AUDITING

CHAPTER 12
Purchases & Cash Disbursements
Transactions
 TOPICS
• Nature of expenditure/disbursement cycle
– Flow of information
• Auditor’s assessment of control risk
– Audit of internal control for purchases, cash
disbursements
• Computer auditing, sampling, tests of
controls
• Assurance, consulting services

GBW 8th ed., Ch. 12 2

 NATURE EXPENDITURE/
DISBURSEMENT CYCLE

• Goods, services acquired from vendors,

employees in exchange for obligations to
pay
• Obligations to vendors, employees are paid

GBW 8th ed., Ch. 12 3

 EXPENDITURE, DISBURSEMENT CYCLE
• Flow of information
– Purchase requisition received to purchase goods
– Purchasing department issues purchase order to vendor for
purchase of goods
– Receiving department creates report that identifies
information about goods received
– Accounts payable receives vendor’s invoice
– Accounts payable creates voucher to authorize payment
– Cash disbursement prepares check for vendors.

GBW 8th ed., Ch. 12 4

Expenditure / Disbursement Cycle:
Purchases and Cash Disbursements
 Expenditure Cycle Accounts
• Typically, the accounts affected by the expenditure cycle are:
1. Purchases
2. Accounts and notes payable - trade
3. Purchase returns and allowances
4. Cash in bank (credits for cash disbursements)
5. Purchase discount
6. Inventories (merchandise; finished goods; raw materials:
goods in process)
7. Manufacturing and operating expenses requiring cash
payments.

GBW 8th ed., Ch. 12 6

 DOCUMENTS
• Purchase requisition • Voucher package
– Request to purchase goods; issued by – Voucher & supporting documents
user department or stockroom (invoice, RR, PO & Purchase
• Purchase order requisition)
– Request issued by Purchasing dept. to • Debit memo
vendor
– Reduction in the amount owed to
• Receiving report a vendor
– Identifies information about goods
received • Check
• Receiving log – Authorization to a bank to transfer
– Records received goods process funds to the payee
• Vendor’s invoice • Master list of price
– Formal notice amount, terms of • Master list of approved vendors
payment
• Vendor’s statement • Cash voucher or Check Voucher
– Prepared monthly by the vendor • Journal voucher

GBW 8th ed., Ch. 12 7

 DOCUMENTS

Authorization
Open purchase requisition - an unfulfilled request by the purchasing
department to acquire a good or service 8
 DOCUMENTS

- A binding contract once accepted

by the recipient/vendor.
- One copy each for purchasing,
receiving, & AP departments
• Purpose: to order goods from the
- vendor.
• indicates item description, quantity, and
Authorization
price, except receiving department 9
(blind copy
open PO –- force to count)
the orders that have not been received.
Closed PO - a copy of the receiving report arrives in the purchasing department
 DOCUMENTS

- Accompany goods / physical inventories

to the storeroom or warehouse
- One copy as file copy
Recording
- One copy goes to AP, purchasing (for
closed PO)
GBW 8th ed., Ch. 12 10
 DOCUMENTS

Or Supplier’s Invoice

- Where the financial value of a

purchase is determined, also in PO Recording
& RR.
- triggers the recording of a liability.

GBW 8th ed., Ch. 12 11

 DOCUMENTS

This document provides

evidence about a returned items
or discount from defective items.

- internal documents used to

communicate the need for a journal
entry to decrease the AP balance for
Recording
that supplier
GBW 8th ed., Ch. 12 12
 DOCUMENTS

or Voucher Packet

Recording &
- called a 3-way match
Authorization
GBW 8th ed., Ch. 12 13
 DOCUMENTS

- Or cash disbursement should arrive at

the vendor’s place of business on the
due date to maintain a good credit
rating and to optimize cash
management Recording
GBW 8th ed., Ch. 12 14
DOCUMENTS

GBW 8th ed., Ch. 12 15

 DOCUMENTS

• Cash voucher or Check Voucher

• Journal voucher
• Master list of price
• Master list of authorized vendors

GBW 8th ed., Ch. 12 16

 Accounting Records Involved in the
Expenditure Cycle
• Purchase Journal
– A journal for recording purchase transactions.
• Cash Disbursement Journal/transaction file
– A file for recording the individual payments made by check.
– Contains the total cash paid, the DR (the liability account is
decreased) to AP, discounts taken, and other DR and CR.
• AP subsidiary ledger/master file
– A file for recording individual acquisitions, cash disbursements,
and acquisition returns and allowances for each vendor.
• GL
– A file for recording all the transaction summaries.
GBW 8th ed., Ch. 12 17
 Entities Involved
• Requisitioning departments / Inventory • Cash disbursements (Treasury
Control Department)
– Issues purchase requisition to purchase goods
needed.
– Prepares check for vendors and daily
• Purchasing department summary.
– issues purchase order to vendor for purchase • Mailroom
of goods – Receives the vendor’s invoice &
• Receiving department forwards to AP department.
– creates report that identifies information
about goods received
• General accounting
• AP department – Receives a copy of the daily summary
– receives vendor’s invoice & creates voucher of vouchers, prepared in AP.
to authorize payment. – records in a voucher register. Column
• Inventory control department totals in the voucher register are
– Records in an inventory subsidiary ledger. posted to GL accounts.
• Warehouse / Stockroom • Vendor
– Stores the goods.

GBW 8th ed., Ch. 12 18

 Summary of Purchasing and Cash
Disbursements Activities
• Requisitioning departments / Inventory
Control
– Purchase requisition: Responsible for
authorization of the purchase of inventory
– Approved Purchase Requisition:
• An employee of the department that requests the
purchase prepares a purchase requisition, which is
submitted to a supervisor for approval.
• forwarded to Purchasing, where the request is
reviewed, a vendor selected, and a PO prepared.

