1. PURCHASE AND PAYMENT CYCLE
1.1 INTRODUCTION OF THE TOPIC
The activities and controls of this cycle are primarily concerned with the ordering,
receiving and payments of goods by a company. Inherently this cycle is a high risk
cycle from an audit perspective due to the fact that cash is involved. Cash per the
ISA standards carries an inherent fraud risk and in this cycle this risk is increased
due to the fact that payments can be made for goods that the company never
actually really received. In many companies in the corporate environment, this cycle
present one of their major risk areas. In this module we will endeavor to explore the
UNIVERSITY OF JOHANNESBURG intricacies of this cycle and also find out how this will affect the audit procedures to
be performed in order to attain sufficient and appropriate audit evidence to reduce
audit risk to an acceptably low level.
DEPARTMENT OF ACCOUNTANCY 1.2 CHARACTERISTICS AND ACTIVITIES IN THE CYCLE
The purchases and payments cycle consists of four functions which we will explore
throughout this module. These functions can be described as:
3.3 The ordering of goods and services;
AUDITING 300/BCTA 3.4 The receiving of goods and services;
3.5 The recording of purchases and accounts payable;
3.6 The payment of goods received.
2018
But before we start our journey through the cycle, it is important to understand that
the auditor does not provide an opinion over individual cycles audited, but over the
financial statements as a whole. With that in mind, it is important to, as we are about
to start, provide a big picture as to which accounts is affected in the financial
statements, over which the auditor will provide assurance. The accounts that are
typically affected by this cycle are the following:
1) Within the Statement of Comprehensive Income
Salaries and wages
General company expenses
MODULE: Purchases & Payment Cycle Goods and services consumed
2) Within the Statement of Financial Position 1.4 RECEIVING OF ORDERED GOODS
Trade payables
Other payables As soon as the delivery clerk of the supplier delivers goods, the receiving clerk must
Provisions agree the reference per the supplier delivery note to a numerically filed order. This is
Accruals to ensure that the goods to be received were in actual fact ordered and that the
Bank quantity delivered agrees to the quantity ordered. Once verified, the receiving clerk
Inventory should perform a superficial quality check. Superficial due to the fact the rarely will
Cash the receiving clerk open all the boxes received but a quality check can still be
Discount receivable performed by verifying that no wet or damaged or opened boxes are excepted.
Prepaid expenses
VAT and both the receiving clerk as well as the delivery clerk must sign off on the
amendments made.
mentioned earlier on an individual basis starting with the ordering function. It is recommended that additional security measures are introduced to the receiving
function of companies as most theft occurs in this function. Goods could be signed
1.3 ORDERING OF GOODS for as approved by the receiving clerk but only half of them are taken delivery of. The
delivery clerk could then leave with half the truckload and in collusion with the
receiving clerk, sell the goods at cheaper prices at the expense of the company.
It is important to note that the system descriptions that is about to be provided are for Additional measures could be the installation of surveillance cameras.
a company with the necessary staff capacity to ensure the necessary levels of If goods are returned which were taken into receipt, a pre numbered credit note must
segregation of duties between each function. be completed and must be approved by the purchases manager.
The ordering function is concerned with the company being able to request goods Once the receiving clerk has accepted delivery, signed off the supplier delivery note,
from the procurement (purchasing) department who in turn will ensure that the goods made amendments (if applicable), a pre numbered good received note must be
requested are acquired from the most reliable and cost efficient supplier without completed of the actual quantity of goods taken receipt of. This goods received note
sacrificing quality. To initiate the purchase process, the requesting department must (GRN) must be cross referenced to the relevant purchase order and delivery note.
complete a requisition, requesting the procurement department to purchases specific Copies of this cross referenced documents must be sent to the accounting
item\s. Upon receipt of the requisition, a buyer within the procurement department department for recording of the transaction.
will then source the required goods.
