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CHAPTER 11
AUDITING THE PURCHASING PROCESS
11-2 The three types of transactions that are processed through the purchasing process are:
• Purchase of goods and services for cash or credit
• Payment of the liabilities arising from such purchases
• Return of goods to suppliers for cash or credit
The more common accounts affected by each major type of transaction are:
Purchase transaction:
• Accounts payable
• Inventory
• Purchases or cost of goods sold
• Various asset and expense accounts
11-1
Chapter 11 - Auditing the Purchasing Process
11-3 A purchase requisition is a request for goods and services by an authorized individual or
department within the entity. A purchase order contains the description, quality, quantity,
and other information on the goods and services being purchased. A receiving report is
used to record the receipt of goods. A vendor invoice is the bill from the vendor that
includes the description and quantity of the goods shipped or services provided, the price
including freight, the terms of trade including cash discounts, and the date billed. A
voucher is a document that is frequently used by entities to control the payment of
acquired goods and services.
An entity would combine all these documents into a "voucher packet" because such a
packet would contain all the information on a particular purchase transaction. If there are
questions about the transaction at a later time, the entity can obtain access to all the
documents and information more easily.
11-4 The key segregation of duties and the errors or fraud that can occur if such duties are not
segregated are:
Possible Errors or Fraud Resulting
Segregation of Duties from Conflicts of Duties
The purchasing function should be Theft of goods and possible payment for
segregated from the requisitioning and unauthorized purchases.
receiving functions.
The invoice-processing function should Overpayment for goods and services or
be segregated from the accounts payable theft of cash.
function.
The disbursement function should be Theft of cash.
segregated from the accounts payable
function.
The accounts payable function should A defalcation that would normally be
be segregated from the general ledger detected by reconciling subsidiary records
function. with the general ledger control account.
11-5 Two inherent risk factors that directly affect the purchasing process are (1) industry-
related factors, and (2) misstatements detected in prior audits.
If the entity deals with a large number of vendors and prices tend to be relatively stable,
there is less risk that the entity's operations will be affected by raw-material shortages or
that production costs will be difficult to control. However, if an entity is dependent on a
single vendor to supply a critical component and the vendor is unable to provide the
component, the entity may suffer production shortages and shipping delays that
significantly affect financial performance. Additionally, industries that use commodities
such as oil, coal, and precious metals may be subject to both shortages and price
instability that significantly affect their financial results.
The presence of misstatements in previous audits is a good indicator that misstatements
are likely to be present during the current audit. If misstatements were present in
previous audits, the auditor should assess inherent risk to be high.
11-2
Chapter 11 - Auditing the Purchasing Process
11-6 The following controls and related tests are utilized to ensure that the occurrence,
authorization, and completeness assertions are met for purchase transactions:
Assertion Control Procedures Tests of Controls
11-3
Chapter 11 - Auditing the Purchasing Process
11-8 The analytical procedures that can be used to test accounts payable
and accrued expenses and the possible misstatements that can be
detected by each analytical procedure are:
11-9 The following audit procedures may be used as part of the search for unrecorded
liabilities:
• Inquiry of management about control procedures used to identify unrecorded
liabilities and accruals at the end of an accounting period.
• Obtain copies of vendors' monthly statements and reconcile the amount to client's
11-4
Chapter 11 - Auditing the Purchasing Process
11-5
Chapter 11 - Auditing the Purchasing Process
11-10 The following are examples of disclosures for the purchasing process and related
accounts:
• Payables by type (trade, officers, employee, affiliate, etc.).
• Short- and long-term payables.
• Long-term purchase contracts, including any unusual or adverse purchase
commitments.
• Purchases from and payables to related parties.
• Dependence on a single vendor or small number of vendors.
• Costs by reportable segment of the business.
11-11 Accounts payable confirmations are generally used less frequently by auditors than
accounts receivable confirmations because the auditor can test accounts payable by
examining vendor invoices and monthly vendor statements. Since these documents
originate from sources external to the client, this evidence is viewed as reliable.
Accounts payable confirmations primarily provide evidence on the completeness
assertion, while accounts receivable confirmations primarily provide information on the
validity (occurrence/existence) assertion. When confirming accounts payable, auditors
generally use a form of positive confirmation referred to as a "blank or zero-balance"
confirmation. This type of positive confirmation does not state the balance owed.
