Bac2664auditing L9 Purchase Cycle

AUDITING BAC2664 (New), BAC2287(Old) Topic 8, Lecture 9 Audit of the Acquisition and Payment Cycle 1

Audit of Acquisition and Payment Cycle • System cycle and internal control • Objective of audit on purchase and account payable • Tests of controls system and internal control • Test on real transactions • Substantive tests of transactions and account payable • Balance confirmation on creditors and accrued liabilities 2

Overview of the purchase cycle Purchases and cash payments cycle covers the purchase of raw materials and consumables on credit, payments to creditors, purchase returns and discount received. Two classes of transactions (credit purchases and cash payments) are processed by the accounting system in a different manner. Internal controls are applied to ensure: 6 Complete processing of transactions; 7 Transactions are processed accurately; and 8 Only valid transactions are processed. (Refer to transactions and credit purchases cycle diagram)

3

Purchases cycle • A purchase begins with the request made by various dept (a purchase requisition is generated, approved by the respective HOD). • Purchase order prepared by purchase dept, approved and sent to supplier. • Approved purchase order provides the authority that goods sent by the supplier can be received. • Purchas invoices received after goods had been received. • Supplier expects payment to be made within credit period. 4

Account Balances in the purchase cycle Credit purchases: Debit: purchases (summarized in the PJ) Credit: purchase ledger control account (summarized in the purchase ledger) Payments made to supplier: Debit: purchase ledger control account (summarized in the cash book) Credit: bank account (summarized in the cash book) The accounts pertinent to the test of details of transactions are purchases account and bank account. Test of details of balances are performed on purchases ledger control account and its detailed counterpart, the purchase ledger.

5

Purchases Activities, Documents, Records Auditor has to understand the flow of purchase transactions through the accounting system. To facilitate understanding and identification of appropriate controls, an auditor has to gain sufficient knowledge about the activities in purchase cycle, the documents, the records, related to processing purchase. Then, the auditor describes his understanding in flowcharts. 6

Purchases Activities, Documents, Records continued

Activity Document Authorization: Accepting and processing purchase requisition

Purchase requisition Purchase order

Approving purchases

Approved suppliers quotation Approved purchase order Delivery note Receiving report Purchase invoice

Receiving of goods from supplier Billing by supplier

Record

7

Purchases Activities, Documents, Records continued

Recording: Journalizing and Purchase invoice posting the purchases Summarizing the journal entries, posting the summary

Purchase journal Purchase ledger General ledger

Custody: Access to documents, records, limited to authorized personnel

8

Purchase Department Activity/responsibilities: 1 Accepting and processing purchase requisition (PR). 2 Approving purchases entry. 3 Selecting a supplier. 4 Issuing purchase orders (PO). Possible errors/irregularities: 8 PO could be issued for fictitious purchase 9 PO does not agree with PR pertaining to the specification and quantity of items required 10 PO misplaced Control procedures: 13 Matched particulars of PR to suppliers quotations 14 Matched particulars of PO with PR 15 PO are pre-numbered 16 PR are kept on file together with PO

9

Stores Activity/responsibilities: 2 Receiving of goods from supplier delivery note – DN) 3 Checking goods and preparing receiving report Potential risk: 6 Receiving of damaged goods or wrong specification and quantity 7 Goods received by-pass the checking or approved without making reference to PO Control procedures: 10 Numerical sequence of approved receiving report 11 Copy 1, sent to account dept, copy 2 used to update the bin card

10

Accounts Department Activity/responsibilities: 2 Billing (invoicing) by supplier 3 Keeping the supporting document (approved PO, DN) 4 Ensure PO, DN sequence Possible errors/irregularities: 1 goods billed, but not yet received Amount billed may be incorrect Control procedures: 11 Account for pre-numbered PO to determine all invoices are for goods actually received 12 Match invoice with DN and approved PO to determine the validity of authorized transactions PO, DN, approved PO, copy 2, are stapled and filed numerically 11

Accounts Department

continued

Activity/responsibilities: 2 Journalizing the PJ, posting, recording the purchases and purchase invoices into the GL 3 Monitoring the amount owing Possible errors/irregularities: 6 Purchases are not recorded 7 Purchases recorded to the wrong account 8 Purchases are received twice 9 Purchases recorded in the wrong financial year Control procedures: 12 Account for pre-numbered invoice 13 Establish proper chart of account 14 Invoices marked ‘POSTED’ or cancelled after posting are done 15 Establish internal verification of pricing, extensions, footings 16 Establish proper cut-off, i.e., all receiving report issued before the year end are not billed by suppliers in the following year 12

Cash Payments Activity Document Authorization: Approving payment vouchers

Approving cheques

Records

Suppliers remittance advice (SRA) Approved purchase invoice (API) Approved payment vouchers (APV) SRA, API, APV cheques 13

