Internal Control Questionnaire on Payables

1. Problem EP 12-9, Page 679 • Listed below is a selection of items from internal control questionnaire on payables. • Are invoices, receiving reports, and purchase orders reviewed by the cheque signer? • Are cheques dated in the cash payments 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.

2. Solution, Problem EP 12-9 • Accounts payable internal control questionnaire items •  1. • Purchases and accounts payable are authorized according to company policy (proper authorization). • For a sample of cash payments, vouch to approval signatures on invoices, receiving reports and purchase orders. • Liabilities might be incurred in the company's name without the knowledge of responsible officers. •  2. • Cash payments are recorded in the proper period (proper period cut-off, completeness) • Select a sample of dated cash payments and vouch to cancelled cheques, comparing the dates. • Cash payments could be recorded late, thus temporarily overstating cash. •  3. • Valid liabilities are recorded and none omitted (sound error checking practices). • Observe auditee personnel making comparisons. Review correcting journal entries that result from the comparison. • Purchases or other liabilities may fail to be recorded and the error not detected by any other means. •  4. • Recorded liabilities and cash payments valid and documented (sound record keeping). • Select a sample of recorded supplier invoices, and vouch them to purchase orders and receiving reports for proper quantities and prices. • The company might record overstated or understated liabilities.

3. Problem: DC 12-3, Page 683 You were in the final stages of your examination of the financial statements of Ozine corporation for the year ended December 31, 20X2, when you were consulted by the corporation’s president. The president believes that there is no point to your examining the 20X3 accounts payable records and testing data in support of 20X3 entries. He stated that (1) bills pertaining to 20X2 that were received too late to be included in the December accounts payable were recorded as of the year end by the corporation by journal entry, (2) the internal auditor made tests after the year end, and (3) he would furnish you with a letter certifying that here were no unrecorded liabilities. Required: Should your procedures for unrecorded liabilities be affected by the fact that the auditee made a journal entry to record 20X2 bills that were received late? Explain. Should your test for unrecorded liabilities be affected by the fact that a letter is obtained in which a responsible management official certifies that to the best of his knowledge all liabilities have been recorded? Explain. Should your test for unrecorded liabilities be eliminated or reduced because of the internal audit work? Explain. What sources in addition to the 20X3 accounts payable records should you consider to locate possible unrecorded liabilities?

4. Solution, Problem DC 12-3 • The fact that the auditee made a journal entry to record suppliers' invoices which were received late should: • Simplify the PA's audit for unrecorded liabilities; • Reduce the possibility of a need for a further adjustment • But the PA's audit is nevertheless required. • If the auditee has not journalized late invoices, • The PA is compelled in his testing to substantiate what will ultimately be recorded as an adjusting entry. • In this examination the PA should audit entries in the accounts payable records (e.g., trial balance) for the year being audited to ascertain that all items which according to dates of receiving reports or suppliers' invoices were applicable to that year have been included in the journal entry recorded by the auditee. • No. • The PA should obtain a letter in which responsible executives of the auditee's organization represent that to the best of their knowledge all liabilities have been recognized. • However, this is done as a normal audit procedure to afford additional assurance to the PA and it does not relieve the responsibility for doing other substantive audit work.

5. Whenever a PA is justified in relying on work done by an internal auditor, • He or she should curtail (but not eliminate) his or her own audit work. • In this case, the PA should have ascertained early in the examination that Ozine's internal auditor • Is qualified by being both technically competent and reasonably independent. • Once satisfied as to these points, the PA should discuss the nature and scope of the internal audit program with the internal auditor and review the working papers in order that the PA may properly coordinate the audit program with that of the internal auditor. • If the Ozine internal auditor is qualified and has made tests for unrecorded liabilities, the PA may limit further audit work in this audit area. • NOTE: What is the level of internal independence of the internal auditor?

6. In addition to the next-year accounts payable records, the PA should consider the following sources for possible unrecorded liabilities: • Unentered suppliers' invoice file. • Status of tax returns for prior years still open. • Discussions with employees. • Representations from management. • Comparison of account balances with preceding year. • Examination of individual accounts during the audit. • Existing contracts and agreements. • Minutes. • Attorney's bills and letter of representation. • Status of renegotiable business. • Correspondence with principal suppliers. • Audit testing of cutoff date for reciprocal accounts, e.g., inventory and fixed assets.

