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CAUA 3871 AUDITING 2

Topic and Reference:


AUDITING NOTES
JACKSON & STENT
Chapter 11

ACQUISITION AND PAYMENT


CYCLE
Divided in two sections
First Activities, documents, internal
control
Second Auditing cycle

SIGNIFICANT ACTIVITIES
Ordering and Receiving of Goods from
Supplier
The Payment of amounts due for
goods ordered and received
Mayor balance is Trade Creditors

DOCUMENTATION

Requisitions
Order forms
Suppliers delivery note
Goods received note
Purchase invoice
Credit note
Creditors statements
Cheque requisitions
Remittance advice

CHARACTERISTICS OF GOOD
INTERNAL CONTROL
Control environment
Competent trustworthy personnel
Segregation of duties:
Ordering goods not access to goods,
Access to goods not access to amendments,
Sign cheques and prepare

Isolation of responsibilities
Access/custody control
Source documents design
Comparison and reconciliation

INTRODUCTION
Cycle important and needs
comprehensive Auditing
Cycle produces Trade Creditors
Cycle produces Purchases

FINANCIAL STATEMENT
ASSERTIONS

Purchase transactions

Payments (Transactions)

Occurrence
Accuracy
Cut-off
Completeness
Classification

Occurrence
Accuracy
Cut-off
Completeness
Classification

Creditors (Account Balance)

Existence
Obligations
Completeness
Valuation
Presentation
Disclosure

FRAUD

Fraudulent Financial Reporting

Understating Trade Creditors


Manipulation of cut-off
Fraudulent increase of purchases to reduce profits
Manipulation of current liabilities related parties

Misappropriation of Assets

Ordering of goods by employees or management for


their personal use and having the company pay
Making completely fictitious payments to creditors
Company claims VAT to which it is not entitled
Directors or employees accepting bribes from
suppliers as an inducement to purchase from the
company
Theft of goods at the receiving stage

TEST OF CONTROLS AND


SUBSTANTIVE PROCEDURES

Test of Controls

Inspect

Enquiry

Procedures by receiving clerk on deliveries

Re-performance

Supporting documentation appropriately stamped

Observe

Receiving clerk on procedures

Inspection

sample purchase orders


requisitions for authorising signature

Creditors reconciliation

Substantive procedures

Inspection

Supporting documentation

Re-performance, calculations
Inspect returned paid cheque
Inspect supporting documentation
Re-calculation
Analytical procedures

SUBSTANTIVE PROCEDURES FOR


AUDIT OF TRADE CREDITORS
Assertion: obligation

(the creditors represent obligations pertaining to


the company)

Assertion: existence

(creditors included in the balance actually exist,


they are not fictitious)

Assertion: valuation

(creditors are included in the financial


statements at appropriate amounts)

Assertion: completeness

(all creditors and accruals which should have


been recorded have been recorded)

THE USE OF AUDIT SOFTWARE


(SUBSTANTIVE PROCEDURES)

The creditors master file can be cast (added) to obtain the total amount owing and a
detailed list of creditors and their balances can be printed out. The aging of creditors
can also be cast and cross cast to the total.
Master file scanned for error conditions

The master file for the current year-end can be compared to the prior year master file
to identify

significantly reduced balances


creditors who no longer appear

software can be used to extract samples ,e.g.

Blank fields, e.g. missing account numbers


Debit balances

nil balances
amounts above a certain amount

Software can be used to extract lists of any creditors which can be identified by a
particular field or code, e.g. a creditor with whom the company is in dispute may be
identified by the addition of a code to its record.

The creditors master file will usually contain the following fields,

account name
name
address and contact details
total amount payable
aging of total amount payable
discount terms

INTRODUCTION
Most systems are computerised today
Does not alter the need for systems of internal
control
Does not affect the control objectives
Validity
Accuracy
Completeness
Computerised systems risks that need to be
addressed

OVERVIEW OF CYCLE
Ordering function
Requisitioning
Ordering
Receiving function
Ordered goods are received
Recording of acquisitions
Reconciliation of supporting documentation AND entering
of invoices
Payments for goods (and recording of transaction)
Payment by cheque or EFT

REQUISITIONING OF GOODS AND


SERVICES
Risks
Ordering of unnecessary or incorrect goods
Wastage
Liquidity problems

Ordering of unauthorized goods


Losses to company through fraud
Examples

Ordering goods for private use


Ordering goods to sell privately

Mitigate risks by implementing internal controls

REQUISITIONING OF GOODS AND


SERVICES
Documentation
Creation of an electronic Requisition in
Stores / Production

Requisitions are prepared by


Stores / Production staff
Authorized by supervisor

REQUISITIONING OF GOODS AND


SERVICES
Risks related to creation of requisition
(or any other document)