1.5 RECORDING OF THE TRANSACTION
First point of call for the buyer should be a list of approved suppliers for the supplier
who can provide the best product at the best price. The list of approved suppliers is a
summary of all the suppliers from whom the department have bought from before Once goods have been received, the purchase and the liability must then be raised
who provided either the best price, quality, shortest delivery time or a combination of (as risks and rewards have passed) but before the transaction is recorded, the
these factors. In order to make amendments to this, the approval of the chief buyer accounting clerk should compare the details of the invoice received from the supplier
should be obtained. to the underlying supporting documents by making use of a grid stamp detailing the
following:
Once the supplier is selected, a pre numbered purchase order (completed in
triplicate) must be completed and approved by the chief buyer. This approval is to
ensure that goods are bought from suppliers with the best price and quality and in so
doing avoids the risk of a buyer purchasing from another supplier merely because
the company. Copies of the purchase orders (PO) must be provided to the supplier
and to the receiving department to be filed numerically.
Telephonic orders must be discouraged but in circumstances where they could not
be avoided, the order should be followed up with an official order.
Once the order has been placed, the focus now shifts from the ordering function to
the receiving function.
, Agree: Performed by: Before we however conclude on the activities, it is important to reflect on all the
Quantity invoiced to GRN functions relevant within each function. This is important due to fact that it is literally
Price per invoice to PO impossible to audit anything if you are not certain about what documents to
VAT accounted @ 14% scrutinize. Below is a list of all the documents discussed above accompanied with
Recalculate invoiced the function within which they can be found:
amount
Requisition
All these checks must be performed and the supporting documents such as the Order form Ordering function
GRN, PO and delivery note must be attached to the invoice. Only once all these
checks have been performed, can the transaction be posted. Once posted, the Supplier delivery note
liability now exists and payment must be effected when it becomes due. Goods received note Receiving function
Credit note
1.6 PAYMENT
Purchase invoice Recording function
This function can be divided into two separate sub functions in order to achieve
better segregation of duties. The two sub functions are preparation of payment and
Payment requisitions Payment (Preparation of payment)
actual payment of the creditor. Within the preparation function, a payment requisition
Remittance advice
Receipt Payment (Payment)
received from the recording clerk. A reconciliation should be performed by this clerk
EFT Proof of payment
whereby the monthly creditors statements received from the creditors are reconciled
to the invoices received from the suppliers as well as payment made to the creditors.
Once the clerk is confident of the amount outstanding, the clerk can then request
audited.
payment by means of a payment requisition. All the documents supporting the
payments should be present before a payment requisition should be effected. The
1.7 AUDIT OF PURCHASES AND PAYMENTS
main purpose of this function within the cycle is to make sure only valid creditors are
paid, on time and at the correct amount.
Having had taken time to understand the activities in the cycle, the auditor would
The second function is the presentation of the requisition, supported with all have become aware of certain controls which, if they operate effectively, can assist
documents to the authorised payment signatories. There should always be two the auditor in ensuring that the balances in the financial statements are fairly stated.
signatories and they must make sure that they inspect to verify the amount, payee, If internal controls are properly designed, implemented correctly and operate
date, supporting documents and afterwards cancel the supporting documentation effectively throughout the period under review, they will help the auditor in assessing
before they sign a cheque or affect the EFT (Electronic Funds Transfer). A
remittance advice is then prepared to indicate to the supplier what invoice each
payment made refers to. If cheques are still being used, they should be numerically The auditor follows a risk based audit approach and it is therefore key for you to
- ed from the bank must understand just some of the risks the auditor is faced within the purchases and
be filed and reviewed for suspicious endorsements. payment cycle.
These risks are:
Please note that EFTs are becoming a more popular form of funds transfer. The Deliberate misapplication of IFRS/GAAP and fraud by management by:
controls around cheques are still relevant. Additional risks that arise due to EFT Capitalization of expenditure and subsequent impairment of assets that
payments are the fact that EFT payments are instant and significant loss can should have been expensed
therefore be suffered almost instantly. Raising of excessive provisions to be held in reserves, which are then
linked with your computers module. released as income as and when management wishes to do so.
Use of special purpose entities to move liabilities
This then concludes the discussion around the functions within the purchases and
payment cycle. It is important for the auditor to understand these activities because related parties.
through understanding the activities the auditor is put in a position whereby risk of Complex tax schemes to defer or hide income tax or VAT liabilities.
material misstatements can be detected as well as the measures management Charging personal expenses to the business, and cases of senior
implemented to mitigate the risk(s). management treating business funds as their own slush funds.
