Completing the Tests in the

Acquisition and Payment

Cycle: Verification of
Selected Accounts

Chapter 20

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 20 - 1

 Learning Objective 1

Recognize the many accounts

in the acquisition and
payment cycle.

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 20 - 2

 Accounts Associated with the
Acquisition and Payment Cycle

Cash
Cash
Inventory
Inventory
Supplies
Supplies
Property,
Property,plant,
plant,and
andequipment
equipment
Patents,
Patents,trademarks,
trademarks,and
andcopyrights
copyrights
Prepaid
Prepaidrent
rent
Prepaid
Prepaidtaxes
taxes
Prepaid
Prepaidinsurance
insurance
©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 20 - 3
 Accounts Associated with the
Acquisition and Payment Cycle

Cost
Costof ofgoods
goodssold
sold
Rent
Rentexpense
expense
Property
Propertytaxes
taxes
Income
Incometax taxexpense
expense
Insurance
Insuranceexpense
expense
Professional
Professionalfees
fees
Retirement
Retirementbenefits
benefits
Utilities
Utilities
©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 20 - 4
 Accounts Associated with the
Acquisition and Payment Cycle

Accounts
Accountspayable
payable
Rent
Rentpayable
payable
Accrued
Accruedprofessional
professionalfees
fees
Accrued
Accruedproperty
propertytaxes
taxes
Other
Otheraccrued
accruedexpenses
expenses
Income
Incometaxes
taxespayable
payable

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 20 - 5

 Methodology for Designing Tests
of Details of Balances for A/P
Phase
PhaseII

Identify
Identifyclient
clientbusiness
businessrisks
risksaffecting
affectingother
other
accounts.
accounts.

Set
Settolerable
tolerablemisstatement
misstatementand
andassess
assessinherent
inherent
risk
riskfor
foraccounts.
accounts.

Assess
Assesscontrol
controlrisk
riskfor
foraccounts.
accounts.
©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 20 - 6
 Methodology for Designing Tests
of Details of Balances for A/P
Phase
PhaseIIII

Design
Designand
andperform
performtests
testsof
ofcontrols
controlsand
and
substantive
substantivetests
testsof
oftransactions
transactionsfor
forthe
the
acquisition
acquisitionand
andpayment
paymentcycle.
cycle.

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 20 - 7

 Methodology for Designing Tests
of Details of Balances for A/P
Phase
PhaseIII
III

Design
Designand
andperform
performanalytical
analyticalprocedures
proceduresfor
forthe
the
acquisition
acquisitionand
andpayment
paymentcycle.
cycle.

Design
Designtests
testsof
ofdetails
detailsof
ofaccount
accountbalances
balancesto
to
satisfy
satisfybalance-related
balance-relatedaudit
auditobjectives.
objectives.
Audit
Audit Sample
Sample Items
Itemstoto Timing
Timing
procedures
procedures size
size select
select
©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 20 - 8
 Learning Objective 2

Design and perform audit tests of

property, plant, and equipment
and related accounts.

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 20 - 9

 Classifications of Property, Plant,
and Equipment Accounts

 Land and land improvements

Land and land improvements
 Buildings and building improvements
Buildings and building improvements
 Manufacturing equipment
Manufacturing equipment
 Furniture and fixtures
Furniture and fixtures
 Autos and trucks
Autos and trucks
 Leasehold improvements
Leasehold improvements
 Construction-in-process for property,
Construction-in-process for property,
plant,
plant,and
andequipment
equipment

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 20 - 10

 Manufacturing Equipment and
Related Accounts
Manufacturing Accumulated
Equipment Depreciated
Beginning Disposals Disposals Beginning
balance balance
Acquisitions Current period
depreciation
Ending
balance Ending balance

Gain or Loss Depreciation

on Disposals Expense

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 20 - 11

 Auditing Manufacturing
Equipment and Related Accounts
Analytical
Analyticalprocedures
procedures

••Current
Currentyear
yearacquisitions
acquisitions
••Current
Currentyear
yeardisposals
disposals
••Ending
Endingbalance
balanceininthe
theasset
assetaccount
account
••Depreciation
Depreciationexpense
expense
••Ending
Endingbalance
balanceininaccumulated
accumulateddepreciation
depreciation

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 20 - 12

 Analytical Procedures for
Manufacturing Equipment
Analytical Procedure Possible Misstatement
Compare depreciation expense Misstatement in
divided by gross manufacturing depreciation expense
equipment cost with previous and accumulated
years. depreciation.
Compare accumulated
depreciation divided by gross Misstatement in
manufacturing equipment accumulated depreciation.
cost with previous years.

