Everything You Need to Know About an Accounts Payable Audit

In many audits, the main focus is your accounts payable department. That’s because it’s quite easy to increase a company’s net income by not recording end-of-term payables. This results in many types of theft and is the reason why AP is often the sole focus of audits.

Thus, accounts payable auditing strategies rely heavily on fraud risk assessment standards set out by the Auditing Standards Board of the American Institute of Certified Public Accountants (AICPA). 

This ensures that all statements and invoices (as well as any other accumulated expenses or liabilities) are properly recorded manually or with accounting software.

Methods of Auditing

The basic way to audit an accounts payable department is to match general ledger transactions to the figures in your general ledger. 

Running cutoff tests will ensure whether transactions for the fiscal year are included in your end-of-year financial statements. An audit is checking to see you have established an internal control system that documents everything accurately and within the correct timeframe. 

There is no standard way to perform an AP audit. Typically, it is the auditor’s choice. The method is chosen based on the size and shape of a particular business, as well as the desired thoroughness. 

The implementation of GAAP regulations will vary by state. Some states allow public companies to push extra reports that don’t need to follow GAAP standards or rules.

Despite these differences, auditors are generally looking for the same things, which include:

• Completeness
• Accuracy
• Validity
• Compliance of records
• Proper disclosure

This confirms whether an organization’s records present an accurate view of the business.

The sole purpose of an audit is to establish an effective internal control system. This is typically done in four separate stages.

The Four Stages of an AP Audit

Whether you are a small business or a vast enterprise, if your journal entries and bank records don’t match, there’s going to be an issue. In order to establish the most effective internal control system, an audit trail is divided into four stages:

#1) Scheduling the Audit

The first stage of an AP audit is the planning phase. Your business will receive notification of the audit and a meeting will be scheduled to discuss standard operating procedures (SOPs). This is the time to go over the scope and objections of the evaluation and draw up a plan for the assessment itself.

#2) Doing the Fieldwork

Now it’s time to dig in. The auditor will spend several days or weeks sifting through financial reporting. They typically use a “cut-off test” to determine the correct recording of a transaction in the proper time period.

An auditor will look over documents like:

• Balance sheet
• Check register
• Purchase orders
• Vendor invoices
• General ledger                

#3) Final Audit Report

Once all fieldwork is complete, the findings are put into a final audit report. This will summarize the auditor’s findings and evaluation of those findings.

#4) Follow-Up Review

Just because the report has been turned in, it doesn’t mean the job is over. The final step is for the auditor to perform a follow-up review. This happens one year later to ensure all recommendations have been met and the desired results have been achieved.

What Accounts Payable Documents are Required?

Before the audit takes place, you should gather all the necessary documents. The easier you make it on the auditor, the faster it goes. Consider the following to align with auditing standards:

• A detailed AP ledger
• Analysis of budgets compared to expense reports
• A review of internal controls
• Documentation of any unrecorded liabilities
• Overview of planned audit procedures
• A comprehensive risk assessment of accounts payable and expenses
• A summary of possible weak points in AP controls
• Documents on any fraud investigation

Accounts Payable Auditing Objectives

During an accounts payable audit, there are many objectives that an auditor is looking to meet. Here are some of the top goals:

Completeness

Auditing for completeness is typically the main objective in an AP audit and the most vital part of the process. The primary ways an auditor indicates whether documents have been adequately recorded and calculated are through:

• Cut-off tests
• Reconciliation
• Audit trails

A business must produce its year-end financial statements cut-off tests for cash payments and purchases of goods and services received by the end of the year. An auditor will then use an audit trail to match payments to recorded payables and look for any files with unmatched documents.

Validity

Auditors will also be looking at the validity of your accounts payable transactions and procurement process. An auditor will attempt to establish the legitimacy of a transaction by reaching out to suppliers and vendors for a confirmation request. 

The number and type of vendors that receive these requests can vary depending on the type of business you run. Most auditors will contact regular suppliers and vendors, regardless of whether there is an outstanding balance or not.

It should also be noted that if an auditor discovers one or more open invoices for a vendor, they will reach out to a percentage of your business partners as well.

Compliance

All accounts payable transactions must be recorded in a specific way. When an auditor is looking at whether a business has followed general accounting principles and procedures, they’re looking at compliance. 

An audit usually starts from the back to the front. An auditor will begin with your year-end financial statements which can include documents like:

• Cash flow statements
• Income statements
• Balance sheets

An auditor can also choose random entries in your general ledger to trace back to their origin. Your company’s audit trail allows an auditor to discover the exact path of a transaction. They can then evaluate whether the correct accounting procedures were used.

Disclosure

The final step to an AP audit is to ensure that all transactions and activity were properly disclosed. This means your payable balance must be recorded in your year-end financial statements. 

An auditor will look for disclosure by inspecting things like current liability and cost of goods calculations. Unusual transactions may require footnotes to provide details for what can’t be discerned from the simple recording. 

As a final request, auditors may ask a business to disclose a mandatory management representation letter that attests that all financial statements fully represent the true accounts payable transactions and purchases. 

Preparing for an Accounts Payable Audit

You never want to be caught off guard by an AP audit—whether it’s an external or internal audit. 

Accounts payable is found on a company’s balance sheet as a liability. It represents the short-term debt and money owed to suppliers and creditors and indicates the number of vendor invoices that have been recorded (but not yet paid).

Generally accepted accounting principles will vary by region, so the first step in planning for an audit is to schedule a meeting ASAP to discuss what you need. 

