Efficient Tests of Balances Series—No. 24: Auditing Accounts Payable
Learning “how” to audit accounts payable begins with a focus on the completeness assertion. Understatement of accounts payable results in understatement of related expense or asset accounts. Some small to medium-size entities use accounting software that permits recording accounts payable when vendor invoices are received; account activity is maintained for each vendor. Other smaller entities may simply keep open invoices and receiving reports in tickler files for recording when disbursements are made. In both cases, the auditor’s primary concern is that all accounts payable for vendor invoices and statements have been recorded. The auditor is also concerned that any other liabilities and accrued expenses have been properly calculated and recorded.
APPLICABLE ACCOUNTING AND ANDITING STANDARDS
Basic generally accepted accounting principles for accounts payable and accrued expenses are related primarily to the matching principle, i.e., matching all costs and expenses with revenues in the proper period. The FASB Statement of Financial Accounting Concepts No. 6, Elements of Financial Statements defines liabilities and their characteristics:
Liabilities are probable future sacrifices of economic benefits arising from present obligations of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events.
A liability has three essential characteristics: (a) it embodies a present duty or responsibility to one or more other entities that entails settlement by probable future transfer or use of assets at a specified or determinable date, on occurrence of a specified event, or on demand, (b) the duty or responsibility obligates a particular entity, leaving it little or no discretion to avoid the future sacrifice, and (c) the transaction or other event obligating the entity has already happened.
The Financial Accounting Standards Board’s Accounting Standards Codification (ASC), Topic 310, (www.fasb.org) contains specific guidance on accounting measurement and disclosure requirements for accounts payable and various accrued expenses. Several important basic issues for the auditor’s consideration are:
• Accounts payable should be recorded when goods or services are delivered or expenses are incurred.
• Present value calculations should guide the accounting and measurement for accounts payable and other liabilities due in more than a year. For example, notes exchanged for property, goods or services should be accounted for at the present value of the consideration exchanged, which is presumed to be the same as for a cash sale. When the interest rate is not stated, and when the stated rate is unreasonable, the property, goods or services exchanged should be recorded at the discounted value of the future payments on the obligation.
Audit strategies are based on the standards issued by the Auditing Standards Board of the AICPA, specifically the risk assessment standards in Statements on Auditing Standards Nos. 106 through 111 and SAS No. 99 on fraud risk assessment. These standards indicate that all risk assessment procedures, tests of controls, analytical procedures and tests of balances produce substantive evidence that enables an auditor to express an opinion on audited financial statements. Risk assessment, using heightened professional skepticism, is required on all audits to indentify risks of material misstatement and to design audit responses to prevent such risks from causing the audited financial statements from becoming misleading.
The principal auditing standards specifically applicable to accounts payable and accrued expenses are AU Section 342, Auditing Accounting Estimates, and AU Section 336, Using the Work of a Specialist, from the AICPA Professional Standards. Some of the key issues in these standards include:
Auditing Accounting Estimates:
Accounting estimates measure the effects of past business transactions or events or the present status of an asset or liability. Examples include allowances for doubtful accounts, net realizable values for inventories, percentage of completion method of revenue recognition for construction contracts, pension costs and warranty expenses.
Management is responsible for making the accounting estimates and the auditor is responsible for evaluating their reasonableness. The auditor’s objective when evaluating accounting estimates is to obtain sufficient evidence to provide reasonable assurance that all material estimates have been developed, that those estimates are reasonable and that the estimates are presented in accordance with the applicable reporting framework.
Using the Work of a Specialist:
When an auditor encounters complex matters during an audit that require special skill or knowledge, a specialist may be engaged to obtain appropriate audit evidence. Such matters may include valuations of financial instruments, real estate or works of art, physical characteristics of mineral reserves, actuarial determinations for employee benefit obligations and disclosures and interpretation of technical and legal matters.
The auditor must evaluate the qualifications of the specialist and the appropriateness and reasonableness of methods and assumptions used and applied by the specialist.
Efficient substantive procedures for accounts payable and other account classifications resulting from cost-beneficial audit strategies are discussed in my live and on-demand webcasts which can be accessed by clicking the applicable box on the left side of my home page, www.cpafirmsupport.com.