AP-13: Audit Program for the

Income Statement
Company

Balance Sheet Date

The company has the following general ledger account groupings classified in the following
captions in the income statement.
General
Ledger Number1

Account
Description

Income Statement Component

Audit Program for the Income Statement

Company

Balance Sheet Date

Audit
Objectives

N/A
Workpaper
Performed Index
by

Audit Procedures for Consideration

FINANCIAL STATEMENT ASSERTIONS
E/O Existence or occurrence.
allocation.

V/A

Valuation or

C
Completeness.
and disclosure.
R/O Rights and obligations.

P/D

Presentation

AUDIT OBJECTIVES
A. Revenue is for valid transactions in the ordinary course of
business that are recorded correctly as to account, amount, and
period, and uncollectible amounts, returns, or allowances are
adequately provided for (assertions E/O, R/O, V/A, and P/D).
B. Recorded revenue includes billings at the correct amount
for products shipped or services provided (assertion C).
C. Costs of products or services are valid, complete, and
recorded correctly as to account, amount, and period (assertions
E/O, C, R/O, V/A, and P/D).
D. Expenses are valid, complete, and recorded correctly as to
account, amount, and period (assertions E/O, C, R/O, V/A, and
P/D).
E. Revenues, cost of products or services, expenses, and
extraordinary, unusual, or infrequent items are properly described
and disclosed in the income statement (assertion P/D).
IDENTIFICATION CODES
The letters preceding each of the above audit objectives, i.e., A, B,
etc., serve as identification codes. These codes are presented in the
left column labeled Audit Objectives when a procedure
accomplishes an objective. If the alpha code appears in a bracket,
e.g., [A], [B], etc., the audit procedure only secondarily
accomplishes the objective. If an asterisk precedes a procedure, it is
a preliminary step or a follow up step that does not accomplish an
objective.
BASIC AUDIT PROCEDURES
*

1. Inquire of management or review documentation obtained

previously (see CX-3) on the nature of the clients business and
industry and the factors that affect operations. Inquire about any
major changes during the period. Obtain an understanding of the

clients revenue recognition policies and determine that they are in

accordance with GAAP. Inquire of management about, and
evaluate, changes in revenue recognition policies and significant,
unusual, and complex transactions occurring at or near year end.
Practical Considerations:
It is important that the auditor understand the business and how
it makes money. Discussion with the owner/manager may provide
insight on how management views its approach to making a
bottom-line profit. The auditors understanding normally should
include:

The types of products and services sold.

Whether the clients business is seasonal or cyclical.

The clients and the industrys marketing and sales policies.

Whether the clients compensation arrangements depend on

recording of revenue (for example, whether sales commissions are
based on invoiced or collected amounts, frequency for paying sales
commissions, etc.).
Client policies related to sales returns, discounts, extension of
credit, delivery, and payment terms.
What personnel are involved in processes affecting revenues
(such as order entry, extension of credit, and shipping).
The auditors understanding of the companys business related
to revenue recognition should include understanding how controls
over revenue transactions may be overridden and what the clients
motivation to misstate revenue may be.
If the client has entered into unusual or complex sales
transactions (for example, bill and hold transactions or other
unusual contractual terms), the auditor should consider performing
additional procedures.
Other conditions that may indicate improper revenue
recognition practices and require special consideration in a small
business engagement include:

Sales recorded for products shipped in advance of the

scheduled shipping date without the customers consent.

Invoicing of products prior to shipment (for example, billing
for items still being manufactured).

Sales recorded for shipments made after year end.

Transactions with related parties.

Shipments made on canceled or duplicate orders.

Shipments made to a warehouse or another location without

instructions from the customer.

Barter transactions.

Significant sales or volume of sales near year end.

Longer-than-expected payment terms or installment

receivables.

Altered dates on contracts or shipping documents.

Unusual volume of sales to distributors or resellers.

Sales recorded based on letters of intent or purchase orders.

Shipments to freight companies pending return to the seller

because the customer has canceled or requires modifications prior
to delivery.
Shipments of only a portion of the product when the portion
not delivered is a significant part of the product.

A change in the companys revenue recognition policy.

The existence of side agreements.

