Chapter 13 reading guide

Question 1

What are some examples of major risks of error, fraud and fraudulent financial reporting in the acquisition and payment cycle

What controls should be in place to reduce these risks?

Answer 1

Risks of error:
- Posting A/p for goods still in transit when ownership has not yet passed
- Payments posted to the wrong vendor account
- incorrect or confusing disclosures about vendor allowances

Fraud or Misappropriation of Assets:
- Issuing payments to fictitious vendors and stealing the funds
- Using fictitious vendor allowances to reduce accounts payable
- deliberately recording payables in the next period to understate liabilities

Fraudulent financial reporting:
- intentionally understating provisions
- failing to record a required provision
- omitting disclosures

CONTROLS:
- Authorization
- Processing
- Payment

Question 2

What is the assertion that auditors are primarily concerned with for accounts payable? Why? Why is this
more difficult for the auditor?

Answer 2

Completeness (along with cutoff)

why: because management has an incentive to understate expense and liabilities to make profits appear higher, so the risk rises that some paybles may not be recorded

why its more difficult for auditors:
- unrecorded liabilities leave no direct audit trail
- auditors must perform search procedures in order to find the unrecorded payables
- cutoff testing is also challenging because auditors must ensure liabilities are recording in the correct accounting period

Question 3

For acquisitions, describe the key controls for each transaction-related audit assertion. Provide a test of
control for each key control identified. 5

Answer 3

Occurence
- Key control: purchases authorized and supported by valid documentation
- Test of control: inspect sample of recorded acquisitions to verify authorization and supporting documents exist for each

Completeness
- Key control: all goods received are recorded in A/p system
- Test of control: trace receiving reports to related vendor invoices and entries in the purchases journal to ensure all acquisitions are recorded

Accuracy
- Key control: recorded acquisitions are mathematically accurate and agree with the vendor invoice
- Test of control: reperform calculations on a sample of invoices and check agreement between quantities, prices, and extensions to supporting documents

Classification
- Key control: acquisitions are coded to the correct accounts
- Test of control: review accounting coding on a sample of acquisitions and verify classification with chart of accounts and uspporting documents

Cutoff
- Key control: Purchases are recorded in the correct period, based on shipping terms (FOB origin/ destination
- Test of control: compare receiving reports and vendor invoices dated near year end to ensure acquisitions are recorded in the proper accounting period

Question 4

Identify some of the procedures you would perform when doing a search for unrecorded liabilities (out of liability tests) 5

Answer 4

1. Inspect subsequent cash disbursements
   - review payments made after year-end and inspect supporting documents
2. Examine unpaid bills
   - inspect bills not paid several weeks after year end
3. Trace receiving reports
   - look at receiving reports issued before year end
4. Review vendor statements
   - compare vendor statements showing balances
5. Send vendor confirmations

Question 5

What procedures are included in Cut-off tests? Why should the cut-off information for purchases be obtained
during the physical inventory observation? 3 each

Answer 5

procedure:
- reviewing receiving reports and vendor invoices dated a few days before and after year end
- verifying shipping terms to see when ownership transfers
- tracing selected transactions to ensure pruchases and related payable are record in the correct periuod

why:
- purchases affect both inventory and A/P
- During physical count, auditors can verify whether goods received before year end are included in inventory and if the related liabilities are recorded
- Coordinating cutoff testing with inventory observation ensures inventory quantities and payable are consistent, avoiding double counting or omission

Question 6

What information must be disclosed in the financial statements when there are related party transactions? 5

Answer 6

1. nature of the related party relationships - who the related parties are and how they are connected
2. nature and extent of the transactions - what transactions occurred and their terms
3. amounts due to or from related parties - outstanding balances at year end
4. Contractual obligations and contingencies - any guarantees, commitments, or other obligations from related party dealings
5. valuation considerations - whether goods or services from related parties are recorded at appropriate values

Question 7

What are accrued liabilities? Can you provide an example of a few? What are the most important audit
objectives (key risks)? What audit procedures will the auditor use to ensure that all have been recorded?

Answer 7

definition: estimated unpaid obligations for services or benefits that have been received before the balance sheet date but not yet billed or paid

examples:
- accrued wages or salaries
- accrued payroll taxes or bonuses
- accrued interest payable
- accrued utilities or professional fees

objectives:
1. completeness
2. accuracy
3. cutoff

audit procedures:
- inquire of management to identify existing accruals
- review the client’s policy for establishing accruals
- inspect supporting documentation, such as subsequent payroll journals or invoices
- recalculate accruals to verify accuracy
- assess the reasonableness of assumptions used in the estimates

Question 8

What types of analysis can be performed on equipment and related accounts (amortization, gain and /or loss
on sale of equipment, repairs and maintenance)? What possible misstatements could the analysis indicate?

Answer 8

auditors use substantive analytical procedures to test reasonableness for ppe related accounts, these include the following

1. compare current year additions to prior years to identify unexpected increases or decreases
2. Analyze repairs and maintenance expense to detect items that may have been incorrectly capitalized or expensed
3. recalculate and compare amortization (depreciation) to prior periods, considering changes in asset base or methods
4. compares gains or losses on disposal of assets to prior years and investigate significant fluctuations
5. review ppe turnover ratios

possible misstatements indicated
- misclassifciation of repairs and maintenance as assets
- misstatement of amorization expense (wrong rate, method, pvs)
- unrecorded disposals or incorrect gain/ loss calculation
- omitted or misstated impairments
- incomplete recording of new asset acquisitions

Question 9

Describe audit procedures (test of details of account balances) you would perform on equipment acquisitions
and equipment disposals and the audit assertion(s) addressed.

Answer 9

equipment acquisitions
1. inspect supporting documentation
2. review large repair and maintenance transactions
3. search for trade ins or exchanges that may affect valuation
4. physically inspect the asset to verify existence and condition
5. recalculate totlas and trace them to the general ledger and PPE subsidiary records

assertions addresed:
- existence
- valuation and accuracy
- classification
- rights and obligations

disposals:
1. inquire about disposals and review supporting documents
2. recalculate gains or losses on disposal
3. trace disposal entries
4. physically inspect locations to see if fully disposed
5. inspect acquisitions files for possible unrecorded disposals

assertions:
- existence
- completeness
- accuracy and valuation
- rights and obligations

Question 10

What is the most important assertion when testing amortization expense? Remember, this account is on the
income statement. What are some of the tests auditors perform to ensure this assertion is met?

Answer 10

most important: valuation and accuracy

audit tests to ensure accuracy:
- recompute amortization expense for a sample of assets
- review consistency of amortization methods, rates, useful lives with previous years and company policy
- compare total amortization expense with prior periods and investigate unexpected fluctuations
- inspect PPE records to confirm additions and disposals have been properly reflected in the ammortization schedule
- evaluate estimates of remaining useful lives and residual values for reasonableness