## **Learning Outcomes**

This article explains the audit of purchases, payables, accruals, and provisions for the ACCA AA exam. After reading, you will be able to: identify assertions and risks related to purchases and payables; describe key internal controls; design and explain substantive procedures for payables, accruals, and provisions; distinguish provisions from accruals and contingencies; and evaluate common misstatements and audit responses. You will be prepared to answer exam questions on this important audit area.

## **ACCA Audit and Assurance (AA) Syllabus**

For ACCA Audit and Assurance (AA), you are required to understand the audit of purchases, payables, accruals, and provisions in detail. In your revision, focus on:

- The objectives of auditing purchases, payables, accruals, and provisions.
- Common internal controls and their defects in the purchase system.
- Tests of controls: how to assess if purchase and payable controls are operating.
- Substantive procedures for payables and accruals, including external confirmations and cut-off testing.
- Audit of provisions under IAS 37: identifying, testing, and evaluating the adequacy of provisions.
- The distinction between accruals, provisions, and contingent liabilities.
- Evaluating supplier statement reconciliations and addressing discrepancies.
- Recognising risks and typical misstatements linked to payables, accruals, and provisions.

## **Test Your Knowledge**

_Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision._

1. Name three key assertions relevant to payables and accruals at the year end.
2. What audit evidence provides the strongest support for the existence and completeness of trade payables?
3. State two substantive procedures you would perform to verify an accrual for utility expenses.
4. Briefly contrast an accrual and a provision according to auditing and accounting standards.

## **Introduction**

The audit of purchases, payables, and accruals is central in ensuring the completeness and accuracy of liabilities within financial statements. Provisions are separately assessed as they require judgement about future outflows under particular conditions. The auditor must design procedures to confirm that all liabilities—including regular payables and more uncertain obligations (provisions)—are properly recorded and valued.

> **Key Term: purchases system**
> The process and related controls for ordering goods and services, receiving them, recording purchases, and settling payables.
>
> **Key Term: payables**
> Amounts owed by the entity at the period end for goods and services received, usually evidenced by invoices from suppliers.
>
> **Key Term: accruals**
> Liabilities for expenses incurred but not yet invoiced or paid as at the reporting date.
>
> **Key Term: provision**
> A liability of uncertain timing or amount, recognised when an obligation exists, payment is probable, and a reliable estimate can be made.
>
> **Key Term: supplier statement reconciliation**
> The process of matching balances per the entity's accounts to those per supplier’s external statements, identifying and explaining any differences.

## Audit Objectives for Purchases, Payables, and Accruals

The main audit objectives in this area are to obtain sufficient appropriate evidence that:

- All purchases and payables that should be recorded are recorded (completeness).
- Only valid liabilities are included (existence, occurrence, and rights & obligations).
- Amounts are recorded correctly and in the correct period (accuracy, valuation, and cut-off).
- All obligations requiring provisions are appropriately recognised and disclosed.
- There is adequate distinction between accruals, provisions, and contingent liabilities.

### Key Risks and Assertions

- **Completeness:** There is a risk that liabilities (payables, accruals, provisions) are understated to improve reported profit or capital position.
- **Existence/Occurrence:** Invoices or accruals may be recorded for non-existent goods/services, possibly due to fraud or error.
- **Cut-off:** Purchases and payables may be included in the wrong period, overstating or understating current liabilities and expenses.
- **Valuation:** Amounts provided for accruals or provisions may be incorrectly estimated.

### Typical Controls in the Purchases System

Strong internal controls help ensure accuracy and reliability of payables and accruals. Controls include:

- Use of pre-numbered purchase orders, authorised by a responsible official.
- Three-way matching: purchase order, goods received note, and supplier invoice.
- Segregation of duties between ordering, receiving, and paying for goods.
- Timely review and reconciliation of supplier statements to records.
- Sequential filing and reviewing of purchase documents to ensure completeness.

### **Worked Example 1.1**

**Scenario:**  
The finance team at Alpha Co notices that some utility bills arrive after year end. The year-end is 31 December. The financial controller wants to ensure an accrual is made for electricity consumed but not yet billed by that date.

**Question:**  
What substantive procedures should the auditor perform to obtain evidence over this accrual?

> **Answer:**

- Inspect invoices received after year end and ensure charges relate to consumption prior to 31 December.
- Recalculate the estimated amount by using pre-year end meter readings and previous invoice rates.
- Compare the accrual amount with prior years for reasonableness and investigate significant variances.

## Audit Procedures Over Trade Payables

### Substantive Procedures

- Obtain the year-end list of payables, cast and cross-check to the general ledger and financial statements for completeness.
- Select a sample of supplier balances, obtain supplier statements, and perform supplier statement reconciliations. Investigate unmatched items, such as invoices not on the ledger or unposted credit notes.
- Inspect post-year-end payments to suppliers to identify liabilities outstanding at year end.
- Examine goods received notes and unpaid invoices around the period end to confirm liabilities are included in the correct period (cut-off testing).
- Review manual accrual entries for appropriateness and supporting evidence.

