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Auditing and Assurance Services 5th Edition Louwers Solutions Manual 1
Auditing and Assurance Services 5th Edition Louwers Solutions Manual 1
CHAPTER 08
LEARNING OBJECTIVES
Review Exercises,
Multiple Choice
Checkpoints Problems, and
Simulations
3. Give examples of tests of controls over 7, 8, 9 24, 27, 28, 32, 33, 39(*), 45(*)
purchases of inventory and services. 38
4. Explain the importance of the 10, 11 26, 29, 30, 31, 37 40, 41, 42, 50,
completeness assertion for the audit of 52, 53
accounts payable, and list some
procedures for a search for
unrecorded liabilities.
5. Discuss audit procedures for other 12, 13, 14, 15, 35, 36 45(*), 46, 47,
accounts affected by the acquisition 48, 49, 51
and expenditure cycle.
8-1
Chapter 08 - Acquisition and Expenditure Cycle
6. Specify some ways fraud can be found 16, 17, 18 39(*), 43, 45
in accounts payable and cash
disbursements.
7. Describe some common errors and 19, 20, 21, 22 39(*), 43, 44,
frauds in the acquisition and 45(*)
expenditure cycle and design some
audit and investigation procedures for
detecting them.
8. Describe the payroll cycle, including 8C1, 8C2 8C3, 8C8, 8C9, 8C10, 8C16, 8C17,
typical source documents and controls. 8C4, 8C5, 8C6, 8C11, 8C12, 8C13, 8C18, 8C19,
8C7, 8C14, 8C15 8C20
8-2
Chapter 08 - Acquisition and Expenditure Cycle
8.2 A voucher is a package of documents, usually with a cover page. (The package can be a small envelope.)
The voucher package contains supporting documents for a transaction. For example, a purchase voucher
usually contains a purchase requisition, purchase order, receiving report, vendor invoice, and a negotiable
check (check copy when the vendor invoice has been paid). Required approvals and signatures are on the
documents. The voucher presents evidence of the documentation and control over a transaction.
Computerized systems may have all this documentation in memory.
In a voucher system, each voucher is “payable” and the detail of the payables is the vouchers themselves.
At any time, the company may owe a single vendor more than one invoice represented on several vouchers.
In a voucher system, there is no balance payable to each vendor—just a file of different vouchers payable.
8.3 A purchasing manager can direct purchases toward vendors who provide the manager kickbacks or other
inducements. This can be prevented by notifying suppliers that the company will not permit payment of
kickbacks to its employees. The company can also rotate purchasing managers to different vendors. Finally,
significant purchases should be reviewed and approved by a higher level manager.
8.4 A “blind” purchase order is one that does not show the quantity ordered. It is given to the receiving
department so personnel there will know what has been ordered, but they will have to do an independent
count. If a blind purchase order is not used, receiving personnel may not count the goods received and just
record the amount indicated on the purchase order.
8.5 You will find evidence about losses on purchase commitments in the open purchase order file. Evidence
about unrecorded liabilities to vendors is in the (a) unmatched invoice file and (b) unmatched receiving
report file.
8.6 Management reports that can be used for audit evidence, and information in them can be useful to auditors
are as follows:
Unmatched receiving reports: Goods received but not recorded as purchases or liabilities.
Unmatched vendor invoices: Unrecorded invoices that may represent unrecorded liabilities or
items in dispute
Accounts payable trial balance: Subsidiary ledger of accounts payable that may show balances by
vendors, indicating small balances that should be large. Invoice dates may reveal failure to record
invoices late in the accounting period.
Purchases journal: Listing of all purchases available for analysis of purchasing patterns and
oddities. Population for sample of purchases for tests of controls.
Fixed asset reports: Fixed assets subsidiary ledger trial balance. Scan for negative balances,
capitalized repairs, and depreciation in excess of salvage value; depreciation recalculation.
8.7 The functions that should be separated to maintain internal control in a purchasing system include (a)
custody of the goods (receiving and stores departments), (b) authority to initiate a transaction (purchasing
department), (c) bookkeeping (accounts payable department, inventory record-keeping department), and (d)
periodic physical counts (reconciliation) of inventory and fixed assets.
8-3
Chapter 08 - Acquisition and Expenditure Cycle
8.8 (a) Blank vouchers kept in secure location available only to authorized personnel.
(b) Blank supporting documents (invoices, receiving reports, requisitions, purchase orders) kept in
secure locations available only to authorized personnel.
(c) Supporting documents canceled by the cash disbursement function when checks are prepared.
(d) Separation of duties of preparers of supporting documents, preparation of vouchers, check
preparation, and check signing.
(e) Vouchers and other supporting documents reviewed by check signers.
(f) Checks mailed directly by signer and not returned to accounts payable.
