Chapter 11

Auditing the
Purchasing
Process

McGraw-Hill/Irwin Copyright 2010 by the McGraw-Hill Companies, Inc. All rights reserved.

Expense and Liability
Recognition
Expenses are outflows or
other using up of assets
or incurrences of liabilities
from delivering or
producing goods,
rendering services, or
carrying out other
activities that constitute
the entitys ongoing major
or central operations.
LO# 1
Liabilities are probable
future sacrifices of
economic benefits arising
from present obligations
of a particular entity to
transfer assets or provide
services to other entities
in the future as a result of
past transactions or
events.
11-2
 LO# 3

Types of Transactions and Financial

Statement Accounts Affected
Three types of transactions are processed
through the purchasing process:

11-3
 LO# 3

Flowchart of the Purchasing Process

EarthWear Clothiers
Department
Requesting Purchasing IT
Approved Accounts
Purchase purchase Purchase payable
requisition requisition order file master file
received

Purchase
Input order
program

Error Error Vendor

Purchase
corrections report order A/P
(4 part)
Receiving
PO #2
Filed Purchasing
Numerically

11-4
 LO# 3

Flowchart of the Purchasing Process

EarthWear Clothiers
Department
Receiving Accounts Payable (A/P)
PO #1 PO #A
Compare invoice
to PO and RR

Receiving Review
Goods report account
received, distribution
counted, and
Vendor
inspected Voucher
invoice
packet
Enter vendor,
Receiving
quantity, and To IT
report (RR) Input
PO #

Error From IT
Daily correction
receiving log 11-5
 LO# 3

Flowchart of the Purchasing Process

EarthWear Clothiers
Department
IT

Purchase A/P master General

order file file ledger file

Open PO report
A/P expense
Accounts
Input Weekly Monthly distribution report
from A/P
payable Monthly A/P reporting
reports Voucher register
update
Daily Cash disbursements
A/P listing journal

Report Error
to A/P report Cash
Daily
disbursement General
report ledger

11-6
 LO# 3

Flowchart of the Purchasing Process

EarthWear Clothiers
Department
Accounts Payable (A/P) IT Cashier

Cash A/P master

disbursement Checks
file
report

Review documents Cash Review checks

and authorize payment disbursement and mail to
program vendors

Cash
disbursement
Checks Checks
report

Input To Vendors
11-7
 LO# 4

Types of Documents and Records

Purchasing
Purchasing documents
documents and
and records
records .. .. ..
1.
1. Purchase
Purchase Requisition
Requisition request
request to to purchase
purchase goods
goods or or services.
services.
2.
2. Purchase
Purchase Order
Order includes
includes description,
description, quality,
quality, and
and quantity
quantity or
or goods
goods
or
or services
services being
being purchased.
purchased.
3.
3. Receiving
Receiving Report
Report records
records the the receipt
receipt ofof goods.
goods.
4.
4. Vendor
Vendor Invoice
Invoice the
the bill
bill from
from the
the vendor.
vendor.
5.
5. Voucher
Voucher serves
serves asas the
the basis
basis for
for recording
recording aa vendors
vendors invoice.
invoice.
6.
6. Voucher
Voucher Register
Register used
used to to record
record vouchers
vouchers forfor goods
goods and
and services.
services.
7.
7. Accounts
Accounts Payable
Payable Subsidiary
Subsidiary Ledger
Ledger includes
includes amount
amount owed
owed to
to
individual
individual vendors.
vendors.
8.
8. Vendor
Vendor Statement
Statement represents
represents the the purchase
purchase activity
activity with
with vendor.
vendor.
9.
9. Check
Check pays
pays for
for goods
goods or or services.
services.
10.
10. Check
Check Register
Register contains
contains columns
columns to to record
record credits
credits to
to cash
cash and
and
debits
debits to
to accounts
accounts payable
payable and and cash
cash discounts.
discounts.
11-8
 LO# 5

The Major Functions

11-9
 LO# 6

The Key Segregation of Duties

11-10
 LO# 7

Inherent Risk Assessment

Industry-Related Factors
2.
1.
How volatile are
Is the supply of raw
raw material
materials adequate
prices
?
?

11-11
 LO# 7

Inherent Risk Assessment

Misstatements Detected in Prior Audits

Generally,
Generally, the
the purchasing
purchasing process
process is
is not
not difficult
difficult
to
to audit
audit and
and does
does not
not present
present contentious
contentious
accounting
accounting issues.
issues. However,
However, the
the auditors
auditors
experience
experience inin past
past audits
audits must
must be
be considered
considered
when
when assessing
assessing inherent
inherent risk.
risk.