Unauthorized data entered


Errors in capture / input of data
Data lost during input
Data could be added or altered
Errors in correction or re-entering of data
Corruption of data during capture or transfer

REQUISITIONING OF GOODS AND


SERVICES
Validity of input
Logical access controls
Access to application
Authorized terminals, users
Write vs. Read Access to applications

Mandatory log out after session

Segregation of duties
Isolation of responsibilities
Staff recruitment policies
Trustworthy and competent staff

REQUISITIONING OF GOODS AND


SERVICES
Validity of input

Authorization of transactions

By user

Computer

Against codes e.g. stock codes


Against data on file e.g. goods received matched against order

Overrides of system-generated information

Signatures on input documents


On-line authorisation of input using passwords and access rights

Specific authorisation
Overrides to be reflected on exception reports

Reviewing of authorization procedures

On a regular basis by management


By Internal Audit

REQUISITIONING OF GOODS AND


SERVICES
Validity of input
Authorization of changes to data (e.g.
correction of transactions / standing data)
By senior, independent person
Under supervision
Documentation of corrections e.g. MAFs

Transactions generated by computer e.g. order


for purchase of inventory
Authorization of transactions by users before
execution

REQUISITIONING OF GOODS AND


SERVICES
Accuracy of input
Matching
Computer matches input transactions with data on file

E.g. goods received to orders

Information is generated by computer where possible

E.g. price is generated when product code is input

Review by senior staff


Of information on screen
Of computer input reports to physical source
documents

REQUISITIONING OF GOODS AND


SERVICES
Accuracy of input
Edit checks (performed by computer program
to test accuracy of data during input)
Checks
Formatting check
Numerical / alpha-numerical
Sign check
Screen check
Checking of accuracy of data on screen by user
Screen prompts
Are you sure?

REQUISITIONING OF GOODS AND


SERVICES
Accuracy of input
Edit checks (performed by computer program
to test accuracy of data during input
Checks
Validity / existence

E.g. stock codes (in orders placed by


customers) are checked against database

Limit and reasonableness check

Input is compared against predetermined values


e.g. 50 hours worked per week per employee

Control totals

REQUISITIONING OF GOODS AND


SERVICES
Accuracy of input
Edit checks (performed by computer
program to test accuracy of data during
input
Checks
Well-designed documents
User-friendly screens
Staff training

REQUISITIONING OF GOODS AND


SERVICES
Completeness of input
Stationery controls
Proper form / screen design
Pre-numbered documents

Matching by computer
Entered transactions are compared by computer to
data on master files

E.g. invoice to GRN

Exception reports of unmatched / long outstanding /


duplicated items

Field presence checks


To ensure all critical fields are present

REQUISITIONING OF GOODS AND


SERVICES
All objectives
Control totals and reconciliations

Financial totals
Hash totals
Record count

Batch processing
Reviewing of output reports by users
Regular backups during input, and after
processing
Adequate error correction procedures

Follow-up and correction


Re-entry of corrected transactions
Supervision and control of independent manager

ORDERING OF GOODS (AND


SERVICES)
Computerised system
Order prepared from requisition

Screen formatted as order data pulled through


Order generated by Ordering staff

Access to application is controlled


Authorised terminals and users
Write vs. Read only access to application

1 or 2 copies of Order printed

Copy 1 Filed in Ordering dept

Follow up of long outstanding orders


May be stored electronically though

System matches Orders to GRNs generate


Exception Report

Copy 2 Sent to supplier

ORDERING OF GOODS (AND


SERVICES)
Before order is placed, must be authorised
Review order
Approved supplier?? Master file amendments

Refer to Chapter 8/30 for controls to ensure that


Master File amendments are valid, accurate, and
completed.

Suitability of supplier
Reasonableness of price and quantity
Nature of goods being ordered
Delivery address
Availability of goods in required timeframe

Specific approval for large orders

RECEIVING OF GOODS
Segregation of duties between Ordering and Receiving
Limits misappropriation of assets by staff

E.g. goods ordered for own use


Computerized system
Access to order via order number (refer to suppliers DN)
Logical access controls
Authorized terminal, user
Read-only access to Order application

RECEIVING OF GOODS
Procedure to be followed
Match order to suppliers DN
Ensure goods received relates to a valid order
Do not accept goods that were not ordered

Count and inspect goods (quantity, condition)


Incorrect or reject goods
Marked as such on DN and signed by both parties

Prepare GRN
Prepared from Order and DN
Sequentially numbered and cross-referenced to Order

Attach copy of DN to GRN

RECEIVING OF GOODS
Generation of GRNs computerized system
Controls in place to ensure that GRN is valid,
accurate and complete
Important controls
Matching by computer

