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Auditing- A Practical Approach

Chapter 10: AUDITING PURCHASES, PAYABLES, AND PAYROLL

FMGT 4310

Auditing 2

Chapter 10 Learning Objectives

1. Identify the audit objectives applicable to purchases, payables and payroll

2. Describe the functions and control procedures normally found in information systems for processing purchase, payment and purchase adjustment transactions

3. Describe the functions and control procedures normally found in information systems for payroll transactions

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Chapter 10 Learning Objectives

4. Discuss considerations relevant to determining the audit strategy for purchases, payables, and payroll

5. Indicate the factors relevant to determining an acceptable level of detection risk for the audit of purchases, payables, and payroll

6. Design a substantive audit program for purchases, payables, and payroll

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Audit Objectives

Key Issues • Purchases are all recorded and

not understated • Payables that are derived from the

purchases are fully recorded as a liability

 C (COMPLETENESS) 10-4

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Business functions in the Purchases and Payments cycle

What are the typical business functions?

• “purchases”

• “payables”

• “payments”

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Business functions in the Purchases and Payments cycle

Key functions – requisitioning goods and services – preparing purchase orders – receiving the goods – storing goods received for inventory – checking and approving the supplier’s

invoice – recording the liability

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Business functions in the Purchases and Payments cycle

Key functions  Purchase requisition

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Who should prepare purchase requisitions?How many copies?

Business functions in the Purchases and Payments cycle

Key functions  Purchase order

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Who should prepare purchase orders?

How many copies?

Business functions in the Purchases and Payments cycle

Key functions  Receiving report

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Who should prepare receiving reports? How many copies?

Business functions in the Purchases and Payments cycle

Key functions  Vendor Invoice

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Who should receive invoices?

Procedures?

Business functions in the Purchases and Payments cycle

Key functions  Recording AP

– AP Master file – Supplier statements – Review/oversight (budgets?) – Incompatible functions?

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Recording / Custody / Authorization / Reconciliation

Business functions in the Purchases and Payments cycle

Key functions  Paying AP

– Regular cheque runs – Supporting documents

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Who should sign cheques?

Business functions in the Purchases and Payments cycle

Key functions  Other control procedures

– Independent review – Independent bank reconciliations

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What is the Human Resources and Payroll cycle?

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Business functions in the Human Resources and Payroll cycle

• Personnel evaluation and hiring

• Master file changes (semi-permanent information)

• Timekeeping and payroll preparation

• Payment of payroll

• Employee withholdings and benefit remittances

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Business functions in the Human Resources and Payroll cycle

• Personnel evaluation and hiring

– Résumé

– Interview(s)

– Offer/contract

– Employee Master File

– TD1

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Who should process payroll?

Business functions in the Human Resources and Payroll cycle

• Master file changes (semi- permanent information)

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What information?

Authorization for changes?

Business functions in the Human Resources and Payroll cycle

• Timekeeping and payroll preparation

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Authorization of hours?

Termination?

Business functions in the Human Resources and Payroll cycle

• Payment of payroll

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 Imprest account

Who should distribute cheques?

Business functions in the Human Resources and Payroll cycle

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Who should review?

Business functions in the Human Resources and Payroll cycle • Employee withholdings and benefit

remittances

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Funds in trust

Set materiality and Assess IR

Methodology- Designing Test of Details

Assess CR Design/perform Control tests

Design Tests of Detail: •Audit procedures •Sample size •Items to select •Timing

Purchases/Payments & HR/Payroll Cycles

Assess Inherent risk • Pressures on management to:

• Over or understate Purchases?

• Over or understate AP? • Other inherent risk factors

• Major expense

• High volume of transactions

• Employee theft/false payroll

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Procurement fraud?

Over or Under statement?

Assess Control risk

• Is CR LESS than maximum?

• Must assess WCGW for each assertion

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Purchases/Payments & HR/Payroll Cycles

COCCA CERV

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Purchases/Payments Cycle

Procurement fraud?

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Purchases/Payments Cycle

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Purchases/Payments Cycle

Procurement fraud?

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HR/Payroll Cycle

Overpayment O

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HR/Payroll Cycle

Control testing

 Test of Operating Effectiveness

Is the control effective for the entire period of audit?

May also provide substantive evidence

i.e. “Dual purpose” tests

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Purchases/Payments & HR/Payroll Cycles

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Purchases/Payments & HR/Payroll Cycles

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Purchases/Payments & HR/Payroll Cycles

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Purchases/Payments & HR/Payroll Cycles

• Transactions that occur throughout the year.

• Accounts payable  balance sheet.

• Material balance?

Substantive Testing

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1.Initial Procedures – Trace opening AP balances – Review activity – Agree year end accounts payable to the GL

trial balance

Substantive Testing

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1.Initial Procedures • AP listing as at balance sheet date

– Check arithmetic – Agree to GL control account – Agree supplier balances to AP subledger

Substantive Testing

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2.Analytical Procedures – Review understanding of entity

 expectations? – Year to year comparisons, ratio analysis – Are actual results consistent with

expectations?

Substantive Testing

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Key ratios/analytics?

2.Analytical Procedures – Persuasive evidence for payroll expenses?

Substantive Testing

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Key calculations?

3.Tests of Details of Transactions - Vouch purchases to supporting

transactions, OR - Trace supporting documents to purchases

 sample? - Test purchases cut off

Unmatched PO’s, receiving reports

Substantive Testing

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O C

Co

Accounts Payable

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• How does the audit of AP differ from the audit of AR?

–Overstatement vs. Understatement

Existence vs. Completeness

Accounts Payable

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• Substantive testing

–Reconciling supplier statements

–Confirmations

–Subsequent payments

Which suppliers?

• What is the approach for selecting AP items for confirmation?

–Large account balances?

–Small account balances?

–Significant vendors

Accounts Payable

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• Search for unrecorded liabilities

–Review subsequent payments

–Discussions with management

• Contingencies?

Accounts Payable

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4. Presentation & Disclosure – GAAP requirements

– Management representation letter

Substantive Testing

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