Unrecorded liabilities. Expense fraud. Duplicate payments. No clear separation of accounting duties. These are just a few of the risks that may be lurking along the audit trail in your accounts payable (AP) department. Undetected and uncontrolled, they can damage your business’ success, competitiveness, and longevity.
That’s why a thorough and properly conducted audits are so important for both your accounting department’s performance and the health of your company as a whole. By employing the right accounts payable audit procedures, you can make sure your AP department is transparent, accurate, and fully supporting the goals of your business.
Hallmarks of Effective Accounts Payable Audit Procedures
Auditing accounts payable, whether as part of a larger internal audit or as a standalone process, is an essential weapon in the war on fraud and inaccuracy. For companies doing business in or with the United States, accounts payable audit procedures are ideally guided by auditing standards set forth by the American Institute of Certified Public Accountants (AICPA). This ensures the audit achieves four critical benchmarks for clarity, accuracy, and comprehensiveness—namely:
- Proper disclosure of end-of-year financial statements is critical to accurate financial reporting, strategic forecasting, and procurement. Unusual transactions are documented, contextualized, and clarified as needed. Management completes all necessary documentation verifying that the company’s financial statements are complete, and fully record all AP and purchasing amounts.
- A thorough payable audit is one that ensures accounts payable is fully compliant with generally accepted accounting principles (GAAP). Using the year-end (or end-of-period) financial statements (including income and cash flow statements as well as the balance sheet), auditors choose and trace general ledger entries back to their creation to form an audit trail. This trail reveals any potential control weaknesses in the accounting system and areas where compliance can be improved.
- Verified transactions are accurate and legitimate transactions. Auditors contact the company’s entire roster of regular suppliers (whether the company currently has an outstanding balance or not) to verify data on transactions conducted with that vendor in the period being audited. This verification helps ensure the accounts payable function of your company is free from material misstatement, or incorrect financial data that affects reporting, planning, and other decisions made by those using it.
- To be effective, a payable audit must examine all available information and reconcile all transactions. Auditors use cutoff tests—i.e., procedures that determine whether a transaction was recorded in the proper recording period—to confirm AP ledger transactions are accurate and complete. They use audit trails to follow transactions and confirm payments match the values recorded by payables, with a special focus on open files containing unmatched documents.
In an AP audit, the goals are to review financial records for accuracy and completeness, while also identifying potential areas of improvement for internal controls and reducing risk exposure caused by fraud.
Conducting a Successful AP Audit
In an AP audit, the goals are to review financial records for accuracy and completeness, while also identifying potential areas of improvement for internal controls and reducing risk exposure caused by fraud. Audit procedures will vary from company to company, but audits that hit the target for transparency, compliance, legitimacy, and completeness share certain common features and follow the same basic outline.
In general, an accounts payable audit is conducted in four distinct steps:
- Audit Reporting
- Follow-up/Audit Review
Note: If you’ve implemented a comprehensive procurement software solution that includes AP automation, all phases of your accounts payable audit will be much easier.
The first step in an AP audit is to schedule a meeting with management and other stakeholders to discuss the scope of, and desired outcomes for, the audit. This discussion, along with any expressed concerns (e.g., potential fraud, the need for process improvement, etc.), provides an outline for the audit and a supplemental checklist during the fieldwork, reporting, and follow-up stages.
Prepare on Paper
Essential work documents for a thorough AP audit include:
- A review of existing internal controls for accounts payable.
- A detailed period-end accounts payable ledger
- A comparison and comprehensive analysis of budgets as compared to expense reports, with clarifying information on any unexpected deviations.
- Complete documentation of any unrecorded liabilities
- A detailed risk assessment of AP and expenses
- A summary of potential weak points in accounts payable controls.
- Overview of planned audit procedures for accounts payable
- Documentation related to any fraud investigation required by weak or absent controls
Consider Your Goals
Some of the considerations that factor into a well-planned AP audit include:
- Is there a software solution in place to simplify the audit?
- If so, does the system support three-way (PO, receiving document/packing list, and invoice) matching?
- Is the software used in conjunction with a purchasing policy that follows GAAP?
- What is the company’s annual expense budget, if any?
- Who receives budget and expense reports?