11-12
 LO# 8

Control Risk Assessment

Major steps in setting the control risk in the
purchasing process.
Understanding
Understanding and
and documenting
documenting thethe purchasing
purchasing
process
process (assuming
(assuming aa reliance
reliance strategy.)
strategy.)

Planning
Planning and
and performing
performing tests
tests of
of controls
controls of
of
purchase
purchase transactions.
transactions.

Setting
Setting and
and documenting
documenting the
the control
control risk
risk for
for the
the
purchasing
purchasing process.
process.
11-13
 LO# 8

Control Risk Assessment

Control Environment

1. Understanding of the control environment is usually done

once at the beginning stages of the audit.
2. See Table 6-3 for factors normally considered as part of the
control environment.
3. Important components for the purchasing process:
Organizational structure
Methods of assigning authority and responsibility
11-14
 LO# 8

Control Risk Assessment

Entitys Risk Assessment Process

Need to understand how management:

Weighs the risks that are relevant to the purchasing
process
Estimates the significance of the risks identified
Assesses the likelihood of occurrence
Decides how to address the risks

11-15
 LO# 8

Control Risk Assessment

Information Systems and Communication
For each major class of transactions in the
purchasing process, the auditor must obtain the
following information:
1. How purchase, cash disbursements, and purchase return
transactions are initiated.
2. The accounting records, supporting documents, and accounts
involved in processing purchases, cash disbursements, and
purchase returns.
3. The flow of each type of transaction from initiation to inclusion
in the financial statements, including computer processing.
4. The process used to estimate accrued liabilities.
11-16
 LO# 8

Control Risk Assessment

Monitoring
1. The auditor needs to understand the clients monitoring
process over purchases and cash disbursements.
2. How does management assess the design and operation of
the controls?
3. How do supervisory personnel review the personnel who
perform the controls?

11-17
 LO# 8

Control Risk Assessment

Control Activities
1. When a reliance strategy is adopted, the auditor must identify
specific controls that assure the management assertions are
being met.
2. To rely on the controls (and gather less substantive
evidence), the auditor must test the controls to be sure they
are operating effectively.

11-18
 Control Activities and Tests of LO# 9

Controls Purchase Transactions

Assertions about Classes of Transactions and Events for
the Period under Audit

11-19
 LO# 9

Control Activities and Tests of

Controls Cash Disbursement
Transactions
Occurrence of Cash Disbursement Transactions
The auditor is concerned with a misstatement
caused by a cash disbursement being recorded in
the clients record when no payment was made.
The primary control procedures to prevent such
misstatements include proper segregation of
duties, independent reconciliation and review of
vendor statements, and monthly bank
reconciliations.

11-20
 LO# 8

Control Risk Assessment

After testing controls, the auditor sets the achieved
level of control risk. When tests of controls support
the planned level of control risk, no modifications are
necessary to detection risk. The auditor may proceed
with the substantive procedures as planned.

When tests do not support

the planned control risk, the
auditor lowers the level of
detection risk leading to
more substantive
procedures.
11-21
 LO# 9

Control Activities and Tests of

Controls Purchase Return
Transactions
Generally, the number and magnitude of purchase
return transactions are not material. The auditor
normally does not test controls relating to purchase
returns. Substantive analytical procedures are
used to test the reasonableness of the amount.

11-22
 LO# 10

Relating the Assessed Level of

Control Risk to Substantive
Procedures
IfIf the
the results
results ofof the
the tests
tests of
of controls
controls support
support the the
achieved
achieved level level of
of control
control risk,
risk, the
the auditor
auditor conducts
conducts
substantive
substantive procedures
procedures at at the
the planned
planned level.
level. IfIf the
the
results
results do do notnot support
support the
the achieved
achieved level
level of
of control
control
risk,
risk, the
the auditor
auditor reduces
reduces the
the detection
detection risk,
risk, which
which
will
will increase
increase substantive
substantive procedures.
procedures.

11-23
 LO# 10

Auditing Accounts Payable

and Accrued Expenses

11-24
 LO# 10

Auditing Accounts Payable

and Accrued Expenses

11-25
 LO# 11

Auditing Accounts Payable

and Accrued Expenses
Substantive Analytical Procedures

11-26
 LO# 12
& 13

Tests of Details of Transactions,

Account Balances, and Disclosures
Accuracy
Obtain a listing of accounts payable, foot the listing,
and agree it to the general ledger control account.
Selected vouchers or vendor accounts should be
traced to the supporting documents or subsidiary
accounts payable records to verify the accuracy of
the details.