Management bias and incentive to misstate expenditure 1.8 DIRECTION OF TESTING
Complexity of expenditures incurred e.g. where management has started off
shore businesses where they have limited experience of problems that might Debits (Assets/Expenses) Credits
be encountered. This would result in errors in expenditure allocation and (Liabilities/Reserves)
translation of foreign currencies. Risk/Test Overstatement Understatement
Management override of controls or fraud by employees in collusion with third Direction Accounting records to Supporting documentation
parties to process personal expenditure as business expenditure and the supporting documentation to accounting records
possible duplication of payments.
Incorrect cut-off applied
Understate accounts payable where management may be under pressure to ASSERTIONS CLASSES OF ACCOUNT PRESENTATION
reflect high levels of earnings and working capital. TRANSACTIONS BALANCES AT & DISCLOSURE
Incorrect recording of foreign exchange transactions. PERIOD END
Discounts not claimed. OCCURRENCE
COMPLETENESS
Now having reflected on the risks within the cycle it is important for you to remember ACCURACY
the applicable direction of testing as well as the assertions relevant to each financial CUT OFF
statement caption. CLASSIFICATION
EXISTENCE
RIGHT &
OBLIGATION
VALUATION
Having refreshed your memory of assertions and direction of testing, we are now
ready to take a look at how the auditor will go about decreasing his/her audit risk.
Relying on controls can be beneficial to the auditor as it will result in a more efficient
and sometimes cost effective audit.
1.9 CONTROL OBJECTIVES AND TEST OF CONTROLS
For an entity to ensure that a sound control environment exists in their purchases
and payments cycle the following control objectives must be met:
Purchase transactions are valid (validity)
Purchase transactions have been properly authorised (authorisation)
Purchase transactions shown at the correct values (accuracy)
Purchase transactions are classified correctly (classification)
Purchase transactions recorded correctly (recording)
All purchase transactions have been recorded (completeness)
Purchase transactions recorded timely in the correct period (cut-off)
The auditor now needs to test these control objectives by evaluating the control as
well as performing test of controls over the control identified as being of audit
importance. Below is a layout of control objectives as well as the controls that must
be operating effectively to support the objective. The auditor must then also perform
tests on these controls to assess whether it was operating effectively throughout the
period under review if the control is of audit importance.
1.1 INTRODUCTION OF THE TOPIC
The activities and controls of this cycle are primarily concerned with the ordering,
receiving and payments of goods by a company. Inherently this cycle is a high risk
cycle from an audit perspective due to the fact that cash is involved. Cash per the
ISA standards carries an inherent fraud risk and in this cycle this risk is increased
due to the fact that payments can be made for goods that the company never
actually really received. In many companies in the corporate environment, this cycle
present one of their major risk areas. In this module we will endeavor to explore the
UNIVERSITY OF JOHANNESBURG intricacies of this cycle and also find out how this will affect the audit procedures to
be performed in order to attain sufficient and appropriate audit evidence to reduce
audit risk to an acceptably low level.
DEPARTMENT OF ACCOUNTANCY 1.2 CHARACTERISTICS AND ACTIVITIES IN THE CYCLE
The purchases and payments cycle consists of four functions which we will explore
throughout this module. These functions can be described as:
3.3 The ordering of goods and services;
AUDITING 300/BCTA 3.4 The receiving of goods and services;
3.5 The recording of purchases and accounts payable;
3.6 The payment of goods received.
2018
But before we start our journey through the cycle, it is important to understand that
the auditor does not provide an opinion over individual cycles audited, but over the
financial statements as a whole. With that in mind, it is important to, as we are about
to start, provide a big picture as to which accounts is affected in the financial
statements, over which the auditor will provide assurance. The accounts that are
typically affected by this cycle are the following:
1) Within the Statement of Comprehensive Income
Salaries and wages
General company expenses
MODULE: Purchases & Payment Cycle Goods and services consumed
2) Within the Statement of Financial Position 1.4 RECEIVING OF ORDERED GOODS
Trade payables
Other payables As soon as the delivery clerk of the supplier delivers goods, the receiving clerk must
Provisions agree the reference per the supplier delivery note to a numerically filed order. This is
Accruals to ensure that the goods to be received were in actual fact ordered and that the
Bank quantity delivered agrees to the quantity ordered. Once verified, the receiving clerk
Inventory should perform a superficial quality check. Superficial due to the fact the rarely will
Cash the receiving clerk open all the boxes received but a quality check can still be
Discount receivable performed by verifying that no wet or damaged or opened boxes are excepted.