7. Problem 2 – From another Text: • Explain why it is common for auditors to send confirmation requests to vendors with “zero balances” on the client’s accounts payable listing but uncommon to follow the same approach in verifying accounts receivable.

8. Solution to Problem 2 • Auditors traditionally follow a conservative approach in selecting vendors for accounts payable confirmations and customers for accounts receivable confirmations. • The auditor assumes that the client is more likely to understate accounts payable • and therefore concentrates on the vendors with whom the client deals actively, especially if that vendor’s balance appears to be lower than normal on the client’s accounts payable listing at the confirmation date. • In verifying accounts receivable • the auditor assumes that the client is more likely to overstate account balances • and for that reason he concentrates more on the higher balances and is not particularly concerned with “zero balances.”

9. Problem DC 12-4 • Accounts Payable Confirmations: • Clark and his partner, Kent, both Pas, are planning their audit program for the audit of accounts payable on the LeClair Corporation’s annual audit. Saturday afternoon, they reviewed the thick file of last year’s working papers, and both of them remembered all to well the six days they spent on last years accounts payable. • Last year, Clark had suggested that they email confirmations to 100 of LeClair’s suppliers. The company regularly purchased from about 1,000 suppliers, and these account payable balances fluctuate widely, depending on the volume of purchases and the terms LeClair’s purchasing agent is able to negotiate. Clark’s sample of 100 was designed to include accounts with large balances. In fact, the 100 accounts confirmed last year covered 80% of the total accounts payable. • Both Clark and Kent spent many hours tracking down minor differences reported in confirmation responses. Non-responding accounts were investigated by comparing LeClair’s balance with monthly statements received from suppliers. Ultimately, they determined that the accounts payable balance was not materially misstated. • Required: • Identify the accounts payable audit objectives that the auditors must consider in determining the audit procedures to be performed. • Identify situations when the auditors should use accounts payable confirmations, and discuss whether they are required to use them. • Discuss why the use of large dollar balances as the basis for selecting accounts payable for confirmation may not be the most efficient approach, and indicate a more efficient sample selection procedure that could be followed when choosing accounts payable for confirmation.

10. Solution to Problem DC 12-4 • The accounts payable audit procedures should be directed toward searching for • proper inclusion of all accounts payable and ascertaining that recorded amounts are reasonably stated because the primary audit purpose is to reveal any possible material understatements. The principal objectives of the accounts payable examination are • To determine adequacy of internal control for processing and payment of invoices. • To prove that amounts shown on the balance sheet are in agreement with supporting accounting records. • To determine that all liabilities existing at the balance sheet date have been recorded.

11. Clark and Kent are not required to use accounts payable confirmation procedures. • The auditor can examine external evidence such as supplier invoices and supplier statements which substantiate the accounts payable balance. • Although not required, the accounts payable confirmation is often used. The auditor might consider such use when • Internal controls are weak. • The company is in a "tight" cash position and bill-paying is slow. Debt covenants based on working capital minimums that may be violated are also a consideration in the amount of assurance required for accounts payable. • Physical inventories exceed general ledger inventory balances by significant amounts. • Certain suppliers do not send statements. • Supplier accounts are pledged by assets. • Supplier accounts include unusual transactions.

12. When auditing accounts payable the auditor is primarily concerned with the possibility of unrecorded payables or understatement of recorded payables. Selection of accounts with relatively small or no balances for confirmation is the more efficient direction of testing since understatements are more likely to be detected when examining such accounts. • When selecting accounts payable for confirmation, the following procedures could be followed: • Analyze the accounts payable population and stratify it into accounts with large balances, accounts with small balances, accounts with zero balances, etc. • Use a sampling technique that selects items based on criteria other than the dollar amount of the items (e.g., select based on terminal digits, select every nth item based on predetermined interval, etc). • Design a statistical sampling plan that will place more emphasis on selecting accounts with zero balances or relatively small balances, particularly when the auditee has had substantial transactions with such suppliers during the year, or a substantial balance in a previous year. • Select prior-year suppliers who are no longer used. • Select new suppliers used in the subsequent years. • Select suppliers that do not provide periodic statements. • Select accounts reflecting unusual transactions during the year. • Select accounts secured by pledged assets