11-27
 LO# 12

Tests of Details of Transactions, & 13

Account Balances, and Disclosures

Completeness
The auditor should conduct a search for unrecorded
liabilities that includes the following:
1. Ask management about control procedures used to identify
unrecorded liabilities at the end of the period.
2. Obtain copies of vendors monthly statements and reconcile
the amounts to the clients accounts payable records.
3. Confirm vendor accounts, including accounts with small or
zero balances.
4. Vouch large-dollar items from the purchases journal and
cash disbursements journal for a limited time after year-end.
5. Examine the files of unmatched purchase orders, receiving
reports, and vendor invoices for any unrecorded liabilities.
11-28
 LO# 12
& 13

Tests of Details of Transactions,

Account Balances, and Disclosures
Existence
The auditors major concern is whether the recorded
liabilities are valid obligations of the entity. The auditor
should vouch a sample of items on the listing of
accounts payable to other supporting documents.

11-29
 LO# 12

Tests of Details of Transactions,

& 13

Account Balances, and Disclosures

Cutoff
The
The auditor
auditor attempts
attempts to
to determine
determine ifif all
all purchase
purchase
transactions
transactions areare recorded
recorded in
in the
the proper
proper period.
period. On
On
most
most audits,
audits, the
the purchase
purchase cutoff
cutoff is
is coordinated
coordinated with
with
the
the clients
clients physical
physical inventory
inventory count.
count. Proper
Proper cutoff
cutoff
should
should also
also be
be determined
determined for
for purchase
purchase return
return
transactions.
transactions.

11-30
 LO# 12

Tests of Details of Transactions,

& 13

Account Balances, and Disclosures

Rights and Obligations
There is little risk related to this assertion because
clients seldom have an incentive to record liabilities
that are not obligations of the entity.

11-31
 LO# 12
& 13

Tests of Details of Transactions,

Account Balances, and Disclosures
Valuation
Accounts payable are recorded at either the gross
amount of the invoice or net of cash discount
amount. The valuation of accruals depends upon
the type and nature of the accrued expense. Most
accruals are relatively easy to value.

11-32
 LO# 12
& 13

Tests of Details of Transactions,

Account Balances, and Disclosures
Classification, Presentation, and Disclosure
Major
Major classification
classification issues
issues include
include .. .. ..
1.
1. Identifying
Identifying and
and reclassifying
reclassifying any
any material
material debits
debits
contained
contained inin accounts
accounts payable.
payable.
2.
2. Segregating
Segregating short-term
short-term and
and long-term
long-term payables.
payables.
3.
3. Ensuring
Ensuring that
that different
different types
types of
of payables
payables are
are properly
properly
classified.
classified.

11-33
 LO# 12

Tests of Details of Transactions, & 13

Account Balances, and Disclosures

Disclosure Items for the Purchasing Process
Payables
Payables byby type
type (trade,
(trade, Purchases
Purchases from
from and
and
officers,
officers, employees,
employees, payables
payables to
to related
related parties.
parties.
etc.).
etc.).

Dependence
Dependence on on aa single
single
Short-
Short- and
and long-term
long-term vendor
vendor or
or aa small
small number
number
payables.
payables. of
of vendors.
vendors.

Long-term
Long-term purchase
purchase
contracts, Costs
Costs by
by reportable
reportable
contracts, including
including any
any
unusual segment
segment of
of the
the business.
business.
unusual purchase
purchase
commitments.
commitments.
11-34
 LO# 14

Accounts Payable Confirmation

Accounts
Accounts payable
payable confirmations
confirmations are are used
used less
less
often
often than
than accounts
accounts receivable
receivable confirmations.
confirmations. The
The
auditor
auditor is
is able
able to
to examine
examine externally
externally created
created
source
source documents
documents relating
relating toto accounts
accounts payable.
payable.
When
When confirmations
confirmations areare used,
used, they
they are
are usually
usually
positive
positive and
and referred
referred toto as
as blank
blank confirmations
confirmations.. The
The
vendor
vendor isis asked
asked toto supply
supply the
the balance
balance owed
owed by
by the
the
client.
client.

11-35
 LO# 15

Evaluating the Audit Findings

All
All identified
identified misstatements
misstatements should
should be
be aggregated
aggregated
(including
(including any any consideration
consideration for for sampling
sampling risk).
risk). The
The
likely
likely misstatement
misstatement is is then
then compared
compared to to tolerable
tolerable
misstatement.
misstatement. IfIf the the likely
likely misstatement
misstatement is is less
less than
than
the
the tolerable
tolerable misstatement,
misstatement, the the auditor
auditor has
has evidence
evidence
that
that thethe account
account is
is fairly
fairly presented.
presented. Conversely,
Conversely, ifif
the
the likely
likely misstatement
misstatement exceeds
exceeds thethe tolerable
tolerable
misstatement,
misstatement, the the auditor
auditor should
should conclude
conclude that that
the
the account
account isis not
not fairly
fairly presented.
presented.

11-36
End of Chapter 11