Completing the Tests in the Acquisition and Payment Cycle: Verification of Selected Accounts
We try to cover the audit of two or three accounts in this cycle, if we cover the chapter at all. Our emphasis is on showing the relationship between tests of controls, substantive tests of transactions, and tests of details, and differences between various types of account balances. The following are the primary topical areas we cover:
Chapter opening vignette
Types of tests applied to acquisitions and cash disbursements
Audit of income and expense accounts
Audit of property, plant, and equipment Related areas
Chapter Opening Vignette - ^correct Classifications Hide a Greate r Net Loss
This vignette can be used to emphasize the importance of adequate internal controls and the importance of the auditor adequately understanding and testing of internal control. It is also useful to emphasize one of the reasons that auditors perform tests of account classifications and how these tests should be done. Finally, covering the vignette provides a good opportunity to remind students of the importance of obtaining independent evidence instead of relying solely on inquiry.
Types of Tests Applied to Acquisitions and Cash Disbursements
Start by referring students to the list of accounts in Table 20-1 (page 668) and identify the accounts you plan to discuss. As a review, then ask students to identify the relationship between analytical procedures, tests of controls, substantive tests of transactions, and tests of details of balances for accounts payable. At this point, you should expect fairly specific answers. You may want to use Figure 20-1 (page 669) to summarize this discussion.
(See Table 20-1)
(See Figure 20-1)
Audit of Income and Expense Accounts (page 681)
We start with this area because it is reasonably easy, yet important. Three terms and phrases are defined before proceeding (see top of next page).
Income statement account balances resulting from transactions (including a discussion of how balances get into the general ledger)
Income statement account balances resulting from allocations (including a discussion of how balances get into the general ledger) Analysis of account balances
Figure 20-3 (page 677) and Figure 20-4 (page 680) may provide a useful basis for the discussion of the relation between transactions and account balances.
(See Figures 20-3 and 20-4)
The following questions are then asked about the audit of income and expense accounts:
Ask students to explain how cost of goods sold for a wholesale company can be verified by each of the following tests: analytical procedures, tests of controls and substantive tests of transactions, analysis of account balances, and tests of details of balance sheet accounts.
Assume all tests of controls and substantive tests of transactions and all analytical procedures for the audit have been completed. The audit of the
sales and collection cycle, payroll, and all tests of accounts payable have also been completed. The auditor is now auditing utilities expense. How have the objectives on T-20-1 already been partially or fully met?
What additional tests of utilities expense would ordinarily be made?
Assuming a significant likelihood of misstatements, what additional tests of utilities expense would be performed? Be specific.
How do each of the following accounts differ somewhat from utilities expense in the audit approach or evidence requirements?
Property tax expense
Use the quiz on T-20-2.
Case 20-30 is excellent for deciding tests of income and expense accounts based on the results of analytical procedures
Audit of Property, Plant, and Equipment (page 668)
The difficult aspect of this area is the need to be concerned with additions, disposals, the asset balance, accumulated depreciation, and depreciation expense. For this area, we emphasize the overall objectives of each segment rather than the balance-related audit objectives.
We start by describing the three accounts that concern the auditor and why they are audited simultaneously. Reference Figure 20-2 (page 670) during this discussion. We emphasize that the discussion is meant to be representative of other audit areas.
(See Figure 20-2)
We then deal with individual balances, starting with the asset account (property, plant, and equipment), and use questions such as the following:
What are the most important differences in the audit of property, plant, and equipment and the following:
Cash in bank?
On a continuing engagement, why is the audit of current period additions and disposals emphasized?
For additions, which of the balance-related audit objectives in Table 20-4 (page 673) are most important?
(See Table 20-4)
How does the audit of current period additions relate to tests of controls and substantive tests of transactions?
What factors would determine sample size and items to select in tests of accounts of property, plant, and equipment?
Why does the auditor have considerable flexibility in timing for tests of acquisitions of property, plant, and equipment?
What are the purposes of each of the procedures listed on T-20-3 ?
For disposals we ask questions such as the following:
What are the two most important objectives in auditing disposals?
Identify procedures that are useful for uncovering unrecorded disposals.
How is the audit of accumulated depreciation directly related to the accuracy objective for disposals?
For depreciation, we ask questions such as the following:
When might analytical procedures be sufficient for auditing depreciation expense?
Explain how detailed tests of depreciation might be done assuming that the client has a master file of fixed assets.
For the balance in the fixed asset account we like to ask:
Why are the presentation and disclosure-related audit objectives more important for fixed assets than most other asset balances?
Why is a physical observation of fixed assets less common than for inventory or marketable securities? When should it be done?
What audit problems in fixed assets are encountered when a CPA firm is a successor auditor? How can the problem be solved?
Any of Problems 20-21 to 20-23 will help to reinforce the topic. A good way to finish the audit of fixed assets is to use Case 20-28. It ties the material in Case 19-32 to fixed assets. It should only be used if Case 19-32 was covered.
If there is time left, we like Discussion Question 20-26, which addresses the search for unrecorded liabilities.
CROSS-REFERENCE OF LEARNING OBJECTIVES AND PROBLEM MATERIAL
Questions and Problems
20-1 Recognize the many accounts in the acquisition and payment cycle.
20-2 Design and perform audit tests of property, plant, and equipment and related accounts.
20-3, 20-4, 20-5, 20-15
20-3 Design and perform audit tests of prepaid expenses.
20-4 Design and perform audit tests of accrued liabilities.
20-10, 20-11, 20-12
20-5 Design and perform audit tests of income and expense accounts.
BALANCE-RELATED AUDIT OBJECTIVES:
, Recorded utilities expense transactions as listed exist
, Existing utilities services received are recorded
, Utilities expense transactions as listed are correctly stated
, Utilities expense transactions as listed are properly classified
, Utilities expense transactions are recorded in the proper period
, The amounts in the general ledger are correctly totaled and the total agrees with the trial balance
HOW EXPENSES ARE TESTED
Match each of the following eight expense accounts, each one assumed to be material, into one of four categories.
Will ordinarily be tested sufficiently by normal tests of controls and substantive tests of transactions, analytical procedures, and accounts payable tests.
Frequently requires additional account analysis due to high expectation of misstatements.
Typically audited as a part of an accrual or prepaid account.
Not tested as a part of (1) except for normal analytical procedures.
Bond discountInterest expense
Raw material purchases
Repair and main. expense
PARTIAL AUDIT PROGRAM FOR PROPERTY, PLANT, AND EQUIPMENT ADDITIONS
, Foot the client-prepared listing of current year additions and reconcile the total with debits to property, plant, and equipment in the general ledger.
, Trace individual additions included on the client-generated listing to the acquisitions journal.
, Examine rent and lease agreements for rented and leased property, plant, and equipment.
? Examine vendors' invoices and receiving reports for additions included on the listing.
, Trace the total of individual additions to the related master files.
, Analyze repair and maintenance expense for large and unusual items.
, Examine loan agreements for equipment acquired by loans or contracts.