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AUDITINGBAC2664 (New), BAC2287(Old)

Topic 8, Lecture 9

Audit of the Acquisition and Payment Cycle

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Audit of Acquisition and Payment Cycle

• System cycle and internal control• Objective of audit on purchase and account

payable• Tests of controls system and internal control• Test on real transactions• Substantive tests of transactions and account

payable• Balance confirmation on creditors and accrued

liabilities

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Overview of the purchase cyclePurchases and cash payments cycle covers the purchase of raw

materials and consumables on credit, payments to creditors, purchase returns and discount received.

Two classes of transactions (credit purchases and cash payments) are processed by the accounting system in a different manner.

Internal controls are applied to ensure:1 Complete processing of transactions;2 Transactions are processed accurately; and3 Only valid transactions are processed.

(Refer to transactions and credit purchases cycle diagram)

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Purchases cycle

• A purchase begins with the request made by various dept (a purchase requisition is generated, approved by the respective HOD).

• Purchase order prepared by purchase dept, approved and sent to supplier.

• Approved purchase order provides the authority that goods sent by the supplier can be received.

• Purchas invoices received after goods had been received.

• Supplier expects payment to be made within credit period.

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Account Balances in the purchase cycle

Credit purchases: Debit: purchases (summarized in the PJ) Credit: purchase ledger control account (summarized in the

purchase ledger)

Payments made to supplier: Debit: purchase ledger control account (summarized in the cash

book) Credit: bank account (summarized in the cash book)

The accounts pertinent to the test of details of transactions are purchases account and bank account. Test of details of balances are performed on purchases ledger control account and its detailed counterpart, the purchase ledger.

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Purchases Activities, Documents, Records

Auditor has to understand the flow of purchase transactions through the accounting system.

To facilitate understanding and identification of appropriate controls, an auditor has to gain sufficient knowledge about the activities in purchase cycle, the documents, the records, related to processing purchase.

Then, the auditor describes his understanding in flowcharts.

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Purchases Activities, Documents, Records continued

Activity

Authorization:Accepting and processing purchase requisition

Approving purchases

Receiving of goods from supplier

Billing by supplier

Document

Purchase requisition

Purchase order

Approved suppliers quotation

Approved purchase order

Delivery note

Receiving report

Purchase invoice

Record

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Purchases Activities, Documents, Records continued

Recording:

Journalizing and posting the purchases

Summarizing the journal entries, posting the summary

Custody:Access to documents, records, limited to authorized personnel

Purchase invoice Purchase journal

Purchase ledger

General ledger

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Purchase DepartmentActivity/responsibilities:1 Accepting and processing purchase requisition (PR).2 Approving purchases entry.3 Selecting a supplier.4 Issuing purchase orders (PO).

Possible errors/irregularities:1 PO could be issued for fictitious purchase2 PO does not agree with PR pertaining to the specification and quantity of

items required3 PO misplaced

Control procedures:1 Matched particulars of PR to suppliers quotations2 Matched particulars of PO with PR3 PO are pre-numbered4 PR are kept on file together with PO

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StoresActivity/responsibilities:1 Receiving of goods from supplier delivery note – DN)2 Checking goods and preparing receiving report

Potential risk:1 Receiving of damaged goods or wrong specification and quantity2 Goods received by-pass the checking or approved without

making reference to PO

Control procedures:1 Numerical sequence of approved receiving report2 Copy 1, sent to account dept, copy 2 used to update the bin card

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Accounts DepartmentActivity/responsibilities:1 Billing (invoicing) by supplier2 Keeping the supporting document (approved PO, DN)3 Ensure PO, DN sequence

Possible errors/irregularities:1 goods billed, but not yet receivedAmount billed may be incorrect

Control procedures:1 Account for pre-numbered PO to determine all invoices are for

goods actually received2 Match invoice with DN and approved PO to determine the validity of

authorized transactions

PO, DN, approved PO, copy 2, are stapled and filed numerically

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Accounts Department continued

Activity/responsibilities:1 Journalizing the PJ, posting, recording the purchases and purchase invoices

into the GL2 Monitoring the amount owing

Possible errors/irregularities:1 Purchases are not recorded2 Purchases recorded to the wrong account3 Purchases are received twice4 Purchases recorded in the wrong financial year

Control procedures:1 Account for pre-numbered invoice2 Establish proper chart of account3 Invoices marked ‘POSTED’ or cancelled after posting are done4 Establish internal verification of pricing, extensions, footings5 Establish proper cut-off, i.e., all receiving report issued before the year end

are not billed by suppliers in the following year

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Cash Payments

Activity

Authorization:Approving payment vouchers

Approving cheques

Document

Suppliers remittance advice (SRA)

Approved purchase invoice (API)

