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TOPIC 3
AUDIT OF PURCHASE CYCLE

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EXPENSE RECOGNITION

Expenses are generally recognized when an entity's

economic benefits are used up in delivering or
producing goods, or rendering services.

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CATEGORIES OF EXPENSES

 Product costs-cost of goods sold

 Period costs-administrative salaries
 Allocable costs-10% for depreciation

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TYPES OF TRANSACTIONS

 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.

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FINANCIAL STATEMENT
ACCOUNTS
 Purchase transaction:
 Accounts payable
 Inventory
 Cost of goods sold
 Various expense accounts

 Cash disbursement transaction:

 Cash
 Accounts payable
 Cash discounts

 Purchase return transaction:

 Purchase returns
 Purchase allowances
 Accounts payable

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DOCUMENTS AND RECORDS

 Purchase requisition.  Voucher register/purchase journal.
 Purchase order.  Accounts payable subsidiary ledger.
 Receiving report.  Vendor statements.
 Vendor invoice.  Check.
 Voucher.  Cash disbursements journal/check
register.

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FUNCTIONS

 Requisitioning
 Purchasing
 Receiving
 Invoice processing
 Disbursements
 Accounts payable
 General ledger

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SEGREGATION OF DUTIES

 The purchasing function should be segregated from the

requisitioning 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.

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INHERENT RISK ASSESSMENT

 Industry-related factors-adequate/volatile (high

technology)
 Misstatements detected in prior audits-starting
point for determining the inherent risk

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CONTROL RISK ASSESSMENT

Understanding and documenting

the purchasing internal control system based
on the planned level of control risk

Planning and performing tests of controls

on purchasing cycle transactions

Assessing and documenting the

control risk for the purchasing cycle

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CONTROL PROCEDURES AND

TESTS OF CONTROLS -
PURCHASE RETURNS TRANSACTIONS
 The number and magnitude of purchase returns
transactions is generally not material for most entities.
 Because of the possibility of manipulation the auditor
should at a minimum inquire about how the client
controls purchase return transactions.
 When goods are returned to a vendor, the client usually
prepares a debit memo that reduces the amount of the
vendor's accounts payable.
 Analytical procedures are usually performed.

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SUBSTANTIVE TESTS OF
TRANSACTIONS

 The intended objective of such tests is to detect

monetary misstatements.

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ANALYTICAL PROCEDURES

 Compare payables turnover and days outstanding in

accounts payable to previous years’ and industry data.
 Compare the current-year balances in accounts payable
and accruals with prior years' balances.
 Compare amounts owed to individual vendors in the
current year's accounts payable listing to amounts owed in
prior years.
 Compare purchase returns and allowances as a percentage
of revenue or cost of sales to prior years’ and industry data.

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TESTS OF ACCOUNT BALANCES

The test of account balances for each audit objective.

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SEARCH FOR UNRECORDED

LIABILITIES (COMPLETENESS)
 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 accounts payable
records.
 Confirm accounts payable with vendors.

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SEARCH FOR UNRECORDED

LIABILITIES (continued)
 Vouch large-dollar items from the purchase journal
and cash disbursements journal for a limited period of
time after year-end; examine the dates on the receiving
report or vendors' invoice to determine if the liability
relates to the current audit period.
 Examine the files of unmatched purchase orders,
receiving reports, and vendors' invoices for any
unrecorded liabilities.

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ACCOUNTS PAYABLE
CONFIRMATIONS
 Accounts payable confirmations are generally used less
frequently by auditors than accounts receivable
confirmations because the auditor generally has access
to vendor invoices and monthly vendor statements.
 The auditor focuses on large dollar accounts, regular
vendors with small or zero balances, and a sample of
other accounts.

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ACCOUNTS PAYABLE
CONFIRMATIONS
 When confirming accounts payable, auditors generally
use a form of positive confirmation referred to as a
"blank or zero balance" confirmation.

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