Study unit 7

Purchases and payments cycle

GEAR111
Auditing Fundamentals 2nd edition
Chapter 7 (page 259 to 307)
Learning outcomes
After completion of this study unit, you should be able to:
• explain the nature and purpose of the purchases and payments cycle;
• demonstrate an understanding of a typical transaction in the purchases
and payments cycle;
• identify and describe the major general ledger accounts affected by the
purchases and payments cycle;
• explain the accounting treatment required for some of the transactions
in the purchases and payments cycle;
• list the purchases and payments cycle’s functional areas;
• describe each of the purchases and payments cycle’s functional areas,
with specific reference to the purpose, main activities, and persons
involved;
• demonstrate an understanding of the information system used in the
purchases and payments cycle;
Learning outcomes
After completion of this study unit, you should be able to:
• name and describe the documents and records utilised in the purchases and
payments cycle and the purpose of each;
• describe the flow of transactions in the purchases and payments cycle through the
information system, including its relation to source documents and accounting
records and its relation to classes of transactions and events, and balances;
• identify and describe the risks of material misstatement affecting the account
balances, classes of transactions and events in the financial statements in the
purchases and payments cycle;
• demonstrate a basic understanding of the computer technologies typically applied in
the purchases and payments cycle;
• describe the control objectives for the revenue and receipts cycle;
• demonstrate an understanding of how internal controls may assist in achieving the
control objectives in the revenue and receipts cycle and how these control objectives
relate to management's assertions in the financial statements;
• describe the internal control activities for the revenue and receipts cycle and
• apply all of the above-mentioned in a case study.
Content
Nature and purpose, typical transaction
Major general ledger accounts and accounting
Functional areas (functions)
Information system, documents and records
Flow of transactions
Risk of material misstatement
Computer technologies
Control objectives, link to cycle, link to assertions
Internal control activities
 Acquisition of goods
(NOT capital assets) Acquisition of services

Payments to suppliers
in exchange
Nature and purpose

Business function Accounting function

Sufficient products and services are purchased at a competitive price in order to satisfy the
demand from customers

The purchase is promptly and appropriately recorded in the financial records

Suppliers are paid in a timely manner for only those goods and services actually purchased

Auditing Fundamentals page 261 - 262

 Construction PURCHASE: PAYMENT:
Purchase Payment – made
requisition from to supplier based
warehouse on invoice
Manufacturing

Internal controls

Internal controls
Nature and purpose

Retail

Wholesale PURCHASE: PAYMENT:

Purchase / service Payment recorded
recorded in in cash book & GL
For use e.g. purchase journal and cash in
stationery,
fuel, etc. & GL bank

Auditing Fundamentals page 261 - 262

 CREDIT

Requesting goods

Order the goods

Receive the goods

Invoice from supplier

Typical transaction

Record purchase

Make payment

Record payment

Auditing Fundamentals page 262 - 263

Major general ledger accounts and

Period costs –
Cost of sales expenses
XX XX
XX

Cash and cash Inventory Trade and other

equivalents payables
XX XX XX XX XX
accounting

XX XX XX
XX

Auditing Fundamentals page 263 - 266

 Purchase Ordering goods and Receiving goods and
requisition services from suppliers services from suppliers

Recording of Payment Paying the

purchases preparation supplier
Functional areas

Returning goods and

Recording of
recording a purchase
payments
adjustment

Auditing Fundamentals page 267 - 269

 Purchase Ordering goods and Receiving goods and
requisition services from suppliers services from suppliers

Warehouse Buying staff Goods receiving clerk

Functional areas

Auditing Fundamentals page 267 - 269

 Recording of Payment Paying the
purchases preparation supplier

Accounts payable Accounts payable Management staff

clerk clerk
Senior bookkeeping Senior accounting
Functional areas

clerk staff

Auditing Fundamentals page 267 - 269

 Returning goods and
Recording of
recording a purchase
payments
adjustment

Cash book clerk Warehouse staff

Accounts payable
Functional areas

clerk
Senior financial and
accounting staff

Auditing Fundamentals page 267 - 269

 Source documents Journals Ledgers

Financial statements
Period costs –
Cost of sales expenses
XX XX
XX
Information system

Cash and cash Inventory Trade and other

equivalents payables
Cash
XX / XX/
Cash XX XX
Payments XXCredit
Payments / Other
XX XX
credit XX
XX

Auditing Fundamentals page 269 - 270

 Masterfile
Purchase Purchase
amendment Quotation
form requisition order

Supplier Goods
Supplier Supplier
delivery received
Documents and records

invoice statement
note note
Remittance Goods
returned to
advice supplier
Debit note
(POP) voucher

Cash Purchase
Purchase General
payments returns
journal journal
journal journal

Creditors General
ledger ledger

Auditing Fundamentals page 270 - 275

 Creditors Inventory
ledger list
Documents and records

Creditors
Creditors
age
list
analysis
Supplier
Creditors
statement
reconciliation
reconciliation

Auditing Fundamentals page 270 - 275

Flow of transactions

Refer to diagrams in 7.3.6 in Chapter 7 as per the above for details of major
activities, documentation created and flow of transactions in the cycle.
Also refer to page 289 – 307 (next session).

