Accounting Research Manager - Audit Private Accounting Research Manager Miller Interpretations and Other Resources Knowledge-Based Audit Procedures Chapter 15: Accounts Payable and Purchases Chapter 15: Accounts Payable and Purchases Audit Objectives and Procedures The overall objective of the audit of accounts payable and purchases is to determine whether they are fairly stated and properly disclosed in the context of the financial statements as a whole. The purchases account is closely tied to accounts payable; therefore, evidence supporting accounts payable tends to support purchases. For example, having established that an account payable is a true obligation of the entity, the auditor has thereby supported the validity of the purchase. Analytical procedures often can be used to test the purchases (and cost of sales) account. An unusual relationship detected in the audit of accounts payable and inventory may reflect a problem for the reported purchases and cost of sales amount as well. Because of these interrelationships, the combined analytical review of purchases, cost of sales, inventories, and accounts payable is probably the most effective audit approach. Therefore, an effective and efficient audit approach for purchases (and cost of sales) usually is to limit the testing in this area to analytical procedures. See the section titled Analytical Review Procedures later in this chapter.
The table below summarizes specific audit objectives related to financial statement assertions for accounts payable and identifies common substantive audit procedures that accomplish these objectives. Specific Audit Objectives Common Substantive Audit Procedures Financial Statement Assertions Accounts payable reflected in the balance sheet represent authentic obligations of the entity and include (1) unprocessed invoices and (2) liabilities for goods and services received but not billed. Search for unrecorded liabilities by examination and inquiry of post-balance sheet transactions. Confirm selected accounts payable with the client's major vendors, regardless of the balances in those accounts at the confirmation date. Existence Completeness Rights and obligations Review accounts payable aging, test clerical accuracy, and reconcile to the general ledger. Accounts payable amounts agree with invoices or other supporting documents and are recorded correctly as to account and period. Agree selected items to vendors invoices, goods receipt advices, copy of purchase orders, or other supporting documents. Existence Rights and obligations Accuracy Reconcile selected vendors statements to amounts in the accounts payable aging. Cutoff Classification Determine if proper cutoff procedures were applied to assure that purchases and debit memos have been recorded in the proper period. Valuation and allocation Accounts payable are properly classified as current liabilities; Review the listing for related parties, notes payable, long- Occurrence and rights and
significant debit balances are reclassified to current assets; and adequate disclosures are made for related-party accounts payable, payables with specified payment terms, and assets pledged as collateral on accounts payable. Disclosures are clearly expressed. term debt, debit balances, and unusual items. Inquire of the client about any assets that are pledged on accounts payable. obligations Completeness Classification and understandability Accuracy and valuation Search for Unrecorded Accounts Payable Because understatements in liability accounts are often a significant risk related to the completeness assertion, the search for unrecorded accounts payable, for the period from the balance-sheet date to the completion of fieldwork, is probably the most important test in auditing accounts payable. When performing the search for unrecorded accounts payable, the auditor selects transactions over a preestablished dollar amount and inspects the supporting documentation (e.g., vendor s invoice) for all such transactions. The extent of tests the auditor performs to discover unrecorded accounts payable depends primarily on (1) the assessed level of control risk and (2) the materiality of the potential accounts payable balance to the financial statements. When the assessed level of control risk for the completeness and valuation assertions is low, the auditor may review fewer cash disbursement transactions in the period after the balance-sheet date, shorten the length of the review period, or omit or reduce reconciling vendor monthly statements with the client records. The following steps are involved in carrying out this test: Test subsequent cash disbursements The search for unrecorded liabilities generally begins with a review of the cash disbursements journal for a period after the balance-sheet date. The purpose of this step is to identify disbursements made during the subsequent accounting period (i.e., the period from the balance-sheet date to the completion of fieldwork) that are liabilities as of the balance-sheet date. Payments that relate to the period under audit should be traced to the accounts payable listing to ensure that they have been properly included as a liability. If they have not been included in accounts payable by the client, the auditor should propose an adjustment to record such liabilities, if they are material to the financial statements. Test unpaid invoices If the client does not pay its bills on a timely basis or is having cash flow problems, certain invoices over the dollar amount preestablished by the auditor may remain unpaid near the date of fieldwork. Therefore, the auditor should obtain from the client the files for all unpaid invoices and examine them to determine whether they are obligations of the entity as of the balance-sheet date.
