Overview

The acquisition and expenditure cycle affects numerous general ledger accounts, and auditors must identify significant accounts—those with a reasonable chance of containing material misstatements—and their relevant assertions using the audit risk model. This cycle’s significant risks often relate to the completeness of expenditures, valuation of acquisitions, and validity of expenses due to potential fraud or errors.

Significant Accounts and Relevant Assertions

The document highlights the following significant accounts and their associated assertions, summarized in Exhibit 8.2 on Page 7 (327):

Accounts Payable

• Importance: Central to the purchasing process, accounts payable ensures liabilities for goods and services are recorded. Poor purchasing practices can disrupt operations (e.g., raw material shortages for manufacturers or inventory issues for retailers).

• Relevant Assertions:

  • Completeness: Ensuring all liabilities are recorded, as unrecorded liabilities are a common source of misstatement.

  • Cutoff: Liabilities must be recorded in the correct period to avoid shifting expenses across periods.

  • Existence: Verifying that liabilities represent actual obligations, not fictitious or personal expenses processed through accounts payable.

  • Presentation: Liabilities should be correctly classified and disclosed in financial statements.

  • Valuation: Ensuring payables are recorded at the correct amount, reflecting actual costs incurred.

• Risks: The text notes the potential for individuals to run personal expenses through accounts payable, emphasizing the validity (existence) assertion alongside completeness and valuation.

Various Expenses

• Importance: Expenses in this cycle (e.g., cost of goods sold, operating expenses) can be manipulated to improve financial statement appearance, as seen in historical fraud cases like WorldCom.

• Relevant Assertions:

  • Completeness: All expenses must be recorded to avoid understating costs.

  • Cutoff: Expenses should be recorded in the period incurred, preventing premature or delayed recognition.

  • Accuracy: Expenses must be recorded at the correct amount, ensuring proper valuation.

  • Classification: Expenses should be recorded in the appropriate accounts, as misclassification (e.g., capitalizing operating expenses) can distort financial results.

• Risks: Fraudulent schemes often involve shifting expenses to incorrect periods or accounts (e.g., capitalizing expenses to inflate assets and income), making classification a critical assertion.

Additional Context

Audit Risk Model: The auditor uses this model (introduced in earlier chapters) to assess risks and plan the engagement, focusing on where material misstatements could occur. In this cycle, completeness of expenditures and valuation of acquisitions are highlighted as the most significant risks, with validity (existence) also noted due to potential misuse of accounts payable.

Examples of Misstatements: The text references cases like WorldCom, where ordinary expenses were capitalized, underscoring the importance of accurate classification and valuation. It also mentions closing accounting records early or holding back large bills to manipulate cutoffs, affecting completeness and cutoff assertions.

Summary