ch18 70 360

Chapter 18: Completing the Tests in the
Acquisition and Payment Cycle:

Verification of Selected Accounts
1
Copyright © 2007 Pearson Education Canada
Chapter 18 objectives
 Identify the process to be followed in the audit of
manufacturing asset acquisitions
 Discuss the difficulties in auditing intangible
assets
 Explain the importance of and the audit processes
for prepaid expenses
 List typical accrued liabilities
 Explain how property taxes are audited
 Discuss the role of analytical review in the audit
of income and expense accounts
18-2
Methodology for designing tests of details
for the audit of manufacturing asset
acquisitions
 Set materiality and assess audit risk and inherent risk
for manufacturing asset acquisitions
 Assess control risk for manufacturing asset acquisitions
 Design and perform tests of controls for manufacturing
asset acquisitions
 Design and perform analytical procedures for
manufacturing asset acquisitions
 Design tests of details for manufacturing asset
acquisitions (audit procedures, sample size, items to
select, timing)
18-3
The nature of manufacturing assets
 Manufacturing assets are capital assets that

normally have expected lives of more than one
year, are used in the business, and are not
acquired for resale
 The assets are used as a part of the operation of
the client’s business
 Operational use and normal life of greater than
one year distinguishes these assets from
inventory, prepaid expenses, or investments
18-4
Tracking manufacturing assets
 Large organizations will normally have a
capital asset master file, where each asset
is described and tracked. This master file is
also the source of information for
calculating and recording amortization.
 Small organizations may have a manual
listing of such assets, or may simply track
a balance forward from year to year
18-5
Differences between manufacturing
assets and current asset accounts
 There are usually fewer current period
acquisitions
 The amount of any given acquisition may
be material
 The equipment is likely to be kept and
maintained in the accounting records for
several years
18-6
Audit emphasis for manufacturing
asset additions
 Emphasis is on auditing current period
acquisitions
 These are also traced to the capital cost allowance
section of the tax working papers
 Amortization and accumulated amortization
accounts are also verified
 Other accounts that are verified in a similar
manner include: patents, copyrights, catalogue
costs
18-7
Categories of audit tests conducted for
manufacturing equipment and related
accounts
 Analytical procedures
 Verification of:
– Current-year acquisitions
– Current-year disposals
– The ending balance in the asset account
– Amortization expense
– The ending balance in accumulated
amortization
18-8
Analytical procedures for
manufacturing equipment
Analytical procedure Potential misstatement
detected
Compare amortization Misstatement in amortization
expense divided by gross expense and accumulated
manufacturing equipment cost amortization
with previous years
Compare accumulated Misstatement in accumulated
amortization divided by gross amortization
manufacturing equipment cost
with previous years
18-9
Analytical procedures for
manufacturing equipment (cont’d)
Analytical procedure Potential misstatement
detected
Compare monthly or annual Expensing amounts that
repairs and maintenance, should be capital items
supplies expense, small tools
expense, and similar accounts
with previous years
Compare gross manufacturing Idle equipment or equipment
cost divided by some measure that has been disposed of but
of production with previous not written off
years
18-10
Verification of current year
acquisitions
 Important because of the long-term effect
that assets have on financial statements
 Starting point is normally a continuity
schedule prepared by the client (showing
additions, disposals and amortization)
 An important technique is examination of
supporting documentation
18-11
Verification of current year
disposals
 The most important internal control over
disposals is the existence of a formal
method to inform management and record
the results of sale, trade-in, abandonment
or theft
 The most important audit procedures are
those for searching for unrecorded
disposals
18-12
Verification of asset balances
 The nature of the internal controls over
existing assets determines whether it is
necessary to verify manufacturing
equipment acquired in prior years
 Relevant controls include a periodic count
and a formal method of informing the
accounting department of disposals
18-13
Verification of amortization
expense
 Recorded amounts are internal allocations
rather than exchange transactions with
outside parties
 Primary audit objectives involve
determining whether the client is:
– Following a consistent amortization policy
from period to period and whether
– Making calculations accurately
18-14
Verification of accumulated
amortization
 Debits are normally
tested as a part of the
audit or disposals of
assets
 Credits are verified as
part of the audit of
amortization expense
18-15
Practice problem 18-18 (p. 544)
 Discuss your
responsibilities for
auditing opening and
closing asset balances
 Prepare an audit
program for the audit
of asset balances
18-16
Auditing intangible assets
 Intangible assets include goodwill, copyrights,
trademarks, deferred expenses, capitalized
charges for brand names, and others
 May be extremely difficult to value as they do
not have a ready value, and can rapidly drop in
value
 Audit expertise in the area is required, or the
auditor may need to engage an independent
expert to value material intangible assets
18-17
 Evaluate an audit
approach for verifying
interest and legal
expense
 Suggest a better
approach
18-18
Audit of prepaid expenses
 Prepaid expenses arise from the concept of
matching expenses with revenues
 These types of accounts are found in
almost every audit
 Prepaid insurance is used as an example
because it is a common expense and the
auditor is responsible for reviewing the
adequacy of insurance coverage
18-19
Audit of prepaid insurance expense
 The auditor considers internal controls in