Examine receiving reports unmatched with vendors invoices All merchandise the entity received before the end of the accounting period, indicated by the issuance of a receiving report, should be included in accounts payable as of the end of the accounting period. The auditor should obtain from the client the files for all receiving reports that have not been matched with vendors invoices. The auditor should then trace the receiving reports issued as of the end of the accounting period to the related vendors invoices and determine if they have been included in accounts payable. If the client has not received the related vendor s invoice, the auditor should refer to the client s purchase order or prior vendor s invoices for similar items, or could consider calling the vendor to determine the amount of the obligation. Examine vendors statements If the client maintains a file of vendors statements, the auditor can trace those statements that show a balance due as of the end of the accounting period to the accounts payable listing to make sure that the obligation has been recorded. Inquire of client The auditor should inquire of client personnel regarding their knowledge of unrecorded accounts payable. The auditor should specifically: Inquire of accounting personnel about disputed amounts and past due amounts involving vendors. Inquire of purchasing personnel about open purchase orders, which would help detect commitments to acquire inventories at fixed prices. Reconciliation of Accounts Payable Listing to the General Ledger The auditor should obtain from the client a listing of accounts payable showing balances owed to creditors. The auditor should test the clerical accuracy of the listing and reconcile the balance to the general ledger control account. In addition, the auditor should perform the following procedures: Review the listing for debit balances. If the amounts of debit balances are material, the auditor should reclassify them as receivables. The auditor also should consider confirming such balances with the vendors. Review the listing for related-party payables. If the amounts due to related parties are material, the auditor should segregate them in the balance sheet or disclose them in notes to the financial statements. The auditor also should consider confirming such balances with the related parties.
Potential Errors and Fraud and Examples of Fraud-Related Audit Procedures Potential Errors and Fraud Schemes The following are types of potential errors and fraud relating to accounts payable and purchases: Unauthorized purchases are incurred. Purchases are recorded but goods or services are not received. Liability is incurred but not recorded. Purchase amount is recorded incorrectly. Purchase is charged to wrong account or recorded in wrong period. Purchases are made at other than favorable terms to facilitate side deals for the personal benefit of employees. Purchases are misclassified to conceal lack of authorization. Purchase discounts are taken but not recorded, and amounts of discounts are misappropriated. Improper deferrals of income are recorded in order to shift income to future periods. Employees are concealing unauthorized purchases for their own benefit. Contingent liability is understated or not recorded. Kickbacks are paid by vendors to the company s purchasing agent. Fraud-Related Audit Procedures The following are example audit procedures that may be performed in response to accounts payable and purchases fraud schemes: Send blank confirmations to vendors requesting them to furnish information about all outstanding invoices and other pertinent items such as payment terms, payment histories, etc. Include new vendors and accounts with small or zero balances. Confirm collectibility of debit memos with vendors. Match vendor names and addresses per invoices with master vendor list.
Search for unusual or large year-end transactions and adjustments, e.g., transactions not containing normal processing initials, not going through normal processes, or not having normal supporting documentation. Review vendor files for unusual items, such as manual and not customized forms; different delivery addresses; and vendors that have multiple addresses. Examine disbursements made for items that do not require delivery of goods. Examine voided checks. Examine supporting documents for payments for amounts just under the threshold required for approval. Examine original cancelled checks and scrutinize for items such as the following: discrepancies between cancelled checks, invoices, and the disbursements journal; multiple endorsements; the identity of the endorsees. Examine supporting documents for significant reconciling items appearing in the reconciliation between the aging and the general ledger. Expand testing of receiving cutoff. Perform analytical procedures and predictive tests of key ratios. Search public records (e.g., UCC filings). Perform tests of controls over accounts payable and purchases. Financial Accounting and Reporting Accounts Payable Accounts payable at the balance-sheet date should include all trade payables arising from the purchase of goods and services that have been received or that are in transit. Trade accounts payable may be recorded net of discounts if (1) the entity normally takes cash discounts, (2) the entity has the means to continue this practice, and (3) such policy is consistently followed. Material debit balances due from vendors should be reclassified as receivables.