GBW 8th ed., Ch. 12 19

 Summary of Purchasing and Cash
Disbursements Activities
• Purchasing Department
– Accept approved purchase requisitions from user
departments / inventory control department (within the
minimum limit).
– Prepare PO, distribute copies, and retain file copy.
• A purchase order describes the goods or services requested,
specifying price, quantity, shipping terms, and catalog numbers.
– Copies of POs are sent by Purchasing to the:
• Vendor
• Requisitioning (for closed PR)
• Receiving (for comparison or reconciliation)
• Accounts Payable (for voucher package)

GBW 8th ed., Ch. 12 20

 Summary of Purchasing and Cash
Disbursements Activities
• Receiving Department
– Where adequate supervision is most critical
– Receive a blind copy of the PO
– File PO until goods are received.
– Upon receipt of goods from the vendor, count quantities and compare with
PO.
– Prepare RR
– Forward goods to warehouse / storeroom – for safekeeping
– Forward copies of RR to:
• AP (for voucher package)
• Inventory Control (for recording of goods received)
• Purchasing (for closed PO)
– retain file copy of RR, PO, and updated receiving log.

GBW 8th ed., Ch. 12 21

 Summary of Purchasing and Cash
Disbursements Activities
• Warehouse or Storeroom and Inventory
Control
– Separate warehouse from inventory control
– Warehouse or storeroom - for safekeeping of
goods
– Inventory control - for recording of goods received

GBW 8th ed., Ch. 12 22

 Summary of Purchasing and Cash
Disbursements Activities
• Accounts Payable
– Voucher package: Responsible for the authorization of the payment of
inventory or AP liability
– Three-way match: Compare PR (optional), PO, RR, and vendor’s invoice.
– Prepare voucher and daily summary; assemble voucher package
– File voucher package or open VP file by due date (if still unpaid);
– Forward:
• Voucher package to cash disbursements (Treasury department) based on date
due.
• daily summary to General Accounting for recording; retain file copy.
– Understatement of Liability:
• Because of time delays between receiving inventory and making the journal
entry, liabilities are usually understated.

GBW 8th ed., Ch. 12 23

 Summary of Purchasing and Cash
Disbursements Activities
• Cash Disbursements (Treasury Department)
– Review voucher packages received from AP based on
due date – for completeness and accuracy
– Prepare checks and daily summary.
– Have checks signed by authorized signatories.
– Forward checks to vendors,
– Forward summary to General Accounting and AP for
recording; retain file copy of summary.
– Cancel (marks the supporting documents paid) and file
voucher packages.
GBW 8th ed., Ch. 12 24
 Summary of Purchasing and Cash
Disbursements Activities
• GL department
– post the journal voucher from the accounts
payable department
– post the account summary from inventory control
– reconcile the inventory control account with the
inventory subsidiary summary

GBW 8th ed., Ch. 12 25

Summary

GBW 8th ed., Ch. 12 26

Lesson 2 of Chapter 12

GBW 8th ed., Ch. 12 27

 TOPICS
• Nature of expenditure/disbursement cycle
– Flow of information
• Auditor’s assessment of control risk
– Audit of internal control for purchases, cash
disbursements
• Computer auditing, sampling, tests of
controls
• Assurance, consulting services

GBW 8th ed., Ch. 12 28

GBW 8th ed., Ch. 12 29
 Control Objectives
• Transaction authorization
• Transaction execution
• Recording
• Access to assets

GBW 8th ed., Ch. 12 30

 Control Objectives
TRANSACTION AUTHORIZATION
Control Errors or Frauds if To prevent or detect Tests of Controls
Objectives Ineffective Control errors or frauds
Vendors Purchase could be •Establish criteria for Scan the voucher
should be made from adding to, changing, or register for unusual
approved unauthorized deleting from the items (for example,
prior to vendors, resulting vendor list. unfamiliar vendor
purchasing in purchasing from •Prepare lists of names) and unusually
goods. related parties. authorized vendors. large amounts, and
Document: Master list investigate any items
of Approved Suppliers identified.
or Vendors.

GBW 8th ed., Ch. 12 31

 Control Objectives
TRANSACTION AUTHORIZATION
Control Errors or Frauds if To prevent or detect Tests of Controls
Objectives Ineffective Control errors or frauds
Approval of •Unnecessary •Maintain updated
the types, goods may be guidelines for purchase
quantities, ordered, resulting transactions (e.g.,
payment, to write-down of competitive bids,
terms, and unusable or specific-authorization
prices unsaleable exceeding the
inventory. minimum amount.
•Purchases at •Establish procedure
noncompetitive for reviewing and
prices or approving purchase
unfavorable terms, prices and terms prior
resulting to to purchase.
reduced earnings. •Document: Company
Manual / Handbook

GBW 8th ed., Ch. 12 32

 Control Objectives
TRANSACTION AUTHORIZATION
Objectives Errors or Frauds if To prevent or
Ineffective Control detect errors
or frauds
Inventory Purchasing agents The inventory
control could purchase inventories control
department at their own discretion, function
authorizes being in a position both to continually
authorize and to process the
replenishment purchase transactions. monitors
with a purchase Unauthorized purchasing can inventory
requisition. result in excessive inventory Levels---
levels for some items, while inventory levels
others go out of stock. drop to their
Excessive inventories tie up predetermined
the organization’s cash reorder points.
reserves, and stock-outs
cause lost sales and
manufacturing delays.

GBW 8th ed., Ch. 12 33

 Control Objectives
TRANSACTION AUTHORIZATION
Objectives Errors or Frauds To prevent or detect Tests of Controls
if Ineffective errors or frauds
Control
AP authorizes •The cash •A cash disbursements journal
cash disbursements function (check register) containing the
disbursement should not write checks voucher number authorizing
(Complete without this explicit each check provides an audit
authorization from AP. trail for verifying the
Voucher •A voucher should be authenticity of each check
packet) to pay prepared for the written.
the vendor. payment to vendors. •Auditor observes the
This should be procedure and examines file of
supported by properly documents. If entity does not
executed purchase prepare vouchers, the auditor
requisition, PO, RR, and should review the entries in the
vendor’s invoice. purchases journal and examine
the documents underlying
them for authenticity and
reasonableness.

