Accounts payable is usually one of the more important audit areas. Why? Risk. First, it’s easy to increase net income by not recording period-end payables. Second, many forms of theft occur in the accounts payable area. Show
In this post, I’ll answer questions such as, “how should we test accounts payable?” And “should I perform fraud-related expense procedures?” We’ll also take a look at common payables-related risks and how to respond to them. In short, you will learn what you need to know about auditing accounts payable. Auditing Accounts Payable and Expenses — An OverviewWhat is a payable? It’s the amount a company owes for services rendered or goods received. Suppose the company you are auditing receives $2,000 in legal services in the last week of December 2019, but the law firm sends the related invoice in January 2020. The company owes $2,000 as of December 31, 2019. The services were provided, but the payment was not made until after the year-end. Consequently, the company should accrue (record) the $2,000 as payable at year-end. In determining whether payables exist, I like to ask, “if the company closed down at midnight on the last day of the year, would it have a legal obligation to pay for a service or good?” If the answer is yes, then record the payable even if the invoice is received after the year-end. Was a service provided or have goods been received by year-end? If yes (and the amount has not already been paid), accrue a payable. In this chapter, we will cover the following things an accounts payable auditor need to consider:
So, let’s begin our journey of auditing accounts payable and expenses. Primary Accounts Payable and Expense AssertionsThe primary relevant accounts payable and expense assertions are:
Of these assertions, I believe completeness and cutoff (for payables) and occurrence (for expenses) are usually most important. When a company records its payables and expenses by period-end, it is asserting that they are complete and that they are accounted for in the right period. Additionally, the company is implying that amounts paid are legitimate. Accounts Payable and Expense Walkthroughs
As we perform walkthroughs of accounts payable and expenses, we are looking for understatements (though they can also be overstated as well). We are asking, “what can go wrong?” whether intentionally or by mistake. In performing accounts payable and expense walkthroughs, ask questions such as:
As we ask these questions, we inspect documents (e.g., payables ledger) and make observations (e.g., who signs checks or makes electronic payments?). So, we are inquiring, inspecting, and observing. If controls weaknesses exist, we create audit procedures to respond to them. For example, if--during the walkthrough--we see that one person prints and signs checks, records payments, and reconciles the bank statement, then we will perform fraud-related substantive procedures (more about this in a moment). Here's a short video about risk assessment for accounts payable auditors.
Directional Risk for Accounts Payable and ExpensesThe directional risk for accounts payable and expenses is an understatement. So, perform procedures to ensure that invoices are properly included. For example, perform a search for unrecorded liabilities (see below). Primary Risks for Accounts Payable and ExpensesThe primary risks for accounts payable and expenses are:
Keep these in mind as you audit accounts payable. Common Payable and Expense Control DeficienciesIn smaller entities, it is common to have the following control deficiencies:
When segregation of duties is lacking, consider whether someone can use the expense cycle to steal funds. How? By making payments to fictitious vendors, for example. Or intentionally paying a vendor twice--and then stealing the second check. (See the section titled Auditing for Fraud below.) Risks of Material Misstatement for Payables and ExpensesIn smaller engagements, I usually assess control risk at high for each assertion. When I assess control risk at less than high, I have to test controls to support the lower risk assessment. Therefore, assessing risks at high is usually more efficient (than testing controls). When control risk is assessed at high, inherent risk becomes the driver of the risk of material misstatement (control risk X inherent risk = risk of material misstatement). The assertions that concern me the most are completeness, occurrence, and cutoff. So my RMM for these assertions is usually moderate to high. My response to higher risk assessments is to perform certain substantive procedures: namely, a search for unrecorded liabilities and detailed expense analyses. The particular expense accounts that I examine are often the result of my preliminary planning analytics. Search for Unrecorded LiabilitiesHow does one perform a search for unrecorded liabilities? Use these steps:
As the RMM for completeness increases, vouch payments at a lower dollar threshold.
How should you perform a detailed analysis of expense accounts? First, compare your expenses to budget—if the entity has one—or to prior year balances. If you note any significant variances (that can’t be explained), then obtain a detail of those particular expense accounts and investigate the cause. Theft can occur in numerous ways—such as fictitious vendors or duplicate payments. If control weaknesses are present, consider performing fraud-related procedures. When fraud-related control weaknesses exist, assess the RMM for the occurrence assertion at high. Why? There is a risk that the expense (the occurrence) is fraudulent. So, how should you respond to such risks? Auditing for FraudAn example of a fraud-related test is one for duplicate payments. How?
In a duplicate payment fraud, the thief intentionally pays an invoice twice. He steals the second check and converts it to cash. This is just one example of expense fraud. There are dozens of such schemes. (See White Collar Crime is Knocking at Your Door: Are You Prepared?) Substantive Procedures for Accounts Payable and ExpensesMy customary audit tests are as follows:
If there are going concern issues, you may need to examine the aged payables listing. Why? Management can fraudulently shorten invoice due dates. Doing so makes the company appear more current. For example, suppose the business has three unpaid invoices totaling $1.3 million that were due over ninety days ago. The company changes the due dates in the accounts payable system, causing the invoices to appear as though they were due just thirty days ago. Now the aged payables listing looks better than it would have. Typical Payable and Expense Work PapersMy accounts payable and expense work papers usually include the following:
So, now you learned about auditing accounts payable. My next post addresses auditing payroll. In some entities such as governments, payroll makes up over 50% of total expenses. Consequently, knowing how to audit payroll expenses is of great importance. My next post is titled The Why and How of Auditing Payroll. So, stay tuned. See my prior posts in The Why and How of Auditing. Get Your Copy of the Why and How of AuditingClick the book cover below to go to Amazon. Get your copy of the Why and How of Auditing. Which of the following audit procedures is the most effective in testing sales for understatement?Which of the following audit procedures is the most effective in testing sales for understatement? Trace a sample of shipping documents to sales invoices recorded in the sales journal. To determine whether sales transactions have been recorded in the proper accounting period, the auditor performs cutoff tests.
Which of the following is an analytical procedure that should be applied to the income statement?Which of the following is an analytical procedure that should be applied to the income statement? Compare the actual revenues and expenses with the corresponding figures of the previous year and investigate significant differences.
Which of the following pairs of income statement and balance sheet accounts typically would not be audited in conjunction with each other?Which of the following pairs of income statement and balance sheet accounts typically would not be audited in conjunction with each other? Long-term debt and interest income.
What are the 7 audit assertions?There are numerous audit assertion categories that auditors use to support and verify the information found in a company's financial statements.. Existence. ... . Occurrence. ... . Accuracy. ... . Completeness. ... . Valuation. ... . Rights and obligations. ... . Classification. ... . Cut-off.. |