Are you auditing payables and expenses? In this post, we’ll answer questions such as, “how should we test accounts payable?” and “should I perform fraud-related expense procedures?” We’ll also take a look at common risks and how to respond to them.
What is a payable? It’s the amount a company owes for services rendered or goods received. Suppose the company you are auditing receives $2,000 in legal services in the last week of December, but the law firm sends the related invoice in January. The company owes $2,000 as of December 31, 2016. The services were provided, but the payment was not made until after the period-end. Consequently, the company records the $2,000 in its year-end payables.
In determining whether payables exist, I like to ask, “if the company closed down at midnight on the last day of the month, would it have a legal obligation to pay for a service or good?” If the answer is yes, then record the payable—even if the invoice is received after the month-end. Has the service been received by month-end? Have the goods been received by month-end? If yes and the company has not paid for the service or good by month-end, then the company has a payable.
In this post, we will cover the following:
The primary relevant accounts payable and expense assertions are:
Of these assertions, I believe—in general—completeness and cutoff (for payables) and occurrence (for expenses) are most important. When a company records its payables and expenses by period-end, it is asserting that they are complete and that they are accounted for in the right period. Additionally, the company is implying that amounts paid are for legitimate purposes.
As we perform walkthroughs of accounts payable and expenses, we are looking for understatements of accounts payable and expenses (though they can also be overstated as well). We are asking, “What can go wrong—whether intentionally or by mistake?”
In performing accounts payable and expenses walkthroughs, ask questions such as:
As we ask these questions, we inspect documents (e.g., payables ledger) and make observations (e.g., who signs checks or makes electronic payments?).
If controls weaknesses exist, we create audit procedures to respond to them. For example, if—during the walkthrough—we see that one person prints and signs checks, records payments, and reconciles the bank statement, then we will perform fraud-related substantive procedures (more about this in a moment).
The directional risk for accounts payable and expenses is an understatement. So, in performing your audit procedures, perform procedures to ensure that invoices are properly included. For example, perform a search for unrecorded liabilities (explained below).
The primary risks for accounts payable and expenses are:
In smaller entities, it is common to have the following control deficiencies:
When segregation of duties is lacking, consider whether someone can use the expense cycle to steal funds. How? By making payments to fictitious vendors. Or intentionally paying a vendor twice—and then stealing the second check.
In smaller engagements, I usually assess control risk at high for each assertion. When I assess control risk at less than high, I have to test controls to support the lower risk assessment. Therefore, assessing risks at high is usually more efficient (than testing controls).
When control risk is assessed at high, inherent risk becomes the driver of the risk of material misstatement (controls risk X inherent risk = risk of material misstatement). The assertions that concern me the most are completeness, occurrence, and cutoff. So my RMM for these assertions is usually moderate to high.
My response to higher risk assessments is to perform certain substantive procedures: namely, a search for unrecorded liabilities and detailed expense analyses.
How does one perform a search for unrecorded liabilities? Use these steps:
As the RMM for completeness increases, vouch payments at a lower dollar threshold.
How should you perform a detailed analysis of expense accounts? First, compare your expenses to budget—if the entity has one—or to prior year balances. If you note any significant variances (that can’t be explained), then obtain a detail of those particular expense accounts and investigate the cause.
Theft can occur in numerous ways—such as duplicate payments or fictitious vendors. If you see control weaknesses in the expense cycle, consider performing fraud-related procedures. (For information about fraud prevention, check out my book on Amazon.) When fraud-related control weaknesses exist, assess the RMM for the occurrence assertion at high. Why? There is a risk that the expense (the occurrence) is fraudulent. So, how should you respond to such risks?
An example of a fraud-related test is one for duplicate payments. How?
In a duplicate payment fraud, the thief intentionally pays an invoice twice. He then steals the second check and converts it to cash.
Be aware of other expense fraud schemes including:
My customary audit tests are as follows:
My accounts payable and expenses work papers frequently include the following:
So, now you know the why and how of auditing accounts payable and expenses.
This post is a part of my series titled the Why and How of Audits. If you’ve missed the previous series articles, click here.
Next week, we’ll look at how to audit payroll. Subscribe below to see this audit series.
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Charles Hall is a practicing CPA and Certified Fraud Examiner. For the last thirty years, he has primarily audited governments, nonprofits, and small businesses.He is the author of The Little Book of Local Government Fraud Prevention and Preparation of Financial Statements & Compilation Engagements. He frequently speaks at continuing education events.Charles is the quality control partner for McNair, McLemore, Middlebrooks & Co. where he provides daily audit and accounting assistance to over 65 CPAs. In addition, he consults with other CPA firms, assisting them with auditing and accounting issues.
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