The additional procedures section of this audit program

includes common procedures for auditing revenue recognition in

small businesses.
Information obtained from discussions regarding the business
and economic effects on the business of current situations can also
be helpful as the auditor evaluates the reasonableness of revenues
and expenses and explanations of differences.
The auditor should determine at the start of the audit any major
changes that have been made in the production and sales areas that
would affect the normal relationships. For example, significant
changes in employee benefits might affect salaries and employee
compensation and have an effect on the procedures the auditor will
perform for the payroll area.
The AICPA Audit Guide, Auditing Revenue in Certain
Industries, provides general accounting and auditing guidance
related to revenue recognition as well as specific guidance on
auditing revenue transactions in the computer software and hightechnology manufacturing industries. The Audit Guide can be
ordered by calling (888) 777-7077 or online at www.cpa2biz.com.
A, B

2. Perform an analytical test of sales by obtaining for the

workpapers a schedule summarizing sales by major product line
and geographic location for the year compared to prior year
amounts, budgets, or other expectations. Analyze this schedule and
critically evaluate and document explanations for significant
differences that are unusual in amount or nature.
Practical Considerations:
Analytical tests involve comparisons of recorded amounts to
the auditors expectations. Examples of sources of information for
the auditor to consider in developing such expectations may
include:

Prior year financial information.

Budgets or amounts extrapolated from interim figures.

Relationships of financial amounts within the period.

Industry statistics, such as gross margins.

Relationships of financial amounts to nonfinancial data.

 If desired, this schedule can be combined with the schedule

described in basic procedure 3.
The auditor should attempt to design efficient predictive tests
of sales or revenue to reduce or avoid substantive tests of details of
sales transactions. This can be a very effective method of auditing
sales, and its feasibility should be assessed at the start of the audit.
In designing predictive tests, it is necessary to determine the key
factor associated with the sales or revenue during the period. (This
information can be obtained from prior period workpapers or
discussions with the client.)
The auditor should be aware that the predictive tests performed
or other analytical procedures applied will be valid only if the
supporting data or information used for the test is relevant and
reliable. Caution should be exercised so that the auditor has
confidence about the validity of this information. The supporting
information is more apt to be reliable if it is obtained from an
independent source, e.g., a trade association or an operating
department not responsible for the amount being audited; if it was
developed from a variety of sources and under a reliable system
with adequate controls; or if it was subjected to audit testing in the
current or prior year.
This step is extremely important because sales or revenue is
usually a key measure for evaluating the reasonableness of cost of
sales and major expenses.
If the auditor identifies significant differences between the
predictive test and the recorded amount, the business reasons for
the differences should be identified. It is important that the
explanations be based on sound business reasons corroborated with
other evidential matter, and not merely on managements
rationalizations. If an explanation for the difference cannot be
obtained, the auditor should perform sufficient other audit
procedures to determine whether the difference should be
considered a likely misstatement.
When an analytical procedure is used as the principal
substantive test of a significant financial statement assertion, SAS
No. 56, Analytical Procedures, as amended by SAS No. 96, Audit
Documentation, requires the auditor to document (1) the
expectation and the factors considered in its development (unless

readily determinable from the work performed), (2) the results of

the comparison between the expectation and recorded amounts, and
(3) any additional procedures performed in response to significant
unexpected differences and the results of those procedures. SAS
No. 96 is effective for audits of financial statements for periods
beginning on or after May 15, 2002, with early application
permitted.
Auditors should carefully evaluate changes in revenue
recognition policies and significant, unusual, and complex
transactions occurring at or near year end. The additional
procedures section of this program includes common procedures
for auditing revenue recognition in small businesses.
C

3. Obtain or prepare for the workpapers an analysis of sales,

cost of sales, and gross profit summarized by product line,
department, location, or other meaningful division, in total and by
meaningful interim period (monthly, quarterly, etc.). Perform the
following procedures:
a. Test the analysis by selecting a few categories and compare
the amounts shown with those recorded in the sales journal. Trace
the sales journal balances to the general ledger.
b. Review the analysis and identify any unusual trends or
variations within the period or compared to the prior period.
c. Determine the average or standard mark-up percentage for
goods sold, if such percentage exists. Calculate the gross profit
using the normal percentage (with an allowance for spoilage or
waste) and compare it to the actual percentage realized during the
period. Document the comparison.
d. Obtain and document sound business reasons for large or
unusual differences in interim or total amounts included in the
analysis. Relate sales by product line, if available, to inventory
categories for possible overstock or obsolete inventory items.
Practical Considerations:
The auditor must be careful to avoid a mechanical approach to
explaining significant differences noted in this analysis. Only if
meaningful explanations are obtained can this step be effective.

