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CHAPTER

4
4-1.

AUDIT OF THE EXPENDITURE CYCLE: TESTS OF CONTROLS AND SUBSTANTIVE TESTS OF TRANSACTIONS - I

Transactions in the expenditure cycle are recorded in the purchases and cash payments journal or in the voucher register and the check register. Relevant accounts are cash; vouchers payable; inventory, property, plant and equipment; purchases; purchase returns and allowances; purchase discounts; prepaid rent and other prepaid accounts; and expense accounts. Errors that occur in the expenditure cycle include recording purchases in the wrong period cuto!! errors", recording goods held on consignment as a purchase, misclassi!ying purchases, !ailing to record payments, recording payments twice, and !ailing to recogni#e prepaid expenses. $rregularities o!ten relate to purchases and include paying !or !ictitious purchases, purchasing goods !or personal use, and obtaining kickbacks. %udit objectives !or acquisitions transactions are to veri!y the !ollowing assertions& Existence or occurrence& Recorded acquisitions are !or items that were acquired. Completeness& %cquisitions that occurred are recorded. Rights and obligations& Recorded acquisitions are the entity's purchases and liabilities. Valuation or allocation& %cquisitions are recorded !or the proper amounts. Presentation and disclosure& %cquisitions are recorded to result in presentation and disclosure in accordance with (%%).

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4-3.

4-4.

The !ollowing misstatements could arise i! controls !or payments are ine!!ective& Existence or occurrence *nauthori#ed or inappropriate payments may be made. +hecks may be issued and not recorded. Completeness

Rights and obligations *nauthori#ed payments may be made.

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Solutions Manual to Accompany Applied Auditing, 200 Edition

Valuation or allocation $mproper amounts may be paid because o! math errors or incorrect discount. %ccount may not reconcile or discrepancy may not be disclosed.

Presentation and disclosure 4-5. )ayments may be credited to wrong accounts.

% vendor's invoice is a bill !or a single purchase, whereas the vendor's monthly statements report the beginning balance, additional sales, any payments, and the ending balance. %uditors reconcile the monthly statements to the details included in the vouchers payable listing to ascertain that all vouchers payable are recorded. ,endors' statements are generally considered to be a strong !orm o! evidence about amounts owed to particular vendors. -" a -" b -" d ." a -" b -" d -. a. b. c. .. a. b. c. a. b. c. 2. a. b. c. ." b ." c /" a 2" d ." b ." a % purchase requisition, purchase order, receiving report, and vendor's invoice should be compared and !iled in support o! each acquisition. Examine !ile o! documents. Existence Receiving reports should be prenumbered and accounted !or. Examine !ile o! documents. Existence % purchase requisition, purchase order, receiving report, and vendor's invoice should be compared and !iled in support o! each acquisition. Examine !ile o! documents. Existence $nvoice amounts should be veri!ied by re!erence to purchase orders, and mathematics o! invoice should be rechecked. Examine vouchers !or signature indicating per!ormance. ,aluation /" c /" c 0" b 3" a /" c 1" c

4-6. 4-7. 4-8. 4- . 4-1!. 4-11.

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Audit o! the Expenditure Cycle" #ests o! Controls and Substanti$e #ests o! #ransactions % & 0. a. b. c. 3. a. b. c.

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+hart o! accounts should adequately describe accounts to be debited. %ccount coding should be assigned by one person and checked by another. Examine chart o! accounts. Examine signature o! employee per!orming check. )resentation and disclosure ,ouchers should be prenumbered and accounted !or. 4bserve procedure. %ccount !or a numerical sequence. +ompleteness ." b

4-12. 4-13.

-" a

Fresh Foods Grocery Store -. a. b. c. .. a. b. c. -" %dequate documents and records. ." $ndependent checks on per!ormance. Transactions are properly valued. -" 5ake sure the billing clerk receives the current price list. ." $nternal veri!ication by someone who has the current price list. %dequate documents and records. Recorded transactions are valid. -" Require that payments only be made on original invoices. ." Require a receiving report be attached to vendor's invoice be!ore a payment is made. -" %dequate documents and records. ." )hysical control over assets. /" $ndependent checks on per!ormance. Recorded transactions are valid. -" 6ence in the physical !acilities and prohibit employees !rom parking inside the !encing. ." Require the accounting department to maintain perpetual inventory records and take physical counts o! actual sides o! bee! periodically. $ndependent checks on per!ormance. Transactions are properly valued. +ounts by quali!ied personnel and independent checks on per!ormance.

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a.

b. c.

2.

a. b. c.

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Solutions Manual to Accompany Applied Auditing, 200 Edition 0. a. b. c. )roper procedures !or authori#ation. -" Transactions are properly valued. ." Transactions are properly authori#ed. -" 5ake sure the salesman has a current price list. ." Require independent approval o! all transactions including the price be!ore shipment is made. -" %dequate documents and records. ." $ndependent checks on per!ormance. Transactions are recorded at their proper time. +are!ully coordinate the physical count o! inventory on the last day o! the year with the recording o! sales to make certain counted inventory has not been billed and billed inventory has not been counted.

3.

a. b. c.

4-14.

Love Company
". F#$%&'($ -. 4rdering items requested ). E**(* (* I**+,#-"*'&. )urchases may be !or unauthori#ed purposes or items. %. C(/0-'"$%+ T+1&213 Review evidence o! matching o! purchase orders with receiving reports and vendors' invoices. Review evidence o! numerical sequencing o! receiving reports. Review receiving report !or signature o! requisitioner.

..

