TOPIC 3; AUDITING THE PURCHASING AND

EXPENSES PROCESSES
 Introduction

• Mention the auditing process stages

• Where are we at those stages?
• Activities involved at the acquisition and expenditure includes;
– Purchasing goods and services,
– Receiving the good or service,
– Recording the asset or expense and related liability, and
– Payment.
 Source Document

• Mention the possible source documents at each acquisition

and expenditure activity
 Source Document cont.

– purchase requisition
– purchase order
– receiving report
– Purchase invoice
• From our assumption, transactions are on credit, when a
voucher will be written?
• In total these documents are referred to as ‘voucher package’
 Accounts affected

• This cycle affects more general ledger accounts than any other cycle
• Accounts to be affected are such as;
– Inventory/Raw Materials
– Prepaid Expenses
– Property, Plant, and Equipment
– Intangible Assets
– Accrued Liabilities
– Various Expenses
– Cash
– Accounts Payable
– Payroll
 Recognition

• What are recognition criteria for expenses? Mention them

• Let us begin the audit process now!
• What makes an auditor identify an account as significant?
• Significant accounts to be dealt with
– Accounts payable
– Expenses
 Relevant Assertions

• All the time remember the risk model at this stage three of
auditing process.
• Summary of the assertions are shown here below
Significant accounts assertion Risk level

Account payable Completeness High

Cutoff High

Existence Moderate

Rights and Obligations Moderate

Valuation Moderate

Expenses accounts Completeness High

Cutoff High

Accuracy High

Classification High
 Accounts Payable

• Management may desire to improve the books by not

recording an obligation in the correct period. An incomplete
listing of accounts payable at the end of the period lowers
current liabilities and corresponding expenses.
• THUS Completeness and cutoff are necessary assertions to be
undertaken
 expenses accounts

• Read the case of worldcom.inc

• Major problem in expenses accounts is wrong classification
• For example, capitalizing expenses increases net income in the
year in which they should have been completely expensed
 Task

• Why do auditors focus on completeness of expenditures as a

significant account and relevant assertion in the expenditure
cycle?
• Why is inherent risk for the existence of inventory an issue in
the expenditure cycle audit?
• Why is a service expense a good account for recording a
fictitious expense?
 Test of Risk of Misstatement

• Should we use a ‘what can go wrong’ approach

Account Assertion WCGW

Account Payable Completeness Liabilities are not recorded

Cutoff Liabilities have been recorded in incorrect periods

Existence Liabilities may not represent actual obligations of the

company
Rights and Obligations Liabilities may not represent actual obligations of the
company
Valuation Payables are recorded at an incorrect amount

Expenses accounts Completeness Not all expenses are recorded

Cutoff Expenses have not been recorded in incorrect periods

Accuracy Expenses are recorded at an incorrect amount

Classification Expenses have been improperly recorded as capitalized

expenses
 Internal Control Activities

• Control risk assessment is important because it governs the

– nature,
– timing, and
– extent of substantive procedures.
 Internal Control Activities cont.

• It is important that auditors consider entity-level controls in all

processes and procedures.
– In the expenditure process, management should have a process for
continually reviewing expenses and comparing them to budgets and
forecasts.
– Proper authorization for all expenditures should be established and
included in company policy and procedures.
– Corporate values and ethics that have been established should be
communicated to suppliers and other partners of the entity along with
a place where inappropriate behavior (such as the solicitation of a bribe
or kickback) may be reported.
 Internal Control Activities cont.

• Specifically, major controls are;

– separation of responsibilities
– Custody both in by place and by accesses of documents
– Periodic reconciliation
 Tests of Control

• Tests of controls are done to determine whether company

controls actually are in place and operating effectively.
• Yesterday we said, it is management responsibilities to ensure
controls are in place and operating to prevent, detect, and
correct accounting errors.
• In the four activities, purchasing is the most risk activity
• Tests of controls consist of identification of;
– the control that will be relied on to reduce assessed control risk and
– the data population from which a sample of items will be selected for
audit.
 Tests of Control cont.

• In general, the actions in tests of controls involve;

– inspecting,
– inquiry,
– observing,
– scanning,
– matching, and
– recalculating.
 Tests of Control cont.

• An auditor might select a sample of voucher packages and

inspect the documents for indications that reconciliations and
approvals for payment are evident.
• Procedures such as matching, recalculating, and scanning for
unusual items often can be performed electronically using
computer-assisted audit techniques (CAATs).
 Tests of Control cont.

• Tests of controls over occurrence involve tests of the additions to the

expense accounts.
• Selecting a sample of closed purchase orders, receiving reports, or
vendor invoices and tracing them to the accounts payable journal
provides evidence of
– Completeness
– proper authorization
• Taking a sample of payments to vendors and vouching those payments to
the receiving report and purchase order provides evidence that
– the delivery occurred and the purchase existed
– may find fictitious vendors
 Task

• How should an auditor test for proper authorization in the

expenditure cycle?
• Where would an auditor find the proper authorization that
indicates it is okay to pay a vendor?
 Substantive analytic procedure and Tests of
Details
• The audit of account balances consists of making procedural
efforts to detect errors and frauds that could exist in the
balances, thus making them misleading in financial
statements.
• First as an auditor we should learn where to obtain evidence
• Purchase orders - no liability exists until the transactions have
been completed
 Substantive analytic procedure and Tests of
Details cont.
• Receiving reports - Liabilities should be recorded on the date
the goods and services are received and accepted by the
receiving department or by another responsible person
• Invoice- Sometimes purchase invoices arrive in the accounts
payable department before the receiving activity is complete.
 Substantive analytic procedure and Tests of
Details cont.
• Accounts payable trial balance amount - The total should
agree with the accounts payable control account.
• Purchase journal –it provides information for;
– the analysis of purchasing patterns that can exhibit characteristics of
errors and frauds and
– the sample selection of transactions for tests of controls
• Fixed assets reports - Auditors should trace large purchases to
the fixed asset reports and ensure that the details of fixed
assets in control accounts are consistent with purchase orders.
 Substantive analytic procedure and Tests of
Details cont.
• There is emphasis on completeness in this cycle because
financial statement users are typically more concerned if a
company understates expenses and liabilities than if
management overstates those accounts.
• Procedure to search for unrecorded liabilities
 Note

• Many accounts, particularly expense accounts, can be tested

using analytical procedures, such as horizontal and vertical
analyses
• vouching payments is the main way of accumulating evidence
for prepaid, deferred, and accrued expenses.
 Accrued income tax and other expenses

• It is by law companies to estimate deferred income tax assets

and liabilities – income tax expenses
• most expense accounts can be tested in conjunction with tests
of related assets and liabilities (e.g., depreciation) or through
analytical procedures.
• Auditors vouch payments, test the expense, and recalculate
the liability.
 Presentation and Disclosure

• Once auditors are satisfied that controls have been examined and significant
transactions and balances have been appropriately tested, then it follows the
disclosure issue.
• Depreciation methods, asset impairments, leases, and details about income
taxes are only a few of the essential items with specific presentation and
disclosure requirements.
• These disclosures must ensure that the presentation and disclosure assertions of;
– occurrence
– rights and obligations,
– completeness,
– classification and understandability, and
– accuracy and valuation are all met.
 issues

• Auditing the acquisition and expenditure cycle is not

straightforward.
• Because it is ripe for fraud, an auditor must be aware that
inappropriate policies and procedures or poor execution of
processes can lead to problems for the client