Approved payment vouchers (APV)

SRA, API, APV

cheques

Records

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Cash Payments continued

Recording:Journalizing, posting the payments

Summarizing journal entries, posting the summary

Custody:Access to documents, records limited to authorized personnel

Approved payment vouchers

Cash book

Purchase ledger

General ledger

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Accounts Department

Activity/responsibilities:1 Approving payments vouchers (PV)2 Issue PV in sequence, in order to ensure

completeness of the payment made to suppliers

3 Approval for payment given after the officer is satisfied with the supporting documents that were attached together with the PV

4 Cashier before signing the cheques, needs to ensure the validity, accuracy of the payment.

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Cashier

Activity/responsibilities:1 Approve cheques

Irregularities:1 Payment made for unauthorized payments

Control procedures:1 Supporting documents are marked “PAID’ or

cancelled at the time cheques are signed

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Accounts Department

Activity/responsibilities:

1 journalizing, posting the payments, by using particulars from the PV

2 Update the cash book and purchase ledger

3 Keep the PV by serial number

4 Summarizing the journal entries and posting the summary for the month from the PJ, cash payments from cash book, to the GL

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Subsequent Accountability

Activity

Agreeing GL balance with creditors balances in PL

Agreeing creditors balances in PL with statement of accounts

Preparing bank reconciliation statement

Record

GL, PL, Creditors reconciliation statement

PL, statement of account, creditors reconciliation statement

Cash book, bank statement, bank reconciliation statement

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Accounts Department

Activity/responsibilities:1 Agreeing GL balances with creditors balances

in PL2 Determine accuracy of recording on monthly

basis by verifying agreement of the total balances in the PL with the PL control account in the GL

Possible errors1 Errors in recording are highlighted in the

creditors reconciliation statement

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Accounts Department

Activity:

1 Agreeing creditors balances in PL with statement of accounts

2 Check and confirm entries made in the accounts

3 Highlight the age of the debts

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Accounts DepartmentActivity:1 Preparing bank reconciliation statement2 Prepare bank reconciliation every month for the following

reasons: (a) the differences between the balances as per bank statement

and cash book are valid ones (b) the differences in balances are not a result of errors made by

the book-keeper or the bank (c) ensure that no payments have been passed through the bank

account which has not been entered in the cash book (d) irregular items, such as statute barred unrepresented cheques,

will be shown in the bank statement, thus ensuring their reversal in the accounting records

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Internal Control Questionnaire for Purchases

Does the System Ensure That No Invoice Can Be Passed for Payment Without Proof of Receipt of Goods or Services?

1 Are receiving report used?2 Are invoices and receiving report sent directly to

accounting dept and promptly recorded in the PJ?3 Is the PL functions independent of purchasing, stores,

cashier, GL functions?4 Are invoices compared to Po and receiving report by

different people who cross referenced and initial? (alternatively, are the signed receiving report and PO attached to the purchase invoice?)

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Internal Control Questionnaire for Purchases continued

Does the System Prevent Invoices Being Passed for Payment Without Proper Approval?

1 Is the numerical continuity of pre-numbered purchase requisitions and PO checked?

2 Are PO approvals required?3 Is purchasing independent of stores, receiving, PL, cashier, and

inventory record keeping functions?4 Are quotations obtained from suppliers?5 Is the PJ balanced monthly and agreed to the GL?

Does the System Ensure That Invoicing Errors Do Not Escape Attention?

1 Are prices and calculations independently checked?2 Are documents cancelled to prevent re-use?3 Are unmatched documents investigated regularly?

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Internal Control Questionnaire for Cash Payments

Does the System Ensure That Payments Cannot Be Made If Not Properly and Independently Authorized?

1 Do cheques require two signatures independent of purchasing, receiving, PL, invoice approvals and cheque preparation functions?

2 Are cheque signatories authorized by the BOD?3 Is advance signing of blank cheques prohibited?4 Are cheques mailed out directly and supporting

documents cancelled at the time when cheques are signed?

5 Are altered or corrected cheques prohibited?

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Internal Control Questionnaire for Cash Payments continued

Does the System Ensure That Payments Cannot Be Made for Goods and Services Not Received?

1 Does signatories examine supporting documents accompanying cheques and review for propriety and completeness?

2 Are cheques prepared independent of payment voucher approval?

3 Are calculations, additions, discounts, freight, terms and quantities checked?

4 Are cheques payable to ‘bearer’ or ‘cash’ prohibited?5 Is there evidence of cross check between details on

PO and goods received?

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Evaluation of Internal Control: Purchases

Audit objectives:The audit of purchases should be sufficiently comprehensive to determine whether:1 Purchases are properly charged to the company; and2 Purchases have been correctly recorded in the books.