Explanations should be evaluated in the light of audit evidence

obtained in other related audit areas.
Comparison of such information can also be made to industry
statistics in some cases.
Other tests of cost of sales can be avoided or reduced if the
significant differences identified on this analysis are adequately
explained and corroborated.
Step 3c can be used only if the company uses a standard
percentage of mark-up for goods sold. (See the inventory program
for other tests.) The effectiveness of this test depends on whether
the company has few or many products with different mark-up
percentages. If there is no effective way to predict the gross profit
percentage, comparisons should be made to the results of prior
periods to obtain evidence about the reasonableness of the gross
profit percentage realized.
When an analytical procedure is used as the principal
substantive test of a significant financial statement assertion, SAS
No. 56, Analytical Procedures, as amended by SAS No. 96, Audit
Documentation, requires the auditor to document (1) the
expectation and the factors considered in its development (unless
readily determinable from the work performed), (2) the results of
the comparison between the expectation and recorded amounts, and
(3) any additional procedures performed in response to significant
unexpected differences and the results of those procedures. SAS
No. 96 is effective for audits of financial statements for periods
beginning on or after May 15, 2002, with early application
permitted.
D

4. For specific selected expense accounts that are sensitive or

subject to unusual risk, select specific individual large
disbursements and examine the documents supporting such
transactions. This should be considered for repairs and
maintenance, legal fees, consulting fees, and similar accounts, and
any other expenses that should be vouched because the auditor, or
his firm, has tax return preparation responsibility.
a. Explain the nature and reason for any expense amounts that
lack the proper support.

b. Determine that the amounts tested are properly classified

and recorded in the correct general ledger account.
c.

Document the items tested.

Practical Considerations:
CX-7a, Planning Worksheet To Determine Extent of
Substantive Tests, may be used to determine the extent of detail
testing needed.
This procedure is done for legal fees to identify legal counsel
engaged by the company. The legal counsel used for litigation
should be identified for purposes of obtaining lawyers letters. (See
Chapter 14.) Space should be provided on the schedule to explain
the services described in each bill examined.
This procedure is done for consulting fees to identify any
payments related to environmental remediation liabilities. AP-1
provides specific inquiries for identifying an increased risk for
liabilities of this sort.
Basic procedure 4b is essential in industries that have
accounting methods especially sensitive to proper classification of
expense amounts, e.g., construction contracting, or where expenses
are presented in great detail in the income statement. In some cases,
applying this procedure may involve audit sampling. Section 405
explains an efficient sampling approach for tests of classifications
of transactions, and CX-7c presents a Sampling Worksheet for
Testing Account Coding and Classifications. See also the
additional procedures section of this audit program.
A common form of fraudulent financial reporting in small
businesses is to charge fixed asset additions to repairs and
maintenance or some other expense account to reduce income
taxes. If the auditor has identified risk factors that indicate
management may be inclined to understate income for tax reasons
through inappropriate means, consideration should be given to
testing material repair and maintenance transactions to determine if
amounts should be capitalized as fixed assets.
See additional procedures for expanded testing of expenses if
the auditor decides to modify his or her procedures in response to

identified fraud risk factors.

SAS No. 96, Audit Documentation, requires documentation of
substantive tests of details involving inspection of documents to
include identification of the items tested. The authors believe items
tested can be identified by listing the items; by including a detail
schedule in the workpapers, such as an expense account detail, on
which the items are identified; or by documenting in the
workpapers the source and selection criteria. For example:
For tests of significant items, documentation may describe the
auditors scope and the source of the items (for example, all
disbursements greater than $5,000 from the 20X2 repairs and
maintenance expense detail).
For haphazard or random samples, documentation should
include the identifying characteristics of the items (for example, the
specific invoice numbers, check numbers, etc.).
For systematic samples, documentation may indicate the
source, starting point, and sampling interval (for example, a
selection of checks from the cash disbursements journal for the
period 1/1/X2 to 12/31/X2, starting with check number 2150 and
selecting every 100th check thereafter).
SAS No. 96 is effective for audits of financial statements for
periods beginning on or after May 15, 2002, with early application
permitted.
Expense vouching undertaken in connection with tax return
preparation should be coordinated with the tax staff.
D