Prepaid expenses
VAT and both the receiving clerk as well as the delivery clerk must sign off on the
amendments made.
mentioned earlier on an individual basis starting with the ordering function. It is recommended that additional security measures are introduced to the receiving
function of companies as most theft occurs in this function. Goods could be signed
1.3 ORDERING OF GOODS for as approved by the receiving clerk but only half of them are taken delivery of. The
delivery clerk could then leave with half the truckload and in collusion with the
receiving clerk, sell the goods at cheaper prices at the expense of the company.
It is important to note that the system descriptions that is about to be provided are for Additional measures could be the installation of surveillance cameras.
a company with the necessary staff capacity to ensure the necessary levels of If goods are returned which were taken into receipt, a pre numbered credit note must
segregation of duties between each function. be completed and must be approved by the purchases manager.
The ordering function is concerned with the company being able to request goods Once the receiving clerk has accepted delivery, signed off the supplier delivery note,
from the procurement (purchasing) department who in turn will ensure that the goods made amendments (if applicable), a pre numbered good received note must be
requested are acquired from the most reliable and cost efficient supplier without completed of the actual quantity of goods taken receipt of. This goods received note
sacrificing quality. To initiate the purchase process, the requesting department must (GRN) must be cross referenced to the relevant purchase order and delivery note.
complete a requisition, requesting the procurement department to purchases specific Copies of this cross referenced documents must be sent to the accounting
item\s. Upon receipt of the requisition, a buyer within the procurement department department for recording of the transaction.
will then source the required goods.
1.5 RECORDING OF THE TRANSACTION
First point of call for the buyer should be a list of approved suppliers for the supplier
who can provide the best product at the best price. The list of approved suppliers is a
summary of all the suppliers from whom the department have bought from before Once goods have been received, the purchase and the liability must then be raised
who provided either the best price, quality, shortest delivery time or a combination of (as risks and rewards have passed) but before the transaction is recorded, the
these factors. In order to make amendments to this, the approval of the chief buyer accounting clerk should compare the details of the invoice received from the supplier
should be obtained. to the underlying supporting documents by making use of a grid stamp detailing the
following:
Once the supplier is selected, a pre numbered purchase order (completed in
triplicate) must be completed and approved by the chief buyer. This approval is to
ensure that goods are bought from suppliers with the best price and quality and in so
doing avoids the risk of a buyer purchasing from another supplier merely because
the company. Copies of the purchase orders (PO) must be provided to the supplier
and to the receiving department to be filed numerically.
Telephonic orders must be discouraged but in circumstances where they could not
be avoided, the order should be followed up with an official order.
Once the order has been placed, the focus now shifts from the ordering function to
the receiving function.
, Agree: Performed by: Before we however conclude on the activities, it is important to reflect on all the
Quantity invoiced to GRN functions relevant within each function. This is important due to fact that it is literally
Price per invoice to PO impossible to audit anything if you are not certain about what documents to
VAT accounted @ 14% scrutinize. Below is a list of all the documents discussed above accompanied with
Recalculate invoiced the function within which they can be found:
amount
Requisition
All these checks must be performed and the supporting documents such as the Order form Ordering function
GRN, PO and delivery note must be attached to the invoice. Only once all these
checks have been performed, can the transaction be posted. Once posted, the Supplier delivery note
liability now exists and payment must be effected when it becomes due. Goods received note Receiving function
Credit note
1.6 PAYMENT
Purchase invoice Recording function
This function can be divided into two separate sub functions in order to achieve
better segregation of duties. The two sub functions are preparation of payment and
Payment requisitions Payment (Preparation of payment)
actual payment of the creditor. Within the preparation function, a payment requisition
Remittance advice
Receipt Payment (Payment)
received from the recording clerk. A reconciliation should be performed by this clerk
EFT Proof of payment
whereby the monthly creditors statements received from the creditors are reconciled
to the invoices received from the suppliers as well as payment made to the creditors.
Once the clerk is confident of the amount outstanding, the clerk can then request
audited.
payment by means of a payment requisition. All the documents supporting the
payments should be present before a payment requisition should be effected. The
1.7 AUDIT OF PURCHASES AND PAYMENTS
main purpose of this function within the cycle is to make sure only valid creditors are
paid, on time and at the correct amount.
