Completing the Tests in the

Acquisition and Payment

Cycle: Verification of
Selected Accounts
Chapter 18

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Learning Objective 1
Recognize the many accounts
in the acquisition and
payment cycle.

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Accounts Associated with the

Acquisition and Payment Cycle
Assets:
Cash
Inventory
Supplies
Property, plant, and equipment
Patents, trademarks, and copyrights
Prepaid rent
Prepaid taxes
Prepaid insurance

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Accounts Associated with the

Acquisition and Payment Cycle
Expenses:
Cost of goods sold
Rent expense
Property taxes
Income tax expense
Insurance expense
Professional fees
Retirement benefits
Utilities

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Accounts Associated with the

Acquisition and Payment Cycle
Liabilities:
Accounts payable
Rent payable
Accrued professional fees
Accrued property taxes
Other accrued expenses
Income taxes payable

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Methodology for Designing

Tests of Details of Balances
Identify client business
risks affecting
other accounts

Phase I

Set tolerable misstatement

and assess inherent
Phase I
risk for accounts
Assess control risk for
accounts

Phase I

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Methodology for Designing

Tests of Details of Balances
Design and perform
tests of controls and
substantive tests
Phase II
of transactions
for the acquisition
and payment cycle

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Methodology for Designing

Tests of Details of Balances
Design and perform
analytical procedures
Phase III
for the acquisition
and payment cycle
Design tests of details
of account balances
to satisfy
balance-related
audit objectives

Audit procedures
Sample size

Phase III

Items to select
Timing

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Learning Objective 2
Design and perform audit tests of
property, plant, and equipment
and related accounts.

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Classifications of Property,
Plant, and Equipment Accounts

Land and land improvements

Buildings and building improvements
Manufacturing equipment
Furniture and fixtures
Autos and trucks
Leasehold improvements
Construction-in-process for property,
plant, and equipment

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Manufacturing Equipment
and Related Accounts
Manufacturing
Equipment
Disposals
Beginning
balance
Acquisitions
Ending
balance

Accumulated
Depreciated
Disposals Beginning
balance
Current period
depreciation
Ending balance

Gain or Loss
on Disposals

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

Depreciation
Expense

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Auditing Manufacturing Equipment

and Related Accounts
Perform analytical procedures
Plus verify:
Current year acquisitions
Current year disposals
Ending balance in the asset account
Depreciation expense
Ending balance in accumulated depreciation

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Analytical Procedures for

Manufacturing Equipment
Analytical procedure

Possible misstatement

Compare depreciation expense Misstatement in

divided by gross manufacturing depreciation expense and
accumulated depreciation
equipment cost with previous
years
Misstatement in
Compare accumulated
depreciation divided by gross accumulated depreciation
manufacturing equipment cost
with previous years

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Analytical Procedures for

Manufacturing Equipment
Analytical procedure

Possible misstatement

Compare monthly or annual

repairs and maintenance,
supplies expense, small tools
expense, and similar accounts
with previous years

Expensing accounts that

should be capitalized

Compare gross manufacturing

cost divided by some measure
of production with previous
years

Idle equipment or
equipment that was
disposed of but not
written off

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Verify Current Year

Acquisitions
The correct recording of current year additions
is important because of the long-term effect
the assets have on the financial statements.
Because of the importance of current period
acquisitions, seven of the eight balance-related
audit objectives are used as a frame of reference.

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Balance-Related Audit
Objectives
Detail tie-in:
Current acquisitions agree
with the master file.
1. Foot the acquisition schedule.
2. Trace the individual acquisitions
to the master file.
3. Trace the total to the general ledger.

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Balance-Related Audit
Objectives
Existence:
Current acquisitions as listed exist.
1. Examine vendors invoices and
receiving reports
2. Physically examine assets.

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Balance-Related Audit
Objectives
Completeness:
Existing acquisitions are recorded.
1. Examine vendors invoices of closely
related accounts to uncover items that
should be manufacturing equipment.
2. Review lease and rental agreements.

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Balance-Related Audit
Objectives
Accuracy:
Current year acquisitions as listed
are accurate.
1. Examine vendors invoices.

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Balance-Related Audit
Objectives
Classification:
Current year acquisitions as listed
are correctly classified.
1. Examine vendors invoices in
manufacturing equipment account.
2. Examine vendors invoices of closely
related accounts.
3. Examine rent and lease expense
for capitalizable leases.
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Balance-Related Audit
Objectives
Cutoff:
Current year acquisitions are recorded
in the correct period.
1. Review transactions near the balance
sheet date for correct period.

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Major Balance-Related
Audit Objectives
Rights:
The client has rights to current year
acquisitions.
1. Examine vendors invoices.

