Chapter 19

Completing the Tests in the Acquisition

and Payment Cycle: Verification
of Selected Accounts

We try to cover the audit of two or three accounts in this cycle, if we cover the
chapter at all. Our emphasis is on showing the relationship between tests of controls,
substantive tests of transactions, and tests of details, and differences between various
types of account balances. The following are the primary topical areas we cover:

 Chapter opening vignette

 Types of tests applied to acquisitions and cash disbursements
 Audit of income and expense accounts
 Audit of property, plant, and equipment
 Related areas

Chapter Opening Vignette – “Incorrect Classifications Hide a Greater Net Loss”

This vignette can be used to emphasize the importance of adequate internal

controls and the importance of the auditor adequately understanding and testing of
internal control. It is also useful to emphasize one of the reasons that auditors perform
tests of account classifications and how these tests should be done. Finally, covering
the vignette provides a good opportunity to remind students of the importance of
obtaining independent evidence instead of relying solely on inquiry.

Types of Tests Applied to Acquisitions and Cash Disbursements

Start by referring students to the list of accounts in Table 19-1 (page 634) and
identify the accounts you plan to discuss. As a review, then ask students to identify the
relationship between analytical procedures, tests of controls, substantive tests of
transactions, and tests of details of balances for accounts payable. At this point, you
should expect fairly specific answers. You may want to use Figure 13-4 (page 413)
as a framework to guide the discussion about the audit approach to acquisitions and
cash disbursements.

(See Table 19-1)

(See Figure 13-4)

Audit of Income and Expense Accounts (page 646)

We start with this area because it is reasonably easy, yet important. Three terms
and phrases are defined before proceeding (see top of next page).

19-1
  Income statement account balances resulting from transactions (including a
discussion of how balances get into the general ledger)
 Income statement account balances resulting from allocations (including a
discussion of how balances get into the general ledger)
 Analysis of account balances

Figure 19-3 (page 645) and Figure 19-4 (page 649) may provide a useful basis
for the discussion of the relation between transactions and account balances.

(See Figures 19-3 and 19-4)

The following questions are then asked about the audit of income and expense
accounts:

1. Ask students to explain how cost of goods sold for a wholesale company
can be verified by each of the following tests: analytical procedures, tests of
controls and substantive tests of transactions, analysis of account balances,
and tests of details of balance sheet accounts.
2. Assume all tests of controls and substantive tests of transactions and all
analytical procedures for the audit have been completed. The audit of the
sales and collection cycle, payroll, and all tests of accounts payable have
also been completed. The auditor is now auditing utilities expense. How
have the objectives on T-19-1 already been partially or fully met?

(See T-19-1)

3. What additional tests of utilities expense would ordinarily be made?

4. Assuming a significant likelihood of misstatements, what additional tests of
utilities expense would be performed? Be specific.
5. How do each of the following accounts differ somewhat from utilities expense
in the audit approach or evidence requirements?

 Property tax expense

 Depreciation expense
 Legal expense

6. Use the quiz on T-19-2.

(See T-19-2)

7. Case 19-30 is excellent for deciding tests of income and expense accounts
based on the results of analytical procedures

Audit of Property, Plant, and Equipment (page 634)

The difficult aspect of this area is the need to be concerned with additions,
disposals, the asset balance, accumulated depreciation, and depreciation expense.
For this area, we emphasize the overall objectives of each segment rather than the
balance-related audit objectives.

19-2
 We start by describing the three accounts that concern the auditor and why they
are audited simultaneously. Reference Figure 19-1 (page 635) during this discussion.
We emphasize that the discussion is meant to be representative of other audit areas.

(See Figure 19-1)

We then deal with individual balances, starting with the asset account (property,
plant, and equipment), and use questions such as the following:

1. What are the most important differences in the audit of property, plant, and
equipment and the following:

 Cash in bank?
 Accounts receivable?
 Patents?
 Inventory?

2. On a continuing engagement, why is the audit of current period additions and

disposals emphasized?
3. For additions, which of the balance-related audit objectives in Table 19-4
(page 638) are most important?