GBW 8th ed., Ch. 12 34

 Control Objectives
TRANSACTION AUTHORIZATION
Objectives Errors or Frauds if To prevent or detect
Ineffective Control errors or frauds
Approved
purchase
order

GBW 8th ed., Ch. 12 35

 Control Objectives
TRANSACTION AUTHORIZATION
Objectives Errors or Frauds if To prevent or detect
Ineffective Control errors or frauds
Approved
purchase
order
Complete
Voucher
packet

GBW 8th ed., Ch. 12 36

 Control Objectives
TRANSACTION EXECUTION
Objectives Errors or Frauds if To prevent or detect Tests of Controls
Ineffective Control errors or frauds
Received * Damaged or Establish procedures Auditor should observe
goods should unordered goods for inspecting and that the procedure is
be counted could be accepted counting goods being performed.
and potentially creating received before
inspected for delays in receiving releasing the carrier.
quantity and the goods desired. Document: Receiving
quality. report, Manual

GBW 8th ed., Ch. 12 37

 Control Objectives
TRANSACTION EXECUTION
Objectives Errors or Frauds if To prevent or Tests of Controls
Ineffective Control detect errors or
frauds
All cash •Cash could be •Prenumber and •Auditor should
disbursements disbursed to control vouchers observe procedure and
for goods and unauthorized and checks. account for numerical
services should parties, potentially •Cancel voucher sequence of the
be based on a resulting in packages voucher.
bona fide fraudulent immediately upon •Auditor can examine
liability. payments. payment. cancellations on the
•Duplicate •Require manual documents.
payments could be dual signatories for
made, potentially all checks over a
resulting in prespecified
misspent cash. amount.
Document: Voucher
packages

GBW 8th ed., Ch. 12 38

 Control Objectives
RECORDING
Objectives Errors or Frauds if To prevent or detect Tests of Controls
Ineffective Control errors or frauds
All goods and •Goods may be •Prenumber receiving Auditor should observe
services received but not reports, and the procedure and
received reported , subsequently review account for the
should be potentially for prompt recording. numerical sequence of
accurately resulting in the RR.
and promptly understated
reported. inventory and
liabilities

GBW 8th ed., Ch. 12 39

 Control Objectives
RECORDING
Objectives Errors or Frauds if To prevent or detect Tests of Controls
Ineffective errors or frauds
Control
Purchases and •Account balances •Total input documents
cash may be (e.g., number of
disbursements inaccurate, documents, dollar
transactions potentially amounts) and
should be resulting in reconcile journals and
recorded misstated FS. ledgers.
properly and in •Establish processing
the proper and recording
accounting procedures.
period.

GBW 8th ed., Ch. 12 40

 Control Objectives
RECORDING
Objectives Errors or Frauds if To prevent or detect Tests of Controls
Ineffective Control errors or frauds
Purchases and •Summaries of •Establish validation
cash detailed records procedures to verify
disbursements may not agree with postings (e.g., check
transactions control accounts. digits).
should be posted •Transactions may •Batch and reconcile
accurately to be posted to input totals to
individual vendor improper vendor processed and
accounts. accounts, output controls.
potentially •Promptly investigate
resulting in correspondence from
improper vendors (e.g.,
payments. collection notices).

GBW 8th ed., Ch. 12 41

 Control Objectives
ACCESS TO ASSETS
Objectives Errors or Frauds if To prevent or detect Tests of Controls
Ineffective errors or frauds
Control
Access to •Records, forms, •Establish physical
purchasing and or documents controls over unused
cash may be misstated forms and documents.
disbursement by unauthorized •Segregate
records and to personnel, responsibilities for
forms and potentially authorization,
documents resulting in execution, and
should be misstated recording functions.
restricted to payables or •Maintain listings and
personnel diversion for samples of authorized
authorized by personal use. signatories.
management.

GBW 8th ed., Ch. 12 42

 TOPICS
• Nature of expenditure/disbursement cycle
– Flow of information
• Auditor’s assessment of control risk
– Audit of internal control for purchases, cash
disbursements
• Computer auditing, sampling, tests of
controls
• Assurance, consulting services

GBW 8th ed., Ch. 12 43

Assessing Control Risk & Auditing Internal
Control Over Financial Reporting
• Obtain an Understanding of Internal Controls
• Assess Control Risk
• Form a Preliminary Opinion on Management’s
Assessment of Internal Control Over Financial
Reporting

GBW 8th ed., Ch. 12 44

Assessing Control Risk & Auditing Internal
Control Over Financial Reporting
• Obtain an Understanding of Internal Controls
• is a means to an end—the end being an audit
plan
– in the case of a public company, to report on
internal controls over financial reporting—and
addresses these questions:
• How is the system supposed to work?
• What control activities has management implemented
to assure that the system does indeed work?

GBW 8th ed., Ch. 12 45

 Assessing Control Risk & Auditing Internal
Control Over Financial Reporting
• Obtain an Understanding of Internal Controls
– Apart from evaluating the audit committee’s effectiveness and
obtaining an understanding of IT and reviewing Sarbanes-
Oxley, Section 404, documentation, an auditor obtains an
understanding of internal control by:
1. Performing a review of Section 404 or other documentation,
2. Documenting the system,
3. Performing transaction walkthroughs, and
4. Determining whether existing control activities are
potentially reliable in assessing control risk below the
maximum.

GBW 8th ed., Ch. 12 46

 Obtain an Understanding of Internal
Controls
1. Performing a review of Section 404 or other documentation.

