Auditing Accounts Payable
Accounts Payable (AP) is a significant liability on a company's balance sheet and often constitutes a focal point in audits. Given its importance, it's unsurprising that questions related to auditing AP frequently appear in the Auditing and Attestation (AUD) section of the U.S. CPA exam. Within the domain of AP audits, three essential procedures stand out: Search for Unrecorded Liabilities, Vendors Reconciliation, and Cut-off Review. Understanding these can make a big difference in both your CPA exam performance and your professional auditing career.
Search for Unrecorded Liabilities
The Search for Unrecorded Liabilities involves looking for obligations that the company has incurred but has not yet recorded in its financial statements. This step is crucial for validating the completeness assertion for accounts payable. Failing to identify unrecorded liabilities can lead to an understatement of liabilities and expenses, thereby presenting a more favorable financial position than what truly exists.
Example: Imagine you are auditing a manufacturing company. You decide to scrutinize invoices received during the first two weeks of the new accounting period. You find an invoice for raw materials dated December 30th of the year being audited, but it was not recorded until January. This is a red flag that suggests an unrecorded liability, which needs to be recorded in the correct accounting period.
Vendors Reconciliation
Vendor reconciliation is the process of comparing the company's accounts payable ledger to vendors' statements or invoices to ensure that they agree. This is especially important for validating the accuracy and existence assertions. CPA candidates must understand that discrepancies could arise from several factors such as timing differences, errors, or fraud.
Example: While auditing a retail store, you perform a vendor reconciliation. The company's AP ledger shows a balance of $25,000 owed to a particular vendor. However, the vendor's statement indicates only $20,000 is due. After investigating, you find that the company inadvertently recorded an invoice twice. This example highlights why reconciliation is necessary— to catch and rectify errors that can misstate financial conditions.
Cut-off Review
A Cut-off Review helps auditors ensure that transactions around the year-end are recorded in the correct accounting period. This is essential for the accurate representation of the liability and is a frequently tested area in the CPA exam. Incorrect cut-offs can distort key performance indicators and ratios, impacting various stakeholders from investors to lenders.
Example: You notice that an invoice for office supplies, dated December 29, was recorded in accounts payable on January 5 of the next year. For accurate financial reporting, it is essential to record this expense and corresponding liability in the year in which it was incurred, not when it was recorded.