(See Table 19-4)

4. How does the audit of current period additions relate to tests of controls and
substantive tests of transactions?
5. What factors would determine sample size and items to select in tests of
accounts of property, plant, and equipment?
6. Why does the auditor have considerable flexibility in timing for tests of
acquisitions of property, plant, and equipment?
7. What are the purposes of each of the procedures listed on T-19-3?

(See T-19-3)

For disposals we ask questions such as the following:

1. What are the two most important objectives in auditing disposals?

2. Identify procedures that are useful for uncovering unrecorded disposals.
3. How is the audit of accumulated depreciation directly related to the accuracy
objective for disposals?

For depreciation, we ask questions such as the following:

1. When might analytical procedures be sufficient for auditing depreciation

expense?
2. Explain how detailed tests of depreciation might be done assuming that the
client has a master file of fixed assets.

19-3
 For the balance in the fixed asset account we like to ask:

1. Why are the presentation and disclosure-related audit objectives more

important for fixed assets than most other asset balances?
2. Why is a physical observation of fixed assets less common than for inventory
or marketable securities? When should it be done?
3. What audit problems in fixed assets are encountered when a CPA firm is a
successor auditor? How can the problem be solved?

Any of Problems 19-21 to 19-23 will help to reinforce the topic. A good way to
finish the audit of fixed assets is to use Case 19-28. It ties the material in Case 18-32
to fixed assets. It should only be used if Case 18-32 was covered.

Related Areas

If there is time left, we like Discussion Question 19-26, which addresses the search
for unrecorded liabilities.

19-4
 CHAPTER 19
CROSS-REFERENCE OF LEARNING OBJECTIVES AND PROBLEM MATERIAL

Multiple Discussion
Review Choice Questions
Learning Objectives Questions Questions and Problems Cases
19-1 Recognize the many accounts in the acquisition and 19-23 19-28
payment cycle.

19-2 Design and perform audit tests of property, plant, 19-1, 19-2, 19-17, 19-18, 19-21, 19-22, 19-28, 19-29
19-5

and equipment and related accounts. 19-3, 19-4, 19-19, 19-20 19-23, 19-24
19-5, 19-15

19-3 Design and perform audit tests of prepaid 19-6, 19-7, 19-23
expenses. 19-8, 19-9

19-4 Design and perform audit tests of accrued liabilities. 19-10, 19-11, 19-20 19-25, 19-26
19-12

19-5 Design and perform audit tests of income and 19-13, 19-14, 19-18, 19-20 19-23, 19-27 19-28, 19-30
expense accounts. 19-15, 19-16
 BALANCE-RELATED AUDIT OBJECTIVES:
UTILITIES EXPENSE

 Recorded utilities expense transactions as listed

exist

 Existing utilities services received are recorded

 Utilities expense transactions as listed are

correctly stated

 Utilities expense transactions as listed are

properly classified

 Utilities expense transactions are recorded in

the proper period

 The amounts in the general ledger are correctly

totaled and the total agrees with the trial balance

T-19-1
 QUIZ -
HOW EXPENSES ARE TESTED

Match each of the following eight expense accounts,

each one assumed to be material, into one of four
categories.

1. Will ordinarily be tested sufficiently by normal tests

of controls and substantive tests of transactions,
analytical procedures, and accounts payable tests.

2. Frequently requires additional account analysis

due to high expectation of misstatements.

3. Typically audited as a part of an accrual or prepaid

account.

4. Not tested as a part of (1) except for normal

analytical procedures.

Bond discount Insurance expense

Interest expense Raw material purchases
Advertising expense Depletion expense
Miscellaneous expense Repair and main. expense

T-19-2
 PARTIAL AUDIT PROGRAM
FOR PROPERTY, PLANT, AND
EQUIPMENT ADDITIONS

 Foot the client-prepared listing of current year

additions and reconcile the total with debits to
property, plant, and equipment in the general
ledger.

 Trace individual additions included on the client-

generated listing to the acquisitions journal.

 Examine rent and lease agreements for rented

and leased property, plant, and equipment.

 Examine vendors' invoices and receiving reports

for additions included on the listing.

 Trace the total of individual additions to the

related master files.

 Analyze repair and maintenance expense for

large and unusual items.

 Examine loan agreements for equipment acquired

by loans or contracts.

T-19-3