.

2. Obtain an understanding of internal control over accounts payable.

3. Assess the risks of material misstatement and design tests of controls and substantive procedures that:

a. Substantiate the existence of accounts payable and the client’s obligation to pay these liabilities and establish the occurrence of purchase transactions

b. Establish the completeness of recorded accounts payable

c. Verify the cutoff of transactions affecting accounts payable

d. Establish the proper valuation of accounts payable and the accuracy of purchase transactions

e. Determine that the presentation and disclosure of accounts payable are appropriate

14-5

Primary concern

Possibility of understatement or omission

of liabilities

Exaggerates the financial strength of

company

Conceals fraud as effectively as

overstatement of assets

Accompanied by understatement of expenses

and overstatement of net income

14-6

Controls Over the

Acquisition Cycle

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

14-7

Acquisition Cycle--Documents

Purchase order

Receiving report

Vendor’s invoice

Vendor’s statement

14-8

14-9

Audit Documentation

Working papers

Lead schedule for accounts payable

Trial balances of various types of accounts

payable

Confirmation requests for accounts payable

Listing of unrecorded accounts payable

14-10

14-11

Risks of Material Misstatement

Controls against misstatements

Auditors found serially numbered receiving

reports are prepared

Serially numbered vouchers are prepared

Payments made promptly on due dates

Immediately recorded in accounting records

Independent employee reconciles subledger

to general ledger

14-12

Risks of Material Misstatement Risks of misstatements

Subsidiary records not in agreement with

general ledger

Receiving reports and vouchers used

haphazardly

Purchase transactions often not recorded until

payment is made

Many accounts payable long past due

Risks such as these indicate the need for

extensive substantive procedures

14-13

Accounts Payable Audit

Steps (1 of 4)

A. Use the understanding of the client and

its environment to consider inherent risks,

including fraud risks, related to accounts

payable.

B. Obtain an understanding of internal

control over accounts payable.

C. Assess the risks of material misstatement

and design further audit procedures.

14-14

Accounts Payable Audit

Steps (2 of 4)

D. Perform further audit procedures—tests

of controls.

1. Examples of tests of controls.

a. Verify a sample of postings to the accounts payable control

account.

b. Vouch to supporting documents a sample of postings in

selected accounts of the accounts payable subsidiary ledger.

c. Test IT application controls.

d. If necessary, revise the risks of material misstatement based

on the results of tests of controls.

14-15

Accounts Payable Audit

Steps (3 of 4)

E. Perform further audit procedures—substantive

procedures for accounts payable.

1. Obtain or prepare a trial balance of accounts payable

as of the balance sheet date and reconcile with the

general ledger.

2. Vouch balances payable to selected creditors by

inspection of supporting documents.

3. Reconcile liabilities with monthly statements from

creditors.

4. Confirm accounts payable by direct correspondence

with vendors.

14-16

Accounts Payable Audit

Steps (4 of 4)

E. Substantive procedures (continued) 5.Perform analytical procedures for accounts payable

and related accounts.

6. Search for unrecorded accounts payable.

7. Perform procedures to identify accounts payable to

related parties.

8. Evaluate proper balance sheet presentation and

disclosure of accounts payable.

14-17

Summary of Substantive Tests of

Accounts Payable

14-18

Contrasting Confirmation of Accounts

Payable and Accounts Receivable

Accounts Payable Accounts Receivable

Primary Audit Completeness Existence

Objective

Other Evidence External evidence Internal evidence

Available held by client (i.e.., (i.e., sales invoices,

vendors’ invoices receiving reports) and statements)

Confirmation

Generally No Yes

Required?

14-19

Search for Unrecorded A/P

Be alert during reconciliations,

confirmations and analytical procedures

for unrecorded liabilities

Examine transactions recorded following

year-end

Compare cash payments after year-end to a/p

trial balance

Examine cash disbursements over specific

dollar amounts during subsequent period

14-20

Potential Sources of

Unrecorded A/P Unmatched invoices and unbilled receiving

reports

Vouchers payable entered in the voucher

register subsequent to balance sheet date

Invoices received after balance sheet date

Consignments in which client acts as a

consignee

14-21

14-22

Adjusting entry needed?

Misstatements and omissions are judged

based on impact on the financial

statements

Materiality

• Effect on net income

• Need to consider cumulative effect on the financial

statements

14-23

Amounts withheld from

employees’ pay Income taxes withheld from employees’

pay but not remitted as of balance sheet

date

Trace amounts withheld to payroll

summary sheets

Test computations of taxes withheld and

accrued

Determine that taxes have been deposited

in accordance with law

14-24

Sales Tax Payable

Required to collect sales tax imposed by

state and local governments

Not an expense, just collecting agent

Liabilities until remitted

Verify liability by reviewing tax return

Test reasonableness of amount

Test invoices for correct tax charge

14-25

Unclaimed wages

Subject to misappropriation

Concerned with adequacy of internal

control

Should not be left for more than a few day

Prompt deposit in special bank account

Analyze unclaimed wages to determine

Credit represents all unclaimed wages after

each payroll distribution

Debits represent authorized payments

14-25

14-26

Customers’ Deposits

Deposits on returnable containers or to

guarantee payment of bills

Review procedures followed in accepting

and returning deposits

Verify list of individual deposits and

compare to general ledger account

Generally do not confirm

14-27

Accrued Liabilities (1 of 3)

Obligations payable sometime during the succeeding

period for services or privileges received before balance

sheet date

Examples: Interest payable, accrued property taxes

Accounting estimates

Review and test management’s process of

developing the estimate

Review subsequent events

Independently develop estimate to compare

14-28

Accrued Liabilities (2 of 3)

Basic audit steps

1. Examine any contracts or other documents on hand that provide the

basis for the accrual.

2. Appraise the accuracy of the detailed accounting records maintained

for this category of liability.

3. Identify and evaluate the reasonableness of the assumptions made

that underlie the computation of the liability.

4. Test the computations made by the client in setting up the accrual.

5. Determine that accrued liabilities have been treated consistently at

the beginning and end of the period.

6. Consider the need for accrual of other accrued liabilities not

presently considered (that is, test completeness).

7. For significant estimates, perform a retrospective analysis of the prior

year’s estimates for evidence of management bias.

14-29

Accrued Liabilities (3 of 3)

Accrued Property Taxes

Accrued Payrolls

Pension Plan Accruals

Postemployment Benefits other than Pensions

Accrued Vacation Pay

Product Warranty Liabilities

Accrued Commission and Bonuses

Income Tax Payable

Accrued Professional Fees

14-30

Presentation

Current liability

Accrued expenses

Deferred income tax for next year

Deferred credits for rent

Deposits on contracts

Long-term liability

Deferred income tax - noncurrent

14-31

Time of Examination

Most effective when performed

immediately after the balance sheet date

Little value if done before because

concern with understatements

Some can be done at interim:

Accrued property taxes

Amounts withheld from employees’ pay