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 20 - 13

 Analytical Procedures for
Manufacturing Equipment
Analytical Procedure Possible Misstatement
Compare monthly or annual
repairs and maintenance,
Expensing amounts that
supplies expense, small tools
should be capitalized.
expense, and similar accounts
with previous years.

Compare gross manufacturing Idle equipment or

cost divided by some measure equipment that was
of production with previous disposed of but not
years. written off.

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 20 - 14

 Verifying Current Year
Acquisitions

The
Theproper
properrecording
recordingof
ofcurrent
currentyear
yearadditions
additions
isisimportant
importantbecause
becauseofofthe
thelong-term
long-termeffect
effect
the
theassets
assetshave
haveononthe
thefinancial
financialstatements.
statements.

Because
Becauseof ofthe
theimportance
importanceofofcurrent
currentperiod
period
acquisitions,
acquisitions,seven
sevenofofthe
thenine
ninebalance-related
balance-related
audit
auditobjectives
objectivesare
areused
usedas
asaaframe
frameofofreference.
reference.

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 20 - 15

 Major Balance-Related Audit
Objectives
Detail
Detailtie-in
tie-in

Current
Currentacquisitions
acquisitionsagree
agree
with
withthe
themaster
masterfile.
file.

1.
1.Foot
Footthe
theacquisition
acquisitionschedule.
schedule.
2.
2.Trace
Tracethe
theindividual
individualacquisitions
acquisitions
to
tothe
themaster
masterfile.
file.
3.
3.Trace
Tracethe
thetotal
totalto
tothe
thegeneral
generalledger.
ledger.
©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 20 - 16
 Major Balance-Related Audit
Objectives
Existence
Existence

Current
Currentacquisitions
acquisitionsas
aslisted
listedexist.
exist.

1.
1.Examine
Examinevendors’
vendors’invoices
invoicesand
and
receiving
receivingreports
reports
2.
2.Physically
Physicallyexamine
examineassets.
assets.

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 20 - 17

 Major Balance-Related Audit
Objectives
Completeness
Completeness

Existing
Existingacquisitions
acquisitionsare
arerecorded.
recorded.

1.
1.Examine
Examinevendors’
vendors’invoices
invoicesofofclosely
closely
related
relatedaccounts
accountsto
touncover
uncoveritems
itemsthat
that
should
shouldbe
bemanufacturing
manufacturingequipment.
equipment.
2.
2.Review
Reviewlease
leaseand
andrental
rentalagreements.
agreements.

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 20 - 18

 Major Balance-Related Audit
Objectives
Accuracy
Accuracy

Current
Currentyear
yearacquisitions
acquisitionsas
as
listed
listedare
areaccurate.
accurate.

1.
1.Examine
Examinevendors’
vendors’invoices.
invoices.

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 20 - 19

 Major Balance-Related Audit
Objectives
Classification
Classification

Current
Currentyear
yearacquisitions
acquisitionsas
aslisted
listedare
areproperly
properly
classified.
classified.

Examine:
Examine:
1.
1.Vendors’
Vendors’invoices
invoicesininmfg.
mfg.equipment
equipmentaccount.
account.
2.
2.Vendors’
Vendors’invoices
invoicesofofclosely
closelyrelated
relatedaccounts.
accounts.
3.
3.Rent
Rentand
andlease
leaseexpense
expenseforforcapitalizable
capitalizableleases.
leases.
©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 20 - 20
 Major Balance-Related Audit
Objectives
Cutoff
Cutoff

Current
Currentyear
yearacquisitions
acquisitionsare
arerecorded
recorded
ininthe
theproper
properperiod.
period.

1.
1.Review
Reviewtransactions
transactionsnear
nearthe
thebalance
balance
sheet
sheetdate
datefor
forproper
properperiod.
period.

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 20 - 21

 Major Balance-Related Audit
Objectives
Rights
Rights

The
Theclient
clienthas
hasrights
rightsto
to
current
currentyear
yearacquisitions.
acquisitions.

1.
1.Examine
Examinevendors’
vendors’invoices.
invoices.

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 20 - 22

 Verifying Current Year Disposals

Review
Reviewwhether
whethernewly
newlyacquired
acquiredassets
assets
replace
replaceexisting
existingassets.
assets.

Analyze
Analyzegains
gainsand
andlosses
losseson
ondisposal.
disposal.

