Chapter04 - Answer

CHAPTER

4

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

4-1.

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.

4-2.

Errors that occur in the expenditure cycle include recording purchases in the wrong period (cutoff errors), recording goods held on consignment as a purchase, misclassifying purchases, failing to record payments, recording payments twice, and failing to recognize prepaid expenses. Irregularities often relate to purchases and include paying for fictitious purchases, purchasing goods for personal use, and obtaining kickbacks.

4-3.

Audit objectives for acquisitions transactions are to verify the following assertions:     

4-4.

Existence or occurrence: Recorded acquisitions are for items that were acquired. Completeness: Acquisitions that occurred are recorded. Rights and obligations: Recorded acquisitions are the entity’s purchases and liabilities. Valuation or allocation: Acquisitions are recorded for the proper amounts. Presentation and disclosure: Acquisitions are recorded to result in presentation and disclosure in accordance with GAAP.

The following misstatements could arise if controls for payments are ineffective: Existence or occurrence 

Unauthorized or inappropriate payments may be made.

Completeness 

Checks may be issued and not recorded.

Rights and obligations 

Unauthorized payments may be made.

4-2

Solutions Manual to Accompany Applied Auditing, 2006 Edition Valuation or allocation 

Improper amounts may be paid because of math errors or incorrect discount.



Account may not reconcile or discrepancy may not be disclosed.

Presentation and disclosure 

Payments may be credited to wrong accounts.

4-5.

A vendor’s invoice is a bill for a single purchase, whereas the vendor’s monthly statements report the beginning balance, additional sales, any payments, and the ending balance. Auditors reconcile the monthly statements to the details included in the vouchers payable listing to ascertain that all vouchers payable are recorded. Vendors’ statements are generally considered to be a strong form of evidence about amounts owed to particular vendors.

4-6.

1) a

2) b

3) c

4-7.

1) b

2) c

3) c

4-8.

1) d 2) a

3) a 4) d

5) b 6) a

4-9.

1) b

2) b

3) c

4-10.

1) d

2) a

4-11.

1.

a.

7) c

b. c.

A purchase requisition, purchase order, receiving report, and vendor’s invoice should be compared and filed in support of each acquisition. Examine file of documents. Existence

2.

a. b. c.

Receiving reports should be prenumbered and accounted for. Examine file of documents. Existence

3.

a.

A purchase requisition, purchase order, receiving report, and vendor’s invoice should be compared and filed in support of each acquisition. Examine file of documents. Existence

b. c. 4.

a. b. c.

Invoice amounts should be verified by reference to purchase orders, and mathematics of invoice should be rechecked. Examine vouchers for signature indicating performance. Valuation

Audit of the Expenditure Cycle: Tests of Controls and Substantive Tests of Transactions – I 5.

a.

c.

Chart of accounts should adequately describe accounts to be debited. Account coding should be assigned by one person and checked by another. Examine chart of accounts. Examine signature of employee performing check. Presentation and disclosure

a. b. c.

Vouchers should be prenumbered and accounted for. Observe procedure. Account for a numerical sequence. Completeness

b.

6.

4-12.

1) a

4-13.

Fresh Foods Grocery Store 1.

2.

3.

4.

4-3

2) b

a.

1) Adequate documents and records. 2) Independent checks on performance.

b.

Transactions are properly valued.

c.

1) Make sure the billing clerk receives the current price list. 2) Internal verification by someone who has the current price list.

a.

Adequate documents and records.

b.

Recorded transactions are valid.

c.

1) Require that payments only be made on original invoices. 2) Require a receiving report be attached to vendor’s invoice before a payment is made.

a.

1) Adequate documents and records. 2) Physical control over assets. 3) Independent checks on performance.

b.

Recorded transactions are valid.

c.

1) Fence in the physical facilities and prohibit employees from parking inside the fencing. 2) Require the accounting department to maintain perpetual inventory records and take physical counts of actual sides of beef periodically.

a.

Independent checks on performance.

b.

Transactions are properly valued.

c.

Counts by qualified personnel and independent checks on performance.

4-4

Solutions Manual to Accompany Applied Auditing, 2006 Edition 5.

6.

4-14.

a.

Proper procedures for authorization.

b.

1) Transactions are properly valued. 2) Transactions are properly authorized.

c.

1) Make sure the salesman has a current price list. 2) Require independent approval of all transactions including the price before shipment is made.

a.

1) Adequate documents and records. 2) Independent checks on performance.

b.

Transactions are recorded at their proper time.

c.

Carefully coordinate the physical count of inventory on the last day of the year with the recording of sales to make certain counted inventory has not been billed and billed inventory has not been counted.

Love Company a. Function

b. Error or Irregularity

c. Compliance Test(s)

1.

Ordering items requested

Purchases may be for unauthorized purposes or items.

Review evidence of matching of purchase orders with receiving reports and vendors’ invoices.

2.

Receiving items ordered

Goods received may not be accounted for.

Review evidence of numerical sequencing of receiving reports.

3.

Receiving items ordered

Goods delivered to requisitioner may not agree with goods shown on receiving report.

Review receiving report for signature of requisitioner.

4.

Preparing the voucher

Vouchers may be prepared for goods that were not ordered or received.