Instead, the confirmation requests that the recipient fill in the amount or furnish other
information. Both positive and negative confirmations are used for accounts receivable.
Lastly, accounts payable confirmations are generally mailed at year-end rather than at an
interim date because of the auditor's concerns about unrecorded liabilities. Accounts
receivable confirmations are sent at both dates.
11-12 Some of the typical procedures that might be applied to the audit of the tax provision by
the auditors and/or tax specialist include:
• Compare the size and trend in the tax provision and related balance sheet accounts
over time.
• Perform walkthroughs and test the design and operating effectiveness of internal
controls over the income tax provision (required for an integrated audit). Identify
issues that should be given particular attention in substantive testing and evaluate the
client’s documentation.
• Document the testing performed to evaluate the design and operating effectiveness of
internal controls over the income tax process (primarily integrated audits).
• Test the mathematical accuracy of the computations supporting the tax provision and
related balance sheet accounts and vouch underlying data to supporting
documentation.
• Identify and test significant permanent and temporary differences in the tax provision
calculation.
• Review and evaluate management’s position on significant uncertain tax positions for
appropriate disclosure and accounting under FIN 48.
• Consider the realizability of net deferred tax assets.
• Test the reconciliation of income taxes payable, deferred income tax assets/liabilities
(including any related valuation allowances), and FIN 48 liabilities to supporting
11-6
Chapter 11 - Auditing the Purchasing Process
documentation, including the general ledger, financial statements, and related footnote
11-7
Chapter 11 - Auditing the Purchasing Process
• disclosure.
• Ensure proper documentation in the audit working papers to allow for reperformance
of the audit procedures applied to the tax accounts.
11-13 c 11-19 c
11-14 c 11-20 d
11-15 b 11-21 c
11-16 d 11-22 c
11-17 b 11-23 a
11-18 b
Solutions to Problems
11-24 This is a relatively straightforward analytical procedures problem. Here are some of the
concerns the auditor might have about potential misstatements in both accounts:
• Both inventory and accounts payable have increased significantly in absolute
dollar terms from 2008 to 2009.
• The inventory increase is 69 percent while the accounts payable increase is 28
percent.
• An auditor would have expected the increase in inventory to be approximately the
same as the increase in accounts payable.
• Based on the auditor’s expectations and the client’s data, the auditor might
suspect that there are at least two possible misstatements: (1) inventory is overstated
because obsolete and/or slow-moving products have not been written down to fair
market value and (2) there are unrecorded accounts payable. Other misstatements are
possible.
11-8
Chapter 11 - Auditing the Purchasing Process
11-25 The internal control procedures that most likely would provide reasonable assurance that
specific control objectives for the financial statement assertions regarding purchases and
accounts payable will be achieved are:
Requisitioning Department:
• Proper authorization of requisitions by department head is required
before purchase orders are prepared.
• The requisitioning department head independently verifies the
quantity and quality of the goods received.
Purchasing Department:
• The purchasing department ensures that requisitions are within
budget limits before purchase orders are prepared.
• The adequacy of each vendor's past record as a supplier is verified.
Receiving Department:
• Secure facilities limit access to the goods during the receiving
activity.
• The receiving department makes a blind count of the goods
received, independently of any other department.
11-9
Chapter 11 - Auditing the Purchasing Process
11-26 a. The flowchart for Kida Company is shown on the following page:
11-10
b. Kida Company's major internal control weaknesses are:
Purchasing:
• The buyer does not verify that the department head's request is within budget
limitations.
• No procedures have been established to ensure that the best price is obtained.
Large-dollar requisitions should be ordered after receiving quotes and/or sealed
bids.
• Prior to placing an order, the buyer does not determine the adequacy of the
vendor's past record as a supplier to Kida.
Receiving:
• Receiving clerk does not make blind counts for all special equipment or at least for
large-dollar items.
• Written notice of equipment received is not sent to the purchasing department.
• Written notice of equipment received is not sent to accounts payable department.
Accounts Payable:
• The mathematical accuracy of the invoice is not recomputed.
• Invoice quantity is not compared with a report of quantity received.
• Notification of the acceptability of the equipment from the requisitioning
department is not obtained before the payable is recorded.
• No alphabetic file of vendors from which purchases are made is maintained.