Review
Reviewdocuments
documentsfor
forindications
indicationsof
of
deletion
deletionof
ofequipment.
equipment.

Make
Makeinquiries
inquiriesabout
aboutthe
thepossibility
possibilityof
of
the
thedisposal
disposalofofassets.
assets.
©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 20 - 23
 Verifying Ending Balance
of Asset Accounts

1.
1.All
Allequipment
equipmentowned
ownedisisrecorded.
recorded.

2.
2.All
Allrecorded
recordedequipment
equipmentphysically
physically
exists
existson
onthe
thebalance
balancesheet
sheetdate.
date.

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 20 - 24

 Verifying Depreciation Expense

The
Themost
mostimportant
importantobjective
objectiveisisaccuracy.
accuracy.

Consistent
Consistentdepreciation
depreciationpolicy
policy

Correct
Correctcalculations
calculations

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 20 - 25

 Verifying Ending Balance in
Accumulated Depreciation

1.
1. Accumulated
Accumulateddepreciation
depreciationasasstated
stated
ininthe
theproperty
propertymaster
masterfile
fileagrees
agrees
with
withthe
thegeneral
generalledger.
ledger.

2.
2. Accumulated
Accumulateddepreciation
depreciationininthe
the
master
masterfile
fileisisaccurate.
accurate.

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 20 - 26

 Learning Objective 3

Design and perform audit tests

of prepaid expenses.

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 20 - 27

 Audit of Prepaid Expenses

••Prepaid
Prepaidrent
rent
••Organization
Organizationcosts
costs
••Prepaid
Prepaidtaxes
taxes
••Patents
Patents
••Prepaid
Prepaidinsurance
insurance
••Trademarks
Trademarks
••Deferred
Deferredcharges
charges
••Copyrights
Copyrights

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 20 - 28

 Prepaid Insurance and Related
Accounts
Prepaid Insurance Insurance Expense
Beginning Current period
balance insurance
expense
Acquisitions

Ending
balance

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 20 - 29

 Internal Controls

1.
1.Acquisition
Acquisitionand
andrecording
recordingof
ofinsurance
insurance

2.
2.Insurance
Insuranceregister
register

3.
3.Insurance
Insuranceexpense
expense

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 20 - 30

 Audit Tests
Compare
Comparetotal
totalprepaid
prepaidinsurance
insuranceand
and
insurance
insuranceexpense
expensewith
withprevious
previousyears.
years.

Compute
Computethetheratio
ratioof
ofprepaid
prepaidinsurance
insurance
totoinsurance
insuranceexpense
expenseand andcompare
compare
ititwith
withprevious
previousyears.
years.

Compare
Comparethe
theindividual
individualinsurance
insurancepolicy
policy
coverage
coverageon
onthe
theschedule
scheduleofofinsurance
insurance
obtained
obtainedwith
withthethepreceding
precedingyear’s
year’sschedule.
schedule.
©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 20 - 31
 Audit Tests
Compare
Comparethethecomputed
computedprepaid
prepaidinsurance
insurance
balance
balancefor
forthe
thecurrent
currentyear
yearon
onaapolicy-by-policy
policy-by-policy
basis
basiswith
withthat
thatof
ofthe
thepreceding
precedingyear.
year.

Review
Reviewthe
theinsurance
insurancecoverage
coveragelisted
listedon
on
the
theprepaid
prepaidinsurance
insuranceschedule
schedulewith
withanan
appropriate
appropriateclient
clientofficial
officialor
orinsurance
insurancebroker.
broker.

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 20 - 32

 Balance-Related Audit Objectives

Existence
Existenceand
and Rights
Rights
completeness
completeness

Insurance
Insurancepolicies
policies The
Theclient
clienthas
hasrights
rights
ininthe
theprepaid
prepaid to
toall
allinsurance
insurance
insurance
insuranceschedule
schedule policies
policiesininthe
the
exist
existand
andexisting
existing prepaid
prepaidinsurance
insurance
policies
policiesare
arelisted.
listed. schedule.
schedule.

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 20 - 33

 Balance-Related Audit Objectives

Accuracy
Accuracyand
anddetail
detail Classification
Classification
tie-in
tie-in

Prepaid
Prepaidamounts
amountsare are
accurate
accurateand
andthethetotal
total Insurance
Insuranceexpense
expenseisis
isiscorrectly
correctlyadded
added properly
properlyclassified.
classified.
and
andagrees
agreeswith
with
the
the general
generalledger.
ledger.