Review evidence of matching by voucher clerk.

5.

Paying the liability

Checks may be issued without proper authorization.

Examine supporting documentation for each check.

6.

Paying the liability

An approved voucher may be paid more than once.

Examine mutilation of paid vouchers.

7.

Paying the liability

Checks may not agree with amount or payee on voucher.

Examine voucher for evidence of performance by check signers.

Audit of the Expenditure Cycle: Tests of Controls and Substantive Tests of Transactions – I

4-15.

4-5

8.

Preparing the voucher

Vouchers may be incorrect as to payee and amount.

Examine evidence of verification.

9.

Protecting inventory

Inventory may be stolen.

Observe storage security.

10. Updating inventory records

A purchase may not be posted to inventory records.

Review evidence of reconciliation.

11. Journalizing and posting cash disbursements

A check may not be recorded.

Review evidence of verification.

12. Maintaining correctness of cash in bank

A mathematical error may be made in computing the bank balance.

Review evidence of reconciliation.

13. Paying the liability

Checks may be diverted to unauthorized payees.

Review checks for names of payees.

14. Ordering

Purchases may be for unauthorized purposes.

Examine purchase order for supporting documentation.

15. Requisitioning

Excess quantities of goods may be ordered.

Examine evidence of supervisor approval.

Maybelle Corporation a.

Those internal accounting control procedures that Long would expect to find if Maybelle’s system of internal control over purchases is effective are as follows:  Purchase requisitions are prepared and/or approved only after there has been a proper determination of the need for the goods requested.  One copy of the purchase requisition is maintained on file in the stores department.  Purchase requisitions are approved by a responsible person in the stores department. Approval is given only after that person is satisfied that a need exists and that the requisition is properly prepared. Approval is clearly indicated on requisitions.  Purchase orders are issued only after they are approved by persons given the specific responsibility to make such approval.  Vendors are requested to confirm purchase orders. This indicates acceptance and constitutes a contractual commitment.  Purchase requisitions are filed with purchase orders, and both are maintained in an orderly file in the purchase office.  Copies of purchase orders sent to the receiving department do not include the quantities of merchandise ordered.  All purchase orders are numbered, and all numbers are accounted for. This allows control over purchase orders canceled or rejected by vendors.

4-6

Solutions Manual to Accompany Applied Auditing, 2006 Edition  Receiving department accepts only those goods for which a purchase order is on hand. b. (1) The question of when to order depends primarily on quantities on hand, rate of use, and the lead time between order placement and receipt of goods. Other factors include the trade-off between the cost of owning and storing merchandise versus the risk of being out of stock. (2) Factors considered in determining how much to order include expected use, costs of placing an order, receiving and paying for what has been purchased, set-up costs, storage costs, interest on investment, risk of obsolescence or deterioration, quantity discounts, and shipping costs. The determination is made judgmentally or mathematically by arriving at an economic order quantity.

4-16.

1.

a. b. c. d.

Rights and obligations Unauthorized payments may be made. Inquire and observe separation. Examine vouchers and bank reconciliations.

2.

a. b. c. d.

Existence of liability Documents may be reused and acquisitions may be recorded twice. Examine cancellations on documents. Scan voucher register for duplicate payments.

3.

a. b. c.

Existence or occurrence Unauthorized payments may be made or checks may never be mailed. Inquire and observe that authorized individual signs and promptly mails checks. Examine paid checks for appropriate signature.

d. 4.

a. b. c. d.

5.

6.

a. b. c.

Valuation Improper amounts may be paid because of math errors or incorrect discounts. Examine signature on invoice indicating calculation has been verified. Recalculate paid invoices.

d.

Existence or occurrence Acquisitions that did not occur may be recorded. For a sample of cash payments, examine a purchase requisition, purchase order, receiving report, and vendor’s invoice filed in support of each acquisition. Scan voucher register for large or unusual items.

a. b. c. d.

Completeness Acquisitions or payments may not be recorded. Examine reconciliations. Perform reconciliations.

Audit of the Expenditure Cycle: Tests of Controls and Substantive Tests of Transactions – I

4-17.

4-7

a.

For the four conditions, the following risks are incurred: 1. Buyers would not be officially notified of the strict code of conduct to which management expects them to adhere. Buyers could deny that they were expected to conform to a prescribed code of conduct. 2. Only favored suppliers may be asked to bid. Low-cost supplier may be excluded. 3. Bids from favored suppliers could be retained. Bids from nonfavored suppliers could be discarded. 4. The defect was caused by a minor human error. The procedure seems to be adequate and requires no improvement.

b.

For the four conditions, the following controls are recommended: 1. Require buying personnel to periodically report all outside business affiliations or employment. Issue a formal statement of policy on conflicts of interest. Require buying personnel to report the receipt of gifts and other personal benefits from suppliers. 2. Require personnel at appropriate levels of supervision in the purchasing department to review and approve the list of bidders. Require buyers to use a list of acceptable suppliers. 3. Require receipt and retention of bids until the bid-closing date, either by an independent service or by the purchasing agents’ or purchasing managers’ administrative assistant. 4. Verbally recommend that the responsible buyer should be instructed on the requirements for authorized requisitions.