Auditing Lecture 9

Auditing the Purchasing Process

 Learning Objectives
Understand
— Types of transactions in the purchasing process and the financial
statement accounts affected
— Document and records used and the functions
— Inherent risks and know how to assess control risk
— Develop relevant tests of controls for purchasing and purchase return
transactions
— substantive analytical procedures and tests of details of account balances
and disclosures used to audit accounts payable and accrued expenses
— Understand how confirmations are used to obtain evidence about
accounts payable

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 Expense and Liability Recognition (IASB)

Expenses are decreases

in economic benefits
A liability is a present
during the accounting
obligation of the entity
period in the form of
arising from past
outflows or depletions of
events, the settlement
assets or incurrences of
of which is expected to
liabilities that result in
result in an outflow
decreases in equity,
from the entity of
other than those relating
resources embodying
to distributions to equity
economic benefits
participants
 Overview of the Purchasing Process
1. A purchase transaction usually begins with a purchase
requisition generated by the user department.
2. The purchasing department prepares a purchase order that is
sent to the vendor.
3. Receiving the Goods or Services. Goods are received by
company and evidenced by preparing a Receiving Report
4. When the goods are received or the services rendered, record
the assets or expense and related liability. Vendor bills company
for goods using a Vendor’s Invoice.
5. The entity pays the vendor.
Purchase Purchase Receiving
requisition order report and
liability Vendor
recorded
 Types of Transactions and Financial Statement
Accounts Affected

Type of Transaction Account Affected

Purchase Transaction
Cash disbursement transaction
Purchase return transaction
Accounts payable
Inventory
Purchases or cost of goods sold
Various asset and expense accounts
Cash
Accounts payable
Cash discounts
Various asset and expense accounts
Purchase returns
Purchase allowances
Accounts payable
Various asset and expense accounts
 Types of Documents and Records

Purchasing documents and records . . .

1. Purchase Requisition – request to purchase goods or services.
2. Purchase Order – includes description, quality, and quantity of goods
or services being purchased.
3. Receiving Report – records the receipt of goods.
4. Vendor Invoice – the bill from the vendor.
5. Voucher – serves as the basis for recording a vendor’s invoice.
6. Voucher Register – used to record vouchers for goods and services.
7. Accounts Payable Subsidiary Ledger – includes amount owed to
individual vendors.
8. Vendor Statement – represents the purchase activity with vendor.
9. Electronic Funds Transfer and Cheques – pays for goods or
services.
10. Cash Disbursements Journal – contains columns to record credits to
cash and debits to accounts payable and cash discounts.
Multiple-choice Question

Ball Corp, which has no perpetual inventory records, takes a

monthly physical inventory and reorders any item below a
certain threshold. On 3rd May 2019 the company ordered 5,000
units of item A. On 6th May 2019 the company received 5000
units of item, A which had been ordered on 4th April 2019. To
prevent this excess ordering the company should:
A. keep a record of open purchase orders and review it before
ordering
B. use perpetual inventory records indicating goods received, issued
and amounts on hand
C. use pre-numbered purchase orders
D. prepare purchase orders only on the basis of purchase
requisitions
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 The Major Functions

Functions of the Purchasing Process

Initiation and approval of requests for goods and services
Requisitioning by authorized individuals consistent with management
criteria.
Approval of purchase orders and proper execution as to
Purchasing
price, quantity, quality and vendor.
Receiving Receipt of properly authorized goods and services.
Processing of vendor invoices for goods and services
Invoice processing received; also, processing of adjustments for allowances,
discounts and returns.
Disbursements Processing of payment to vendors.
Recording of all vendor invoices, cash disbursements and
Accounts payable
adjustments in individual vendor accounts.
Proper accumulation, classification, and summarization of
General ledger purchases, cash disbursements and payables in the
general ledger.
 Key Functions and Duties
Segregation of Duties
The purchasing function should be
segregated from the requisitioning purchasing, and receiving functions, fictitious purchases
and receiving functions.
The invoice-processing function
should be segregated from the
accounts payable function.
The disbursement function should be
segregated from the accounts
payable function.
The accounts payable function
should be segregated from the
general ledger function.
Possible Errors or Fraud
If one individual is responsible for the requisition,
can be made. This can result in the theft of goods and
possibly payment for unauthorized purchases.
If one individual is responsible for the invoice-
processing and accounts payable function, purchase
transactions can be processed at the wrong price or
terms, or a cash disbursement can be processed for
goods not received. This can result in overpayment of
goods or the theft of cash.
If one individual is responsible for the disbursement
function and also has access to the accounts payable
records, unauthorized checks supported by fictitious
documents can be issued, and unauthorized
transactions can be recorded. This can result in theft of
the entity's cash.
If one individual is responsible for the accounts
payable records and also for the general ledger, that
individual can conceal any defalcation that would
normally be detected by reconciling subsidiary records
with the general ledger control account.
 The Key Segregation of Duties

