Reading Time: 3 minutes Every business that buys goods and services from its suppliers on credit has to record its accounts payable, or the money that it owes to its suppliers. It is not enough to just record your bills and pay them off—it is important to audit accounts payable regularly to ensure that everything is in order. Not auditing accounts payable can lead to unfavorable consequences for your business, like duplicate or missed vendor payments and unrecorded liabilities. In this guide, we will see what accounts payable is, what auditing accounts payable means, and how to prepare your business for an accounts payable audit. Show So what is accounts payable?Accounts payable is simply the sum of money a business owes its suppliers. Accounts payable is a liability account that shows up in accrual-based accounting when a business buys goods or services from its suppliers on credit and has yet to pay for them. Accounts payable is crucial because it is the record of what a business owes its vendors or creditors. As an example, let’s suppose that you purchase a desktop computer worth $2,500 for your business from a dealer on credit. This increases your assets account because you have bought a computer, and increases your liability account by $2,500 because you have purchased on credit. This liability is recorded as accounts payable to the dealer and will be listed under the current liabilities section of your balance sheet. What does auditing accounts payable mean?In simple terms, auditing means inspection. An accounts payable audit is just a formal, well-organized, and thorough inspection of a business’ accounts payable records. Auditing can be done by either internal or third-party auditors. Auditing is required in all countries, but the rules for when the audit is required change from country to country. Governments usually require that businesses get audited as soon as they cross a certain revenue threshold. Auditing is important because it reveals whether your business’ payables are recorded correctly, and whether your records provide an accurate picture of your business’ liabilities. It also shows that you are playing by the rules, and that your company’s resources are being used for legitimate purposes. Auditing your accounts payable regularly ensures that bills are getting paid on time and helps you prevent duplicate payments, unrecorded liabilities, and defaults on vendor payments. What auditors look for before the accounts payable auditAuditors do not necessarily follow any set patterns while auditing. Their auditing methods vary according to the size of the business, the number of business transactions done over the audited period, and the level of accuracy needed. Generally, the bigger the business, the higher the accuracy required. Accounts payable audit proceduresThere are four stages in a typical accounts payable auditing process: planning, fieldwork, audit reporting, and follow-up review. PlanningThe first stage in the auditing process is planning. Auditors discuss the scope of the auditing process, and also the possible outcomes of the audit. While planning, you can also discuss any concerns you have regarding financial statements, potential fraud, or the need for improvement with your auditors. After this discussion, auditors can come up with a plan of action for the subsequent steps in the auditing process, beginning with fieldwork. FieldworkThis is when the auditing actually starts and the role of an auditor is put into action. Auditors begin to review how your business functions. They examine your business transactions and documents, including purchase orders, vendor invoices, bank records, and journal entries to ensure that the information in them is correct, payments have been made correctly, and the terms and conditions have been adhered to. Fieldwork can take a few days to several weeks, depending on how big your business is and how many transactions it has made. Audit reportingWhen the fieldwork is complete, auditors put their findings into a report. This report contains all the information the auditors have discovered about your business’ accounts payable and how accurate they are. The report also specifies areas where your business is doing well, and areas where it might need improvement. Follow-up reviewThe audit is not over at the reporting stage. Auditors do a follow-up review after a year, to check whether the suggested changes were implemented and the desired outcomes have been achieved. Getting your business audit-readySo how do you get your business audit-ready? Here are a few steps that help ease the work for your auditors.
