There is a question asking for the risk responses to a situation where during the year ended 31/12/2011, the G.P ratio dropped sharply. The preliminary analytical review indicated that the drop was mainly due to a large increase in the purchase costs.
As a response to the risk, could I answer in the following way:
(i) The completeness assertion risk for the purchase is assessed to be high. As a response, I shall perform a test for the validity of the purchase transactions by selecting items from the purchase day book and trace back to the purchase invoices and the goods receipts documents. .
(ii) Cut –off test on the purchases to be performed.
(iii) Look for any material journals made in the purchase day and check against the authorization and the reasonableness of the journals made.
Could you kindly let me know whether this approach to audit risk is correct? IF not, what else should I attend to?
I think if purchases are high you would not be worried so much about completeness as occurrence and accuracy. You should also trace your test purchases back to authorised orders. Also you need to trace from the purchases a/c in the nominal ledger to postings from PDB totals.
Journals would also be traced from the purchases account, not the PDB (which is just a listing of invoices.
Thank you very much for your reply.
But I am rather confused about the ledger names- purchase accounts, purchase day book, purchase ledger and creditors ledger. Could you gvie me some guidance on their functions? In addition, why are journals generally made in the purchase accounts, not PDB? Thanks.
The PDB is simply a list of invoices: it is not a ledger with Dr and Cr sides. From the total of the list a double entry is made:
Dr purchases account in the nominal or general ledger. This is an expense account.
Cr creditors control (or total) account. This records the payables.
From each line/invoice in the PDB a credit is also posted to the appropriate supplier in the payables ledger. This is a memorandum ledger to keep track of exactly who is owed what.
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