15 - 1 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Bea Completing the Tests in the Acquisition and Payment Cycle: Verification of Selected Accounts Chapter 15
15 - 1©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
Completing the Tests in theAcquisition and Payment
Cycle: Verificationof Selected Accounts
Chapter 15
15 - 2©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
Learning Objective 1
Recognize the many accounts in
the acquisition and payment cycle.
15 - 3©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
AssetsCashInventorySupplies Property, plant, and equipmentPatents, trademarks, and copyrightsPrepaid rentPrepaid taxesPrepaid insurance
Accounts Associated with Acquisition
and Payment Cycle Transactions
15 - 4©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
Accounts Associated with Acquisition
and Payment Cycle Transactions
Cost of goods soldRent expenseProperty taxesIncome tax expenseInsurance expenseProfessional feesRetirement benefitsUtilities
Expenses
15 - 5©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
Accounts Associated with Acquisition
and Payment Cycle Transactions
Accounts payableRent payableAccrued professional feesAccrued property taxesOther accrued expensesIncome taxes payable
Liabilities
15 - 6©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
Learning Objective 2
Design and perform audit
tests of property, plant, and
equipment related accounts.
15 - 7©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
Auditing Manufacturing Equipment
and Related Accounts
Analytical procedures
Current year disposals
Ending balance in the asset account
Depreciation expense
Ending balance in accumulated depreciation
Current year acquisitions
15 - 8©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
Analytical Procedures for Manufacturing Equipment
Analytical Procedure Possible MisstatementCompare depreciation Misstatement inexpense divided by gross depreciation expensemanufacturing equipment and accumulatedcost with previous years. depreciation
Compare accumulated Misstatement indepreciation divided by gross accumulatedmanufacturing equipment depreciationcost with previous years.
15 - 9©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
Analytical Procedures for Manufacturing Equipment
Analytical Procedure Possible MisstatementCompare monthly or annual Expensing amountsrepairs and maintenance, that should besupplies expense, small tools capitalizedexpense, and similar accountswith previous years.Compare gross manufacturing Idle equipment orcost divided by some measure equipment that hasof production with previous been disposed of, butyears. not written off.
15 - 10©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
Verifying Current Year Acquisitions
The proper recording of current year additionsis important because of the long-term effectthe assets have on the financial statements.
Because of the importance of current periodacquisitions, seven of the nine balance-related
audit objectives are used as a frame of reference.
15 - 11©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
Major Balance-RelatedAudit Objectives
Existing acquisitions are recorded.
Completeness
1. Examine vendors’ invoices of closely relatedaccounts to uncover items that should bemanufacturing equipment.
2. Review lease and rental agreements.
15 - 12©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
Current year acquisitions as listed are accurate.
Major Balance-RelatedAudit Objectives
Accuracy
1. Examine vendors’ invoices.
15 - 13©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
Current year acquisitions as listed are properly classified.
Major Balance-RelatedAudit Objectives
Classification
Examine:1. Vendors’ invoices in mfg. equipment account.2. Vendors’ invoices of closely related accounts.3. Rent and lease expense for capitalizable leases.
15 - 14©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
Verifying Current Year Disposals
Review whether newly acquired assets replace existing assets.
Analyze gains and losses on disposal.
Review documents for indicationsof deletion of equipment.
Make inquiries about the possibilityof the disposal of assets.
15 - 15©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
Verifying Ending Balanceof Asset Accounts
1. All equipment owned is recorded.
2. All recorded equipment physically exists on the balance sheet date.
15 - 16©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
Verifying Depreciation Expense
The most important objective is accuracy.
Consistentdepreciation
policy
Correctcalculations
15 - 17©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
Verifying Ending Balance in Accumulated Depreciation
1. Accumulated depreciation as statedin the property master file agreeswith the general ledger.
2. Accumulated depreciation in themaster file is accurate.
15 - 18©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
Learning Objective 3
Design and perform audit
tests of prepaid expenses.