Receiving items ordered Receiving items ordered

(oods received may not be accounted !or. (oods delivered to requisitioner may not agree with goods shown on receiving report. ,ouchers may be prepared !or goods that were not ordered or received. +hecks may be issued without proper authori#ation. %n approved voucher may be paid more than once. +hecks may not agree with amount or payee on voucher.

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2.

)reparing the voucher )aying the liability

Review evidence o! matching by voucher clerk. Examine supporting documentation !or each check. Examine mutilation o! paid vouchers. Examine voucher !or evidence o! per!ormance by check signers.

0.

3. 1.

)aying the liability )aying the liability

Audit o! the Expenditure Cycle" #ests o! Controls and Substanti$e #ests o! #ransactions % &
7. 8. )reparing the voucher )rotecting inventory ,ouchers may be incorrect as to payee and amount. $nventory may be stolen. % purchase may not be posted to inventory records. % check may not be recorded. % mathematical error may be made in computing the bank balance. +hecks may be diverted to unauthori#ed payees. )urchases may be !or unauthori#ed purposes. Excess quantities o! goods may be ordered. Examine evidence o! veri!ication.

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4bserve storage security. Review evidence o! reconciliation. Review evidence o! veri!ication. Review evidence o! reconciliation. Review checks !or names o! payees. Examine purchase order !or supporting documentation. Examine evidence o! supervisor approval.

-9. *pdating inventory records --. :ournali#ing and posting cash disbursements -.. 5aintaining correctness o! cash in bank -/. )aying the liability -2. 4rdering -0. Requisitioning

4-15. a.

Maybelle Corporation Those internal accounting control procedures that ;ong would expect to !ind i! 5aybelle's system o! internal control over purchases is e!!ective are as !ollows& )urchase requisitions are prepared and<or approved only a!ter there has been a proper determination o! the need !or the goods requested. 4ne copy o! the purchase requisition is maintained on !ile in the stores department. )urchase requisitions are approved by a responsible person in the stores department. %pproval is given only a!ter that person is satis!ied that a need exists and that the requisition is properly prepared. %pproval is clearly indicated on requisitions. )urchase orders are issued only a!ter they are approved by persons given the speci!ic responsibility to make such approval. ,endors are requested to con!irm purchase orders. This indicates acceptance and constitutes a contractual commitment. )urchase requisitions are !iled with purchase orders, and both are maintained in an orderly !ile in the purchase o!!ice. +opies o! purchase orders sent to the receiving department do not include the quantities o! merchandise ordered. %ll purchase orders are numbered, and all numbers are accounted !or. This allows control over purchase orders canceled or rejected by vendors.

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Solutions Manual to Accompany Applied Auditing, 200 Edition Receiving department accepts only those goods !or which a purchase order is on hand. -" The question o! when to order depends primarily on quantities on hand, rate o! use, and the lead time between order placement and receipt o! goods. 4ther !actors include the trade=o!! between the cost o! owning and storing merchandise versus the risk o! being out o! stock. ." 6actors considered in determining how much to order include expected use, costs o! placing an order, receiving and paying !or what has been purchased, set=up costs, storage costs, interest on investment, risk o! obsolescence or deterioration, quantity discounts, and shipping costs. The determination is made judgmentally or mathematically by arriving at an economic order quantity. -. a. b. c. d. a. b. c. d. a. b. c. d. 2. a. b. c. d. 0. a. b. c. d. 3. a. b. c. d. Rights and obligations *nauthori#ed payments may be made. $nquire and observe separation. Examine vouchers and bank reconciliations. Existence o! liability >ocuments may be reused and acquisitions may be recorded twice. Examine cancellations on documents. ?can voucher register !or duplicate payments. Existence or occurrence *nauthori#ed payments may be made or checks may never be mailed. $nquire and observe that authori#ed individual signs and promptly mails checks. Examine paid checks !or appropriate signature. ,aluation $mproper amounts may be paid because o! math errors or incorrect discounts. Examine signature on invoice indicating calculation has been veri!ied. Recalculate paid invoices. Existence or occurrence %cquisitions that did not occur may be recorded. 6or a sample o! cash payments, examine a purchase requisition, purchase order, receiving report, and vendor's invoice !iled in support o! each acquisition. ?can voucher register !or large or unusual items. +ompleteness %cquisitions or payments may not be recorded. Examine reconciliations. )er!orm reconciliations.

b.

4-16.

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Audit o! the Expenditure Cycle" #ests o! Controls and Substanti$e #ests o! #ransactions % &

4-7

4-17.

a.

6or the !our conditions, the !ollowing risks are incurred& -. @uyers would not be o!!icially noti!ied o! the strict code o! conduct to which management expects them to adhere. @uyers could deny that they were expected to con!orm to a prescribed code o! conduct. .. 4nly !avored suppliers may be asked to bid. ;ow=cost supplier may be excluded. /. @ids !rom !avored suppliers could be retained. @ids !rom non!avored suppliers could be discarded. 2. The de!ect was caused by a minor human error. The procedure seems to be adequate and requires no improvement. 6or the !our conditions, the !ollowing controls are recommended& -. Require buying personnel to periodically report all outside business a!!iliations or employment. $ssue a !ormal statement o! policy on con!licts o! interest. Require buying personnel to report the receipt o! gi!ts and other personal bene!its !rom suppliers. .. Require personnel at appropriate levels o! supervision in the purchasing department to review and approve the list o! bidders. Require buyers to use a list o! acceptable suppliers. /. Require receipt and retention o! bids until the bid=closing date, either by an independent service or by the purchasing agents' or purchasing managers' administrative assistant. 2. ,erbally recommend that the responsible buyer should be instructed on the requirements !or authori#ed requisitions.

b.

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