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Completing the Tests in the Acquisition

and Payment Cycle: Verification of


Selected Accounts
Chapter 19

2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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Learning Objective 1
Recognize the many accounts
in the acquisition and
payment cycle.

2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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Accounts Associated with the


Acquisition and Payment Cycle
Assets:
Cash
Inventory
Supplies
Property, plant, and equipment
Patents, trademarks, and copyrights
Prepaid rent
Prepaid taxes
Prepaid insurance

2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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Accounts Associated with the


Acquisition and Payment Cycle
Expenses:
Cost of goods sold
Rent expense
Property taxes
Income tax expense
Insurance expense
Professional fees
Retirement benefits
Utilities

2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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Accounts Associated with the


Acquisition and Payment Cycle
Liabilities:
Accounts payable
Rent payable
Accrued professional fees
Accrued property taxes
Other accrued expenses
Income taxes payable

2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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Methodology for Designing


Tests of Details of Balances
Identify client business
risks affecting
other accounts

Phase I

Set tolerable misstatement


and assess inherent
Phase I
risk for accounts
Assess control risk for
accounts

Phase I

2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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Methodology for Designing


Tests of Details of Balances
Design and perform
tests of controls and
substantive tests
Phase II
of transactions
for the acquisition
and payment cycle

2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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Methodology for Designing


Tests of Details of Balances
Design and perform
analytical procedures
Phase III
for the acquisition
and payment cycle
Design tests of details
of account balances
to satisfy
balance-related
audit objectives

Audit procedures
Sample size
Items to select

Phase III

Timing

2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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Learning Objective 2
Design and perform audit tests of
property, plant, and equipment
and related accounts.

2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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Classifications of Property, Plant,


and 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

2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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Manufacturing Equipment
and Related Accounts
Manufacturing
Equipment
Beginning
Disposals
balance
Acquisitions
Ending
balance

Accumulated
Depreciated
Disposals Beginning
balance
Current period
depreciation
Ending balance

Gain or Loss
on Disposals

2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

Depreciation
Expense

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Auditing Manufacturing Equipment


and Related Accounts
Perform analytical procedures
Plus verify:
Current year acquisitions
Current year disposals
Ending balance in the asset account
Depreciation expense
Ending balance in accumulated depreciation

2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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Analytical Procedures for


Manufacturing Equipment
Analytical procedure

Possible misstatement

Compare depreciation expense Misstatement in


divided by gross manufacturing depreciation expense and
equipment cost with previous accumulated depreciation
years
Compare accumulated
Misstatement in
depreciation divided by gross accumulated depreciation
manufacturing equipment cost
with previous years
2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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Analytical Procedures for


Manufacturing Equipment
Analytical procedure

Possible misstatement

Compare monthly or annual


repairs and maintenance,
supplies expense, small tools
expense, and similar accounts
with previous years

Expensing accounts that


should be capitalized

Compare gross manufacturing


cost divided by some measure
of production with previous
years

Idle equipment or
equipment that was
disposed of but not
written off

2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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Verify Current Year Acquisitions


The correct recording of current year additions
is important because of the long-term effect
the assets have on the financial statements.
Because of the importance of current period
acquisitions, seven of the eight balance-related
audit objectives are used as a frame of reference.

2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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Balance-Related Audit
Objectives
Detail tie-in:
Current acquisitions agree
with the master file.
1. Foot the acquisition schedule.
2. Trace the individual acquisitions
to the master file.
3. Trace the total to the general ledger.

2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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Balance-Related Audit
Objectives
Existence:
Current acquisitions as listed exist.
1. Examine vendors invoices and
receiving reports
2. Physically examine assets.

2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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Balance-Related Audit
Objectives
Completeness:
Existing acquisitions are recorded.
1. Examine vendors invoices of closely
related accounts to uncover items that
should be manufacturing equipment.
2. Review lease and rental agreements.

2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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Balance-Related Audit
Objectives
Accuracy:
Current year acquisitions as listed
are accurate.
1. Examine vendors invoices.

2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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Balance-Related Audit
Objectives
Classification:
Current year acquisitions as listed
are correctly classified.
1. Examine vendors invoices in
manufacturing equipment account.
2. Examine vendors invoices of closely
related accounts.
3. Examine rent and lease expense
for capitalizable leases.
2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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Balance-Related Audit
Objectives
Cutoff:
Current year acquisitions are recorded
in the correct period.
1. Review transactions near the balance
sheet date for correct period.

2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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Major Balance-Related
Audit Objectives
Rights:
The client has rights to current year
acquisitions.
1. Examine vendors invoices.