Cash Payments Recording: Journalizing, posting the payments Summarizing journal entries, posting the summary

Approved payment vouchers

continued

Cash book Purchase ledger

General ledger

Custody: Access to documents, records limited to authorized personnel 14

Accounts Department Activity/responsibilities: 2 Approving payments vouchers (PV) 3 Issue PV in sequence, in order to ensure completeness of the payment made to suppliers 4 Approval for payment given after the officer is satisfied with the supporting documents that were attached together with the PV 5 Cashier before signing the cheques, needs to ensure the validity, accuracy of the payment. 15

Cashier Activity/responsibilities: 2 Approve cheques Irregularities: 5 Payment made for unauthorized payments Control procedures: 1 Supporting documents are marked “PAID’ or cancelled at the time cheques are signed 16

Accounts Department Activity/responsibilities: 2 journalizing, posting the payments, by using particulars from the PV 3 Update the cash book and purchase ledger 4 Keep the PV by serial number 5 Summarizing the journal entries and posting the summary for the month from the PJ, cash payments from cash book, to the GL

17

Subsequent Accountability Activity

Record

Agreeing GL balance with creditors balances in PL

GL, PL, Creditors reconciliation statement

Agreeing creditors balances in PL with statement of accounts

PL, statement of account, creditors reconciliation statement

Preparing bank reconciliation statement

Cash book, bank statement, bank reconciliation statement

18

Accounts Department Activity/responsibilities: 2 Agreeing GL balances with creditors balances in PL 3 Determine accuracy of recording on monthly basis by verifying agreement of the total balances in the PL with the PL control account in the GL Possible errors 1 Errors in recording are highlighted in the creditors reconciliation statement 19

Accounts Department Activity: 2 Agreeing creditors balances in PL with statement of accounts 3 Check and confirm entries made in the accounts 4 Highlight the age of the debts

20

Accounts Department Activity: 2 Preparing bank reconciliation statement 3 Prepare bank reconciliation every month for the following reasons: (a) the differences between the balances as per bank statement and cash book are valid ones (b) the differences in balances are not a result of errors made by the book-keeper or the bank (c) ensure that no payments have been passed through the bank account which has not been entered in the cash book (d) irregular items, such as statute barred unrepresented cheques, will be shown in the bank statement, thus ensuring their reversal in the accounting records

21

Internal Control Questionnaire for Purchases Does the System Ensure That No Invoice Can Be Passed for Payment Without Proof of Receipt of Goods or Services? 2 Are receiving report used? 3 Are invoices and receiving report sent directly to accounting dept and promptly recorded in the PJ? 4 Is the PL functions independent of purchasing, stores, cashier, GL functions? 5 Are invoices compared to Po and receiving report by different people who cross referenced and initial? (alternatively, are the signed receiving report and PO attached to the purchase invoice?) 22

Internal Control Questionnaire for Purchases continued

Does the System Prevent Invoices Being Passed for Payment Without Proper Approval? 2 Is the numerical continuity of pre-numbered purchase requisitions and PO checked? 3 Are PO approvals required? 4 Is purchasing independent of stores, receiving, PL, cashier, and inventory record keeping functions? 5 Are quotations obtained from suppliers? 6 Is the PJ balanced monthly and agreed to the GL? Does the System Ensure That Invoicing Errors Do Not Escape Attention? • Are prices and calculations independently checked? • Are documents cancelled to prevent re-use? • Are unmatched documents investigated regularly? 23

Internal Control Questionnaire for Cash Payments Does the System Ensure That Payments Cannot Be Made If Not Properly and Independently Authorized? 2 Do cheques require two signatures independent of purchasing, receiving, PL, invoice approvals and cheque preparation functions? 3 Are cheque signatories authorized by the BOD? 4 Is advance signing of blank cheques prohibited? 5 Are cheques mailed out directly and supporting documents cancelled at the time when cheques are signed? 6 Are altered or corrected cheques prohibited? 24

Internal Control Questionnaire for Cash Payments continued

Does the System Ensure That Payments Cannot Be Made for Goods and Services Not Received? 2 Does signatories examine supporting documents accompanying cheques and review for propriety and completeness? 3 Are cheques prepared independent of payment voucher approval? 4 Are calculations, additions, discounts, freight, terms and quantities checked? 5 Are cheques payable to ‘bearer’ or ‘cash’ prohibited? 6 Is there evidence of cross check between details on PO and goods received? 25