Audit procedures:

For 1-3 months:1 Cast total column of PJ from which items are individually posted2 Check posting from PJ to GL3 Check posting from PJ to creditor control account in GL

For, say 30 items or 10%:Vouch PJ with purchase invoices noting:1 Invoices are original and not duplicates2 dates are correct3 Suppliers and clients name on invoice are correct4 Evidence of independent checking with supplier quotation for price5 Evidence of independent comparison with PO and receiving report for specification and quantity6 Evidence of independent check of extension and casts7 Approval were given by correct person8 Nature of expense and account charged (revenue and capital)9 Invoices stamped “PAID” or cancelled at time cheques paying the invoices were signed

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Evaluation of Internal Control: Purchases continued

Select 30 items, say 10% of creditors account, by ensuring all ledgers are available for the selection:

1 Scrutinize and enquire into any old or unusual items2 Cast each account selected

Examine system of reconciliations of creditors ledger balances with creditors statement of accounts, ensure that:

1 Statements of accounts are obtained regularly from the suppliers

2 All statements obtained are reconciled with the creditors ledger

3 Reconciling items are being followed up.

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Evaluation of Internal Control: Cheque Payments

Audit objectives:The audit of cheque payments should be sufficiently comprehensive to

determine whether:1 Cheque payment ought to have been made2 Cheque payment have been received by the payee, or3 Cheque payment have been correctly recorded in the books.

Audit procedures:Control of cheque books:1 Vouch cheque books received/purchased from bank with bank

notifications (note serial number)2 Verify that cheque books issued have been properly recorded in

register3 At all time of audit, count un-issued cheque books and agree with

register

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Evaluation of Internal Control: Cheque Payments continued

Control of payment vouchers:1 Vouch payment voucher books purchased with printers invoices

(note serial number)2 Verify that payment voucher books issued have been properly

recorded in register3 At the time of audit, count un-issued payment voucher books and

agree with the register

For 1-3 months:1 Account the numerical sequence of payments vouchers2 List any missing payment vouchers.3 Cast creditors payment column of cash payments journal from

which item are individually posted: (a) check posting the total for both columns from cash receipts

journal to GL (b) Check posting the total for creditors payments from cash

payment journal to creditors control account

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Evaluation of Internal Control: Cheque Payments continued

For 1-3 months vouch payments made to creditors noting:1 Proof of payments, i.e., official receipts. (list ant missing receipts. Discuss

with independent responsible official)2 Indication that goods or services charged for have been received and

approved, and have been checked with order3 Authorization for payment by the correct person (as listed in the permanent

file)4 Payment vouchers have been stamped “PAID” or cancelled

Select 30 items, say 10% payment vouchers:1 Trace payment vouchers to cash payment journal2 Check posting to creditors ledger

For 1-3 months:1 Check cheque payments with bank statements, noting that cheques are

debited without undue delay2 Cheque payments side of bank statement and find out why unticked

payments are not entered on credit side of cash book.

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Substantive Tests: Verification of Trade Creditors

Audit of trade creditors is to ensure that creditors are not understated and all trade creditors are accounted for in the financial statements.

Audit procedures must ensure:1 Unrecorded liabilities are identified2 Make sure accounting policies being

applied by the client are consistent with those applied in the previous years

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Audit of Creditors Balances

Management Assertions

Existence

Audit Objectives of Test of Details of Balances

Existence

Substantive Audit Procedures

1 Obtain list of balances

2 Agree figures in GL, check individual balance are made up of specific and recent invoices

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Audit of Creditors Balances continued

Completeness Completeness 1 Ensure all year end transactions in respect of creditors are accounted for

2 Creditors for that accounting period have actually been recorded

3 Ensure supporting documents are sequential order

4 Determine how client deal with cancelled documents

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Audit of Creditors Balances continued

Valuation and Allocation

Accuracy 1 Review all creditors balances, check or test the addition of the list

2 Examine supporting documents

3 Review reconciliation by checking to suppliers statements

4 Review prior year list to ensure no omissions

5 Investigate debit balances. Consider their recoverability

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Audit of Creditors Balances continued

Classification

Cut-off

Detail tie-in

Creditors figures are classified properly according to chart of accounts

Obtain and trace creditors cut-off information ( number, amounts, PO) into PJ and PL

Figures of creditors balances in PL tie with creditors figures in GL

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Audit of Creditors Balances continued

Rights and Obligations

Presentation and Disclosure

Ownership

Presentation and disclosure

Send positive confirmation letters

1 Ensure comparative figures agree with last year’s FS

2 Consider whether significant debit balances should be re-classified as debtors

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References

• Text – Chapter 11

• Lecture Notes

• Tutorial Questions

• Past Exam Questions

• ACCA, MIA, MICPA, Articles from Journals and Magazines