Department
Purchasing and Accounts Accounts
Payable Purchasing Receiving Payable Cashier's IT
Preparation and approval of
purchase order X
Receipt, counting and inspection
of purchased materials X
Receipt of vendor
invoices/matching to supporting
documents X
Coding of account distributions X
Updating of accounts payable
records X X
Preparation of payments to
vendors X
Electronic funds transfer, and
signing and mailing of cheques X
Preparation of the voucher
register X
Reconciliation of voucher register
to general ledger X
 Inherent Risk Assessment

Industry-Related Factors

2.
1.Is the supply of raw
How volatile are
materials
raw material
adequate?
prices?
 Inherent Risk Assessment

Misstatements Detected in Prior Audits

Generally, the purchasing process is not
difficult to audit and does not present
contentious accounting issues. However, the
auditor’s experience in past audits must be
considered when assessing inherent risk.
 Control Risk Assessment

Major steps in setting the control risk in the

purchasing process.
Understand and document the purchasing process
based on a reliance strategy.

Plan and perform tests of controls of purchase

transactions.

Set and document the control risk for the purchasing

process.
 Control Risk Assessment
Information Systems and Communication
For each major class of transactions in the purchasing
process, the auditor must obtain the following information:

1. How purchase, cash disbursements and purchase return

transactions are initiated.
2. The accounting records, supporting documents and accounts
involved in processing purchases, cash disbursements and purchase
returns.
3. The flow of each type of transaction from initiation to inclusion in
the financial statements, including computer processing.
4. The process used to estimate accrued liabilities.
 Control Risk Assessment

After testing controls, the auditor sets the level of control

risk. When tests of controls support the planned level of
control risk, no modifications are necessary to detection
risk. The auditor may proceed with the substantive
procedures as planned.

When tests do not support the

planned control risk, the auditor
decreases (increases) the level of
detection risk leading to more
(less) substantive procedures.
 Control Activities and Tests of Controls – Purchase
Transactions
Assertions about Classes of Transactions and Events

All purchases and cash disbursements have been

Occurrence
recorded and have occurred and pertain to the entity.
All purchases and cash disbursements that should
Completeness
have been recorded have been recorded.
All purchase and cash disbursements are properly
Authorization
authorized.
Amounts relating to recorded purchases and cash
Accuracy disbursements have been recorded properly and
properly accumulated from journals to ledgers.

Cut-off
Purchases and cash disbursements have been
recorded in the correct accounting period.
Purchases and cash disbursements have been
Classification
recorded in the proper account.
Control Activities and Tests of Controls – Purchase
Transactions
Assertions Tests of Controls
Observe and evaluate proper segregation of duties. Test a sample
of vouchers for the presence of an authorized purchase order
Occurrence
and receiving report. Examine paid vouchers and supporting
documents for indication of cancellation.
Review procedures for accounting for numerical sequence of
purchase orders, receiving reports, and vouchers. Trace a sample
Completeness
of receiving reports to their vendor invoices and vouchers. Trace
a sample of vouchers to the purchases journal.
Examine purchase requisitions or purchase orders for proper
Authorization
approval. Review client's competitive bidding process.
Recompute the mathematical accuracy of vendor invoice. Agree
information in the sample of vouchers for product, quantity, and
Accuracy
price. Examine reconciliation of vouchers to daily accounts
payable report.
Compare the dates on receiving reports with the dates on the
Cut-off relevant vouchers. Compare the dates of vouchers with the dates
they were recorded in the purchases journal.
Review purchases journal and general ledger for reasonableness.
Classification
Examine a sample of vouchers for proper classification.
Control Activities and Tests of Controls – Purchase
Return Transactions

Generally, the number and magnitude of

purchase return transactions are not material.
The auditor normally does not test controls
relating to purchase returns. Substantive testing
is used to test the reasonableness of the amount.
 Relating the Assessed Level of Control Risk to
Substantive Procedures

If the results of the tests of controls support the

planned level of control risk, the auditor conducts
substantive procedures at the planned level. If
the results do not support the planned level of
control risk, the auditor reduces the detection
risk, which will increase substantive procedures.
 Auditing Accounts Payable and Accrued Expenses

Assertions about Account Balances at the Period End:

Existence. Accounts payable and accrued expenses are valid
liabilities.
Rights and obligations. Accounts payable and accrued
expenses are obligations of the entity.
Completeness. All accounts payable and accrued expenses
have been recorded.
Valuation and allocation. Accounts payable and accrued
expenses are included in the financial statements at appropriate
amounts, and any resulting valuation or allocation adjustments
are appropriately recorded.
Auditing Accounts Payable and Accrued Expenses
Assertions about Presentation and Disclosure:
Occurrence and rights and obligations. All disclosed events, transactions,
and other matters relating to accounts payable and accrued expenses have
occurred and pertain to the entity.
Completeness. All disclosures relating to accounts payable and accrued
expenses that should have been included in the financial statements have been
included.
Classification and understandability. Financial information relating to
accounts payable and accrued expenses is appropriately presented and
described, and disclosures are clearly expressed.

