AUDIT OF THE

ACQUISITION AND
PAYMENT CYCLE: TESTS OF
CONTROLS, SUBSTANTIVE
TESTS OF TRANSACTIONS,
AND ACCOUNTS PAYABLE
CHAPTER 17 2024

Copyright © 2017 Pearson Education, Ltd. 18-1

 CHAPTER 17 LEARNING OBJECTIVES

17-1 Identify the accounts and the classes of transactions in the

acquisition and payment cycle.
17-2 Describe the business functions and the related documents
and
records in the acquisition and payment cycle.
17-3 Understand internal control, and design and perform tests of
controls and substantive tests of transactions for the
acquisition
and payment cycle.
17-4 Describe the methodology for designing tests of details of
balances for accounts payable using the audit risk model.

Copyright © 2017 Pearson Education, Ltd. 18-2

 CHAPTER 17 LEARNING OBJECTIVES

17-5 Design and perform substantive analytical procedures for

accounts payable.
17-6 Design and perform tests of details of balances for accounts
payable, including out-of-period liability tests.
17-7 Distinguish the reliability of vendors’ invoices, vendors’
statements, and confirmations of accounts payable as audit
evidence.

Copyright © 2017 Pearson Education, Ltd. 18-3

 OBJECTIVE 17-1
Identify the accounts and the classes
of transactions in the
acquisition and payment cycle.

Copyright © 2017 Pearson Education, Ltd. 18-4

 ACCOUNTS AND CLASSES OF TRANSACTIONS IN
THE ACQUISITION AND PAYMENT CYCLE
There are three classes of transactions in the acquisition and
payment cycle:
1. Acquisitions of goods and services
2. Cash disbursements
3. Purchase returns and allowances and purchase
discounts
The typical accounts involved in the acquisition and payment
cycle are shown in following Figure

Copyright © 2017 Pearson Education, Ltd. 18-5

Copyright © 2017 Pearson Education, Ltd. 18-6
 OBJECTIVE 17-2
Describe the business functions and
the related documents and
records in the acquisition and
payment cycle.

Copyright © 2017 Pearson Education, Ltd. 18-7

 BUSINESS FUNCTIONS IN THE CYCLE AND
RELATED DOCUMENTS AND RECORDS

There are four business functions involved in the

acquisitions and payment cycle: These business functions
and the related documents are showed in Table 18.1.
1. Processing Purchase Orders—Includes a purchase
requisition which is used to request authorization for
goods or services and a purchase order which is used
to process the order after it has been authorized.
2. Receiving Goods and Services—Includes a receiving
report which is prepared at the time the goods are
received.

Copyright © 2017 Pearson Education, Ltd. 18-8

 BUSINESS FUNCTIONS IN THE CYCLE AND
RELATED DOCUMENTS AND RECORDS(CONT.)
3. Recognizing the Liability—Proper recognition requires
prompt and accurate recording. Documents that may be
involved:
• Vendor’s Invoice—Document from the vendor that shows the amount
owed for an acquisition
• Debit Memo—Also from the vendor; indicates a reduction in the
amount owed
• Voucher—A formal means of recording and controlling acquisitions
• Acquisitions Transaction File—Computer-generated file including all
acquisitions transactions

Copyright © 2017 Pearson Education, Ltd. 18-9

 BUSINESS FUNCTIONS IN THE CYCLE AND
RELATED DOCUMENTS AND RECORDS(CONT.)
3. Recognizing the Liability (cont.) Documents involved:
• Acquisitions Journal or Listing—Often referred to as the purchases
journal; includes vendor name, date, amount, and account
classification
• Accounts Payable Master File—Records acquisitions, cash
disbursements, and acquisition returns and allowances for each
vendor
• Accounts Payable Trial Balance—A listing of the amount owed to each
vendor at a point in time
• Vendor’s Statement—A document prepared monthly by the vendor
that indicates the beginning balance, acquisitions, returns and
allowances, payments to the vendor, and ending balance

Copyright © 2017 Pearson Education, Ltd. 18-10

 BUSINESS FUNCTIONS IN THE CYCLE AND
RELATED DOCUMENTS AND RECORDS(CONT.)
4. Processing and Recording Cash Disbursements—The
payment for goods and services represent a significant
activity for all entities. Typical documents that auditors
examine associated with this activity:
• Check—Document used to pay for an acquisition; may be paper or
an electronic funds transfer (EFT)
• Cash Disbursements Transaction File—A computer-generated file
that includes all cash disbursement transactions processed during
a period
• Cash Disbursements Journal or Listing—Includes all disbursement
transactions for a period

Copyright © 2017 Pearson Education, Ltd. 18-11

Copyright © 2017 Pearson Education, Ltd. 18-12
 OBJECTIVE 17-3
Understand internal control, and
design and perform tests of
controls and substantive tests of
transactions for the acquisition
and payment cycle.