Comparison of data on master files and transaction files

Exception reports

Unmatched orders follow up

Edit checks
Access controls

At least one copy of GRN is printed


accompany goods

RECEIVING OF GOODS
Goods sent to Stores
Goods accompanied by GRN
Segregation between Receiving and Stores
Transfer of custody

Stores clerk to inspect physical goods to GRN


Acknowledge receipt by signing GRN

Discrepancies to be reported immediately


Regular review of Orders file
To identify long-outstanding orders follow-up

Manually
Use of computer-generated exception reports

RECORDING OF ACQUISITIONS
Purpose of function
To record the purchase in accounting records
Source document is the suppliers invoice PJ
Invoice to be matched to
Purchase order
Suppliers DN
GRN

Inspect documentation for required signatures


Check against authorised price list, quote
Check for accuracy of casts, extensions, VAT etc

RECORDING OF ACQUISITIONS
Purchase invoice received from supplier
Matched to corresponding GRN, DN, purchase
order
Quantity and description of goods
Correct prices and discounts authorised price list

Allocations checked
Obtained from Requisition

Re-performance of casts, extensions, calcs

RECORDING OF ACQUISITIONS
Documentation to be signed as evidence of
performance of control
Scrutiny of Pending File
Accurate cut-off
Monthly reconciliations
Creditors statements to Creditors Ledger
Creditors Ledger to GL Control Account
Reviewed by senior staff
Follow up of unusual items

PAYMENT PREPARATION
Risk of unauthorised payments
Matching of all supporting documentation
Order, DN, GRN, Invoice
Reconciliation to creditors statement and
Creditors account in Creditors Ledger
Preparation of cheque requisition
Supporting documentation attached

PAYMENT AND RECORDING


Independent of Payment Preparation function
Responsible for preparation of chqs and
remittance advices for presentation to
signatories
2 Signatories
Scrutinise supporting documentation
Cancel supporting documentation
Sign the chq

Chq and remittance advice sent to supplier


Payment is entered into CPJ

PAYMENT AND RECORDING


Chqs - in numerical sequence in CPJ
Regular review of CPJ by management
Missing chqs
Unusual payments
Regular reconciliation of bank account
Performed by independent staff
Reviewed by management
Returned chqs
Filed in numerical sequence
Reviewed for suspicious endorsements

PAYMENT AND RECORDING


EFT payments (Refer: Ch9/17)
Transfer of cash electronically
Strict controls over authorising and initiating the
transfer

Four important steps


Master file amendments
Account details of recipients are stored
Amendments to master file must be

Valid e.g. fictitious employees must not be added

Accurate e.g. Bank account should be correct

Complete - e.g. all changes made

PAYMENT AND RECORDING


Preparing for the EFT payments
Controls in place to ensure payments will be
Valid
Financial accountant to scrutinise supporting
documentation before authorising payment

Accurate
Financial accountant to test check payments

Complete
Number of EFT transfers to equal the number of
creditors being paid

PAYMENT AND RECORDING


Effecting the payment
Restricted number of terminals from which
able to effect transfers
2 passwords from 2 senior employees
Same as 2 signatories for chqs

Bank to identify terminal before starting


Mandatory logoff
Automatic shutdown after 3 unsuccessful
access attempts
Logging of security violations and follow up

PAYMENT AND RECORDING


Effecting the payment
Access controls in place e.g. passwords, user
Transfer of funds to a clearing account at
the bank i.e.
Limit transfers to specific days of the month
Bank to acknowledge receipt of information
and transmit back to company to confirm
Encryption of data being transferred

PAYMENT AND RECORDING


After the transfer
System to supply an audit trail
I.e. statement of all EFTs effected

Senior staff member to review audit trail


Agree to client supporting documentation

Regular reconciliation of bank accounts


Person independent of EFT function

MANAGEMENT / SUPERVISORY
CONTROLS
Frequent checks over unused stationery
Preparation of budgets and forecasts of
expenditure
Able to detect when unexpected payments
are being processed

Monthly bank recons


Rotation of duties

AUDITING THE CYCLE

FRAUD IN THE CYCLE


Fraudulent financial reporting
Understatement of Trade Creditors
To improve Balance Sheet ratios
Methods
Delay recording of purchases, and account for
physical inventory

Overstatement of Trade Creditors


Of limited concern

FRAUD IN THE CYCLE


Misappropriation of assets
Ordering of goods by employees /
management and getting the company to
pay for them
Making fictitious payments to suppliers
Payments actually made to self, friends etc

VAT claimed inappropriately


Accepting bribes from suppliers
Inducement to purchase from particular supplier

COMPUTER ENVIRONMENTS AND THE


AUDITOR
Approaches that the auditor can follow

Auditing around the computer


Focus on inputting of data, and reports generated
Processing is not important

Auditing through the computer


Testing of computer system and internal controls
Follow a Tests of Controls approach