Accuracy and valuation. Financial and other information relating to accounts

payable and accrued expenses are disclosed fairly and at appropriate amounts.
Auditing Accounts Payable and Accrued Expenses
Substantive Analytical Procedures
Substantive Analytical Procedure Possible Misstatement Detected
Compare payables turnover and days
Under- or overstatement of liabilities and
outstanding in accounts payable to previous
expenses.
years' and industry data.
Compare current-year balances in accounts
Under- or overstatement of liabilities and
payable and accruals with prior years'
expenses.
balances.
Compare amounts owed to individual
vendors in the current year's accounts Under- or overstatement of liabilities and
payable listing to amounts owed in prior expenses.
years.

Compare purchase returns and allowances Under- or overstatement of purchase

as a percentage of revenue or cost of sales returns.
to prior years' and industry data.
Tests of Details of Transactions, Account Balances
and Disclosures
Accuracy
• Obtain a listing of accounts payable, foot the
listing, and agree it to the general ledger control
account.
• Selected vouchers or vendor accounts should be
traced to the supporting documents or subsidiary
accounts payable records to verify the accuracy of
the details.
 Tests of Details of Transactions, Account Balances
and Disclosures
Completeness
Test of unrecorded liability following the following procedures
1. Ask management about control activities used to identify unrecorded
liabilities at the end of the period.
2. Obtain copies of vendors’ monthly statements and reconcile the
amounts to the client’s accounts payable records.
3. Confirm vendor accounts, including accounts with small or zero
balances.
4. Vouch large monetary items from the purchases journal and cash
disbursements journal for a limited time after year-end.
5. Examine the files of unmatched purchase orders, receiving reports,
and vendor invoices for any unrecorded liabilities.
Tests of Details of Transactions, Account Balances
and Disclosures
Existence

• The auditor’s major concern is whether the recorded

liabilities are valid obligations of the entity.
• The auditor should vouch a sample of items on the
listing of accounts payable to other supporting
documents.
Tests of Details of Transactions, Account Balances
and Disclosures
Cut-off
The auditor attempts to determine if all purchase
transactions are recorded in the proper period. On
most audits, the purchase cut-off is coordinated with
the client’s physical inventory count. Proper cut-off
should also be determined for purchase return
transactions.
Tests of Details of Transactions, Account Balances
and Disclosures

Rights and Obligations

There is little risk related to this assertion

because clients seldom have an incentive to
record liabilities that are not obligations of the
entity.
Tests of Details of Transactions, Account Balances
and Disclosures
Valuation
§ Accounts payable are recorded at either
the gross amount of the invoice or net of
cash discount amount.
§ The valuation of accruals depends upon
the type and nature of the accrued
expense. Most accruals are relatively easy
to value.
Tests of Details of Transactions, Account Balances
and Disclosures
Classification, Presentation and Disclosure
Major classification issues include . . .
1. Identifying and reclassifying any material debits
contained in accounts payable.
2. Segregating short-term and long-term payables.
3. Ensuring that different types of payables are
properly classified.
Tests of Details of Transactions, Account Balances
and Disclosures
Disclosure Items for the Purchasing Process
Payables by type Purchases from and
(trade, employees, payables to related
etc.). parties.

Short- and long-term Dependence on a single

payables. vendor or a small number
of vendors.
Long-term purchase
contracts, including Costs by reportable
any unusual purchase segment of the business.
commitments.
 Accounts Payable Confirmation

• Accounts payable confirmations are used less

often than accounts receivable confirmations.
• The auditor is able to examine externally created
source documents relating to accounts payable.
• When confirmations are used they are usually
positive and referred to as blank confirmations.
The vendor is asked to supply the balance owed
by the client.
 Evaluating the Audit Findings

§ The auditor compares the aggregated identified

misstatement to materiality to determine if the identified
misstatement would affect the audit.
§ The auditor requests the client to correct the identified
misstatements and then compares the uncorrected
misstatements with materiality to conclude whether the
financial statements are fairly stated.

• If uncorrected misstatements in accounts payable, when

considered together with other uncorrected
misstatements, are less than materiality, the auditor may
accept that the financial statements are fairly presented.
• Conversely, if the uncorrected misstatement exceeds the
materiality, the auditor should conclude that the financial
statements are not fairly presented.
Exercises and Group Discussions

11-13, 11-16

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