It's easy for things to go wrong in a company's acquisition and payment cycle. Companies can overstate the value of the inventory they purchase, which makes assets look bigger than they actually are. Management can omit or undervalue their accounts payable, which exaggerates financial strength. To prevent this from happening, management and auditors closely monitor internal controls and key acquisition accounts.
A business may have different threats in its acquisition cycle depending on surrounding factors. Companies in a highly competitive industry that sell low-margin products have a strong incentive to fiddle with their margins through inventory and cost-of-goods-sold valuation. Businesses that don't have strong accounting department employees with experience in operations may not be properly tracking purchasing and cash disbursement documents. Auditors will focus more attention on personalized risk factors depending on the inherent strengths and weaknesses of the company.
The stronger internal controls the company has in place, the less likely it is that there are errors or fraud in the purchasing system. Smart companies require their purchasing agents to use a list of approved vendors and review vendors on a regular basis. This reduces the risk of fraud and kickbacks for purchases. Auditors will check that there is separation of duties and approval needed in the purchasing and cash disbursement process. These controls dissuade employees from attempting to misappropriate money and help businesses catch honest errors.
Since inventory is a significant asset, auditors want to ensure it's not overstated. Auditors will observe a physical inventory count to ensure numbers add up, and they'll also perform their own sample count. They'll test inventory purchase transactions near a financial cutoff period to make sure transactions were recorded at the right time. They'll pay special attention to older inventory that the company hasn't been able to sell, since there's a high chance it may have lost value over time.
Accounts payable makes up a large amount of money that the company owes to others, so auditors will search for unrecorded accounts payable. They'll often pull transactions from a subsidiary accounts payable ledger and check that they are also recorded in the general ledger, which determines the financial statements. They may contact large vendors and suppliers and confirm they agree with what the company purports they owe them. Purchasing also affects inventory value, so they'll test transactions to see if inventory values agree with the vendor's sales price.