How to Audit Accounts Payable

Financial information forms the foundation of trust for owners, banks, shareholders, lenders, and employees. A financial audit helps form a high level of assurance that the numbers can be trusted.

A financial audit is typically required if a company is public or holds debt from a 3rd party lender. If you handle accounting records in your business understanding how the audit process of works for accounts payable is important.

The accounts payable component of a balance sheet may not pose the most risk in an audit, but it does require attention.

Accounts payable relate to the liabilities of a company. They are the amounts owed to vendors for goods or services. Balances may be incorrect because of human error, unethical behavior and even fraud so it is important to have the independent verification of an audit.

Accounts payable directly affect cash flow. The biggest risk to an investor or creditor is payable amounts have been omitted from the accounts payable balance. Let’s review the steps of an accounts payable audit.

Accounts payable audit procedures

To audit accounts payable several reports will be needed to test the validity and accuracy. The most common reports used are:

• Balance sheet
• Income statement
• General ledger report
• Accounts payable ledger
• Accounts payable aging report
• Detailed vendor invoices and supporting documents

These are common financial reports that should be maintained by a company. If your accounting system is automated these reports will be easy to directly print from the software. Without an automated system you will need to manually prepare the reports. For smaller businesses, excel is a great alternative.

The audit will verify balances by looking at controls, reviewing detailed transactions, analytics, and review of contractual agreements.

1. Verify the accounts payable ledger totals correctly. The accounts payable ledger details each vendor invoice for the period in question. Auditors will manually total all invoices on the report verifying that the total listed is correctly added. Discrepancies will have to be resolved. It may appear a simple step, but it builds the foundation for the audit of accounts payable.
2. Verify the accounts payable ledger total matches the accounts payable total on the general ledger. Once the detailed accounts payable totals correctly, it must then be compared to the general ledger total for accounts payable. The purpose is to ensure the details match what is reported on the financial statement as financial statements are what people need to trust. If totals don’t match, it requires additional work and brings doubt.

The first 2 steps really are just establishing the foundation that the details match the balance sheet. Once established then the audit can begin to verify and test the following assertions:

• ‍Completeness – all information is included and properly disclosed so readers have a complete picture of the financial condition,
• Accuracy – all information has been accurately recorded including transactions properly classified between asset, liability, equity and expense,
• Cut-off – all transactions have been recorded in the correct period.
• Existence – all information recorded actually occurred in the period and fraudulent information is not included,
• Rights and Obligations – all obligation of the company are reported and included in the financial information,
• Understandability – all information has been clearly presented with no intent to confuse or mislead
• Valuation – all information is properly valued on each transaction

The third step is a list of procedures that may be applied by an auditor to validate and confirm the 7 assertions mentioned above.

3. Verify accounts payable by performing a specific audit test.
   

• Verify opening balances agree to prior year audited balances
• Test internal controls over the accounts payable posting process by selecting a random sampling of vendor invoices and tracing the details through the posting process. Verify dates, amounts, and obligations are properly recorded in the accounts payable ledger. Also test the authorization process and segregation of duties.
• Use analytical procedures to compare balances to prior periods for unusual changes
• Sample vendor invoices and review for valid purposes.
• Confirm a sampling of vendor invoices by sending a confirmation to the vendor to verify the amounts owed.
• Review a sample of vendor invoices recorded after year end to test for unrecorded payables
• Verify the classification of accounts payable between current and long term by reviewing accounts payable aging reports and looking for unusual amounts that may need to be classified as long term.
• Review long-term contractual agreements for terms and penalties to ensure all conditions are met all obligations are recorded

What happens if there is an audit exception in accounts payable?

One final consideration in regards to auditing accounts payable is audit exceptions. Audit exceptions are not uncommon. If an audit exception is found, it will be extrapolated to the entire population of accounts payable to come up with an adjustment.

Auditors have to make assumptions because not every invoice will be reviewed. So, if x amount of error is found in the sample, then that x percentage error exists in the entire accounts payable balance. Auditors typically have a materiality level. If an error falls below the materiality level it becomes a moot point as it would not materially affect anybody’s decision making process.

What risks do accounts receivable audits help avoid?

Audit procedures are valuable steps to take even though they seem cumbersome. It is for the good of the company and all invested parties because it ensures:

• Accounts payable balances are correct and properly recorded
• Purchases/COGS are not inflated or deflated and correctly recorded
• Accounts payable are being paid in a timely manner.
• Expenses are being captured.
• Accounting procedures are in place and functioning properly to safeguard the financial information of the company.

How to detect fraud in an accounts payable audit

Fraud detection is one of the main purposes for an audit. It is estimated on average companies lose 5% of annual revenue due to fraud.

The easiest form of fraud is invoice tampering like duplication of invoices, manipulation of invoices, creating fake invoices or establishing fake vendors. Additionally, because fraudsters know not every invoice will be checked this allows for manipulation of information or creating transactions under materiality threshold levels.

Whatever the fraud approach, it is difficult to catch everything. The best approach is to be thorough in your audit procedures. Internal controls are a valuable deterrent to potential breakdowns in segregation of duties or authorization approvals.

Automated systems can help prevent fraud by creating an instant audit trail making it easier to search for common fraud indicators. Strong accounts payable departments help ensure the prevention of fraud.

Lastly be observant, if it looks odd, acts odd, or doesn’t seem right – it probably isn’t.

Ultimately, audits are a valuable resource in not only preventing fraud but improving the flow of information through a company. Rather than push off an auditor as a nuisance, embrace the audit as a way to improve your company's financial reporting. Beyond the necessary audit component, auditors often provide valuable insight into continuous improvement.