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Verify Current Year Disposals

Review whether newly acquired assets
replace existing assets
Analyze gains and losses on disposal
Review documents for indications of
deletion of equipment
Make inquiries about the possibility of
the disposal of assets

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Verify Ending Balance

of Asset Accounts
1. All recorded equipment physically
exists on the balance sheet date.
2. All equipment owned is recorded.

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Verify Depreciation Expense

The most important objective is accuracy.
Consistent depreciation policy
Correct calculations

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Verify Ending Balance in

Accumulated Depreciation
1. Accumulated depreciation as stated
in the property master file agrees
with the general ledger.
2. Accumulated depreciation in the
master file is accurate.

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Learning Objective 3
Design and perform audit tests
of prepaid expenses.

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Audit of Prepaid Expenses

Prepaid rent
Organization costs
Prepaid taxes
Patents
Prepaid insurance
Trademarks
Deferred charges
Copyrights

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Prepaid Insurance and

Related Accounts
Prepaid Insurance
Beginning
balance

Insurance Expense

Current period
insurance
expense

Acquisitions
Ending
balance

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Internal Controls
Acquisition and recording of insurance
Insurance register
Insurance expense

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Audit Tests
Compare total prepaid insurance and
insurance expense with previous years
Compute the ratio of prepaid insurance
to insurance expense and compare
it with previous years
Compare the individual insurance policy
coverage on the schedule of insurance
obtained with the preceding years schedule
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Audit Tests
Compare the computed prepaid insurance
balance for the current year on a policy-bypolicy basis with that of the preceding year.
Review the insurance coverage listed on
the prepaid insurance schedule with an
appropriate client official or insurance broker.

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Balance-related Audit
Objectives
Existence and completeness:
Insurance policies in the prepaid insurance
schedule exist and existing policies are listed.
Rights:
The client has rights to all insurance policies
in the prepaid insurance schedule.

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Balance-related Audit
Objectives
Accuracy and detail tie-in:
Prepaid amounts are accurate and the total
is correctly added and agrees with the
general ledger.
Classification:
Insurance expense is properly classified.
Cutoff:
Insurance transactions are recorded in the
proper period.
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Learning Objective 4
Design and perform audit tests
of accrued liabilities.

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Audit of Accrued Liabilities

Accrued payroll

Accrued payroll taxes

Accrued officers bonuses

Accrued commissions

Accrued professional fees

Accrued rent

Accrued interest

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Accrued Property Taxes

and Related Accounts
Accrued Property Taxes
Payments
Beginning
(property taxes) balance

Property Tax Expense

Current period
property tax
expense
Ending
balance

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Learning Objective 5
Design and perform audit tests of
income and expense accounts.

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Approach to Auditing Income

and Expense Accounts
Analytical procedures
Tests of controls and substantive
tests of transactions
Tests of details of account balances

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Analytical Procedures for

Income and Expense Accounts
Analytical procedure

Possible misstatement

Compare individual expenses

with previous years

Overstatement or
understatement of a
balance in an expense
account

Compare individual asset and Overstatement or

liability balances with previous understatement of a
years
balance sheet account that
will also affect an income
statement account

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Analytical Procedures for

Income and Expense Accounts
Analytical procedure

Possible misstatement

Compare individual expenses

with budgets

Misstatement of expenses
and related balance
sheet accounts

Compare gross margin

percentage with previous
years

Misstatement of cost of
goods sold and inventory

Compare inventory turnover

ratio with previous years

Misstatement of cost of
goods sold and inventory

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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Analytical Procedures for

Income and Expense Accounts
Analytical procedure

Possible misstatement

Compare prepaid insurance

expense with previous years

Misstatement of insurance
expense and prepaid
insurance

Compare commission expense

divided by sales with
previous years
Compare individual
manufacturing expenses
divided by total manufacturing
expenses with previous years

Misstatement of
commission expense and
accrued commissions
Misstatement of individual
manufacturing expenses
and related balance
sheet accounts

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Tests of Controls and Substantive

Test of Transactions
Both tests of controls and substantive
tests of transactions have the effect of
simultaneously verifying balance sheet
and income statement accounts.

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Tests of Details of Account

Balances Expense Analysis
Expense account analysis:
Repairs and maintenance
Rent and lease
Legal expense

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Tests of Details of Account

Balances Allocation
Several expense accounts result from the allocation
of accounting data rather than discrete transactions.
These include depreciation, depletion, and the
amortization of copyrights and catalog cost.
The allocation of manufacturing overhead between
inventory and cost of goods sold is an example of
a different type of allocation that affects expenses.
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End of Chapter 18

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