The major accounts in the acquisition and payment cycle are inventory, cost of goods sold, accounts payable

and expense. Existence and valuation assertion are usually high risk for inventory. Completeness and valuation are usually higher risk for expense and payables.

Requisition for goods and services

purchase of goods or services according to company policies

receipt of and accounting for goods and services

approval of items for payment

cash disbursement

Because of volume of transactions, as well as the ability to physically move inventory, the acquisition and payment cycle is often the subject of fraud. Ratios like inventory turnover, gross profit margin, number of days sales in inventory and shrinkage ratio can be compared with prior years, industry averages and auditor expectation. Understanding internal controls 1. Requisition of goods and services a. The auditor must thoroughly understand the clients relationships with its suppliers and should examine major contracts that specify delivery, quantity timing and quality conditions. b. Normally, a requisition form is forwarded to the purchasing department by a supervisor, although some have the authority for individual purchases. 2. Purchase of goods and services a. The rationale for separate purchasing function is: i. Promotes efficiency and effectiveness ii. Eliminates potential favoritism that could take place if individual department heads were allowed to place orders

iii. Reduces the opportunity for fraud by segregating the authorization to purchase from the custody and recording functions iv. Centralizes control in one function b. The most important control is an authorized vendor database. c. Prenumbered forms are used to establish the uniqueness of each order and the completeness of the purchase order population. d. Purchase order is used by receiving department to determine whether a shipment of goods should be accepted. The accounting department uses the purchase order to determine whether a purchase was authorized and whether the vendors invoice is correct. 3. Receipt of and accounting for, goods and services a. Prenumbered receiving documents- completeness b. Electronically scans bar codes c. Departments may receive goods directly d. Goods are received directly into the production process 4. Approval of items for payments a. Three way match among the vendor invoice, the purchase order and the receiving report. b. Internal control should assure that all items are recorded in a timely manner that the authorization process includes a review of documents and the supporting documentation is canceled on payment to avoid duplicate payment. c. Automated controls i. Authorized vendors ii. Restricted access(vendor and purchasing database) iii. Automatic process iv. Reconciliations inherent in the process v. Automation of error-prone activities vi. Restricted access to transferring funds vii. Monitoring 5. Cash disbursement a. Review the completeness of the documentations and cancel supporting documents to avoid duplicate payments. Substantive test 1. Substantive tests of accounts payable a. The major concern with accounts payable is that the account will be understated. b. The most relevant serration is the completeness assertion. c. If there is little risk, the testing might be limited to substantive analytical procedures, such as a comparison of underlying expenses with that of the prior year and related tests of the underlying asset or liability account. d. If there is material weakness in internal control

i. Analytical review of related expense accounts and comparison with other underlying economic data ii. Testing of subsequent disbursements iii. Requests for vendor statements. 2. Substantive testing of expense accounts a. It should be considered that management is more likely to understate rather than overstate expenses and classify expense items as assets rather than vice versa. b. If control risk is low, analytical procedures can be used (relationship of clients volume of activity with accounts payable) c. Legal expense- possible indicator of litigation that requires disclosure d. Travel and entertainment expense- examine for questionable or non-business related items. e. Repairs and maintenance-examine with fixed asset additions to assure proper distinction has been made between expenditure that should be expensed and expenditures that should be capitalized. (existence and classification) f. Expenses that do not have accompanied documentations are interest expense and depreciation. Inventory The auditor will normally test perpetual inventory records to determine that authorized receipts and sales of inventory are recorded accurately and promptly and only authorized receipts and sales of inventory have been recorded. The auditor selects item from perpetual records and traces them back to the source documents to determine that only authorized transactions have been recorded. The auditor also selects items from the source documents and traces them to the perpetual recorded to determine that all receipts and sales are recorded accurately and on a timely basis. When multiple locations contain inventory, the auditor should review a variety of locations to determine that they are comparable and should use analytical procedures to see if the locations not visited seem to have inventory levels that are significantly different from those observed. If internal controls are strong, the client may concentrate on testing the accuracy and completeness of the perpetual records by counting all inventory at least once during the year and using statistical sampling to select items to be physically counted. If auditor cannot physical observe inventory, inspecting documents related to the subsequent sale of specific inventory items to valudate theor existence and valuation. Review for obsolescence a. Monitoring turnover or age of products with past performance b. Monitoring the ipact of competitors new product introduction

c. d. e. f. g.

Comparing current sales with budgeted sales Periodically reviewing, by product line, the number of days of sales currently in inventory Adjusting for poor condition of inventory Monitoring sales for amount of product markdown Review current inventory in light of planned new product introduction