15 - 19©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
Audit of Prepaid Expenses
• Prepaid rent• Organization cost• Prepaid taxes• Patents • Prepaid insurance
• Trademarks• Deferred charges• Copyrights
15 - 20©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
Prepaid InsuranceInternal Controls
1. Controls over the acquisition andrecording of insurance
2. Controls over the insurance register
3. Controls over the charge-off ofinsurance expense
15 - 21©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
Prepaid InsuranceAudit Tests
Compare total prepaid insurance and insuranceexpense with previous years.
Compute the ratio of prepaid insurance to insuranceexpense and compare it with previous years.
Compare the individual insurance policy coverageon the schedule of insurance obtained with the
preceding year’s schedule.
15 - 22©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
Prepaid InsuranceAudit Tests
Compare the computed prepaid insurance balancefor the current year on a policy-by-policy basis
with that of the preceding year.
Review the insurance coverage listed on theprepaid insurance schedule with an appropriate
client official or insurance broker.
15 - 23©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
Learning Objective 4
Design and perform audit
tests of accrued liabilities.
15 - 24©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
Audit of Accrued Liabilities
• Accrued income taxes• Accrued interest• Accrued pension costs• Accrued professional fees• Accrued rent• Accrued warranty costs
15 - 25©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
Accrued Property Taxesand Related Accounts
Accrued Property Taxes
Property Tax Expense
Beginning balance
Payments Current period(property taxes) property tax expense
Ending balance
15 - 26©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
Learning Objective 5
Design and perform audit tests
of income and expense accounts.
15 - 27©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
Approach to Auditing Incomeand Expense Accounts
Analytical procedures
Tests of controls and substantivetests of transactions
Tests of details of account balances
15 - 28©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
Analytical Procedures forIncome and Expense Accounts
Analytical Procedure Possible Misstatement
Compare individual Overstatement orexpenses with previous understatement of ayear. balance in an expense
sheet.
15 - 29©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
Analytical Procedures forIncome and Expense Accounts
Analytical Procedure Possible Misstatement
Compare individual asset Overstatement orand liability balances with understatement of aprevious years. balance sheet account
that would also affectan income statementaccount
15 - 30©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
Analytical Procedures forIncome and Expense Accounts
Analytical Procedure Possible Misstatement
Compare individual Misstatement ofexpenses with budgets. expenses and related
balance sheetaccounts
Compare gross margin Misstatement of costpercentage with previous of goods sold andyears. inventory
15 - 31©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
Analytical Procedures forIncome and Expense Accounts
Analytical Procedure Possible Misstatement
Compare inventory Misstatement of costturnover ratio with of goods sold andprevious years. inventory
Compare prepaid insurance Misstatement ofexpense with previous insurance expenseyears. and prepaid insurance
15 - 32©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
Analytical Procedures forIncome and Expense Accounts
Analytical Procedure Possible Misstatement
Compare commission Misstatement ofexpense divided by sales commission expense,with previous years. accrued commissions
Compare individual Misstatement ofmanufacturing expenses individual mfg.divided by total mfg. expenses and relatedexpenses with previous years. balance sheet accounts
15 - 33©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
Tests of Controls and Substantive
Test of Transactions
Understanding internal control and therelated tests of controls and substantive
tests of transactions to determine theappropriate assessed control risk are
the most important means of verifyingmany of the income statement accounts
in each of the transaction cycles.
15 - 34©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
Tests of Details of AccountBalances: Expense Analysis
Expense account analysis is the examination
of underlying documentation of individual transactions and
amounts making up the detail of the total of an expense account.
15 - 35©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
Tests of Details of Account Balances: Allocation
Several expense accounts result from the allocationof accounting data rather than discrete transactions.
These include depreciation, depletion, and theamortization of copyrights and catalog cost.
The allocation of manufacturing overhead betweeninventory and cost of goods sold is an example ofa different type of allocation that affects expenses.
15 - 36©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
End of Chapter 15