Auditing with the computer


Use of the computer as an audit tool i.e. use of CAATS

TESTS OF CONTROL
Before conducting tests of control
Auditor must have expectation that system is
operating effectively

he
wishes to rely on, and tests them to
ensure they are working as intended

Auditor will select internal controls that

If so limit level of substantive testing


required, as well as type of testing
If no extend level of substantive testing

SUBSTANTIVE PROCEDURES
Primary audit risk
Understatement of Trade Creditors balance
Completeness
Focus is on unrecorded liabilities

Also consider transactions that give rise to


liabilities
Auditor seeks evidence regarding

Occurrence
Accuracy
Cut-off
Classification

SUBSTANTIVE PROCEDURES:
ACCOUNTS PAYABLE
Assertion: Obligation
Inspect documentation supporting the
transaction to confirm that
Made out in the name of the company
In respect of goods or services used by the
company

Procedure performed when the creditors


recon is audited at year-end

SUBSTANTIVE PROCEDURES:
ACCOUNTS PAYABLE
Assertion: Existence
I.e. relates to whether balance contains
fictitious creditors
Secondary risk
Do not wish to overstate liability

Procedures
Perform cut-off tests to ensure transactions have not been
raised prematurely
Looking for evidence that PJ has been held open
Inspect GRNs at year-end

SUBSTANTIVE PROCEDURES:
ACCOUNTS PAYABLE
Assertion: Valuation
Agree
List of individual creditors to GL control account
Individual creditors per list to balance in CL
Accruals and GL control account to TB, AFS

Re-perform casts of GL control account,


creditors list
Identify debit balances in CL and consider
need to transfer to DL

SUBSTANTIVE PROCEDURES:
ACCOUNTS PAYABLE
Assertion: Valuation
Select sample of creditors from creditors list
Obtain year-end recons
Re-perform reconciliation
Re-perform casts of recon
Agree balances per recon to creditors statement
and creditors listing
Test logic of recon
Inspect supporting documentation
Confirm validity of reconciling items

SUBSTANTIVE PROCEDURES:
ACCOUNTS PAYABLE
Assertion: Valuation
Foreign creditors

Select sample from creditors list


Determine amount owed in foreign currency
Confirm relevant spot rate
Re-perform calculation of amount owing in
Rands forex losses / gains

SUBSTANTIVE PROCEDURES:
ACCOUNTS PAYABLE
Assertion: Valuation
Accruals
Obtain list of accruals
Cast list
Agree total of list to
GL
TB
AFS

Agree amounts to supporting documentation


Re-perform calculations if needed

SUBSTANTIVE PROCEDURES:
ACCOUNTS PAYABLE
Assertion: Completeness
Note
Focus is on unrecorded liabilities
Direction of testing
Source documents accounting records

Procedures
Compare list of creditors to previous years
Missing creditors
Balances that are significantly lower
Reasons??

SUBSTANTIVE PROCEDURES:
ACCOUNTS PAYABLE
Assertion: Completeness
Creditors correspondence file
Evidence of unsettled disputes
Discuss need for adjustments with management

List of unmatched GRNs


Confirm journal entry at year-end to account for
adjustment
Correct price list

SUBSTANTIVE PROCEDURES:
ACCOUNTS PAYABLE
Assertion: Completeness
Other procedures
Payments in CPJ after year-end
Confirm whether goods received prior to year-end
Inspect supporting documentation e.g. GRN
Confirm that creditor was raised

Inspect post-period bank statements


Cheque presented within a reasonable time
Possibility of window-dressing

SUBSTANTIVE PROCEDURES:
ACCOUNTS PAYABLE
Assertion: Completeness
Other procedures
Inventory count
Evidence that physical inventory is materially
different to recorded inventory

Periodic expenses
12 payments

Inspect creditors control account for unusual


debits

SUBSTANTIVE PROCEDURES:
ACCOUNTS PAYABLE
Assertion: Completeness
Other procedures
Direct confirmation of balances from creditors
Nil balances
Major creditors
Creditors for which there are no statements

Management Representation Letter


Completeness assertion

SUBSTANTIVE PROCEDURES:
ACCOUNTS PAYABLE
Assertion: Completeness
Other procedures
Analytical review
Compare current amounts to prior years
Purchases

Creditors

Accruals
Trade creditors as a % of current liabilities
Creditors days

SUBSTANTIVE PROCEDURES:
ACCOUNTS PAYABLE
Assertion: Presentation and Disclosure
IASs and 4th Schedule
E.g. Trade creditors disclosed as Current
Liability