Public Company: Review the Sarbanes- Non-Public Company: Other

Oxley Section 404 & other documentation Documentation
By reviewing SOX 404, the auditor • may not have documented internal control
develops a general understanding of: • Preliminary review by interviewing client
personnel—for example, the purchasing manager,
1. the control environment receiving clerk, and AP department manager.
2. the control activities • Reviews accounting procedures manuals
– to develop a general understanding of the client’s
3. how the entity identifies, captures, control environment; accounting system (for example,
communicates, and monitors the flow of purchase and payment transactions); and
how the entity identifies, captures, communicates, and
external and internal information monitors external and internal information ithat
that enables employees to discharge enables employees to discharge their assigned
responsibilities.
their assigned responsibilities. • If existing controls are inadequate or control risk
Reviews the client’s documentation. is high
– auditor’s documentation of the system is limited simply
Interviews employees in Purchasing, to a memorandum in the working papers that describes
Receiving, AP, and Cash the reasons for not continuing to consider internal
control.
Disbursements.
 Obtain an Understanding of Internal
Controls
2. Documenting the system.
• flowcharts, questionnaires, and/or narratives.
• An auditor could describe the system—or segments
of the system—in a written narrative.
• For example, a narrative could be used to describe the
distribution of documents and reports outside of the
dominant areas of concern—that is, outside of
purchasing, receiving, accounts payable, and cash
disbursements.

GBW 8th ed., Ch. 12 48

 Obtain an Understanding of Internal
Controls
3. Performing transaction walkthroughs.
• Transaction Walkthroughs
• The auditor could select canceled voucher packages and
compare the related purchase requisitions, POs, RRs, and
invoices for compliance with company policies and with
documents filed in Purchasing, Receiving, and AP.
• System documentation—for example, the flowchart—
would be revised if transaction walkthroughs reveal that
the auditor’s understanding of internal control is
inaccurate.

GBW 8th ed., Ch. 12 49

 Obtain an Understanding of Internal
Controls
4. Determining whether existing control activities are potentially reliable in assessing control risk
below the maximum.
• Identification of Control Activities
• Following system documentation, and if control risk is low, then an auditor continues as follows:
1. Identify the system’s control objectives.
The first column of Figure 12-4 identifies control objectives for purchases and cash disbursements
transactions.
2. Consider the potential errors or frauds that might result if specific control objectives are not
met.
The second column of Figure 12-4 identifies examples of potential errors or frauds.
3. Determine what control activities management uses to prevent or detect potentially material
errors or frauds.
The third column of Figure 12-4 identifies examples of potential controls.
4. Design tests of controls.
Those control activities relevant to management’s financial statement assertions about accounts payable,
prepaid expenses, and accrued liabilities are subjected to tests of controls, described next.

GBW 8th ed., Ch. 12 50

 Identification of Control Activities
PURCHASING DEPARTMENT
Audit Objectives Errors or To prevent or detect Tests of Controls
Frauds if errors or frauds
Ineffective
Control
a. To tests whether 1. Randomly select a samp1e
paid voucher of paid voucher
packages are packages
canceled, thereby a. Review each voucher
package for cancellation
addressing whether (for example
duplicate payments perforation). Only direct
could occur. observation by the
auditor could assess
whether the time span
between payment and
cancellation is
reasonable.

Perforation - a small hole or row of small holes punched in a sheet

51
of paper, e.g., of postage stamps, so that a part can be torn off
 Purchasing Department:
Control Activities
1. A Clear definition of policies and procedures for reviewing and processing
purchase requisitions .
2. Preparation of prenumbered POs for all approved-purchase requisitions
3. Obtain of Competitive bids or price quotations for purchased goods and
services?
4. Master lists of price for repetitive transactions that do not require competitive
bids or price quotations.
5. Review periodically of purchase transactions by personnel independent of
Purchasing.
6. Forward copies of Pos to the Requisitioning, to Receiving and AP departments.
7. Master lists of authorized vendors by Purchasing.

A paid voucher package is the primary source from which the tests of
purchasing are performed.

GBW 8th ed., Ch. 12 52

 Purchasing
Control Objectives Specific Control Procedures
• All acquisitions of goods and • Approved POs and requisitions.
• Master list of approved vendors & Master
services should be list of prices - Vendors, prices, quality of
authorized. goods, and terms should be approved by
management.
• Written authorizations (e.g., • Clearly indicate quantities, description of
goods, prices, and other terms such as
PO) should contain freight and discounts.:
sufficient details for – Approved POs, purchase requisitions, and other
written authorizations should
subsequent comparison • Prenumbered POs
with RRs & vendor invoices. • Accounting for its numerical sequence;
• All approved purchases • Follow up of missing orders.
• Adequate written procedures for the
should be reported. purchasing function.

GBW 8th ed., Ch. 12 53

 Purchasing
Potential Errors or Irregularities FS Affected
• No Purchase Requisition:
– Goods not needed such as those for personal use
• Misstatement of inventories
or in excess of the required quantity may be
purchased.
and income.
• No RR, no PO: • Misstatement of expenses.
– Fictitious invoices for goods and services that were
not actually received may be processed and paid. • Misstatement of losses from
• No master list of price:
– Excessive payments may be made because the
fraud.
company does not have the basis in verifying the
quantity ordered and propriety of the prices shown
on
the vendors’ invoices.
• Maintaining one copy of PO:
– Written POs may be lost and the company may
make invalid payments (e.g., freight) as there is no
means of verifying the terms (e.g., FOB terms).

GBW 8th ed., Ch. 12 54

 Identification of Control Activities
PURCHASING DEPARTMENT
Audit Objectives Errors or To prevent or detect Tests of Controls
Frauds if errors or frauds
Ineffective
Control
a. To tests whether 1. Randomly select a samp1e
paid voucher of paid voucher
packages are packages
canceled, thereby a. Review each voucher
package for cancellation
addressing whether (for example
duplicate payments perforation). Only direct
could occur. observation by the
auditor could assess
whether the time span
between payment and
cancellation is
reasonable.

Perforation - a small hole or row of small holes punched in a sheet

55
of paper, e.g., of postage stamps, so that a part can be torn off
 Identification of Control Activities
PURCHASING DEPARTMENT
Audit Objectives Errors or To prevent or detect Tests of Controls
Frauds if errors or frauds
Ineffective
Control
b. addresses 1. Randomly select a
transaction samp1e of paid voucher
authorization packages
b. Review documents in each
sampled voucher
package for
authorization
- examine signatures or
initials on the (1) PO,
indicating an authorized
transaction; (2) RR,
indicating responsibility for
incoming goods; and (3)
voucher, indicating a cash
payment was authorized.

