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Completing the Tests in the Acquisition Completing the Tests in the Acquisition and Payment Cycle: Verification of and Payment Cycle: Verification of
Selected AccountsSelected Accounts
Chapter 19Chapter 19
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Learning Objective 1Learning Objective 1
Recognize the many accountsRecognize the many accountsin the acquisition andin the acquisition andpayment cycle.payment cycle.
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Accounts Associated with the Accounts Associated with the Acquisition and Payment CycleAcquisition and Payment Cycle
Cash Inventory Supplies Property, plant, and equipment Patents, trademarks, and copyrights Prepaid rent Prepaid taxes Prepaid insurance
Assets:
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Accounts Associated with the Accounts Associated with the Acquisition and Payment CycleAcquisition and Payment Cycle
Cost of goods sold Rent expense Property taxes Income tax expense Insurance expense Professional fees Retirement benefits Utilities
Expenses:
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Accounts Associated with the Accounts Associated with the Acquisition and Payment CycleAcquisition and Payment Cycle
Accounts payable Rent payable Accrued professional fees Accrued property taxes Other accrued expenses Income taxes payable
Liabilities:
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Identify client businessrisks affectingother accounts
Methodology for Designing Methodology for Designing Tests of Details of BalancesTests of Details of Balances
Set tolerable misstatementand assess inherent
risk for accounts
Assess control risk foraccounts
Phase I
Phase I
Phase I
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Methodology for Designing Methodology for Designing Tests of Details of BalancesTests of Details of Balances
Design and performtests of controls and
substantive testsof transactions
for the acquisitionand payment cycle
Phase II
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Timing
Items to select
Sample size
Audit procedures
Methodology for Designing Methodology for Designing Tests of Details of BalancesTests of Details of Balances
Design and performanalytical procedures
for the acquisitionand payment cycle
Design tests of detailsof account balances
to satisfybalance-relatedaudit objectives
Phase III
Phase III
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Learning Objective 2Learning Objective 2
Design and perform audit tests of Design and perform audit tests of property, plant, and equipmentproperty, plant, and equipmentand related accounts.and related accounts.
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Classifications of Property, Plant, Classifications of Property, Plant, and Equipment Accountsand Equipment Accounts
Land and land improvements Buildings and building improvements Manufacturing equipment Furniture and fixtures Autos and trucks Leasehold improvements Construction-in-process for property,
plant, and equipment
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Manufacturing EquipmentManufacturing Equipmentand Related Accountsand Related Accounts
Manufacturing Equipment
AccumulatedDepreciated
Beginningbalance
Beginningbalance
DepreciationExpense
Gain or Losson Disposals
Current perioddepreciationEnding balance
DisposalsDisposals
AcquisitionsEndingbalance
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Auditing Manufacturing Equipment Auditing Manufacturing Equipment and Related Accountsand Related Accounts
Perform analytical procedures
Current year acquisitions Current year disposals Ending balance in the asset account Depreciation expense Ending balance in accumulated depreciation
Plus verify:
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Analytical Procedures for Analytical Procedures for Manufacturing EquipmentManufacturing Equipment
Compare accumulateddepreciation divided by grossmanufacturing equipment costwith previous years
Misstatement inaccumulated depreciation
Analytical procedure
Compare depreciation expensedivided by gross manufacturingequipment cost with previousyears
Misstatement indepreciation expense andaccumulated depreciation
Possible misstatement
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Analytical Procedures for Analytical Procedures for Manufacturing EquipmentManufacturing Equipment
Analytical procedure
Compare monthly or annualrepairs and maintenance,supplies expense, small toolsexpense, and similar accountswith previous years
Expensing accounts thatshould be capitalized
Possible misstatement
Compare gross manufacturingcost divided by some measureof production with previousyears
Idle equipment orequipment that wasdisposed of but notwritten off
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Verify Current Year AcquisitionsVerify Current Year Acquisitions
The correct 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 eight balance-relatedaudit objectives are used as a frame of reference.
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Balance-Related Audit Balance-Related Audit ObjectivesObjectives
Current acquisitions agreewith the master file.
Detail tie-in:
1. Foot the acquisition schedule.2. Trace the individual acquisitions to the master file.3. Trace the total to the general ledger.
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Balance-Related Audit Balance-Related Audit ObjectivesObjectives
Current acquisitions as listed exist.Existence:
1. Examine vendors’ invoices andreceiving reports
2. Physically examine assets.
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Balance-Related Audit Balance-Related Audit ObjectivesObjectives
Existing acquisitions are recorded.Completeness:
1. Examine vendors’ invoices of closelyrelated accounts to uncover items thatshould be manufacturing equipment.
2. Review lease and rental agreements.
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Balance-Related Audit Balance-Related Audit ObjectivesObjectives
Current year acquisitions as listedare accurate.
Accuracy:
1. Examine vendors’ invoices.
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Balance-Related Audit Balance-Related Audit ObjectivesObjectives
Current year acquisitions as listedare correctly classified.
Classification:
1. Examine vendors’ invoices inmanufacturing equipment account.
2. Examine vendors’ invoices of closelyrelated accounts.
3. Examine rent and lease expensefor capitalizable leases.
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Current year acquisitions are recordedin the correct period.
Balance-Related Audit Balance-Related Audit ObjectivesObjectives
Cutoff:
1. Review transactions near the balancesheet date for correct period.
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The client has rights to current yearacquisitions.