Having had taken time to understand the activities in the cycle, the auditor would
The second function is the presentation of the requisition, supported with all have become aware of certain controls which, if they operate effectively, can assist
documents to the authorised payment signatories. There should always be two the auditor in ensuring that the balances in the financial statements are fairly stated.
signatories and they must make sure that they inspect to verify the amount, payee, If internal controls are properly designed, implemented correctly and operate
date, supporting documents and afterwards cancel the supporting documentation effectively throughout the period under review, they will help the auditor in assessing
before they sign a cheque or affect the EFT (Electronic Funds Transfer). A
remittance advice is then prepared to indicate to the supplier what invoice each
payment made refers to. If cheques are still being used, they should be numerically The auditor follows a risk based audit approach and it is therefore key for you to
- ed from the bank must understand just some of the risks the auditor is faced within the purchases and
be filed and reviewed for suspicious endorsements. payment cycle.
These risks are:
Please note that EFTs are becoming a more popular form of funds transfer. The Deliberate misapplication of IFRS/GAAP and fraud by management by:
controls around cheques are still relevant. Additional risks that arise due to EFT Capitalization of expenditure and subsequent impairment of assets that
payments are the fact that EFT payments are instant and significant loss can should have been expensed
therefore be suffered almost instantly. Raising of excessive provisions to be held in reserves, which are then
linked with your computers module. released as income as and when management wishes to do so.
Use of special purpose entities to move liabilities
This then concludes the discussion around the functions within the purchases and
payment cycle. It is important for the auditor to understand these activities because related parties.
through understanding the activities the auditor is put in a position whereby risk of Complex tax schemes to defer or hide income tax or VAT liabilities.
material misstatements can be detected as well as the measures management Charging personal expenses to the business, and cases of senior
implemented to mitigate the risk(s). management treating business funds as their own slush funds.
Management bias and incentive to misstate expenditure 1.8 DIRECTION OF TESTING
Complexity of expenditures incurred e.g. where management has started off
shore businesses where they have limited experience of problems that might Debits (Assets/Expenses) Credits
be encountered. This would result in errors in expenditure allocation and (Liabilities/Reserves)
translation of foreign currencies. Risk/Test Overstatement Understatement
Management override of controls or fraud by employees in collusion with third Direction Accounting records to Supporting documentation
parties to process personal expenditure as business expenditure and the supporting documentation to accounting records
possible duplication of payments.
Incorrect cut-off applied
Understate accounts payable where management may be under pressure to ASSERTIONS CLASSES OF ACCOUNT PRESENTATION
reflect high levels of earnings and working capital. TRANSACTIONS BALANCES AT & DISCLOSURE
Incorrect recording of foreign exchange transactions. PERIOD END
Discounts not claimed. OCCURRENCE
COMPLETENESS
Now having reflected on the risks within the cycle it is important for you to remember ACCURACY
the applicable direction of testing as well as the assertions relevant to each financial CUT OFF
statement caption. CLASSIFICATION
EXISTENCE
RIGHT &
OBLIGATION
VALUATION
Having refreshed your memory of assertions and direction of testing, we are now
ready to take a look at how the auditor will go about decreasing his/her audit risk.
Relying on controls can be beneficial to the auditor as it will result in a more efficient
and sometimes cost effective audit.
1.9 CONTROL OBJECTIVES AND TEST OF CONTROLS
For an entity to ensure that a sound control environment exists in their purchases
and payments cycle the following control objectives must be met:
Purchase transactions are valid (validity)
Purchase transactions have been properly authorised (authorisation)
Purchase transactions shown at the correct values (accuracy)
Purchase transactions are classified correctly (classification)
Purchase transactions recorded correctly (recording)
All purchase transactions have been recorded (completeness)
Purchase transactions recorded timely in the correct period (cut-off)
The auditor now needs to test these control objectives by evaluating the control as
well as performing test of controls over the control identified as being of audit
importance. Below is a layout of control objectives as well as the controls that must
be operating effectively to support the objective. The auditor must then also perform
tests on these controls to assess whether it was operating effectively throughout the
period under review if the control is of audit importance.