- Is there a policy in place to ensure all payables are recorded in the proper period?
- With regard to purchase orders:
- Are purchase orders digital, physical, or both?
- What is the numbering system used for POs?
- Who authorizes purchase orders?
- Are purchase orders made by any methods other than PO? If so, what other methods are used in the payment process?
- Are credit card purchases recorded and tracked by the system to avoid invisible spend? If not, who controls approval for credit card purchases, and what considerations are in place to limit or eliminate maverick spend?
- What methods (e.g., Automated Clearing House (ACH), wire transfers, etc.) are used to make electronic payments?
- Does the accounts payable department have clear separation of responsibilities for approving, paying, and recording payables, as well as reconciling bank statements?
- Regarding vendors:
- How are new vendors evaluated and added to the approved vendor file?
- Who is authorized to add new vendors to payables?
- Are purchases limited to approved vendors?
Keeping these considerations in mind will ensure that both financial accuracy and process improvement are properly explored during the audit.
Armed with a plan, auditors can devote their attention to the audit process. During this step, your auditors will likely:
- Review (or create, if necessary) standard operating procedures (SOPs) for accounts payable functions and verify their implementation. Any potentially weak internal controls increasing the risk of fraud or inaccuracy are identified, then strengthened or replaced.
- Compare budgets to expenses and/or spend balances from prior years. Significant exceptions are noted and tagged for investigation.
- Review original documents—including purchase orders, vendor invoices, journal entries for both AP and inventory, and bank records—at random to ensure all information is correct, payment has been properly made, and terms and conditions have been satisfied.
- Conduct vendor verifications by requesting outstanding balances and comparing the answers to the amounts recorded in the AP ledger. Exceptions are noted and tagged for follow-up.
- Verify the accuracy of financial statements. Policies and accounting procedures for close processes (month, quarterly, annual, etc.) are evaluated to ensure items are recorded in period in which the expense was actually incurred. Policies and procedures for related-party transactions and cash payments are also scrutinized, along with the transactions themselves, to develop a complete record of all financial information for the audit period.
- Search for unrecorded liabilities and evaluate suspicious activity to detect fraud.
When the audit is complete, the findings are collected and put into a full report—which includes information on both the financial accuracy of accounts payable and how well it conforms to GAAP, as well as potential areas of control improvement—submitted to management and other stakeholders for review.
No audit is truly complete until a year later, when a special follow-up review is performed to confirm how well the suggested changes (if any) were implemented.
Ferreting out Fraud
In a 2016 study, the Association of Certified Fraud Examiners found that the average organization loses somewhere around 5% of its annual revenue to fraud. Whether you’re a mega-corporation or a struggling small business, losing 1/20th of your profits to fraud is simply unacceptable. If you discover your internal controls are inadequate, or there’s significant evidence of fraud, you may need to adjust your audit accordingly.
Common Types of AP Fraud
Before the rise of the paperless office, invoice tampering was the bane of accounts departments everywhere. Knowing busy companies may not have the time to examine every single invoice made it all too easy for thieves to break out the White-Out and “adjust” documents in their favor. Fortunately, purchasing software—especially with built-in AP automation and three-way match verification—has all but eliminated this scourge from the fraudster’s toolkit. Fraud detection is greatly improved with a single, centralized control point for all transactions.
If you’re still using paper invoices, keep an eye out for missing information (company name, dollar amount, etc.) or the addition of correction fluid, whether it’s an original or a (doctored) photocopy.
Another common type of fraud is duplicate payments. In this type of fraud, the would-be thief simply pays an invoice twice, takes the second check for himself, and cashes it.
Three-way match verification makes this type of fraud much harder to commit, but if you suspect fraudulent duplicate payments, you can check for them easily enough.
- Sort your check register by vendor.
- Look for one or more duplicate payments to the same vendor for the same amount.
- Request verification for each transaction with the vendor and investigate any that can’t be confirmed.
Audit AP with Confidence
It’s not just about balancing the books. Accounts payable audits are a key component in building, and maintaining, your company’s financial health and overall success in the marketplace. Performing a thorough and detailed AP audit gives you the information you need to comply with accounting best practices, establish and sustain exceptional financial planning and reporting, and reduce fraud that can rob you of a strong bottom line.