Major Balance-RelatedMajor Balance-RelatedAudit ObjectivesAudit Objectives
Rights:
1. Examine vendors’ invoices.
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Verify Current Year DisposalsVerify Current Year Disposals
Review whether newly acquired assetsreplace existing assets
Analyze gains and losses on disposal
Review documents for indications ofdeletion of equipment
Make inquiries about the possibility ofthe disposal of assets
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Verify Ending BalanceVerify Ending Balanceof Asset Accountsof Asset Accounts
2. All equipment owned is recorded.
1. All recorded equipment physicallyexists on the balance sheet date.
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Verify Depreciation ExpenseVerify Depreciation Expense
The most important objective is accuracy.
Consistent depreciation policy
Correct calculations
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Verify Ending Balance in Verify Ending Balance in Accumulated DepreciationAccumulated Depreciation
1. Accumulated depreciation as statedin the property master file agreeswith the general ledger.
2. Accumulated depreciation in themaster file is accurate.
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Learning Objective 3Learning Objective 3
Design and perform audit testsDesign and perform audit testsof prepaid expenses.of prepaid expenses.
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Audit of Prepaid ExpensesAudit of Prepaid Expenses
Prepaid rent Organization costs Prepaid taxes Patents Prepaid insurance Trademarks Deferred charges Copyrights
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Prepaid Insurance and Related Prepaid Insurance and Related AccountsAccounts
Prepaid InsuranceBeginning balance
Acquisitions
Ending balance
Current period insurance expense
Insurance Expense
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Internal ControlsInternal Controls
Acquisition and recording of insurance
Insurance register
Insurance expense
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Audit TestsAudit Tests
Compare total prepaid insurance andinsurance expense with previous years
Compute the ratio of prepaid insuranceto insurance expense and compareit with previous years
Compare the individual insurance policycoverage on the schedule of insuranceobtained with the preceding year’s schedule
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Audit TestsAudit Tests
Compare the computed prepaid insurancebalance for the current year on a policy-by-policy basis with that of the preceding year.
Review the insurance coverage listed onthe prepaid insurance schedule with anappropriate client official or insurance broker.
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Balance-related Audit Balance-related Audit ObjectivesObjectives
Existence and completeness:Insurance policies in the prepaid insuranceschedule exist and existing policies are listed.
Rights:The client has rights to all insurance policiesin the prepaid insurance schedule.
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Balance-related Audit Balance-related Audit ObjectivesObjectives
Accuracy and detail tie-in:Prepaid amounts are accurate and the totalis correctly added and agrees with thegeneral ledger.
Classification:Insurance expense is properly classified.
Cutoff:Insurance transactions are recorded in theproper period.
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Learning Objective 4Learning Objective 4
Design and perform audit testsDesign and perform audit testsof accrued liabilities.of accrued liabilities.
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Audit of Accrued LiabilitiesAudit of Accrued Liabilities
Accrued payroll Accrued payroll taxes Accrued officers’ bonuses Accrued commissions Accrued professional fees Accrued rent Accrued interest
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Accrued Property TaxesAccrued Property Taxesand Related Accountsand Related Accounts
Accrued Property TaxesBeginning balance
Current period property tax expense
Ending balance
Property Tax ExpensePayments(property taxes)
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Learning Objective 5Learning Objective 5
Design and perform audit tests ofDesign and perform audit tests ofincome and expense accounts.income and expense accounts.
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Approach to Auditing IncomeApproach to Auditing Incomeand Expense Accountsand Expense Accounts Analytical procedures
Tests of controls and substantivetests of transactions
Tests of details of account balances
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Analytical Procedures for Income Analytical Procedures for Income and Expense Accountsand Expense Accounts
Compare individual asset andliability balances with previousyears
Overstatement orunderstatement of abalance sheet account thatwill also affect an incomestatement account
Analytical procedure
Compare individual expenseswith previous years
Overstatement orunderstatement of abalance in an expenseaccount
Possible misstatement
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Analytical Procedures for Income Analytical Procedures for Income and Expense Accountsand Expense Accounts
Analytical procedure
Compare individual expenseswith budgets
Misstatement of expensesand related balancesheet accounts
Possible misstatement
Compare gross marginpercentage with previousyears
Misstatement of cost ofgoods sold and inventory
Compare inventory turnoverratio with previous years
Misstatement of cost ofgoods sold and inventory
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Analytical Procedures for Income Analytical Procedures for Income and Expense Accountsand Expense Accounts
Analytical procedure
Compare prepaid insuranceexpense with previous years
Misstatement of insuranceexpense and prepaidinsurance
Possible misstatement
Compare commission expensedivided by sales withprevious years
Misstatement ofcommission expense andaccrued commissions
Compare individualmanufacturing expensesdivided by total manufacturingexpenses with previous years
Misstatement of individualmanufacturing expensesand related balancesheet accounts
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Tests of Controls and SubstantiveTests of Controls and SubstantiveTest of TransactionsTest of Transactions
Both tests of controls and substantivetests of transactions have the effect ofsimultaneously verifying balance sheet and income statement accounts.
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Tests of Details of Account Tests of Details of Account Balances – Expense AnalysisBalances – Expense Analysis
Expense account analysis:
Repairs and maintenance
Rent and lease
Legal expense
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Tests of Details of Account Tests of Details of Account Balances – AllocationBalances – 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.
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End of Chapter 19End of Chapter 19