Accounts payable are a business entity’s liabilities that arise when the company purchases products or services on credit. The accounts payable of a company can be short-term or long-term. In general, the accounts payable are a current liability in nature.
Accounts payable relates to the expenses of a business entity, and there is a high risk of intentional misstatement to understate the company’s overall liabilities. Therefore, performing a regular audit of accounts payable is a recommended practice for the company.
Besides the regular audit, a comprehensive audit of accounts payable during the final audit is also necessary. In today’s article, we will discuss the audit procedures for accounts payable as well as the objectives, test of controls, audit assertions, and risks associated with accounts payable.
Objectives Of Accounts Payable Audit
The primary objective of performing accounts payable is to verify the audit assertions related to the accounts payable. Besides, the secondary objectives of an AP audit include testing the internal control efficiency of a business entity as well as compliance with the regulations, accounting standards, and policies.
Risks Associated With Accounts Payable Audit
The risks associated with the audit of a certain account relate to the internal controls, inherent risks, and other tendencies which can hinder a true and fair view of the financial statements. Similarly, the auditors must be well-acquainted with the risks associated with the audit or accounts payable for any business entity.
Here is the description of the risks and deficiencies associated with the accounts payable of any business entity:
Risk Of Material Misstatement
The risk of material misstatement in accounts payable can’t be detected or avoided by internal control procedures. Therefore, the material misstatement risk for any account is measured as a combined impact of inherent risk and the control risk associated with a specific account.
When we study the inherent risks of accounts payable, the complexity and nature of a financial transaction is the key determinant of it. The higher inherent risk means a higher risk of material misstatement. It implies that there might be an intentional understatement of the accounts payable or expenses to overstate the business entity’s profitability or understate the company’s liabilities.
The second aspect of material misstatement is the control risk which means if a company is intentionally understating the accounts payables, the internal controls can’t do anything. If the internal controls of a business entity are efficient and effective, there would be no misstatement.
As a gross impact of both inherent and control risk, we can say that a company will have a higher risk of material misstatement with weaker internal control.
Control Deficiencies
Besides the control risk when a personnel is not performing his duty honestly, there can be many other deficiencies in the internal control procedures of an entity regarding the accounts payable. The control deficiencies will vary depending on the size and nature of the business.
For instance, a small business entity is more likely to face deficiencies like one person doing multiple tasks, no surprise inspections & audits, weak bidding procedures, no or rare reconciliation of balances with the ledger, lack of budgeting, etc.
Duplicate Payments Or Missing Accruals
There is also a risk of duplicate payments to the vendors and missing certain accruals in the financial statement.
Assertions For Accounts Payable Audit
The audit assertions are the managerial claims about the trueness and fairness of the figures disclosed in the financial statements of the business entity. The audit procedures are designed to check the assertions made by the management.
Here are the primary assertions to be tested when performing accounts payable audit:
Existence
Existence assertion for the accounts payable means that the audit will perform the tests to verify that the payables recorded in the entity’s financial statements are genuine and actual. The amount posted from the ledger to the balance sheet can be higher than the ledger. Therefore, the auditor might ask for verification by sending confirmations to the vendors about the balances shown.
Cutoff
Cutoff assertion implies that no transaction that relates to the current financial period should be delayed or made earlier. It means transactions related to January should be recorded on 1st Feb or 31st Dec of the previous year. Therefore, an auditor will also test the cutoff assertion when performing an AP audit.
Accuracy
Accuracy relates to the arithmetical accuracy of the account balances reported in the financial statements. Besides, it also relates to the material misstatement of the financial transaction intending to overstate or understate a certain account.
Completeness
Completeness of accounts payable asserts that there is no missing transaction of the relevant account during the current accounting period. Therefore, an auditor might track the general ledger balances with the accounts payable listings and verify balances directly with the vendors.
Rights and Obligations
Rights and obligations assertion for AP audit relates to the audit balances of the vendors and the rights & obligations of the business entity regarding the accounts payable. This assertion can be tested by reviewing agreements between vendors and business entities that highlight all terms and conditions. For instance, the client will be obligated to pay penalties in case of delayed payments and might be entitled to a cash discount for early payments.
Classification
Classification assertion implies that the auditor will check and ensure the classification of accounts payables in the right class. Therefore, he will examine the payable balances to verify that the right balances are debited and credited per the financial transactions.
Presentation
If an unusual item is reported in the accounts payable balance, the company must disclose it properly and present the details in notes to financial statements. The auditor has to inspect the balances for any unusual transaction and verify that it is presented accordingly.
Audit Procedures for Accounts Payable
After understanding and assessing the risks associated with a specific account or business entity, the auditor plans and designs the audit program. When performing an audit for the accounts payables, an auditor will typically adopt the following procedures:
Accounts Payable Walkthrough
Walkthrough Test is often categorized as the test of control and serves as the beginning point for testing the control procedures of a specific department or overall accounting system of the business entity. The walkthrough test for accounts payable is similar to the one designed for other accounts and overall accounting systems.
However, some of the specific questions addressed in the accounts payable walkthrough test are as follows:
Who prepares the accounts payable master file? Who reconciles the AP summary with the general ledger? Who is responsible for ensuring that the AP transactions are recorded and recognized on time?
The auditor will also inspect the documentary evidence and a sample of transactions when performing the AP walkthrough test.
Tests Of Control
When it comes to the accounts payables of any business entity, the primary assertion in tests of controls is the completeness of the accounts. The accuracy of the figures and cutoff assertions can be checked in analytical procedures and walkthrough tests. Therefore, the tests of controls for accounts payable will generally include the following:
- Evaluation of the client’s monthly procedures for reconciling the balances of AP with those of the supplier’s financial statements
- Examination of the independent report of reconciliation prepared by the independent personnel(internal auditor, maybe)
- Compare and trace the vendor’s master file with the supporting documentation to make sure
- Review of the AP ageing report to check the efficiency of the payment department and relevant internal controls
Substantive Procedures
If we talk about the substantive audit procedures for accounts payables, an auditor will most likely perform the following procedures to test different assertions:
Cutoff
The audit procedures to check the cutoff assertion can include choosing a sample of vouchers to verify the dates mentioned on vouchers and those on which they were recorded in the books of accounts. The usual practice to test cutoff assertion is to pick samples from year-beginning or year-end transactions.
Accuracy
An auditor can test the accuracy of the accounts payable by using the following tests:
- Selecting a sample of vendors and individually recalculating the breakup balances of vendors for the current period and tracing it to total figures
- Check the arithmetical accuracy of the balances for selected vendors
- Review the SOPs for recording accounts payable to ensure the minimum risk of material understatement or fraud.
Completeness
An auditor might perform the following tests to check the completeness of the accounts payable of a business entity:
- Verify the current year’s beginning balance with the closing balance of the previous year
- Comparing the total balances from a master list of vendors to the figures recorded in the general ledger
- Inspection of posting process for accounts payable and review of documentary evidence for arithmetical accuracy
- Balance confirmations should be sent to the vendors for verification of balances
- Inspect and detect any unrecorded liabilities by reviewing the unrecorded invoices and year-end transactions
- Relevant analytical procedures to compare year-on-year balances of accounts payable
Occurrence
Occurrence assertion can be tested by selecting a random sample of invoices and performing the proper authorization to ensure that the transactions occurred.
Final Words
An auditor can perform further substantive tests to check more audit assertions. For instance, the auditor might implement the tests of details for valuation, classification, and accuracy assertions. Additionally, an auditor might decide to conduct fraud-related audit procedures if he finds a valid ground for it.