5. Review and document the large or unusual differences in

specific expense accounts compared to the prior period actual
amounts and, if available, the current period budget. From
discussions with management and analysis of evidence from other
audit areas, obtain and document explanations for the variations
noted.
Practical Considerations:
It is important to obtain sound business reasons for significant
differences, (not just excuses) and to corroborate those

explanations.
The explanations should be consistent with changes noted and
tested in balance sheet areas.
When an analytical procedure is used as the principal
substantive test of a significant financial statement assertion, SAS
No. 56, Analytical Procedures, as amended by SAS No. 96, Audit
Documentation, requires the auditor to document (1) the
expectation and the factors considered in its development (unless
readily determinable from the work performed), (2) the results of
the comparison between the expectation and recorded amounts, and
(3) any additional procedures performed in response to significant
unexpected differences and the results of those procedures. SAS
No. 96 is effective for audits of financial statements for periods
beginning on or after May 15, 2002, with early application
permitted.
D

6. Review the payroll procedures with management and

determine the key factors related to payroll (if it is significant).
Determine the total employees by type or class from a review of the
payroll records. Also identify the normal rate of pay for employees
at various levels. Design and document a predictive test of the total
compensation expense recorded and compare the results with the
salary expense in the general ledger. Document explanations for
significant or unusual differences.
Practical Considerations:
This analytical procedure may need to be applied to individual
payroll areas if there are different factors in each one.
Some auditors also prepare or review a reconciliation of
payroll expense per the general ledger to payroll as reported on
payroll tax returns.
The effectiveness of a predictive test naturally depends on the
reliability of the data used. See the fourth practical consideration
following basic procedure 2.
In most small business audits, payroll can be effectively tested
by a well-designed analytic test. In some engagements, however,
payroll transactions may need to be tested, and audit sampling may

be necessary. Section 405 explains an efficient sampling approach.

See also the additional procedures section of this audit program.
The auditor may find it necessary to test a few individual
compensation amounts to supporting documents to obtain
satisfaction about the validity of the data used.
When an analytical procedure is used as the principal
substantive test of a significant financial statement assertion, SAS
No. 56, Analytical Procedures, as amended by SAS No. 96, Audit
Documentation, requires the auditor to document (1) the
expectation and the factors considered in its development (unless
readily determinable from the work performed), (2) the results of
the comparison between the expectation and recorded amounts, and
(3) any additional procedures performed in response to significant
unexpected differences and the results of those procedures. SAS
No. 96 is effective for audits of financial statements for periods
beginning on or after May 15, 2002, with early application
permitted.
E

7. Scan the accounting records for large and unusual

transactions and review evidence obtained in other audit areas to
determine any matters that should be disclosed in the financial
statements. Cross-reference work done in balance sheet areas to the
related revenue and expense accounts. It is important to relate
information from balance sheet audit areas to disclosure
requirements for the income statement. Typical areas of concern are
property and equipment, inventory, liabilities (leases), and income
taxes.
Practical Considerations:
When scanning for large and unusual transactions, auditors
should pay particular attention to nonstandard journal entries,
especially those made at or near the end of the reporting period.
Auditors should consider the business purpose of significant or
unusual transactions.
The additional general procedures at AP-1 provide guidance
when the auditor considers it necessary to perform additional
procedures to review for unusual items.

8. Consider the need to apply one or more additional

procedures. The decision to apply additional procedures should be
based on a consideration of whether information obtained or
misstatements detected by performing substantive tests or from
other sources during the audit alter your judgment about the need to
obtain a further understanding of control activities, the assessed
level of risk of material misstatements (whether caused by error or
fraud), and on an evaluation of whether the basic procedures have
been sufficient to achieve the audit objectives. Attach audit
program sheets to document additional procedures.
Practical Considerations:
Certain common additional procedures relating to the
following topics are illustrated following this program:

Completeness of sales.

Revenue recognition.

Sales cutoff.

Bill and hold transactions.

Sales returns.

Cash disbursements.

Additional procedures in response to fraud risk assessment

related to accounts payable and cash disbursements.

Payroll transactions.

Additional procedures in response to fraud risk assessment

related to payroll expense.
Practitioners may refer to PPCs Guide to Fraud Investigations
for more extensive fraud detection procedures if it is suspected that
the financial statements are materially misstated due to fraud.
*

9. Consider whether procedures performed are adequate to

respond to identified fraud risk factors. If fraud risk factors or other
conditions are identified that require an additional audit response,
consider those risk factors or conditions and the auditors response
in connection with the performance of Step 11 AP-1b.