GBW 8th ed., Ch. 12 56

 Identification of Control Activities
PURCHASING DEPARTMENT
Audit Objectives Errors or To prevent or detect Tests of Controls
Frauds if errors or frauds
Ineffective
Control
c. Tests whether all 1. Randomly select a
documents agree samp1e of paid
and, therefore, that voucher packages
goods were c. Compare details on
purchase requisitions,
received and paid POs, RRs, vendors
for at the price invoices, and
quoted and in the vouchers and verify
quantity ordered. mathematical
accuracy.

GBW 8th ed., Ch. 12 57

 Identification of Control Activities
PURCHASING DEPARTMENT
Objectives Errors or Frauds if To prevent or detect Tests of Controls
Ineffective errors or frauds
Control
a. To 2. For each sampled
determine if all voucher package, obtain a
paid vouchers copy of the related PO &
resulted from requisition from
Purchasing dept. files .
authorized a. Compare POs in voucher
purchases. packages with copies of
POs in Purchasing dept.
files .

GBW 8th ed., Ch. 12 58

 Identification of Control Activities
PURCHASING DEPARTMENT
Objectives Errors or To prevent or detect Tests of Controls
Frauds if errors or frauds
Ineffective
Control
b. & c. address 2. For each sampled
whether the prices voucher package, obtain a
paid are competitive. copy of the related PO &
That is, evidence of requisition from
competitive bids or Purchasing dept. files .
price quotations b. Trace prices on POs to
would suggest competitive bids formal
management is price quotations, or other
conscientiously pricing sources
attempting to c. Examine periodic reports
safeguard assets—in by personnel independent
particular, cash—by of the purchasing dept.
seeking the best about prices and vendor
prices available. selection practices.

GBW 8th ed., Ch. 12 59

 Receiving:
Control Activities
1. Prenumbered RRs - for all goods received.
2. Receiving log - for all RRs processed.
3. Inspection, counting, and comparison of all
received goods with copies of Pos.
4. Independence of Receiving personnel
- from Purchasing, AP, and Cash
Disbursements.

GBW 8th ed., Ch. 12 60

 Receiving
Control Objectives Specific Control Procedures
• The description, quantity, • Goods/Products:
– Check the description, quantities, and
and quality of goods and condition of goods received at the time of
services received should their receipt.
• Receiving Report:
conform with the – Prenumbered RRs in recording goods and
specifications of the order. services received and accepted.
– numerical sequence of RRs;
• All goods and services – follow-up of missing RRs.
received should be • Matched orders:
– Prenumbered POs should be matched with
promptly and accurately RRs to identify unmatched orders;
reported. – follow-up procedures for long-outstanding
unmatched orders.
• Adequate written procedures for the
receiving function.
GBW 8th ed., Ch. 12 61
 Receiving
Potential Errors or Irregularities FS Affected
• If no RR: • Misstatement of inventories
– Vendors’ invoices may include and income.
items which were not actually
received.
• If no debit memo:
– Defective or damaged goods
may be priced at full cost.

GBW 8th ed., Ch. 12 62

 Identification of Control Activities
RECEIVING DEPARTMENT
Objectives Errors or To prevent or detect Tests of Controls
Frauds if errors or frauds
Ineffective
Control
•To determine whether Visiting the Receiving
received goods are dept. on a surprise
conscientiously counted basis,
and compared with POs.
•To address whether
goods received per the
voucher packages used
to test purchasing
controls agree with
Receiving department
files, such as the copy of
the receiving report filed
in Receiving and the
receiving log (a
chronological listing of
goods received),

GBW 8th ed., Ch. 12 63

 Identification of Control Activities
RECEIVING DEPARTMENT
Objectives Errors or Frauds To prevent or detect Tests of Controls
if Ineffective errors or frauds
Control
1. To test For each sampled
whether the voucher package,
copy used by obtain the related copy
AP to prepare a of the RR from
voucher is in Receiving dept. files
error. 1. Compare RRs in
voucher packages with
copies of RRs in
Receiving dept. files.

GBW 8th ed., Ch. 12 64

 Identification of Control Activities
RECEIVING DEPARTMENT
Objectives Errors or Frauds To prevent or detect Tests of Controls
if Ineffective errors or frauds
Control
2. To address the For each sampled
accuracy of voucher package,
quantities obtain the related copy
received by of the receiving report
examining
evidence that from Receiving
received goods department files
are inspected, 2. Review receiving
counted, and report for evidence
agreed with a that received goods
packing slip, the have been inspected,
vendor’s list of counted, and
goods shipped
that is normally compared with packing
found on or slips and purchase
within a shipped orders.
carton.

GBW 8th ed., Ch. 12 65

 Identification of Control Activities
RECEIVING DEPARTMENT
Objectives Errors or Frauds To prevent or detect Tests of Controls
if Ineffective errors or frauds
Control
3. To test For each sampled
further for voucher package,
discrepancies in obtain the related copy
reported of the receiving report
quantities by from Receiving
comparing RRs department files
to entries in the 3. Trace receiving
company’s reports to entries in
receiving log. the receiving log.