the following categories. Controls over:
– The acquisition and recording of insurance,
– Insurance coverage and
– Charge-off of insurance expense
 The organization may have an insurance
register or spreadsheet, or it may simply
have a file of insurance policies in force
18-20
Prepaid insurance expense: audit
tests
 Analytical procedures
 Verification that charges to the insurance
expense arose from credits to prepaid
insurance (based upon a schedule of
insurance charges and prepaid expenses
prepared by the client)
18-21
Typical accrued liabilities
 Payroll-related accruals (bonuses,
commissions, income taxes, interest,
payroll, payroll taxes and pension costs)
 Professional fees
 Rent
 Warranty costs
18-22
Auditing accrued property taxes
 Payments of property taxes have been
partially tested by means of the tests of the
acquisition and payment cycle
 Emphasis in the tests is normally on the
ending property tax liability and payments
18-23
Audit of operations
 The purpose of audit of operations is to
determine whether the income and expense
accounts are fairly presented
 The auditor needs to be aware of the
importance of the income statement to
users
 Matching and consistent application of
accounting principles are evaulated
18-24
Approach to auditing operations
 This part of the audit is closely linked to the audit
of all of the other transaction cycles
 All tests conducted during the audit need to be
considered to evaluate their impact upon the audit
of operations
 Analytical review is an important audit step for
the audit of operations, and is often conducted
using audit software or spreadsheet software
18-25
Typical analytical procedures for
operations
Analytical procedure Possible misstatement
Compare individual expenses Overstatement or

with previous years understatement of a balance
in an expense account
Compare individual asset and Overstatement or

liability balances with understatement of a balance
previous years sheet account that would also
affect an income statement
account
18-26
operations (cont’d)
Compare individual Misstatement of

expenses with budgets expenses and related
balance sheet accounts
Compare gross margin Misstatement of cost of

percentage with previous goods sold and inventory
years
18-27
Compare inventory Misstatement of cost of

turnover ratio with goods sold and inventory
previous years
Compare prepaid Misstatement of insurance

insurance and insurance expense and prepaid
expense with previous insurance
years
18-28
Compare commission Misstatement of
expense divided by sales commission expense and
with previous years accrued commissions
Compare individual Misstatement of
manufacturing expenses individual manufacturing
divided by total expenses and related
manufacturing expenses balance sheet accounts
with previous years
18-29
 Review the results of
analytical review
 Are the explanations
reasonable?
18-30

ch18 70 360

Uploaded by

Document Information

Original Description:

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

ch18 70 360

Uploaded by

Copyright:

Available Formats

Chapter 18: Completing the Tests in the

Acquisition and Payment Cycle:

 Manufacturing assets are capital assets that

 The auditor considers internal controls in

Compare individual expenses Overstatement or

Compare individual asset and Overstatement or

Compare individual Misstatement of

Compare gross margin Misstatement of cost of

Compare inventory Misstatement of cost of

Compare prepaid Misstatement of insurance

You might also like