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Accounting 133 Chapter 8 Notes

Accounting 133 Chapter 8 Notes - Auditing Chapter 8 A...

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Auditing Chapter 8 A company can inflate their books by charging expense items to fixed assets accounts. Understating or capitalizing expenses is a means often used to mislead financial statement users. When expenses can be matched with revenues (matching) (e.g., costs of goods sold with sales), they are recognized when the revenue is recognized. Otherwise they are recognized in the period they are incurred, or, if they benefit future periods, they are allocated by “systematic and rational procedures” (e.g., depreciation) to future periods. The second most common reason for restatements (after improper revenue recognition) was misstated costs and expenses. This category included improperly recognizing costs or expenses, improperly capitalizing expenditures, and improperly accounting for taxes. Unrecorded liabilities in most systems liabilities are not recorded until receiving reports have been matched to purchase orders and invoices. Often when there is a problem with matching the documents the liability is not reported thus understating costs and overstating profits. Noncancelable Purchase Agreements Companies often order goods for future delivery to obtain volume discounts or favorable pricing. However, if market forces or technology cause a decline in the value of those goods, the company must recognize any related losses immediately. Capitalizing Expenses accounts will be expensed over a number of years as depreciation or amortization. Although the expenses do not go away, capitalizing them increases net income in the year when they should have been completely expensed. 1) Identify significant inherent risks in the acquisition and expenditure cycle. 1. Unrecorded liabilities 2. Noncancelable purchase agreements 3. Capitalizing expenses 2) Describe the acquisition and expenditure cycle, including typical source documents and controls. The basic acquisition and expenditure activities are 1. Purchasing goods and services 2. Receiving the good or service 3. Recording the assets or expense and related liability 4. Paying the vendor Purchasing Goods and Services
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Purchases are requested (requisitioned) by people who know the needs of the organization. A purchasing department seeks the best prices and quality and issues a purchase order to a selected vendor. Inventory is often ordered automatically from approved vendors through electronic data interchange (EDI). Receiving the Goods or Services A receiving department inspects the goods received for quantity and quality (producing a receiving report) and then puts them in the hands of other responsible persons (e.g., inventory warehousing, fixed asset installation). A receiving report is completed indicating the quantity and description of the
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Accounting 133 Chapter 8 Notes - Auditing Chapter 8 A...

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