Treasurer:
• Documentation supporting the checks is not sent by the accounts payable
department to the cashier in order for the cashier or treasurer to be assured that the
check is for properly authorized and received equipment.
• Checks for large-dollar purchases are not signed by two officers of Kida Company
to ensure that material expenditures are proper.
• All documentation to support a check is not canceled by the check signer and
returned to the accounts payable department.
• The cashier alone has custody of the key, the signature plate, and record of usage.
• The controller is authorized to sign checks.
11-11
11-28 The substantive audit procedures Coltrane should apply to Jang's trade accounts payable
balances include the following:
• Foot the schedule of the trade accounts payable.
• Agree the total of the schedule to the general ledger trial balance.
• Compare a sample of individual account balances from the schedule with the
accounts payable subsidiary ledger.
• Compare a sample of individual account balances from the accounts payable
subsidiary ledger with the schedule.
• Investigate and discuss with management any old or disputed payables.
• Investigate debit balances and, if significant, consider requesting positive
confirmations and propose reclassification of the amounts.
• Review the minutes of the board of directors' meetings and any written agreements
and inquire of key employees as to whether any assets are pledged to collateralize
payables.
• Perform cutoff tests.
• Perform analytical procedures.
11-29 a. 3
b. 4
c. 5
d. 1
11-12
11-30
a. No adjustment is needed. The goods were received before December 31, 2009
and recorded in the Purchases Journal in December.
c. No adjustment is needed. The goods were received before December 31, 2009
and recorded in the Purchases Journal in December.
Supplies 42,000
Accounts Payable 42,000
f. An adjustment is required. The telephone bill applies to December 2009 and the
$32,450 should be an accrued expense. The entry to correct is:
11-31 a. The accounts payable audit procedures should be directed toward searching for
proper inclusion of all accounts payable and ascertaining that recorded amounts are
reasonably stated because the primary audit purpose is to reveal any possible
material understatements.
The principal objectives of the accounts payable examination are:
1. To determine adequacy of internal control for processing and payment of
invoices.
2. To prove that amounts shown on the balance sheet are in agreement with
supporting accounting records.
3. To determine that liabilities existing at the balance sheet date have been
reconciled.
11-13
b. Mincin is not required to use accounts payable confirmation procedures. The
auditor, with three exceptions, is required to obtain direct confirmation of accounts
receivable, since the primary audit test is for possible material overstatements and
generally the client has available only internal documents such as sales invoices. For
accounts payable, however, the auditor can examine external evidence such as
vendor invoices and vendor statements which substantiate the accounts payable
balance. Although not required, the accounts payable confirmation is often used.
The auditor might consider such use when:
1. Internal controls are weak.
2. The company is in a "tight" cash position and bill paying is slow.
3. Physical inventories exceed general ledger inventory balances by significant
amounts.
4. Certain vendors do not send statements.
5. Vendor accounts are pledged by assets.
6. Vendor accounts include unusual transactions.
7. Change in personnel or management behavior related to payables.
c. A selection technique using the large dollar balances of accounts is generally used
when the primary audit objective is to test for overstatements (e.g., accounts
receivable audit work). Accounts with zero balances or relatively small balances
would not be subjected to selection under such an approach. When auditing
accounts payable, the auditor is primarily concerned with the possibility of
unrecorded payables or understatement of recorded payables. Selection of accounts
with relatively small or no balances for confirmation is the more efficient direction
of testing, since understatements are more likely to be detected when examining
such accounts.
When selecting accounts payable for confirmation, the following procedures
could be followed:
1. Analyze the accounts payable population and stratify it into accounts with large
balances, accounts with small balances, accounts with zero balances, etc.
2. Use a sampling technique that selects items based on criteria other than the dollar
amount of the items (e.g., select based on terminal digits, select every nth item
based on predetermined interval, etc.).
3. Design a statistical sampling plan that will place more emphasis on selecting
accounts with zero balances or relatively small balances, particularly when the
client has had substantial transactions with such vendors during the year.
4. Select prior-year vendors who are no longer used.
5. Select new vendors used in the subsequent period.
6. Select vendors that do not provide periodic statements.
7. Select accounts reflecting unusual transactions during the year.
8. Select accounts secured by pledged assets.
11-14
Solution to Internet Assignment
11-33 A search of the SEC’s website should identify a recent company that has been cited by
the SEC for issues related to the recognition of expenses.
11-15