Chapter 14

Accounts
Payable and
Other Liabilities

McGraw-Hill/Irwin

Copyright 2010 by The McGraw-Hill Companies, Inc. All rights

reserved.

Sources of Accounts Payable

Short-term obligations arising from purchase of

goods and services in ordinary course of
business; examples:

Acquisition of merchandise on credit

Receipt of services such as advertising, repairs

Invoices and statements from suppliers usually

evidence accounts payable
Interest-bearing obligations are not included in
accounts payable; they are included as bonds,
notes, etc.

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Sources of Accrued Liabilities

Accrued

liabilities

Sometimes called accrued expenses

Examples: Salaries, interest, rent
Accumulate over time and management must
make accounting estimate at year-end.
Note that if management does not make such an
estimate, no entry will occur since the related
transactions (e.g., interest) may have occurred
months ago

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Objectives for the Audit Accounts

Payable and Purchases
1.

2.
3.

Use the understanding of the client and its environment to

consider inherent risk, including fraud risks, related to
accounts payable.
Obtain an understanding of internal control over accounts
payable.
Assess the risks of material misstatement and design tests of
controls and substantive procedures that:
a. Substantiate the existence of accounts payable and the clients
obligation to pay these liabilities and establish the occurrence of
purchase transactions
b. Establish the completeness of recorded accounts payable
c. Verify the cutoff of transactions affecting accounts payable
d. Establish the proper valuation of accounts payable and the
accuracy of purchase transactions
e. Determine that the presentation and disclosure of accounts
payable are appropriate

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Primary concern
Possibility

of understatement or omission
of liabilities

Exaggerates the financial strength of

company
Conceals fraud as effectively as
overstatement of assets
Accompanied by understatement of expenses
and overstatement of net income

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Controls Over the

Acquisition Cycle

Segregation of duties--purchases and disbursements

Approval of purchase orders
Numerical control of purchase orders and receiving reports
Matching of details of vendors invoices to purchase orders and
receiving documents
Approval of vendors invoices
Pre-numbered checks
Reconciliation of details of individual disbursements to
controlling accounts
Reconciliation of vendors statements to accounts
Reconciliation of bank accounts
Use of budgets and analysis of variances
Use of chart of accounts and review of account coding

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Acquisition Cycle--Documents
Purchase

order
Receiving report
Vendors invoice
Vendors statement

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14-8

Audit Documentation
Working

papers

Lead schedule for accounts payable

Trial balances of various types of accounts
payable
Confirmation requests for accounts payable
Listing of unrecorded accounts payable

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14-10

Risks of Material Misstatement

Controls

against misstatements

Auditors found serially numbered receiving

reports are prepared
Serially numbered vouchers are prepared
Payments made promptly on due dates
Immediately recorded in accounting records
Independent employee reconciles subledger
to general ledger

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Risks of Material Misstatement

Risks

of misstatements

Subsidiary records not in agreement with

general ledger
Receiving reports and vouchers used
haphazardly
Purchase transactions often not recorded until
payment is made
Many accounts payable long past due

Risks

such as these indicate the need for

extensive substantive procedures
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Accounts Payable Audit

Steps (1 of 4)
A. Use the understanding of the client and
its environment to consider inherent risks,
including fraud risks, related to accounts
payable.
B. Obtain an understanding of internal
control over accounts payable.
C. Assess the risks of material misstatement
and design further audit procedures.
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Accounts Payable Audit

Steps (2 of 4)
D. Perform further audit procedurestests
of controls.
1. Examples of tests of controls.
a. Verify a sample of postings to the accounts payable control
account.
b. Vouch to supporting documents a sample of postings in
selected accounts of the accounts payable subsidiary ledger.
c. Test IT application controls.
2. If necessary, revise the risks of material misstatement based
on the results of tests of controls.