Evaluation of Internal Control: Purchases Audit objectives: The audit of purchases should be sufficiently comprehensive to determine whether: 3 Purchases are properly charged to the company; and 4 Purchases have been correctly recorded in the books. Audit procedures: For 1-3 months: 9 Cast total column of PJ from which items are individually posted 10 Check posting from PJ to GL 11 Check posting from PJ to creditor control account in GL For, say 30 items or 10%: Vouch PJ with purchase invoices noting: 15 Invoices are original and not duplicates 16 dates are correct 17 Suppliers and clients name on invoice are correct 18 Evidence of independent checking with supplier quotation for price 19 Evidence of independent comparison with PO and receiving report for specification and quantity 20 Evidence of independent check of extension and casts 21 Approval were given by correct person 22 Nature of expense and account charged (revenue and capital) 23 Invoices stamped “PAID” or cancelled at time cheques paying the invoices were signed

26

Evaluation of Internal Control: Purchases continued

Select 30 items, say 10% of creditors account, by ensuring all ledgers are available for the selection: 2 Scrutinize and enquire into any old or unusual items 3 Cast each account selected Examine system of reconciliations of creditors ledger balances with creditors statement of accounts, ensure that: 6 Statements of accounts are obtained regularly from the suppliers 7 All statements obtained are reconciled with the creditors ledger 8 Reconciling items are being followed up. 27

Evaluation of Internal Control: Cheque Payments Audit objectives: The audit of cheque payments should be sufficiently comprehensive to determine whether: 3 Cheque payment ought to have been made 4 Cheque payment have been received by the payee, or 5 Cheque payment have been correctly recorded in the books. Audit procedures: Control of cheque books: 9 Vouch cheque books received/purchased from bank with bank notifications (note serial number) 10 Verify that cheque books issued have been properly recorded in register 11 At all time of audit, count un-issued cheque books and agree with register 28

Evaluation of Internal Control: Cheque Payments continued

Control of payment vouchers: 2 Vouch payment voucher books purchased with printers invoices (note serial number) 3 Verify that payment voucher books issued have been properly recorded in register 4 At the time of audit, count un-issued payment voucher books and agree with the register For 1-3 months: 7 Account the numerical sequence of payments vouchers 8 List any missing payment vouchers. 9 Cast creditors payment column of cash payments journal from which item are individually posted: (a) check posting the total for both columns from cash receipts journal to GL (b) Check posting the total for creditors payments from cash payment journal to creditors control account 29

Evaluation of Internal Control: Cheque Payments continued

For 1-3 months vouch payments made to creditors noting: 2 Proof of payments, i.e., official receipts. (list ant missing receipts. Discuss with independent responsible official) 3 Indication that goods or services charged for have been received and approved, and have been checked with order 4 Authorization for payment by the correct person (as listed in the permanent file) 5 Payment vouchers have been stamped “PAID” or cancelled Select 30 items, say 10% payment vouchers: 8 Trace payment vouchers to cash payment journal 9 Check posting to creditors ledger For 1-3 months: 12 Check cheque payments with bank statements, noting that cheques are debited without undue delay 13 Cheque payments side of bank statement and find out why unticked payments are not entered on credit side of cash book.

30

Substantive Tests: Verification of Trade Creditors Audit of trade creditors is to ensure that creditors are not understated and all trade creditors are accounted for in the financial statements. Audit procedures must ensure: 3 Unrecorded liabilities are identified 4 Make sure accounting policies being applied by the client are consistent with those applied in the previous years 31

Audit of Creditors Balances Management Assertions

Existence

Audit Objectives of Test of Details of Balances

Existence

Substantive Audit Procedures

4 5

Obtain list of balances Agree figures in GL, check individual balance are made up of 32 specific and recent invoices

Audit of Creditors Balances continued Completeness

Completeness

1

2

3

4

Ensure all year end transactions in respect of creditors are accounted for Creditors for that accounting period have actually been recorded Ensure supporting documents are sequential order Determine how client deal with cancelled documents 33

Audit of Creditors Balances continued Valuation and Allocation

Accuracy

1

2 3

4

5

Review all creditors balances, check or test the addition of the list Examine supporting documents Review reconciliation by checking to suppliers statements Review prior year list to ensure no omissions Investigate debit balances. Consider their recoverability

34

Audit of Creditors Balances continued Classification

Cut-off

Detail tie-in

Creditors figures are classified properly according to chart of accounts Obtain and trace creditors cut-off information ( number, amounts, PO) into PJ and PL Figures of creditors balances in PL tie with creditors figures in GL 35

Audit of Creditors Balances continued Rights and Obligations

Presentation and Disclosure

Ownership

Presentation and disclosure

Send positive confirmation letters

1 Ensure comparative figures agree with last year’s FS 2 Consider whether significant debit balances should be reclassified as debtors 36

References • • • • •

Text – Chapter 11 Lecture Notes Tutorial Questions Past Exam Questions ACCA, MIA, MICPA, Articles from Journals and Magazines

37