Copyright © 2017 Pearson Education, Ltd. 18-13

METHODOLOGY FOR DESIGNING TESTS OF CONTROLS
AND SUBSTANTIVE TESTS OF TRANSACTIONS

The most time-consuming accounts to verify by tests of

details of balances are accounts receivable, inventory, fixed
assets, accounts payable, and expense accounts. Four of these
are directly related to the acquisition and payment cycle.
• If the auditor can reduce the tests of details of the account
balances by using tests of controls and substantive tests of
transactions for acquisitions and cash disbursements, the time
saved can be dramatic.
The methodology for designing tests of controls and
substantive tests of transactions is illustrated in the following
Figure.

Copyright © 2017 Pearson Education, Ltd. 18-14

Copyright © 2017 Pearson Education, Ltd. 18-15
 METHODOLOGY FOR DESIGNING TESTS OF CONTROLS
AND SUBSTANTIVE TESTS OF TRANSACTIONS (CONT.)

Understand Internal Control: The auditor gains an understanding

of internal control for the acquisition and payment cycle as part of
performing risk assessment procedures.
Assess Planned Control Risk: Key internal controls for the business
functions in this cycle are:
• Authorization of purchases
• Separation of asset custody from other functions
• Timely recording and independent review of transactions (related to
acquisition and payment)
• Authorization of payments
Copyright © 2017 Pearson Education, Ltd. 18-16
 METHODOLOGY FOR DESIGNING TESTS OF CONTROLS
AND SUBSTANTIVE TESTS OF TRANSACTIONS (CONT.)

Determine Extent of Tests of Controls:

• If the auditor intends to rely on controls to support a preliminary
control risk assessment below maximum, the auditor performs tests
of controls to obtain evidence that controls are operating effectively.
Design Tests of Controls and Substantive Tests of Transactions for
Acquisitions:
• Key internal controls, common tests of controls, and common
substantive tests of transactions for each transaction-related audit
objective are summarized in Table 17-2.

Copyright © 2017 Pearson Education, Ltd. 18-17

Copyright © 2017 Pearson Education, Ltd. 18
Copyright © 2017 Pearson Education, Ltd. 19
Copyright © 2017 Pearson Education, Ltd. 20
 METHODOLOGY FOR DESIGNING TESTS OF CONTROLS
AND SUBSTANTIVE TESTS OF TRANSACTIONS (CONT.)

Design Tests of Controls and Substantive Tests of Transactions for

Acquisitions (cont): Four of the six transaction-related audit
objectives should be examined more closely:
1. Recorded acquisitions are for goods and services received,
consistent with the best interests of the client (Occurrence).
2. Existing acquisitions are recorded (Completeness).
3. Acquisitions are accurately recorded (Accuracy).
4. Acquisitions are correctly classified (Classification).

Copyright © 2017 Pearson Education, Ltd. 18-21

 METHODOLOGY FOR DESIGNING TESTS OF CONTROLS
AND SUBSTANTIVE TESTS OF TRANSACTIONS (CONT.)

Design Tests of Controls and Substantive Tests of Transactions for Cash

Disbursements:
• Key internal controls, common tests of controls, and common substantive tests of
transactions for each transaction-related audit objective are summarized in Table
17-3.

Attributes Sampling for Tests of Controls and Substantive Tests of

Transactions: Important differences in acquisition and payment cycle:
• a larger number of accounts involved in this cycle, including both income statement
and balance sheet accounts.
• more common for transactions to require significant judgment, such as for leases
and construction costs.
• dollar amounts of individual transactions in the cycle cover a wide range.
Copyright © 2017 Pearson Education, Ltd. 18-22
Copyright © 2017 Pearson Education, Ltd. 23
Copyright © 2017 Pearson Education, Ltd. 24
Copyright © 2017 Pearson Education, Ltd. 25
 OBJECTIVE 17-4
Describe the methodology for
designing tests of details of
balances for accounts payable using
the audit risk model.

