Audit of the Payments Cycle

1. Audit of the Payments Cycle CAS 265 – Communicating deficiencies in internal control to those charged with governance and management CAS 300 – Planning an audit of financial statements CAS 315 – Identifying and Assessing the Risks of Material Misstatement through Understanding the Entity and its Environment CAS 320 - Materiality in Planning and Performing an Audit CAS 330 - The Auditor’s Response to Assessed Risk CAS 500 – Audit Evidence CAS 530 – Audit Sampling

2. Purchases, Payments, and Payables Process: Typical Activities What are the main activities? Accounts included in acquisition and expenditure: Inventory, Capital assets, Depreciation/Amortization expense, Accumulated depreciation/amortization, Accounts and notes payable, Cash, and Expense categories (administrative, selling, and manufacturing).

3. Begin Request for purchases Cash disbursement Purchase, Payables and Payment Process Enter accounts payable Receive goods and services Receive vendor invoice

4. An Overview of Functions, Documents, and Accounting Systems Starting point: Any department Purchase details Purchase Requisition N Prepare prenumbered Purchase Requisition Accounts Payable Purchasing

6. Purchasing Department Purchase Requisition Originating Department Determine Vendor, Prepare prenumbered Purchase Order N Purchase Order Originating Department Receiving Accounts Payable Vendor

8. Receiving Department Blind copy of Purchase Order Purchasing Filed until goods received along with invoice copy A Count goods, match with Purchase Order, and prepare Receiving Report Blind copy of Purchase Order A Receiving Report Originating Department with goods Purchasing Accounts Payable

9. A note on Custody and Segregation of Duties A receiving department receives goods purchased and forwards them to the proper departments. Custody of cash is the responsibility of personnel assigned to authorize and sign cheques. Access to blank documents should also be considered as an aspect of custody.

12. Accounts Payable Department Purchase Requisition Originating Department Purchase Order Purchasing Voucher Register to General Accounting Compare. Then prepare Voucher and enter in Voucher Register Receiving Report Receiving Vendor’s Invoice Purchase Requisition Vendor Purchase Order Receiving Report Vendor’s Invoice Voucher To Cash Disbursements when due D

14. Cash Disbursements Department From Accounts Payable Check prices, verify math and consistency between documents, prepare cheques and cheque register. Review documentation, sign cheques and cancel vouchers. Purchase Requisition Purchase Requisition Purchase Order Purchase Order Cheque register Cheques or Electronic Fund Transfer Receiving Report Receiving Report Vendor’s Invoice Vendor’s Invoice Voucher Voucher D To Vendor To General Accounting

15. Managing Risk in the Payments Cycle Possible Errors • Cutoff errors • Consignment goods • Misclassification • Recording a transaction

16. General Control Considerations Ensure proper segregation of responsibilities for authorization, custody, recording, and reconciliation. Controls should provide evidence for detail control checking activities.

17. Fraud in the Acquisition and Payment Cycle • Most frauds • Management • Three areas to look at: • Paying for fictitious purchases • Receiving kickbacks • Purchasing goods for personal use

18. Designing Tests of Controls for the Acquisition and Payment Cycle Must consider IR for A/P Materiality for A/P is allocated from planning materiality. Probably want a low audit risk for A/P as it is usually material. E.g. 5% Understand general controls Use last years assessed CR. If not available, estimate based on initial system review and discussions with client. Will eventually use the assessed materiality after testing. Understand internal control; evaluate design effectiveness By assertion: Some parts of an audit may require additional substantive testing beyond was is normal. This could be due to increased chance of material misstatement or due to the significance of the item, E.G. intercompany A/P. i.e. Related party T/A Assess planned control risk; Identify and assess risks of material misstatement e.g. Document examination, voucher package e.g. Sample size, statistical vs. non-statistical e.g. Attribute sampling could be used to select the actual items e.g. Timing, throughout the whole year Design test for those controls on which the auditor will rely. You cannot assess CR without testing Evaluate cost/benefit of testing controls Tests of details can be reduced if CR is low. Analytical procedures are performed as additional persuasive evidence. Amount of testing is indirectly related to DR The type of audit procedure? What is the sample size? Items to be selected? Timing – when to do the procedure? Design tests of controls to meet transaction-related audit objectives

19. Detail Test of Controls Audit Procedures Tests of controls should address all of the control objectives. Tracing Original Documents Journal or Ledger Vouching

20. Control Risk Assessment The purpose of testing controls is to determine nature, extent, and timing of substantive procedures. Good controls Poor controls