Practical Consideration:
Specific responses to identified fraud risk factors are addressed
in individual audit programs. In connection with evaluation and
other completion procedures in AP-1b, the auditor considers the
need to perform additional procedures based on the results of
procedures performed in the individual audit programs and the
cumulative knowledge gained from performing those procedures.
*

10. Consider whether the results of audit procedures indicate

reportable conditions in internal control and, if so, add to the memo
of points for the communication of reportable conditions. (See
section 1504 for examples of reportable conditions, and see CX-18
for a worksheet that can be used to document the points as they are
encountered during the audit.)
CONCLUSION
We have performed procedures sufficient to achieve the audit
objectives for the income statement, and the results of these
procedures are adequately documented in the accompanying
workpapers. (If you are unable to conclude on any objective,
prepare a memo documenting your reason.)

Additional Audit Procedures for the Income

Statement
Instructions: Additional procedures will occasionally be necessary on some small
business engagements. The following listing, although not all-inclusive, represents
common additional procedures and their related objectives.

Completeness of Sales

Perform a test of sales completeness by applying the following

procedures:
a. Select a sample of original shipping documents. Document
the items selected.
b. Trace the information on the documents to the related sales
invoices. Determine that details are appropriately reflected on the
invoice.
c. Determine that the total amount of sales reported on the
invoice is properly computed and approved.
d. Trace the amounts on sales invoices to proper recording in
the sales journal or general ledger, as appropriate.
e. Determine that proper accounting treatment has been
applied to these sales transactions.
Practical Considerations:
The test is designed to test the completeness of sales
transactions.
See section 405 for a discussion of an efficient sampling
approach for this type of test.
The auditor should not provide detailed documentation
regarding the tracing of the invoice amount to the general ledger if
complicated tie-ins are necessary to determine that amounts are
properly recorded. This documentation is unnecessary and
inefficient.

Revenue Recognition
A

a. If the company had sales for which the earnings process

was not complete, consider whether revenue was appropriately
deferred.
Practical Considerations:
Generally, the earnings process is not complete unless all of the

following criteria are met:

evidence of the final understanding between the parties to the
exchange transaction exists,

delivery has occurred or services have been performed,

the sales price is fixed or determinable, and

collectibility is reasonably assured.

Some situations when the earnings process would not be

considered complete include sale and delivery of a piece of
machinery that has not been installed when installation is the
sellers responsibility; sale of a piece of machinery that as part of
the original contract requires customization; sale but not delivery of
goods sold FOB receiving point; or sale of goods subject to
customer cancellation or termination clauses.
b. If the auditor, based on his or her understanding of the
clients business or consideration of fraud risk factors, decides to
modify procedures related to revenue recognition, consider
confirming additional information with customers in conjunction
with accounts receivable confirmation procedures (see AP-3).
Practical Considerations:
Examples of information to confirm include relevant contract
terms such as acceptance criteria, delivery and payment terms, the
absence of future or continuing client obligations, the right to return
product, guaranteed resale amounts, and cancellation and refund
provisions. The auditor should also consider confirming that the
client and customer do not have any side agreements in addition to
stated contract terms.
Practitioners may refer to PPCs Guide to Fraud Investigations
for more extensive fraud detection procedures if it is suspected that
the financial statements are materially misstated due to fraud.
See also the additional procedures related to bill and hold
transactions.

Sales Cutoff

If the auditor, based on his or her understanding of the clients

business or consideration of fraud risk factors, decides to perform
additional procedures related to sales cutoff, perform the following
procedures:
a. Analyze the ratio of sales in the last month or week of the
period to total sales for the period.
b. Compare revenues recorded daily for the periods shortly
before and after year end for unusual fluctuations.
c. Compare sales credits for returns subsequent to year end
with monthly sales credits during the year to determine if there is
an unusual increase that may indicate contingent sales or special
concessions to customers.
d. Compare monthly cash receipts during the year to cash
receipts subsequent to year end to determine if receipts subsequent
to year end are unusually low compared to the collection history
during the months under audit.
e. Vouch large or unusual sales made at year end to original
source documents.
Practical Considerations:
These procedures are generally designed to detect an
overstatement of revenue.
The following factors may influence the scope of sales cutoff
testing:
Large quantities of inventory awaiting shipment noted by the
auditor during the physical inventory observation.