GBW 8th ed., Ch. 12 66

 Accounts Payable
Control Objectives Specific Control Procedures
• Liabilities for all goods and • Purchase journal - Vendors’
services received and accepted invoices should be logged,
should be: numbered, or controlled by other
– recognized and recorded in the means as they are received.
general and subsidiary ledgers.
• RRs should be matched with
• All recorded purchases should be vendors’ invoices & follow-up
based on the quantity, description, procedures should be performed
and condition of goods received. on long- unmatched items.
• Periodic verification of recorded • Control totals should be
purchases and liabilities. established and posted to control
• Adjustments to AP should be account before invoices are
supported by adequate forwarded to the subsidiary
documentation – debit memo. ledger clerk.
• Accruals ‘should be made on a
regular and rational basis.
GBW 8th ed., Ch. 12 67
 Accounts Payable
Specific Control Procedures Specific Control Procedures
• Vendor’s Invoices: • Periodic comparison of recorded
– Validity: Vendors’ invoices should be balances with budgeted amounts and
compared with RR s & POs. with those of prior periods.
– Accuracy: Verify the accuracy of vendors’ • Periodic reconciliation of subsidiary
invoices (e.g., footings and extensions).
records with control account balance
– Review and approve vendors’ invoices by
designated officials before recorded as
and with suppliers’ statements of
AP. accounts.
• Validity: Credit memos (or client- • The subsidiary records should be
prepared debit memos) should be maintained by a person who neither
compared with records of goods approves disbursement documents nor
returned and original purchase maintains the control account.
invoices; extensions and footings of • Documentation:
credit and debit memos should be – adequate written documentation of
adequately checked. procedures for processing and recording
vendors’ invoices.
GBW 8th ed., Ch. 12 68
 Accounts Payable
Potential Errors or Irregularities FS Affected
• Missing invoices: • Misstatement of assets,
– The company may not be able to expenses, and accounts
determine if all transactions have
been recorded since purchase
payable.
invoices are not accounted for. • Misstatement of inventories
• No receiving reports: and income.
– Payments may be made for goods
that were not actually received.
• Missing voucher package:
– Non-detection of unrecorded
liabilities.

GBW 8th ed., Ch. 12 69

 Cash Disbursement and Recording
• Cash disbursement function:
– Cash payment activities are particularly susceptible to frauds, because
cash is liquid and only an unauthorized payee and forged endorsement
are necessary to misappropriate funds.
– An auditor’s tests of controls over payments to vendors focus on
• approvals for payment
• proper journal entries
• to the extent possible, the authenticity of signatures.
• Recording Function for purchases and cash disbursements
– encompasses entries to AP, requiring that an auditor determine
whether details recorded within a voucher register are recorded in the
proper vendor accounts and agree in total with the general ledger.

GBW 8th ed., Ch. 12 70

 Cash Disbursement and Recording:
Control Activities
1. Review of voucher packages before being approved for payment.
2. Assured steps taken that unfamiliar payees (vendors) are bona fide.
3. Review of voucher packages and checks by signatories before they sign checks (or
before submitting vouchers for check preparation).
4. Cancellation of voucher packages when or immediately after checks are signed.
5. Deliver of signed checks directly to the mailroom without intervention by other
personnel.
6. Independence of Cash Disbursements personnel (for example, Treasury department)
from Purchasing, Receiving, and Accounts Payable.
7. Indication of account distribution on the purchase requisition by the requisitioning
department.
8. Preparation of vouchers - from requisitions and POs received from Purchasing, from
RRs received from Receiving, and from invoices received from the mailroom.
9. Forward of daily summaries of processed vouchers by AP, to General Accounting for
summary entries.

GBW 8th ed., Ch. 12 71

 Cash Disbursements
Control Objectives Specific Control Procedures
• All cash disbursements • Prenumbered checks and
should be: vouchers should be used.
– promptly and accurately • Cash disbursements, paid
recorded. checks & bank statement
– be authorized, based on should be compared.
recorded liabilities. • Follow up of missing checks and
• Access to cash should be vouchers.
limited to authorized • Establish control totals (e.g.,
company personnel. totals of columns in the Cash
Disbursements Journal) for
posting to control account prior
to posting to subsidiary records.
GBW 8th ed., Ch. 12 72
 Cash Disbursements
Specific Control Procedures Specific Control Procedures
• Checks: • Access – adequate control:
– check signers should review – access to blank (unissued), used,
disbursement documents and spoiled checks.
before signing checks. – access to check signing
– Dual signatures for unusually equipment and signature plates.
large amounts. • Documentations:
– Signed checks should be – Adequate documentation of
forwarded or mailed directly procedures for processing cash
to payees. disbursements.
– Checks should be prepared – Disbursement documents
based on approved voucher should be stamped “PAID”,
perforated, or voided to prevent
package.
re-use.
GBW 8th ed., Ch. 12 73
 Cash Disbursements
Potential Errors or Irregularities FS Affected
• Fictitious vendors or no • Misstatement of assets,
master list of approved liabilities,, expenses, losses
vendors: from fraud, and income.
– Cash may be misappropriated
by making fraudulent
payments.

GBW 8th ed., Ch. 12 74

 Identification of Control Activities
CASH DISBURSEMENT & RECORDING DEPARTMENT
Objectives Errors or Frauds if To prevent or detect Tests of Controls
Ineffective errors or frauds
Control
1. • A manually signed For each sampled
check would be voucher package,
unusual for a obtain the canceled
company that check.
normally processes
disbursements by 1. Examine canceled
computer. checks for signatures
-The check might and endorsements on
have been for an canceled checks,
amount exceeding looking specifically for
limits authorized, unusual items.
thereby legitimately
requiring manual
signatures.
-The manual
signature might
indicate a fraud.

GBW 8th ed., Ch. 12 75

 Identification of Control Activities
CASH DISBURSEMENT & RECORDING DEPARTMENT
Objectives Errors or Frauds if To prevent or detect Tests of Controls
Ineffective errors or frauds
Control
2. To be For each sampled
assured that voucher package,
the amount obtain the canceled
paid was the check.
amount owed. 2. Compare details of
the voucher package
with the canceled
check; check number,
date payee, and
amount.

GBW 8th ed., Ch. 12 76

 Identification of Control Activities
CASH DISBURSEMENT & RECORDING DEPARTMENT
Objectives Errors or Frauds if To prevent or detect Tests of Controls
Ineffective errors or frauds
Control
3. To test the For each sampled
appropriate voucher package,
account obtain the canceled
distribution, check.
such as expense
classification for 3. Trace voucher
financial packages and canceled
reporting and tax checks to postings in
purposes, and AP and to entries in
the voucher the voucher register.
register is tested a. Review entries in the
for mathematical voucher register for
accuracy and
unusual items. appropriate accounting
distribution
(classification).