### **Worked Example 1.2**

**Scenario:**  
Beta Ltd’s year-end trade payables listing is \$400,000. The total of supplier statements obtained is \$427,000. The difference mainly relates to four suppliers. The largest supplier’s statement shows \$28,000 more than Beta’s records.

**Question:**  
What steps should the auditor take in response to this reconciliation difference?

> **Answer:**

- Obtain and examine supporting documentation (invoices, goods received notes) for the supplier in question.
- Determine if the missing invoices were received/posted after year end but should be accrued.
- If goods/services were received before year end, request an accrual be made for the missing amount.

### **Exam Warning**

> A common exam fault is to focus only on existence testing for payables. Remember: completeness is always the key risk for liabilities—especially where incentives exist to understate liabilities at year end.

## Testing Accruals and Expenses

### Key Audit Steps

- Review significant expense categories where invoices are often received after the year end (utilities, legal, wages, etc.).
- For each, identify and test for unrecorded liabilities by examining payments and invoices received after year end relating to pre-year-end periods.
- Recalculate accruals based on contract terms, passage of time, or known use (e.g., number of days since last bill).

### **Worked Example 1.3**

**Scenario:**  
A company routinely makes a monthly rent payment on the first working day of the month. At 31 December, the December rent has not been paid nor invoiced.

**Question:**  
What would be an appropriate audit procedure over the rent accrual?

> **Answer:**

- Review rental agreement terms for amount and period covered.
- Confirm that an accrual for December’s rent is included and is accurate.
- Inspect payment after year end to confirm the timing and amount paid matches the accrual.

## Audit of Provisions: Recognition and Testing

Auditors must ensure the entity complies with the requirements of IAS 37 when recognising provisions:

- A provision is recognised only when the entity has a present obligation from a past event, payment is probable, and the amount can be estimated reliably.
- Disclosure is required for contingent liabilities or where the obligation is only possible.

### Audit Procedures

- Enquire of management and review minutes, legal correspondence, and board discussions for any ongoing claims or uncertainties.
- Obtain a breakdown of provisions, examine supporting calculations, and agree amounts to supporting documentation (legal letters, contracts).
- For provisions requiring estimation (e.g., warranties), review historical claims data and test the reliability of management’s estimation methods.
- Where necessary, seek direct external confirmation (e.g., from the company’s legal advisers).

### **Worked Example 1.4**

**Scenario:**  
Gamma Co is being sued for breach of contract. At year end, management recognises a provision for \$65,000 based on correspondence with their legal advisers.

**Question:**  
Which audit evidence should you gather to assess the appropriateness of this provision?

> **Answer:**

- Review all correspondence with legal counsel to confirm the probability of payment.
- Agree the provision amount to the most up-to-date legal estimate.
- Consider seeking direct confirmation from the legal adviser on the likelihood and potential quantum of settlement.

## Distinguishing Accruals, Provisions, and Contingent Liabilities

- **Accrual:** Expense incurred, precise amount and timing reasonably certain, not yet invoiced.
- **Provision:** Liability of uncertain timing or amount, where an obligation exists and payment is probable.
- **Contingent liability:** Possible obligation dependent on a future event not wholly within the control of the entity, or present obligation with payment not probable or not reliably measurable. Disclosed, not recognised.

> **Key Term: contingent liability**
> A possible obligation arising from past events, the outcome and payment of which is uncertain and dependent on future events outside the entity’s control.

## Supplier Statement Reconciliations and Dealing with Discrepancies

Supplier statement reconciliations are a critical audit test:

- Provide independent external evidence for the existence and completeness of payables.
- Enable the auditor to identify unrecorded invoices (understatement) or disputes.

When significant reconciling items exist:

- Investigate the timing of goods receipt and invoice posting.
- Request management to accrue for liabilities relating to goods/services received before year end but invoiced later.
- Consider the impact on cut-off and completeness assertions in the audit report if errors are left uncorrected.

## Summary Table: Provisions vs Accruals vs Contingent Liabilities

| Category             | Recognition Criteria                                       | Example                                   | Audit Focus                  |
| -------------------- | ---------------------------------------------------------- | ----------------------------------------- | ---------------------------- |
| Accrual              | Obligation, timing and amount certain                      | Utilities used, not yet billed            | Accuracy, completeness       |
| Provision            | Present obligation, probable payment, estimate can be made | Legal claim probable loss                 | Reasonableness, completeness |
| Contingent Liability | Payment is possible, not probable or not measurable        | Outstanding court case, outcome uncertain | Disclosure only              |

## **Key Point Checklist**

_This article has covered the following key knowledge points:_

- Identify key audit assertions (completeness, existence, valuation, cut-off) in payables, accruals, and provisions.
- Describe typical internal controls in the purchases system.
- Recognise and explain audit procedures for payables: supplier statement reconciliation, cut-off, post-year-end payments.
- Explain procedures for auditing accruals and evaluating provisions under IAS 37.
- Distinguish accruals from provisions and contingent liabilities.
- Address common causes and responses to supplier reconciliation differences.
- Assess reasonableness of calculations and supporting evidence for estimates/provisions.

## **Key Terms and Concepts**

- purchases system
- payables
- accruals
- provision
- supplier statement reconciliation
- contingent liability

Purchases, payables, and accruals - Accruals and provisions review