Auditing Fundamentals page 275 - 278

 Financial
reporting risks
Risk of material misstatement

Major risk affecting Major risk affecting

EXPENSES PAYMENTS

Not all Invalid Not all Invalid

recorded recorded
Incorrect
Not recorded financial
accurately period
Not classified
appropriately

Auditing Fundamentals page 278 - 279

 Misappropriation
risks
Risk of material misstatement

Theft of assets Theft of assets

(INVENTORY) (CASH)

Received from Stolen before

supplier & paying to
stolen supplier

Auditing Fundamentals page 280

 Electronic funds Electronic data
transfer (EFT) interchange (EDI)
Computer technologies

Auditing Fundamentals page 280 - 281

Control objectives

Risks

Validity Completeness Accuracy

Authorised No omissions Correct

Occurred

Auditing Fundamentals page 281 - 283

Control objectives
CONSEQUENCE

Overstatement?

Validity Understatement?

Unauthorised purchases.
Purchases /
Authorised Purchase returns
Unauthorised purchase returns.

Fictitious purchases.
Purchases recorded in the incorrect financial period.
Purchases /
Occurred Purchase returns
Fictitious purchase returns.
Purchase returns recorded in the incorrect financial
period.
Auditing Fundamentals page 281 - 283
Control objectives
CONSEQUENCE

Overstatement?

Validity Understatement?

Invalid payments (e.g. recording in the wrong period).

Invalid payments (due to misappropriation – e.g.
Authorised Payments employee paying personal expenses that are recorded as
entity expenses).

Invalid payments (e.g. recording in the wrong period).

Invalid payments (due to misappropriation – e.g.
Occurred Payments employee paying personal expenses that are recorded as
entity expenses).

Auditing Fundamentals page 281 - 283

Control objectives
CONSEQUENCE

Overstatement?

Completeness Understatement?

Purchases / Incomplete purchases.

No omissions Purchase returns Incomplete purchase returns.

Auditing Fundamentals page 281 - 283

Control objectives
CONSEQUENCE

Overstatement?

Completeness Understatement?

No omissions Payments Incomplete payments.

Auditing Fundamentals page 281 - 283

Control objectives
CONSEQUENCE

Overstatement?

Accuracy Understatement?

Purchases /
Correct Purchase returns
Inaccurate purchases and purchase returns.

Auditing Fundamentals page 281 - 283

Control objectives
CONSEQUENCE

Overstatement?

Accuracy Understatement?

Correct Payments Inaccurate payments.

Auditing Fundamentals page 281 - 283

Link to cycle

CREDIT Valid?

Requesting goods

Order the goods Complete?

Receive the goods

Invoice from supplier

Accurate?
Record purchase

Make payment

Record payment
Auditing Fundamentals page 283 - 286
Link to assertions

Validity Completeness Accuracy

Assertions (Representations by the board (AFS))

Occurrence Accuracy
Completeness
Cut-off Classification

Accuracy,
Existence Completeness valuation & allocation
Rights Classification

Auditing Fundamentals page 283 - 286

Internal control activities
Documentation and records:
Document design, stationery controls, chart of accounts
PO properly designed and placed under proper stationery control

Used in conjunction with a proper chart of accounts

Authorisation and approval:

Levels of authorisation, isolation of responsibility
A new supplier is added to the entity’s approved list of suppliers

A payment is made to a supplier

Segregation of duties:
Incompatible duties performed by different employees
Initiation of a transaction vs Approval of the transaction

Auditing Fundamentals page 286 - 288 Execution of the transaction vs Recording of the transaction
Internal control activities
Access control:
Control / restrict access, safeguarding
The entity takes custody of goods from a supplier

A payment is made to a supplier (in cash or by cheque or EFT)

Independent checks and reconciliation:

Checks / reviews, signatures, reconciliations
Agreeing purchase transaction information collected by the entity to the
supplier’s invoice before the transaction is recorded in the purchase
journal
Performing a creditors’ reconciliation

Auditing Fundamentals page 286 - 288

Learning outcomes
After completion of this study unit, you should be able to:
• explain the nature and purpose of the purchases and payments cycle;
• demonstrate an understanding of a typical transaction in the purchases and payments cycle;
• identify and describe the major general ledger accounts affected by the purchases and payments cycle;
• explain the accounting treatment required for some of the transactions in the purchases and payments cycle;
• list the purchases and payments cycle’s functional areas;
• describe each of the purchases and payments cycle’s functional areas, with specific reference to the purpose, main
activities, and persons involved;
• demonstrate an understanding of the information system used in the purchases and payments cycle;
• name and describe the documents and records utilised in the purchases and payments cycle and the purpose of
each;
• describe the flow of transactions in the purchases and payments cycle through the information system, including
its relation to source documents and accounting records and its relation to classes of transactions and events, and
balances;
• identify and describe the risks of material misstatement affecting the account balances, classes of transactions and
events in the financial statements in the purchases and payments cycle;
• demonstrate a basic understanding of the computer technologies typically applied in the purchases and payments
cycle;
• describe the control objectives for the revenue and receipts cycle;
• demonstrate an understanding of how internal controls may assist in achieving the control objectives in the
revenue and receipts cycle and how these control objectives relate to management's assertions in the financial
statements;
• describe the internal control activities for the revenue and receipts cycle and
• apply all of the above-mentioned in a case study.
 ©
Copyright © 2024 edition.
Prepeared by: Rolé van der Merwe
North-West University, Potchefstroom, South Africa.

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