GBW 8th ed., Ch. 12 77

 Identification of Control Activities
CASH DISBURSEMENT & RECORDING DEPARTMENT
Objectives Errors or Frauds if To prevent or detect Tests of Controls
Ineffective errors or frauds
Control
3. To test the For each sampled
appropriate voucher package,
account obtain the canceled
distribution, check.
such as 3. Trace voucher
expense packages and canceled
classification checks to postings in
for financial AP and to entries in
reporting and the voucher register.
tax purposes, b. Verify the
and the mathematical accuracy
voucher of the voucher register
register is for selected periods
tested for and trace totals to
mathematical entries in the GL.
accuracy and
unusual items.
GBW 8th ed., Ch. 12 78
 Identification of Control Activities
CASH DISBURSEMENT & RECORDING DEPARTMENT
Objectives Errors or Frauds if To prevent or Tests of Controls
Ineffective Control detect errors or
frauds
3. To test the For each sampled voucher
appropriate package, obtain the
account canceled check.
distribution, such 3. Trace voucher packages
and canceled checks to
as expense postings in AP and to
classification for entries in the voucher
financial register.
reporting and tax c. Scan the voucher
purposes, and register for unusual items
the voucher (for ex., unfamiliar vendor
register is tested names) and unusually
large amounts and
for mathematical investigate any items
accuracy and identified.
unusual items.

GBW 8th ed., Ch. 12 79

• A major difference between the two business
• types lies in the way purchases are authorized.
Manufacturing firms purchase raw
• materials for production, and their purchasing
decisions are authorized by the production
• planning and control function. These procedures
are described in Chapter 7. Merchandising
• firms purchase finished goods for resale. The
inventory control function provides the
• purchase authorization for this type of firm.
GBW 8th ed., Ch. 12 80
 Tests of Control – Acquisition/Purchasing
Cycle
GENERAL SPECIFIC CONTROLS TESTS OF CONTROLS
ASSERTIONS ASSERTIONS
Existence or Recorded -Acquisitions should be -Examine the approval
occurrence acquisitions are approved by authorized signature.
for items that personnel, evidenced by -Observes the procedure
were acquired. signature on the PO. and examines documents.
-A voucher should be If no vouchers, then review
prepared for the purchase the entries in the purchase
of goods, supported by journal & examine the
properly executed PR, PO, documents underlying
RR, & vendor’s invoice them for authenticity &
-The check signer should reasonableness.
examine the supporting -Examine cancellations on
documentation & cancel the documents. If not
the documents, making effectively cancel
them “paid” or writing the supporting documents,
date & number of the scan the voucher register
check on the document.. for multiple entries of
similar amounts.

GBW 8th ed., Ch. 12 81

 Tests of Control –
Acquisition/Purchasing Cycle
GENERAL SPECIFIC CONTROLS TESTS OF
ASSERTIONS ASSERTIONS CONTROLS
Completeness Acquisitions that -Prenumbered RRs -Observe the
occurred are should be used and procedure and
recorded. accounted for to account for the
determine that a numerical
liability is recorded sequence of the
for all goods RR.
received. -Observe
-Vouchers are procedure and
prenumbered and account for the
accounted for as numerical
they are entered in sequence of the
the voucher voucher.
register.

GBW 8th ed., Ch. 12 82

 Tests of Control –
Acquisition/Purchasing Cycle
GENERAL SPECIFIC CONTROLS TESTS OF
ASSERTIONS ASSERTIONS CONTROLS
Rights & Recorded RRs should be Observe that the
obligations acquisitions are the prepared by procedure is being
entity’s purchases person having performed.
and liabilities. access only to a
blind copy of PO
details. Requiring
a PO for the
recording of all
acquisitions will
preclude recording
consigned goods
and goods ordered
for personal use of
employees.

GBW 8th ed., Ch. 12 83

 Tests of Control –
Acquisition/Purchasing Cycle
GENERAL SPECIFIC CONTROLS TESTS OF
ASSERTIONS ASSERTIONS CONTROLS
Valuation & Acquisitions are Invoice amounts Examine the
allocation recorded for the are verified by a voucher for
proper amounts. clerk by reference signature indicating
to the Pos & RRs. performance.
Mathematical
accuracy of the
invoice is also
rechecked.

GBW 8th ed., Ch. 12 84

 Tests of Control –
Acquisition/Purchasing Cycle
GENERAL SPECIFIC CONTROLS TESTS OF
ASSERTIONS ASSERTIONS CONTROLS
Presentation & Acquisitions are Require employees Examine the chart
disclosure recorded to result to use a chart of of accounts. Also,
in presentation and accounts that examine the
disclosure. adequately signature of
describes accounts employee
to be debited. performing the
Account coding is checking or
assigned by one verification.
person and
checked by
another.

GBW 8th ed., Ch. 12 85

Acquisition/Purchasing Cycle

GBW 8th ed., Ch. 12 86

 Tests of Control –
Cash Disbursements Cycle
GENERAL SPECIFIC CONTROLS TESTS OF
ASSERTIONS ASSERTIONS CONTROLS
Existence or Recorded cash
occurrence disbursements
occurred.

GBW 8th ed., Ch. 12 87

 Tests of Control –
Cash Disbursements Cycle
GENERAL SPECIFIC CONTROLS TESTS OF
ASSERTIONS ASSERTIONS CONTROLS
Completeness All cash
disbursements
made are
recorded.

GBW 8th ed., Ch. 12 88

 Tests of Control –
Cash Disbursements Cycle
GENERAL SPECIFIC CONTROLS TESTS OF
ASSERTIONS ASSERTIONS CONTROLS
Rights & All cash
obligations disbursements
made are for
obligations of the
entity.