Significant quantities of in-transit inventory at year end.

Unusual increase in sales the last few days of the year

followed by an unusual decrease in sales subsequent to year end.

Numerous shipping locations.

Transactions in which revenue is recognized before title

passes to the buyer.

Bill and Hold Transactions

A

If the company is holding inventory that has been billed to

customers, perform the following procedures:
a.
(1)
(2)
goods.

Determine that the transaction meets the following criteria:

Risks of ownership have passed to the buyer.
The customer has a fixed commitment to purchase the

(3) The customer (not the client) requested the transaction be

on a bill and hold basis and the customer has a substantial business
purpose for doing so.
(4) There is a fixed schedule for delivering the goods and the
delivery date is reasonable.
(5) The client has no specific performance requirements such
that the earnings process is not complete.
(6) The goods are separated from the clients regular
inventory and cannot be used to fill other orders.
(7)

The inventory is complete and ready for shipment.

b. Confirm the details of bill and hold transactions with the

customer. (See CL-41, Confirmation Request for a Bill and Hold
Transaction.)
c.

Retain copies of all confirmations in the workpapers.

Practical Consideration:
When determining whether bill and hold transactions meet the
criteria in Step a, consideration should be given to the following
factors:
The date by which the client expects payment and whether
normal billing and credit terms have been modified for this
customer.

 The clients past experience with bill and hold transactions

(for example, whether the client has a history of reversing bill and
hold transactions in subsequent periods).
Whether the customer has an expected risk of loss in the event
of a decline in the inventorys market value.

Whether the clients custodial risks are insurable and insured.

Whether the related receivable from the customer should be

discounted in accordance with APB Opinion No. 21.
Whether extended procedures are necessary to ensure that
there are no exceptions to the customers commitment to accept and
pay for the inventory (i.e., the business reasons for the bill and hold
transaction have not resulted in a contingency to the customers
commitment).

Sales Returns
A

If the entity sells a product and a right of return exists either

contractually or from existing practice, determine whether revenue
has been recognized in accordance with SFAS No. 48 and the
allowance for future returns is reasonable.

Cash Disbursements
C, D

Determine whether the company records expense amounts using a

voucher system or as they are actually paid. Based on the method
used by the company, select a sample of vouchers or cash
disbursements incurred during the year charged to expense
categories. Document the items selected and perform the following
procedures:
a. Compare the amount, payee or vendor, date, and
description to the vendors invoice and canceled checks, if
appropriate.

b.

Determine that the transaction was properly authorized.

c. Determine that the expense is an appropriate transaction for

the company.
d. Trace the expense amount to determine that it was properly
classified in the general ledger.
e. Summarize exceptions and determine the results of the
overall test.
Practical Considerations:
The test is not normally essential and may be omitted if
adequate evidence is obtained from examination of individual
expense amounts and key accounts combined with analytical
procedures. It may be necessary for some small business clients,
e.g., a contractor or manufacturer where bids or prices are based on
costs of production (i.e., to test valuation), or where expenses are
presented in great detail in the income statement (i.e., to test
classification). If the auditor, based on his or her consideration of
fraud risk factors, concludes that procedures should be modified
related to accounts payable disbursements, the auditor should
consider performing the next additional procedure listed in this
program instead of this procedure.
CX-7a, Planning Worksheet To Determine Extent of
Substantive Tests, can be used to determine the extent of detail
testing needed.
If audit sampling is deemed necessary, refer to section 405 for
a discussion of an efficient sampling approach to this type of test.
The auditor should not examine the nature of discounts paid
and similar items of minimal importance simply because they are
associated with the disbursement or expense voucher. The key
elements related to the transaction should be tested only for
propriety and proper accounting treatment.