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Accounts Payable Audit

Steps (3 of 4)
E. Perform further audit proceduressubstantive
procedures for accounts payable.
1. Obtain or prepare a trial balance of accounts payable
as of the balance sheet date and reconcile with the
general ledger.
2. Vouch balances payable to selected creditors by
inspection of supporting documents.
3. Reconcile liabilities with monthly statements from
creditors.
4. Confirm accounts payable by direct correspondence
with vendors.
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Accounts Payable Audit

Steps (4 of 4)
E. Substantive procedures (continued)
5.Perform analytical procedures for accounts payable
and related accounts.
6. Search for unrecorded accounts payable.
7. Perform procedures to identify accounts payable to
related parties.
8. Evaluate proper balance sheet presentation and
disclosure of accounts payable.

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Summary of Substantive Tests of

Accounts Payable

14-17

Contrasting Confirmation of Accounts

Payable and Accounts Receivable

Accounts Payable Accounts Receivable

Primary Audit
Objective

Completeness

Existence

Other Evidence
External evidence
Internal evidence
Available held by client (i.e.., (i.e., sales invoices,
vendors invoices
receiving reports)
and statements)
Confirmation
Generally
Required?

No

Yes

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Search for Unrecorded A/P

Be

alert during reconciliations,

confirmations and analytical procedures
for unrecorded liabilities
Examine transactions recorded following
year-end

Compare cash payments after year-end to a/p

trial balance
Examine cash disbursements over specific
dollar amounts during subsequent period
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Potential Sources of
Unrecorded A/P
Unmatched

invoices and unbilled

receiving reports
Vouchers payable entered in the voucher
register subsequent to balance sheet date
Invoices received after balance sheet date
Consignments in which client acts as a
consignee

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14-21

Adjusting entry needed?

Misstatements

and omissions are judged

based on impact on the financial
statements

Materiality
Effect on net income
Need to consider cumulative effect on the financial
statements

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Amounts withheld from

employees pay
Income

taxes withheld from employees

pay but not remitted as of balance sheet
date
Trace amounts withheld to payroll
summary sheets
Test computations of taxes withheld and
accrued
Determine that taxes have been deposited
in accordance with law
14-23

Sales Tax Payable

Required

to collect sales tax imposed by

state and local governments
Not an expense, just collecting agent
Liabilities until remitted
Verify liability by reviewing tax return
Test reasonableness of amount
Test invoices for correct tax charge

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14-25

Unclaimed wages
Subject

to misappropriation
Concerned with adequacy of internal
control

Should not be left for more than a few day

Prompt deposit in special bank account

Analyze

unclaimed wages to determine

Credit represents all unclaimed wages after

each payroll distribution
Debits represent authorized payments
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Customers Deposits
Deposits

on returnable containers or to
guarantee payment of bills
Review procedures followed in accepting
and returning deposits
Verify list of individual deposits and
compare to general ledger account
Generally do not confirm

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Accrued Liabilities (1 of 3)

Obligations payable sometime during the succeeding

period for services or privileges received before balance
sheet date
Examples: Interest payable, accrued property taxes
Accounting estimates
Review and test managements process of developing
the estimate
Review subsequent events
Independently develop estimate to compare

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Accrued Liabilities (2 of 3)
Basic audit steps
1. Examine any contracts or other documents on hand that provide the
basis for the accrual.
2. Appraise the accuracy of the detailed accounting records maintained
for this category of liability.
3. Identify and evaluate the reasonableness of the assumptions made
that underlie the computation of the liability.
4. Test the computations made by the client in setting up the accrual.
5. Determine that accrued liabilities have been treated consistently at
the beginning and end of the period.
6. Consider the need for accrual of other accrued liabilities not
presently considered (that is, test completeness).
7. For significant estimates, perform a retrospective analysis of the
prior years estimates for evidence of management bias.
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Accrued Liabilities (3 of 3)

Accrued Property Taxes

Accrued Payrolls
Pension Plan Accruals
Postemployment Benefits other than Pensions
Accrued Vacation Pay
Product Warranty Liabilities
Accrued Commission and Bonuses
Income Tax Payable
Accrued Professional Fees

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Presentation
Current

liability

Accrued expenses
Deferred income tax for next year
Deferred credits for rent
Deposits on contracts

Long-term

liability

Deferred income tax - noncurrent

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Time of Examination
Most

effective when performed

immediately after the balance sheet date
Little value if done before because
concern with understatements
Some can be done at interim:

Accrued property taxes

Amounts withheld from employees pay

14-31