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Completing the Tests in the

Acquisition and Payment Cycle:


Verification of Selected Accounts

Chapter 19

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 5-5


Learning Objective 1

Recognize the many accounts in the


acquisition and payment cycle.

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Accounts Associated with the
Acquisition and Payment Cycle
Assets:

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Learning Objective 2

Design and perform audit tests of property,


plant, and equipment and related
accounts.

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Classifications of Property, Plant
and Equipment

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Equipment and Related
Accounts
Manufacturing Accumulated
Equipment Depreciated
Beginning Disposals Disposals Beginning
balance balance
Acquisitions Current period
depreciation
Ending
balance Ending balance

Gain or Loss Depreciation


on Disposals 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

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Analytical Procedures for
Manufacturing Equipment

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Verify Current Year Acquisitions

Current year additions have a long-term effect


on the financial statements.

Seven of the eight balance-related


audit objectives are used as a frame of reference.

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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.

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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.

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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.

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Balance-related Audit Objectives

Accuracy:

Current year acquisitions as listed


are accurate.

1. Examine vendors invoices.

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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.
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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.

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Major Balance-related
Audit Objectives
Rights:

The client has rights to current year


acquisitions.
1. Examine vendors invoices.

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 19 - 16


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
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Verify Ending Balance
of Asset Accounts

All recorded equipment physically


exists on the balance sheet date

All equipment owned is recorded

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Verify Depreciation Expense

The most important objective is accuracy.

Consistent depreciation policy

Correct calculations

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Verify Ending Balance in
Accumulated Depreciation
Accumulated depreciation as stated
in the property master file agrees
with the general ledger.

Accumulated depreciation in the


master file is accurate.

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Learning Objective 3

Design and perform audit tests of prepaid


expenses.

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Audit of Prepaid Expenses

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

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Prepaid Insurance and Related
Accounts
Prepaid Insurance Insurance Expense
Beginning Current period
balance insurance
expense
Acquisitions

Ending
balance

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Internal Controls

Acquisition and recording of insurance

Insurance register

Insurance expense

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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
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 19 - 25
Audit Tests

Compare the computed prepaid insurance


balance for the current year on a policy-by-
policy 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.

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 19 - 26


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.

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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.

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Learning Objective 4

Design and perform audit tests of accrued


liabilities.

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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

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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

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Learning Objective 5

Design and perform audit tests of income


and expense accounts.

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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

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Analytical Procedures for Income
and Expense Accounts
Analytical procedure Possible misstatement
Compare individual expenses Overstatement or
with previous years understatement of a
balance in an expense
account
Compare individual asset and Overstatement or
liability balances with understatement of a
previous years balance sheet account that
will also affect an income
statement account

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 19 - 34


Analytical Procedures for Income
and Expense Accounts
Analytical procedure Possible misstatement
Compare individual expenses Misstatement of expenses
with budgets and related balance
sheet accounts
Compare gross margin Misstatement of cost of
percentage with previous goods sold and inventory
years
Compare inventory turnover Misstatement of cost of
ratio with previous years goods sold and inventory

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 19 - 35


Analytical Procedures for Income
and Expense Accounts
Analytical procedure Possible misstatement
Compare prepaid insurance Misstatement of
expense with previous years insurance expense and
prepaid insurance
Compare commission Misstatement of
expense divided by sales commission expense and
with previous years accrued commissions
Compare individual Misstatement of
manufacturing expenses individual manufacturing
divided by total mfg. expenses and related
expenses with previous years balance sheet accounts
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 19 - 36
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.

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Analysis of Legal Expense

Expense account analysis:


Repairs and maintenance

Rent and lease

Legal expense

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Analysis of Legal Expense

Expense account analysis:

Repairs and maintenance

Rent and lease

Legal expense

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 19 - 39


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.

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End of Chapter 19

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 5-5