Copyright © 2007 Pearson Education Canada 1 Chapter 18: Completing the Tests in the Acquisition and...
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Transcript of Copyright © 2007 Pearson Education Canada 1 Chapter 18: Completing the Tests in the Acquisition and...
Copyright © 2007 Pearson Education Canada
1
Chapter 18: Completing the Tests in the Acquisition and Payment Cycle:
Verification of Selected Accounts
Copyright © 2007 Pearson Education Canada
18-2
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
Copyright © 2007 Pearson Education Canada
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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)
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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
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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
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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
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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
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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
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Analytical procedures for manufacturing equipment
Analytical procedure Potential misstatement detected
Compare amortization expense divided by gross manufacturing equipment cost with previous years
Misstatement in amortization expense and accumulated amortization
Compare accumulated amortization divided by gross manufacturing equipment cost with previous years
Misstatement in accumulated amortization
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Analytical procedures for manufacturing equipment (cont’d)
Analytical procedure Potential misstatement detected
Compare monthly or annual repairs and maintenance, supplies expense, small tools expense, and similar accounts with previous years
Expensing amounts that should be capital items
Compare gross manufacturing cost divided by some measure of production with previous years
Idle equipment or equipment that has been disposed of but not written off
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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
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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
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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
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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
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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
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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
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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
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Practice problem 18-20 (p. 545)
Evaluate an audit approach for verifying interest and legal expense
Suggest a better approach
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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
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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
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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)
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Typical accrued liabilities
Payroll-related accruals (bonuses, commissions, income taxes, interest, payroll, payroll taxes and pension costs)
Professional fees Rent Warranty costs
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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
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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
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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
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Typical analytical procedures for operations
Analytical procedure Possible misstatement
Compare individual expenses with previous years
Overstatement or understatement of a balance in an expense account
Compare individual asset and liability balances with previous years
Overstatement or understatement of a balance sheet account that would also affect an income statement account
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Typical analytical procedures for operations (cont’d)
Analytical procedure Possible misstatement
Compare individual expenses with budgets
Misstatement of expenses and related balance sheet accounts
Compare gross margin percentage with previous years
Misstatement of cost of goods sold and inventory
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Typical analytical procedures for operations (cont’d)
Analytical procedure Possible misstatement
Compare inventory turnover ratio with previous years
Misstatement of cost of goods sold and inventory
Compare prepaid insurance and insurance expense with previous years
Misstatement of insurance expense and prepaid insurance
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Typical analytical procedures for operations (cont’d)
Analytical procedure Possible misstatement
Compare commission expense divided by sales with previous years
Misstatement of commission expense and accrued commissions
Compare individual manufacturing expenses divided by total manufacturing expenses with previous years
Misstatement of individual manufacturing expenses and related balance sheet accounts
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Practice problem 18-23 (p. 545)
Review the results of analytical review
Are the explanations reasonable?