Question

1. Because of the small size of the company and the limited number of accounting personnel, Dry Goods Wholesale Company Ltd. initially records all acquisitions of goods and services at the time that cash disbursements are made. At the end of each quarter when financial statements for internal purposes are prepared, accounts payable are recorded by adjusting journal entries. The entries are reversed at the beginning of the subsequent period. Except for the lack of a purchasing system, the controls over acquisitions are excellent for a small company. (There are adequate prenumbered documents for all receipt of goods, proper approvals, and adequate internal verification wherever possible.)

   Before the auditor arrives for the year-end audit, the bookkeeper prepares adjusting entries to record the accounts payable as of the balance sheet date. The aged trial balance is listed as of the year-end, and a manual schedule is prepared adding the amounts that were entered in the following month. Thus, the accounts payable balance equals the aged trial balance plus the following month’s journal entry for invoices received after the year-end. All vendors’ invoices supporting the journal entry are retained in a separate file for the auditor’s use.

   In the current year, the accounts payable balance has increased dramatically because of a severe cash shortage. (The cash shortage apparently arose from expansion of inventory and facilities rather than lack of sales.) Many accounts have remained unpaid for several months, and the client is getting pressure from several vendors to pay the bills. Since the company had a relatively profitable year, management is anxious to complete the audit as early as possible so that the audited statements can be used to obtain a larger bank loan.

Required

1. Explain how the lack of a complete aged accounts payable trial balance will affect the auditor’s tests of controls for acquisitions and cash disbursements.

2. What should the auditor use as a sampling unit in performing tests of acquisitions?

3. Assume that no misstatements are discovered in the auditor’s tests of controls for acquisitions and cash disbursements. How will that assumption affect the verification of accounts payable?

4. Discuss the reasonableness of the client’s request for an early completion of the audit and the implications of the request from the auditor’s point of view.

5. List the audit procedures that should be performed in the year-end audit of accounts payable to meet the cutoff objective.

6. State your opinion as to whether it is possible to conduct an adequate audit in these circumstances.

Answer 1

A. Accounts payable trial balance

Accounts payable trial balance shows the amounts due to each of the vendor at a certain point of time. This is important because of the fact that we may want to know what we owe to a particular vendor at a point of time.

The control of acquisition and cash disbursement will be affected because the auditor cannot test the three things

PO processing

Receiving goods

Recording of liability

The cash disbursement can also not be matched because the auditor does not what is owe to the vendor at a particular point of time.

b. The auditor can check if the goods and services are actually received for the liability that has been created for the vendor.

Secondly he may check if the liability has been booked as per the Purchase order that might have sent.

c. even if in case no misstatement has been recognized this does not mean that the rule of acquisition and cash disbursements are fulfilled. This is because even if all the liabilities are matched with the vendor’s bills that are paid, there are still liabilities that are not entered and are accrued.

Since the bills are recorded when paid, this cannot be checked if the bills are paid in time or not.

d. from client point of view this is important because they will not get a loan until they have a audited financial statements.

From the auditor point of view this is not good because there might be some facts that the company does not want to be included in the financials. The some facts may be a large vendor invoice that is yet to receive, and company want to hide that liability.

e.

Audit procedures for cut off

• Examine the supporting documents for the accounts payments
• Examine bills that are not paid even after several weeks of year end close.
• Match the vendor statement that has been issued by the vendors.
• Request and send the confirmation of balances from vendors.
• Check if the bills that are received several weeks after are recorded in the same period to which they belongs.

f.

In such circumstances this is not possible to reasonably reach to a conclusion as there is lack of facts, this is because the books are not prepared as per the accounting standards and some of the tests that the audit do can not be performed in this small business.