21. Attribute Sampling for Tests of Controls Attribute sampling is common in the area of tests of controls of acquisitions and payments. There can be a large number of accounts Stratification The following slides shows test of controls for acquisitions and payments

22. Acquisitions - Assertions and Test of Controls Existence or Occurrence • Recorded acquisitions are for goods and services received, consistent with the best interests of the client. • Approval of acquisition • The voucher package • Breakdown in control

23. Completeness Existing acquisition transactions are recorded. • Receiving reports are prenumbered and accounted for. • Prenumbering of the voucher Breakdown in control

24. Accuracy • Recorded acquisition transactions are accurate. • Accurate as to amount and account to be posted to • Transactions are approved for prices and discounts • Breakdown in control

25. Classification • Acquisitions transactions are properly classified. • A good chart of accounts is necessary • Posting to the correct accounts • Breakdown in control • Transactions may not recorded in the correct account

26. Timing • Acquisition transactions are recorded on the correct dates. • Transactions should be recorded as soon as possible • The transaction date should be the system date • Breakdown in control • Transactions may not be recorded in the correct period

27. Posting and summarization • Acquisition transactions are properly included in the vendor and inventory master files, and are properly summarized. • Reconciliation of accounts payable master file to the general ledger (Very important) • Breakdown in control

28. Cash Disbursements – Assertions and Test of Controls Occurrence • Recorded cash disbursements are for goods and services actually received. • Adequate segregation of duties The control: • Examination of all supporting documentation prior to payment The control: • Approval of payment shown on supporting documents at the time cheques are signed. Test of control • Breakdown in control .

29. PAID

31. Completeness • Existing cash disbursement transactions are recorded. • Cheques. Key control over cheques? • Cash disbursements journal. • Bank reconciliation • Breakdown in control

32. Alpha Bravo Company Proof of Cash For the Month of June 201X Prepared by GHY Dated 8/7/1X Reviewed by ^ Footed d Traced to cash disbursements journal b Traced to bank statement L Traced to general ledger r Traced to cash receipts journal j Customer’s NSF cheque redeposited on July 8 and cleared

33. Accuracy • Recorded cash disbursement transactions are accurate. • Check the calculations • Bank reconciliation • Breakdown in control

34. Classification • Cash disbursement transactions are properly classified. • Chart of accounts • Checking the classification • Breakdown in control

35. Timing • Cash disbursement transactions are recorded on the correct dates. • The date of the transaction • Recording of transactions • Breakdown in control

36. Posting and Summarization • Cash disbursement transactions are properly included in the vendor master file and properly summarized. • Vendor master file • Detail tie-in • Breakdown in control

37. System Conversions System conversions arise when For example

38. Impact of System Conversion When an organization changes an entire system or a set of systems, there are three issues that the auditor needs to address: An example of an accounts payable conversion from batch to online

39. Conversion Tests of Controls and Tests of Detail

40. Problem EP 12-9 Listed below is a selection of items from the internal control questionnaire on payables in Appendix 12A, Page 694. Are invoices, receiving reports, and purchase orders reviewed by the cheque signer? Are cheques dated in the cash payments (disbursements) journal with the date of the cheque? Are the quantity and quality of goods received determined at the time of receipt by receiving personnel independent of the purchasing department? Are suppliers’ invoices matched against purchase orders and receiving reports before a liability is recorded? Required: For each item: Identify the control objective to which it applies. Specify one test of controls audit procedure an auditor could use to determine whether the control was operating effectively. Using your business experience, your logic, your imagination, or all three, give an example of an error or fraud that could occur if the control were absent or ineffective.

41. Problem DC 12-13 On January 11, at the beginning of your annual audit of Grover Manufacturing Company’s financial statements for the year just ended December 31, the company president confides to you that an employee is living on a scale in excess of that which his salary would support. The employee has been a buyer in the purchasing department for six years and has charge of purchasing all raw materials and supplies. He is authorized to sign purchase orders for amounts up to $2,000. Purchase orders in excess of $2,000 require the countersignature of the general purchasing agent. The president understands that the usual audit of financial statements is not designed to disclose immaterial fraud or conflicts of interest, although such events may be discovered. The president authorizes you, however, to expand your regular audit procedures and to apply additional audit procedures to determine whether there is any evidence that the buyer has been misappropriating company funds or has been engaged in activities that are a conflict of interest. Required: List the audit procedures that you would apply to the company records and documents in attempt to do the following: Discover evidence within the purchasing department of defalcations being committed by the buyer. Give the purpose of each audit procedure. Provide leads about possible collusion between the buyer and suppliers. Give the purpose of each audit procedure.