Additional Procedures in Response to Fraud Risk Assessment

Related to Accounts Payable and Cash Disbursements

C, D

If the auditor, based on his or her consideration of fraud risk

factors, decides to modify procedures related to accounts payable or
disbursements, the following procedures should be considered:
a. Review the vendor list for any unusual patterns, such as
names that may be similar but not identical to names of approved
vendors and vendors that have multiple addresses. Review vendor
files for unusual items, such as vendor invoices that appear
different from the norm, consecutive vendor invoice numbers,
preprinted and not customized forms, different delivery addresses,
different telephone numbers, and other unusual patterns.
b. Examine disbursement records for payments of the
following types:
(1) Payments charged to expense accounts in which it is
suspected that fraudulent payments are being hidden.
(2) Payments for services that do not require delivery of
goods or significant documentation to obtain payment (for
example, payment of sales commissions, consulting fees, repair and
maintenance, etc.).
(3) Voided checks. Cash may be embezzled by charging an
expense account, crediting accounts payable, and voiding the check
written to pay the payable and removing it from the mail.
(4) Checks other than payroll checks made out to employees,
or checks with a vendor address or phone number that is the same
as an employees.
(5) Checks with a vendor name that is similar in sound or
appearance to a legitimate vendors name.
(6) Payments for amounts just below the threshold for
approval.
c. Examine original canceled checks (both front and back) for
the following:
(1) The identity of the endorsees. Compare to the payee, date,
and amount and review the signature.
(2)

Discrepancies between related documents, such as the

amount or name on the check differing from the invoice or

discrepancies between documents, the checks, and the cash
disbursements journal.
(3) A second endorsement, for example, a check payable to a
business that is first endorsed by the business name and then by an
individual or then endorsed over to the issuer of the check. (These
are typical indications of fictitious payables.)
(4)

Any check that was cashed rather than deposited.

(5)

Checks exhibiting any other unusual patterns.

Practical Considerations:
Practitioners may refer to PPCs Guide to Fraud Investigations
for more extensive fraud detection procedures if it is suspected the
financial statements are materially misstated due to fraud.
Particular attention should be paid to disbursements occurring
near year end. The clever fraud perpetrator will concentrate his or
her misappropriation at the end of the year to minimize the amount
of time the theft remains on the books.

Payroll Transactions
D

Select a sample of payroll transactions during the year. Document

the items selected and perform the following procedures:
a.
b.
basis.

Trace the gross pay to proper authorization.

Recalculate the gross pay if it is determined on an hourly

c. Trace the hours used to compute gross pay to time cards or

timesheets, as appropriate.
d. Determine that the gross pay amount is appropriate and
properly classified in the general ledger.
Practical Consideration:

This procedure is often inefficient and should be avoided

unless effective analytical procedures cannot be designed. If it must

be performed, see section 405 for an explanation of an efficient
sampling approach.

Additional Procedures in Response to Fraud Risk Assessment

Related to Payroll Expense
D

a. If the auditor, based on his or her consideration of fraud

risk factors, decides to modify procedures related to payroll
expense, the extent of the preceding procedures may be expanded.
In addition, the following procedures may also be performed:
(1) Obtain a list of current and former employees from
personnel files and compare to the payroll list suspected of
including fictitious employees. Note any discrepancies.
(2) Look for employees who have no tax withholding forms,
insurance elections, or other employee benefit elections or
deduction forms.
(3) Determine whether any social security numbers may be
fictitious or are the same for two different people.
(4) Determine whether two different employees have the
same address.
(5) For suspected fictitious employees, examine canceled
payroll checks. If the canceled checks are missing, request copies
from the bank.
Practical Consideration:
If the auditor suspects fictitious employees, the most effective
procedures are paymaster procedures (that is, distribute the checks
or observe their distribution). However, because the auditor
normally performs field work at a date subsequent to year end for
small business clients, it may not be practicable to perform
paymaster procedures. Practitioners may refer to PPCs Guide to
Fraud Investigations for more extensive fraud detection procedures
if it is suspected that the financial statements are materially
misstated due to fraud.

b. If the auditor, based on his or her consideration of fraud

risk factors, decides to modify procedures related to payroll
expense, the payroll register and payroll check register may be
reviewed for:
(1)

Duplicate names or addresses.

(2)

Names of former employees.

(3)

Math errors.

(4)

Unusual pay rates or number of hours worked.

(5)

Factors that might indicate ghost employees.

Practical Consideration:
If the auditor suspects fictitious employees, the most effective
procedures are paymaster procedures (that is, distribute the checks
or observe their distribution). However, because the auditor
normally performs field work at a date subsequent to year end for
small business clients, it may not be practicable to perform
paymaster procedures. Practitioners may refer to PPCs Guide to
Fraud Investigations for more extensive fraud detection procedures
if it is suspected that the financial statements are materially
misstated due to fraud.

Audit Program for

Company

Audit
Objectives

Balance Sheet Date

Audit Procedures for Consideration

N/A
Performed by

Workpaper
Index