8.9 (a) A low risk of material misstatement would normally result in a strategy by which the auditor relies on
controls and reduces substantive tests. First, the auditor would confirm the low control risk evaluation by
testing controls for effectiveness. More reliance would also be placed on analytical procedures. (b) High
risk of material misstatement would result in a more substantive approach with little control testing.
8.10 The purpose of the auditor’s search for unrecorded liabilities is to gather evidence as to whether the
completeness assertion is true. From an evidence-gathering perspective, it is much more difficult to gather
evidence on unrecorded transactions than to gather evidence that recorded account balances exist.
Inquire of client personnel about their procedures for ensuring that all liabilities are recorded.
Scan the open purchase order file at year-end for indications of material purchase commitments at fixed
prices. Obtain current prices and determine whether any adjustments for loss and liability for purchase
commitments are needed.
Examine the unmatched vendor invoices listing and determine when the goods were received, looking
to the unmatched receiving report file and receiving reports prepared after the year-end. Determine which
invoices, if any, should be recorded.
Trace the unmatched receiving reports to accounts payable entries, and determine whether entries
recorded in the next accounting period need to be adjusted to report them in the current accounting period
under audit.
Select a sample of cash disbursements from the accounting period following the balance sheet date.
Vouch them to supporting documents (invoice, receiving report) to determine whether the related
liabilities were recorded in the proper accounting period.
Confirm accounts payable with vendors (especially regular suppliers showing small or zero balances in
the year-end accounts payable.
8.11 Financial statement users are most troubled by overstated assets and understated liabilities. Therefore, they
need to audit for the existence of assets and the completeness of liabilities.
8.12 Typically, when auditing prepaids and accruals, the auditor uses audit documentation that shows beginning
balances, payments, expense, and ending balance. By agreeing beginning balance to prior-years audit
documentation, vouching payments, and calculating the accuracy of the ending balance, the auditor knows
that the amount charged to expense will be correct.
8.13 Noncurrent assets such as property, plant, and equipment and intangibles usually pertain to all four
management assertions about account balances: existence, completeness, rights and obligations, and
valuation and allocation. The auditor must ensure that they exist and are owned. In addition, the valuation
determined by depreciation, amortization, or impairment charges is usually an important issue. Of the four
assertions, completeness is probably the least important, but it cannot be ignored.
8-4
Chapter 08 - Acquisition and Expenditure Cycle
8.14 The auditor is primarily concerned with current-year transactions in property, plant, and equipment
accounts, assuming that the previous year’s balances were audited. Thus, additions, disposals, and
depreciation charges warrant the most attention.
8.15 Most expense accounts can be tested through analytical review procedures, substantive tests of transactions,
or by testing them in conjunction with tests of related assets and liabilities (e.g., depreciation). Some
expenses should be examined separately because of their unique nature (e.g., legal expenses or
miscellaneous expense).
8.16 The following are possible red flags indicating a risk of fraud:
Photocopies of invoices in the files.
Vendor’s invoices submitted in numerical order.
Vendor’s invoice amounts always in round numbers.
Vendor’s invoices always slightly lower than a review threshold.
Vendors with only post office box addresses.
Vendors with no listed telephone number.
Matching vendor and employee addresses or telephone numbers.
Multiple vendors at the same address and telephone number.
Vendors not on the approved vendor list.
Knowing the address of the local mail drops (e.g., shipping and packaging stores that accept client
mail). These stores could provide a street address for fraudulent companies, adding false
legitimacy to their fraudulent invoices.
8.17 The auditor should begin by inquiring of the client about its knowledge of fraud or fraud risks. Analytical
review procedures such as vertical and horizontal analyses can pinpoint accounts that appear to have
unusual fluctuations. Examining invoices and vendor files for the red flags noted in 8.16 will help find
phony billings. The purpose is to identify fraud risk, evaluate the significance of the risk, and determine the
amounts of any actual fraud on the financial statements.
8.18 These procedures are directed at misappropriation of assets by embezzlement. Embezzlement occurs when
employees and their associates are stealing assets from the company by having it pay phony expenses.
8.19 Argus did not have separation of duties. Different people should have authorized the copying services,
approved the bills for payment, and coded them to projects. A supervisor should have been reviewing the
expenses and comparing them to the budget.
8.20 The verbal inquiry procedure might produce knowledge of employee’s responsibilities to authorize
purchases of script copies, receive them, approve payment, and code invoices to projects.
8.21 Given Beta Magnetic’s poor internal controls, it is possible that Martha would never have been caught.
However, if the company ever contacted employees about their health claims, they would have revealed the
fictitious charges.
8.22 If Martha had taken a mandatory vacation, her replacement would probably have questioned the billings
from unknown physicians. If the billings stopped, the sharp drop in insurance costs for that period would
likely be questioned by Martha’s superior.
8-5
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