Lecture Auditing and assurance services (Second international edition) Chapter 11 Auditing the purchasing process

Chapter Eleven

Auditing the
Purchasing Process

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Expense and Liability Recognition
(IASB)
Expenses are
decreases in economic
benefits during the
accounting period in
the form of outflows or
depletions of assets or
incurrences of liabilities
that result in decreases
in equity, other than
those relating to
distributions to equity
participants
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A liability is a present
obligation of the entity
arising from past
events, the settlement
of which is expected to
result in an outflow from
the entity of resources

embodying economic
benefits


Overview of the Purchasing Process
A purchase transaction usually begins with a
purchase requisition generated by the user
department. The purchasing department
prepares a purchase order that is sent to the
vendor. When the goods are received or the
services rendered, a liability is recorded.
Finally, the entity pays the vendor.
Purchase
Purchase
requisition
requisition

Purchase
Purchase
order
order

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Receiving
Receiving
report
reportand
and
liability

liability
recorded
recorded

Vendor


Types of Transactions and Financial
Statement Accounts Affected
Three types of transactions are processed
through the purchasing process:

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Flowchart of the Purchasing Process –
EarthWear Clothiers
Department
Requesting
Purchase
requisition

Purchasing
Approved
purchase
requisition
received
Input

Error

corrections
PO #2
Filed
Numerically

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IT
Purchase
order file

Accounts
payable
master file

Purchase
order
program
Error
report

Purchase
order
(4 part)

Vendor
A/P
Receiving
Purchasing

Flowchart of the Purchasing Process –
EarthWear Clothiers
Department
Receiving

Accounts Payable (A/P)

PO
#1

PO
#3

Receiving
report

Goods
received,
counted and
inspected
Receiving
report (RR)

Vendor
invoice
Enter vendor,
quantity, and
PO #
Daily receiving log

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Compare invoice
to PO and RR
Review
account
distribution
Voucher
packet
Input
Error
correction

To IT

From IT


Flowchart of the Purchasing Process –
EarthWear Clothiers
Department
IT
Purchase
order file

A/P master
file

General

ledger file
Open PO report

Input
from A/P

Accounts
payable
update

Weekly
Monthly

Daily
Report
to A/P

Error
report

A/P reporting

Daily

Monthly
reports

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Voucher register

Cash disbursements
journal

A/P listing
Cash
disbursement
report

A/P expense
distribution report

General
ledger


Flowchart of the Purchasing Process –
EarthWear Clothiers
Department
Accounts Payable (A/P)

IT

Cash
disbursement
report

A/P master
file

Review documents

and authorize payment

Cash
disbursement
program

Cash
disbursement
report
Input
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Cheques

Cashier
Cheques

Review cheques
and mail to
vendors

Cheques

To Vendors


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 of
of goods.
goods.
4.
4. Vendor
Vendor Invoice
Invoice –– the
the bill
bill from
from the
the vendor.
vendor.
5.
5. Voucher
Voucher –– serves
serves as
as the
the basis
basis for
for recording
recording aa vendor’s
vendor’s invoice.
invoice.
6.
6. Voucher
Voucher Register

Register –– used
used to
to record
record vouchers
vouchers for
for 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. Electronic
Electronic Funds
Funds Transfer
Transfer and
and Cheques
Cheques –– pays
pays for
for goods
goods or
or services.
services.
10.
10. Cash
Cash Disbursements
Disbursements Journal
Journal –– 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.

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The Major Functions

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Key Functions and Duties

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The Key Segregation of Duties

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Inherent Risk Assessment
Industry-Related Factors

1.Is the supply of raw
materials
adequate?

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2.
How volatile are
raw material
prices?


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
auditor’s
auditor’s experience
experience in
in past
past audits
audits must
must be
be
considered
considered when
when assessing
assessing inherent
inherent risk.
risk.

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Control Risk Assessment
Major steps in setting the control risk in the
purchasing process.
Understand
Understand and
and document
document the
the purchasing
purchasing process
process

based
based on
on aa reliance
reliance strategy.
strategy.

Plan
Plan and
and perform
perform tests
tests of
of controls
controls of
of purchase
purchase
transactions.
transactions.

Set
Set and
and document
document the
the control
control risk
risk for
for the
the purchasing
purchasing
process.
process.

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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.
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Control Risk Assessment
After testing controls, the auditor sets the 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.
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Control Activities and Tests of Controls –
Purchase Transactions
Assertions about Classes of Transactions and Events for
the Period under Audit

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Control Activities and Tests of Controls –
Purchase Transactions

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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 client’s record when no
payment was made. The primary control
activities to prevent such misstatements
include proper segregation of duties,
independent reconciliation and review of

vendor statements, and monthly bank
reconciliations.
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Control Activities and Tests of Controls –
Cash Disbursement Transactions
Completeness of Cash Disbursement
Transactions

The
The major
major audit
audit concern
concern is
is that
that aa cash
cash
disbursement
disbursement is
is made
made but
but not
not recorded
recorded in
in the
the
records.
records. The
The auditor

auditor should
should examine
examine and
and test
test the
the
client’s
client’s procedures
procedures for
for reviewing
reviewing vendor
vendor
payments
payments lists
lists and
and reconcile
reconcile the
the daily
daily cash
cash
disbursements
disbursements with
with posting
posting to
to the
the accounts
accounts
payable
payable subsidiary
subsidiary records.

records.

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Control Activities and Tests of Controls –
Cash Disbursement Transactions
Authorization of Cash Disbursement Transactions

Proper
Proper segregation
segregation of
of duties
duties reduces
reduces the
the
likelihood
likelihood that
that unauthorized
unauthorized cash
cash disbursements
disbursements
are
are made.
made. The
The individual
individual who
who approves
approves aa
purchase

purchase should
should not
not have
have direct
direct access
access to
to the
the
cash
cash disbursement.
disbursement.

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Control Activities and Tests of Controls –
Cash Disbursement Transactions
Accuracy of Cash Disbursement Transactions
One of the major audit concerns is that the
payment amount is recorded incorrectly. To
detect such an error, client personnel should
reconcile the total of electronic cash
disbursements transfer and the cheques issued
each day with the daily cash disbursements
report.

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Control Activities and Tests of Controls –

Cash Disbursement Transactions
Cut-off of Cash Disbursement Transactions
The auditor’s tests of controls include reviewing
the reconciliation of payments transfers with
postings to the cash disbursements journal and
accounts payable subsidiary records. The auditor
also tests cash disbursements before and after
year-end to ensure that transactions are
recorded in the proper period.

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Control Activities and Tests of Controls –
Cash Disbursement Transactions
Classification of Cash Disbursement
Transactions
The
The auditor
auditor is
is concerned
concerned that
that aa cash
cash
disbursement
disbursement may
may be
be charged
charged to
to the

the wrong
wrong
general
general ledger
ledger account.
account. The
The use
use of
of aa chart
chart of
of
accounts,
accounts, as
as well
well as
as independent
independent approval
approval and
and
review
review of
of the
the account
account code
code on
on the
the voucher
voucher
should
should provide

provide adequate
adequate control.
control.

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