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 20 - 34

 Balance-Related Audit Objectives

Presentation
Presentationand
and
Cutoff
Cutoff disclosure
disclosure

Insurance
Insurancetransactions
transactions Prepaid
Prepaidinsurance
insuranceisis
are
arerecorded
recordedininthe
the properly
properlypresented
presented
proper
properperiod.
period. and
anddisclosed.
disclosed.

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 20 - 35

 Learning Objective 4

Design and perform audit tests

of accrued liabilities.

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 20 - 36

 Audit of Accrued Liabilities

••Accrued
Accruedincome
incometaxes
taxes
••Accrued
Accruedinterest
interest
••Accrued
Accruedpension
pensioncosts
costs
••Accrued
Accruedprofessional
professionalfees
fees
••Accrued
Accruedrent
rent
••Accrued
Accruedwarranty
warrantycosts
costs

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 20 - 37

 Accrued Property Taxes and
Related Accounts
Accrued Property Tax
Property Taxes Expense
Payments Beginning
(property taxes) balance

Current period
property tax
expense

Ending
balance

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 20 - 38

 Learning Objective 5

Design and perform audit tests of

income and expense accounts.

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 20 - 39

 Approach to Auditing Income
and Expense Accounts

Analytical
Analyticalprocedures
procedures

Tests
Testsofofcontrols
controlsand
andsubstantive
substantivetests
tests
of
oftransactions
transactions

Tests
Testsof
ofdetails
detailsof
ofaccount
accountbalances
balances

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 20 - 40

 Analytical Procedures for Income
and Expense Accounts
Analytical procedure Possible misstatement
Overstatement or
Compare individuals expenses understatement of a
with previous years. balance in an expense
account.

Overstatement or
Compare individual asset and understatement of a
liability balances with previous balance sheet account that
years. would also affect an income
statement account.

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 20 - 41

 Analytical Procedures for Income
and Expense Accounts
Analytical procedure Possible misstatement
Misstatement of expenses
Compare individual expenses
and related balance
with budgets.
sheet accounts.

Compare gross margin

Misstatement of cost of
percentage with previous
goods sold and inventory.
years.

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 20 - 42

 Analytical Procedures for Income
and Expense Accounts
Analytical procedure Possible misstatement

Compare inventory turnover Misstatement of cost of

rate with previous years. goods sold and inventory.

Misstatement of insurance
Compare prepaid insurance
expense and prepaid
expense with previous years.
insurance.

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 20 - 43

 Analytical Procedures for Income
and Expense Accounts
Analytical procedure Possible misstatement
Compare commission expense
Misstatement of cost of
divided by sales with
goods sold and inventory.
previous years.

Compare individual Misstatement of individual

manufacturing expenses manufacturing expenses
divided by total manufacturing and related balance
expenses with previous years. sheet accounts.

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 20 - 44

 Tests of Controls and Substantive
Test of Transactions

Understanding
Understandinginternal
internalcontrol
controland
andthe
the
related
relatedtests
testsofofcontrols
controlsand
andsubstantive
substantive
tests
testsof
oftransactions
transactionsto todetermine
determinethethe
appropriate
appropriateassessed
assessedcontrol
controlrisk
riskare
are
the
themost
mostimportant
importantmeans
meansof ofverifying
verifying
many
manyof ofthe
theincome
incomestatement
statementaccounts
accounts
inineach
eachof ofthe
thetransaction
transactioncycles.
cycles.

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 20 - 45

 Tests of Details of Account
Balances – Expense Analysis

Expense
Expenseaccount
accountanalysis
analysis

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 20 - 46

 Tests of Details of Account
Balances – Allocation
Several
Severalexpense
expenseaccounts
accountsresult
resultfrom
fromthe
theallocation
allocation
of
ofaccounting
accountingdata
datarather
ratherthan
thandiscrete
discretetransactions.
transactions.

These
Theseinclude
includedepreciation,
depreciation,depletion,
depletion,and
andthe
the
amortization
amortizationof
ofcopyrights
copyrightsand
andcatalog
catalogcost.
cost.

The
Theallocation
allocationof
ofmanufacturing
manufacturingoverhead
overheadbetween
between
inventory
inventoryand
andcost
costof
ofgoods
goodssold
soldisisan
anexample
exampleof
of
aadifferent
differenttype
typeof
ofallocation
allocationthat
thataffects
affectsexpenses.
expenses.

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 20 - 47

 End of Chapter 20

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 20 - 48