AP Audits don’t have to be a headacheGetting your accounts payable audited helps you catch costly errors and prevent payment-related fraud. Auditing is not a simple task, though, and going over documents by hand is a complex process that actually increases the risk of fraud. On the other hand, an accounting app that uses automation can help keep your accounts payable in order. Besides prepping you for the audit, it’ll reduce the scope for errors and fraud, giving you less to worry about when audit season comes around. Accounts payable is usually one of the more important audit areas. Why? Risk. First, it’s easy to increase net income by not recording period-end payables. Second, many forms of theft occur in the accounts payable area. In this post, I’ll answer questions such as, “how should we test accounts payable?” And “should I perform fraud-related expense procedures?” We’ll also take a look at common payables-related risks and how to respond to them. In short, you will learn what you need to know about auditing accounts payable. What is a payable? It’s the amount a company owes for services rendered or goods received. Suppose the company you are auditing receives $2,000 in legal services in the last week of December 2019, but the law firm sends the related invoice in January 2020. The company owes $2,000 as of December 31, 2019. The services were provided, but the payment was not made until after the year-end. Consequently, the company should accrue (record) the $2,000 as payable at year-end. In determining whether payables exist, I like to ask, “if the company closed down at midnight on the last day of the year, would it have a legal obligation to pay for a service or good?” If the answer is yes, then record the payable even if the invoice is received after the year-end. Was a service provided or have goods been received by year-end? If yes (and the amount has not already been paid), accrue a payable. In this chapter, we will cover the following things an accounts payable auditor need to consider:
So, let’s begin our journey of auditing accounts payable and expenses. The primary relevant accounts payable and expense assertions are:
Of these assertions, I believe completeness and cutoff (for payables) and occurrence (for expenses) are usually most important. When a company records its payables and expenses by period-end, it is asserting that they are complete and that they are accounted for in the right period. Additionally, the company is implying that amounts paid are legitimate. As we perform walkthroughs of accounts payable and expenses, we are looking for understatements (though they can also be overstated as well). We are asking, “what can go wrong?” whether intentionally or by mistake. In performing accounts payable and expense walkthroughs, ask questions such as:
As we ask these questions, we inspect documents (e.g., payables ledger) and make observations (e.g., who signs checks or makes electronic payments?). So, we are inquiring, inspecting, and observing. If controls weaknesses exist, we create audit procedures to respond to them. For example, if--during the walkthrough--we see that one person prints and signs checks, records payments, and reconciles the bank statement, then we will perform fraud-related substantive procedures (more about this in a moment). Here's a short video about risk assessment for accounts payable auditors. The directional risk for accounts payable and expenses is an understatement. So, perform procedures to ensure that invoices are properly included. For example, perform a search for unrecorded liabilities (see below). The primary risks for accounts payable and expenses are:
Keep these in mind as you audit accounts payable. In smaller entities, it is common to have the following control deficiencies:
When segregation of duties is lacking, consider whether someone can use the expense cycle to steal funds. How? By making payments to fictitious vendors, for example. Or intentionally paying a vendor twice--and then stealing the second check. (See the section titled Auditing for Fraud below.) In smaller engagements, I usually assess control risk at high for each assertion. When I assess control risk at less than high, I have to test controls to support the lower risk assessment. Therefore, assessing risks at high is usually more efficient (than testing controls). When control risk is assessed at high, inherent risk becomes the driver of the risk of material misstatement (control risk X inherent risk = risk of material misstatement). The assertions that concern me the most are completeness, occurrence, and cutoff. So my RMM for these assertions is usually moderate to high. My response to higher risk assessments is to perform certain substantive procedures: namely, a search for unrecorded liabilities and detailed expense analyses. The particular expense accounts that I examine are often the result of my preliminary planning analytics. How does one perform a search for unrecorded liabilities? Use these steps:
As the RMM for completeness increases, vouch payments at a lower dollar threshold. How should you perform a detailed analysis of expense accounts? First, compare your expenses to budget—if the entity has one—or to prior year balances. If you note any significant variances (that can’t be explained), then obtain a detail of those particular expense accounts and investigate the cause. Theft can occur in numerous ways—such as fictitious vendors or duplicate payments. If control weaknesses are present, consider performing fraud-related procedures. When fraud-related control weaknesses exist, assess the RMM for the occurrence assertion at high. Why? There is a risk that the expense (the occurrence) is fraudulent. So, how should you respond to such risks? An example of a fraud-related test is one for duplicate payments. How?
In a duplicate payment fraud, the thief intentionally pays an invoice twice. He steals the second check and converts it to cash. This is just one example of expense fraud. There are dozens of such schemes. (See White Collar Crime is Knocking at Your Door: Are You Prepared?) My customary audit tests are as follows:
If there are going concern issues, you may need to examine the aged payables listing. Why? Management can fraudulently shorten invoice due dates. Doing so makes the company appear more current. For example, suppose the business has three unpaid invoices totaling $1.3 million that were due over ninety days ago. The company changes the due dates in the accounts payable system, causing the invoices to appear as though they were due just thirty days ago. Now the aged payables listing looks better than it would have. My accounts payable and expense work papers usually include the following:
So, now you learned about auditing accounts payable. My next post addresses auditing payroll. In some entities such as governments, payroll makes up over 50% of total expenses. Consequently, knowing how to audit payroll expenses is of great importance. My next post is titled The Why and How of Auditing Payroll. So, stay tuned. See my prior posts in The Why and How of Auditing. Click the book cover below to go to Amazon. |