GBW 8th ed., Ch. 12 89

 Tests of Control –
Cash Disbursements Cycle
GENERAL SPECIFIC CONTROLS TESTS OF
ASSERTIONS ASSERTIONS CONTROLS
Valuation &
allocation

GBW 8th ed., Ch. 12 90

 Tests of Control –
Cash Disbursements Cycle
GENERAL SPECIFIC CONTROLS TESTS OF
ASSERTIONS ASSERTIONS CONTROLS

GBW 8th ed., Ch. 12 91

Tests of Control – Cash Disbursements

GBW 8th ed., Ch. 12 92

 Tests of Control –
Cash Disbursements Cycle
GENERAL SPECIFIC CONTROLS TESTS OF
ASSERTIONS ASSERTIONS CONTROLS

GBW 8th ed., Ch. 12 93

 Tests of Control –
Cash Disbursements Cycle
GENERAL SPECIFIC CONTROLS TESTS OF
ASSERTIONS ASSERTIONS CONTROLS

GBW 8th ed., Ch. 12 94

 Tests of Control –
Cash Disbursements Cycle
GENERAL SPECIFIC CONTROLS TESTS OF
ASSERTIONS ASSERTIONS CONTROLS

GBW 8th ed., Ch. 12 95

 Controls and Tests of Controls to determine the
Effectiveness of the Controls on Cash Disbursements

GBW 8th ed., Ch. 12 96

 Controls and Tests of Controls to determine the
Effectiveness of the Controls on Cash Disbursements

GBW 8th ed., Ch. 12 97

Lesson 3 of Chapter 12

GBW 8th ed., Ch. 12 98

 TOPICS
• Nature of expenditure/disbursement cycle
– Flow of information
• Auditor’s assessment of control risk
– Audit of internal control for purchases, cash
disbursements
• Computer auditing, sampling, tests of
controls
• Assurance, consulting services

GBW 8th ed., Ch. 12 99

Assessing Control Risk & Auditing Internal
Control Over Financial Reporting
• Obtain an Understanding of Internal Controls
• Assess Control Risk
• Form a Preliminary Opinion on Management’s
Assessment of Internal Control Over Financial
Reporting

GBW 8th ed., Ch. 12 100

 CASH DISBURSEMENTS
• Process
– Voucher package sent to Treasury department
(separate from AP)
– Treasury department reviews, reconciles,
authorizes payment
– Checks drawn for payment
• May require 2 signatures over a limit

GBW 8th ed., Ch. 12 101

 Purchasing
Audit Threats or How to Control: Tests of Controls / Audit
Objectives Risks, Errors or To prevent or Procedures
Frauds if detect errors or
Ineffective frauds
Control
-Unauthorized -PR must be •Select random sample
purchases approved paid voucher packages.
-Prenumbered PO
-Non- describes price, -Examine for cancellation,
competitive quantity, terms of authorization, details
prices goods ordered *Obtain Purchasing Dept.’s
-Goods received copy of PR, PO
compared to PO in
receiving department -Compare to voucher
-AP matches PO, RR, package
invoice before -Trace to competitive bids
authorizing payment
-AP prepares voucher
for recording by
General Accounting

GBW 8th ed., Ch. 12 102

 Receiving
Audit Threats or How to Control: Tests of Controls / Audit
Objectives Risks, Errors or To prevent or Procedures
Frauds if detect errors or
Ineffective frauds
Control
-Goods Obtain Receiving
received not Department copy of
counted, receiving report for voucher
inspected sample
-Goods -Compare receiving reports
received not -Review RRs for evidence of
compared to count, inspection
POs -Trace RRs to receiving log

GBW 8th ed., Ch. 12 103

 Cash Disbursement & Recording
Audit Threats or How to Control: Tests of Controls / Audit
Objectives Risks, Errors or To prevent or Procedures
Frauds if detect errors or
Ineffective frauds
Control
-Cash Obtain canceled checks for
payments voucher package
made to -Examine for signatures,
unauthorized endorsements
payee -Compare detailed
information about check
-Details from voucher package to
recorded in canceled check
voucher -Trace voucher packages,
register are canceled checks to postings
recorded for - Review for
proper vendor classification, accuracy
-Totals agree - Scan voucher register
to GL for unusual items

GBW 8th ed., Ch. 12 104

 INTERNAL CONTROL & RISK

Controls Risks
Authorization Unauthorized purchases,
vendors
Prenumbered Goods received not ordered,
receiving reports damaged
Recording Received not recorded, used
controls
Restricted access Goods, records, forms misused

GBW 8th ed., Ch. 12 105

 Summary: TEST OF CONTROLS
Purchasing, Disbursements
• Provide a reasonable degree
assurance that employees comply with
management’s procedures
• Purchasing
– Properly authorized, executed, recorded
• Disbursements
– Payments remitted, recorded promptly

GBW 8th ed., Ch. 12 106

 ASSESSING CONTROL RISK
• 2 Questions
– Are controls effective?
– Can controls be relied upon?
• If answer is yes to both
– Assess control risk below maximum
– Assess detection risk above minimum
– Restrict substantive tests of sales, receivables,
cash

GBW 8th ed., Ch. 12 107

 PRELIMINARY OPINION ON INTERNAL
CONTROL
• Required by Sarbanes-Oxley
– Auditor must form opinion on management’s
assessment of internal control over financial
reporting based on
• Reports of internal auditors
• Auditor’s tests of controls
• Substantive audit tests

GBW 8th ed., Ch. 12 108

 COMPUTER AUDITING & SAMPLING
• Understand the system
• Tests of controls
– Input controls
• Code verification
• Data entry controls
– Processing controls
• Control totals
• Limit tests
– Output controls
• Assess control risk
GBW 8th ed., Ch. 12 109
 POTENTIAL ERRORS, FRAUDS
• Cash disbursed to unauthorized parties
• Duplicate payments made
• Account balances inaccurate

GBW 8th ed., Ch. 12 110

 ASSURANCE, CONSULTING SERVICES
• Especially for government procurement
contracts
– Competitive bids
– Compliance with local laws

GBW 8th ed., Ch. 12 111