Auditing the Acquisition & Payment Cycle

Purchases, Accounts Payable, and Cash Disbursements

Acquisition & Payment Cycle Overview

The acquisition and payment cycle encompasses all business activities related to purchasing goods and services and paying for them. This cycle includes the acquisition of inventory, supplies, fixed assets, and services. Key accounts include purchases, accounts payable, inventory, fixed assets, and various expense accounts. Auditors focus on ensuring that recorded liabilities are complete, expenses are properly recorded, and cash disbursements are authorized and accurate.

Acquisition & Payment Cycle Process Flow

Step 1Purchase
Requisition
Step 2Purchase
Order
Step 3Receipt of
Goods/Services
Step 4Vendor
Invoice
Step 5Cash
Disbursement
Step 6Recording
& Posting

💡 Key Control: Three-Way Match

Before payment is authorized, organizations should match three key documents: (1) Purchase Order, (2) Receiving Report, and (3) Vendor Invoice. This ensures goods/services were ordered, received, and properly billed before payment is made.

📌 Audit Focus

Unlike revenue cycle (where overstatement is the main risk), the primary risk in the acquisition cycle is understatement of liabilities - unrecorded payables or expenses that should be recorded but aren't (completeness assertion).

Key Risks in Acquisition & Payment Cycle

  • Unrecorded Liabilities: Failing to record goods/services received before year-end
  • Fictitious Vendors: Creating fake vendors and making fraudulent payments
  • Unauthorized Purchases: Purchasing without proper authorization
  • Duplicate Payments: Paying the same invoice twice
  • Improper Capitalization: Expensing capital items or vice versa
  • Cash Misappropriation: Theft through check tampering or kickbacks
  • Billing Errors: Paying incorrect amounts
  • Inventory Obsolescence: Failing to write down obsolete inventory
  • Personal Purchases: Unauthorized personal purchases
  • Related Party Transactions: Non-arm's length purchases

💡 Completeness is the Primary Risk

Unlike revenue, the main risk is completeness - ensuring all liabilities are recorded. Management has incentive to understate liabilities to improve ratios and profitability.

Management Assertions

Occurrence / Existence

Recorded purchases occurred and pertain to entity. Payables represent valid obligations. Assets actually exist.

Completeness ⭐

PRIMARY RISK: All purchases and liabilities are recorded. Search for unrecorded liabilities is critical.

Accuracy / Valuation

Recorded at correct amounts. Inventory at lower of cost/market. Proper depreciation.

Cutoff

Recorded in proper period. Liabilities recorded when received, not when paid.

Classification

Properly classified between inventory, fixed assets, and expenses.

Rights & Obligations

Entity has obligations to pay liabilities. Entity owns recorded assets.

Presentation & Disclosure

Proper presentation with adequate disclosure of policies, commitments, and related parties.

Accounts Payable Procedures

  • Search for Unrecorded Liabilities: Examine subsequent disbursements and receiving reports
  • Cutoff Testing: Test purchases before/after year-end
  • Vouching: Trace payables to supporting documents
  • Vendor Reconciliation: Compare statements to records
  • Analytical Procedures: Analyze turnover ratios

Purchases & Expenses Procedures

  • Analytical Procedures: Compare to prior periods and budget
  • Vouching: Trace to supporting documents
  • Test Capitalization: Verify proper classification
  • Test Accruals: Evaluate reasonableness

Inventory & Fixed Assets Procedures

  • Physical Observation: Observe inventory counts and inspect assets
  • Test Pricing: Verify costs and depreciation
  • Test Obsolescence: Review slow-moving inventory
  • Impairment Testing: Assess for indicators

Key Internal Controls

  • Segregation of Duties: Separate authorization, recording, and custody
  • Purchase Authorization: Require approval based on thresholds
  • Approved Vendor List: Maintain vetted vendor list
  • Prenumbered Documents: Use for completeness
  • Three-Way Match: Match PO, receiving report, invoice
  • Check Signing Authority: Dual signatures for large amounts
  • Physical Safeguards: Secure inventory and assets
  • Regular Reconciliations: Reconcile ledgers and statements
  • Positive Pay: Prevent check fraud
  • IT Controls: Edit checks and duplicate detection

💡 Preventive vs. Detective

Preventive: Authorization, segregation, three-way match. Detective: Reconciliations, counts, variance analysis.