Copyright © 2017 Pearson Education, Ltd. 18-26

 METHODOLOGY FOR DESIGNING TESTS OF
DETAILS OF BALANCES FOR ACCOUNTS PAYABLE
Because all acquisition and payment cycle transactions typically
flow through accounts payable, it is critical to any audit.
The methodology for designing tests of details for accounts
payable is summarized in following Figure.
• Identify Significant Risks and Assess the Risk of Material
Misstatement for Accounts Payable (Phase I).
• Set Performance Materiality (Phase I).
• Assess Control Risk and Design and Perform Tests of Controls
and Substantive Tests of Transactions (Phases I and II).

Copyright © 2017 Pearson Education, Ltd. 18-27

Copyright © 2017 Pearson Education, Ltd. 18-28
 OBJECTIVE 17-5
Design and perform substantive
analytical procedures for
accounts payable.

Copyright © 2017 Pearson Education, Ltd. 18-29

 DESIGN AND PERFORM SUBSTANTIVE
ANALYTICAL PROCEDURES (PHASE III)

The use of analytical procedures is as important in the

acquisition and payment cycle as it is in every other cycle,
especially for uncovering misstatements in accounts
payable.

Analytical procedures for the balance sheet and income

statement accounts in the acquisition and payment cycle
that are useful in uncovering areas in which additional
investigation is desirable are illustrated in following
Table.

Copyright © 2017 Pearson Education, Ltd. 18-30

Copyright © 2017 Pearson Education, Ltd. 18-31
 OBJECTIVE 17-6
Design and perform tests of details
of balances for accounts
payable, including out-of-period
liability tests.

Copyright © 2017 Pearson Education, Ltd. 18-32

 DESIGN AND PERFORM TESTS OF DETAILS OF
ACCOUNTS PAYABLE BALANCE (PHASE III)

The overall objective in the audit of accounts payable is to

determine whether the accounts payable balance is fairly
stated and properly disclosed.

Balance-related audit objectives and common tests of details of

balances procedures for accounts payable are included in Table
18-5.

Difference in the emphasis in auditing assets and liabilities: In

auditing assets, auditors are concerned about overstatements;
for liabilities, auditors are concerned about understatements.

Copyright © 2017 Pearson Education, Ltd. 18-33

Copyright © 2017 Pearson Education, Ltd. 18-34
 DESIGN AND PERFORM TESTS OF DETAILS OF
ACCOUNTS PAYABLE BALANCE (CONT.)
Because auditors are concerned with understatement of liabilities, the
following tests are performed:
Out-of-Period Liability Tests: Also called search for unrecorded
accounts payable
• Examine underlying documentation for subsequent cash disbursements.
• Examine underlying documentation for bills not paid several weeks after
year-end.
• Trace receiving reports issued before year-end to related vendor’s
invoices.
• Trace vendor’s statements that show a balance due to the accounts
payable trial balance.

Copyright © 2017 Pearson Education, Ltd. 18-35

 DESIGN AND PERFORM TESTS OF DETAILS OF
ACCOUNTS PAYABLE BALANCE (CONT.)
Out-of-Period Liability Tests (cont):
• Send confirmations to vendors with which the client does business.
• Cutoff Tests—To determine whether transactions recorded a few
days before and after the balance sheet date are included in the
correct period.
• Relationship of cutoff to physical observation of inventory—Cutoff
tests must be coordinated with the physical observation of
inventory to determine that both the asset and liability are
recorded in the proper period.
• Inventory in Transit—Determine whether inventory in transit at
year-end was FOB destination or FOB origin.

Copyright © 2017 Pearson Education, Ltd. 18-36

 OBJECTIVE 17-7
Distinguish the reliability of
vendors’ invoices, and
confirmations of accounts payable
as audit evidence.

Copyright © 2017 Pearson Education, Ltd. 18-37

 RELIABILITY OF EVIDENCE
Distinction Between Vendors’ Invoices and Vendors’ Statements:

Vendors’ invoices and supporting documents provide reliable

evidence about individual transactions .
The vendor’s statement is superior for verifying accounts payable
because it includes the ending balance.
Difference between Vendors’ Statements and Confirmations:
• Vendors’ statements have been prepared by the vendor, but is in
the hands of the client.
• Confirmations (example shown in the following Figure) are sent
by the auditor and responses from the vendor are sent directly to
the auditor, and are therefore more reliable.

Copyright © 2017 Pearson Education, Ltd. 18-38

Copyright © 2017 Pearson Education, Ltd. 18-39
Next Lecture:

Chapter 18:
Completing the Tests in
the Acquisition and
Payment Cycle:
Verification of Selected
Accounts

2024

Copyright © 2017 Pearson Education, Ltd. 40