2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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Verify Current Year Disposals


Review whether newly acquired assets
replace existing assets
Analyze gains and losses on disposal
Review documents for indications of
deletion of equipment
Make inquiries about the possibility of
the disposal of assets
2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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Verify Ending Balance


of Asset Accounts
1. All recorded equipment physically
exists on the balance sheet date.
2. All equipment owned is recorded.

2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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Verify Depreciation Expense


The most important objective is accuracy.
Consistent depreciation policy
Correct calculations

2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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Verify Ending Balance in


Accumulated Depreciation
1. Accumulated depreciation as stated
in the property master file agrees
with the general ledger.
2. Accumulated depreciation in the
master file is accurate.

2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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Learning Objective 3
Design and perform audit tests
of prepaid expenses.

2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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Audit of Prepaid Expenses


Prepaid rent
Organization costs
Prepaid taxes
Patents
Prepaid insurance
Trademarks
Deferred charges
Copyrights

2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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Prepaid Insurance and Related


Accounts
Prepaid Insurance
Beginning
balance

Insurance Expense

Current period
insurance
expense

Acquisitions
Ending
balance

2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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Internal Controls
Acquisition and recording of insurance
Insurance register
Insurance expense

2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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Audit Tests
Compare total prepaid insurance and
insurance expense with previous years
Compute the ratio of prepaid insurance
to insurance expense and compare
it with previous years
Compare the individual insurance policy
coverage on the schedule of insurance
obtained with the preceding years schedule
2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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Audit Tests
Compare the computed prepaid insurance
balance for the current year on a policy-bypolicy basis with that of the preceding year.
Review the insurance coverage listed on
the prepaid insurance schedule with an
appropriate client official or insurance broker.

2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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Balance-related Audit
Objectives
Existence and completeness:
Insurance policies in the prepaid insurance
schedule exist and existing policies are listed.
Rights:
The client has rights to all insurance policies
in the prepaid insurance schedule.

2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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Balance-related Audit
Objectives
Accuracy and detail tie-in:
Prepaid amounts are accurate and the total
is correctly added and agrees with the
general ledger.
Classification:
Insurance expense is properly classified.
Cutoff:
Insurance transactions are recorded in the
proper period.
2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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Learning Objective 4
Design and perform audit tests
of accrued liabilities.

2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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Audit of Accrued Liabilities


Accrued payroll
Accrued payroll taxes
Accrued officers bonuses
Accrued commissions
Accrued professional fees
Accrued rent
Accrued interest

2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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Accrued Property Taxes


and Related Accounts
Accrued Property Taxes

Property Tax Expense

Payments
Beginning
(property taxes) balance
Current period
property tax
expense
Ending
balance

2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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Learning Objective 5
Design and perform audit tests of
income and expense accounts.

2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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Approach to Auditing Income


and Expense Accounts
Analytical procedures
Tests of controls and substantive
tests of transactions
Tests of details of account balances

2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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Analytical Procedures for Income


and Expense Accounts
Analytical procedure

Possible misstatement

Compare individual expenses


with previous years

Overstatement or
understatement of a
balance in an expense
account

Compare individual asset and Overstatement or


liability balances with previous understatement of a
years
balance sheet account that
will also affect an income
statement account
2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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Analytical Procedures for Income


and Expense Accounts
Analytical procedure

Possible misstatement

Compare individual expenses


with budgets

Misstatement of expenses
and related balance
sheet accounts

Compare gross margin


percentage with previous
years

Misstatement of cost of
goods sold and inventory

Compare inventory turnover


ratio with previous years

Misstatement of cost of
goods sold and inventory

2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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Analytical Procedures for Income


and Expense Accounts
Analytical procedure

Possible misstatement

Compare prepaid insurance


expense with previous years

Misstatement of insurance
expense and prepaid
insurance

Compare commission expense


divided by sales with
previous years
Compare individual
manufacturing expenses
divided by total manufacturing
expenses with previous years

Misstatement of
commission expense and
accrued commissions
Misstatement of individual
manufacturing expenses
and related balance
sheet accounts

2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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Tests of Controls and Substantive


Test of Transactions
Both tests of controls and substantive
tests of transactions have the effect of
simultaneously verifying balance sheet
and income statement accounts.

2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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Tests of Details of Account


Balances Expense Analysis
Expense account analysis:
Repairs and maintenance
Rent and lease
Legal expense

2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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Tests of Details of Account


Balances Allocation
Several expense accounts result from the allocation
of accounting data rather than discrete transactions.
These include depreciation, depletion, and the
amortization of copyrights and catalog cost.
The allocation of manufacturing overhead between
inventory and cost of goods sold is an example of
a different type of allocation that affects expenses.
2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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End of Chapter 19

2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley

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