Consider the main company goals and the following questions when reviewing your AP processes:

• How are we evaluating new vendors?
• Who receives budget and expense reports?
• Are purchase orders digital, paper, or both?
• What is our annual expense budget?
• Is there an AP software solution in place?
• Is there a policy to ensure documentation of all payables?
• Are credit card purchases recorded?
• Are purchases limited to approved vendors?

Remember, it’s critical that you establish important criteria before the audit takes place.  

Calculate Your Accounts Payable Turnover

One quick way to prepare for an AP audit is to calculate your accounts payable turnover ratio. This is a short-term liquidity calculation that’s used to quantify the rate at which a business pays off its suppliers. 

The AP turnover ratio is calculated by taking the total purchases made from vendors (i.e. cost of sales) and dividing it by the average accounts payable amount during the same time period.

Accounts payable turnover = Total vendors purchases / Average accounts payable

Accounts Payable Negative Liabilities

If a business pays out more than the amount required or invoiced, it’s considered an overpayment and is documented as a negative liability on the balance sheet. This often occurs if a company has been invoiced twice or has sent out duplicate payments. 

Negative liabilities are typically small amounts that end up being aggregated into other liabilities. They often appear as a credit in your accounts payable ledger, which a company can use to offset future payments to vendors. 

Technically speaking, a negative liability is considered a company asset and thus, should be classified as a prepaid expense. 

Automating an Accounts Payable Audit

A traditional AP audit is quite cumbersome. It involves sifting through stacks of paperwork, expense reports, old receipts, etc. A manual audit is highly inefficient, costly, and time-consuming. This is especially the case if your business has a high volume of transactions. 

Luckily, most of the remedial AP audit tasks have been automated through various types of accounts payable software. 

Why AP Automation?

Data Storage and Management

The right platform will also help an organization store data. This can be particularly useful if your business deals with numerous types of transactions. This allows an auditor to work faster and more efficiently. 

AP software will retain important data like:

• Vendor files
• Transaction history
• Company name
• Purchase orders
• Invoice numbers
• Credit card data
• Expense reports
• New suppliers
• And more…

Many types of AP automation software will allow a business to set up custom fields. This ensures you’re always collecting the data you need prior to an AP audit. 

When your company switches to a payment process run through software, it serves as a massive repository for all of your financial data in a single spot. 

Facilitating an Audit

Electronic invoicing and electronic payments means an auditor is never looking for a needle in a haystack. They have everything they need right there and can be out of your hair in no time. 

Giving an auditor “read-only” access to critical documents means the job is done in hours, rather than weeks. It’s a big difference!

Tracking and Monitoring Documents

Admit it! Paper is the antithesis of efficiency, which is why it’s being edged out of business altogether. Paper-only offers an illusion of control. With the onslaught of cloud technology, the threat of losing everything when “the hard drive crashes” is no longer a reality. 

When dealing with paper, records are harder to track, monitor, measure, and organize (to name a few). Documents can be misplaced, shredded, stolen, destroyed, etc. Paper makes the invoicing and payment process less visible and harder to track.

Detecting Fraud and Mitigating Risk

A 2016 study by the Association of Certified Fraud Examiners found that organizations lose an average of 5% annual revenue every year due to fraud. 

Accounts payable is highly vulnerable to theft and using software makes it easier to detect. An AP solution catches material misstatements, invoices that have been tampered with, and things like:

• Duplicate or photocopied invoices
• Invoices below the approved amounts
• Vendors or suppliers with PO boxes
• Invoices with rounded dollar amounts
• Documents with information missing

An electronic invoicing system is one of the quickest and most effective ways to deal with fraud because there is much less room for human error. 

Using AP software is like presenting a third set of eyes for your company’s checks and balances. It neatly organizes critical information and immediately flags anything out of order. 

Additionally, automation will build an audit trail that cannot be misplaced, lost, stolen, or shredded. Smart software means your AP data is always in one, single spot. Completely protected.

The more a business can digitize AP tasks, the less likely they are to be surprised by a negative audit. Automated procedures provide an extra level of security. It’s an instant audit trail that makes it easier to search for documents and harder to fake them.

Why do I Need an Accounts Payable Audit?

There are a million reasons why a company should be interested in an accounts payable audit, whether it is internal or external.  An accounts payable audit is an essential weapon against fraud and inaccuracy. 

An audit shouldn’t scare you if you’ve done nothing wrong. It’s an independent and systematic look into a company’s AP records to ensure everything is being documented correctly. 

Even if there is a negative result, this should be taken as a learning experience on keeping tighter records and maintaining diligent fraud detection. An AP audit is more about risk assessment and is a process that should be appreciated.

Accounts Payable Audits in the United States

In the United States, the American Institute of Certified Public Accountants (AICPA) guides the AP audit procedures and sets the standards for how they should be conducted.

Depending on the state, most accounts payable audits are not optional. The Sarbanes-Oxley Act in 2002 was established to require all businesses submit records to a third-party for external examination.

It is then the responsibility of the auditor to ensure that all company records adhere to the Generally Accepted Accounting Principles, otherwise referred to as GAAP. 

The purpose of an AP audit is to achieve four important benchmarks. These are:

1. Provide proper disclosure of documents. This includes year-end financial statements and bank statements.
2. Ensure complete and total AP compliance in alignment with GAAP.
3. Verify all transactions for legitimacy and accuracy.
4. Examine all AP data and reconcile every transaction for the year.

A streamlined accounts payable audit will detect fraud, duplicate payments, overpayments, and unrecorded liabilities. When gone undetected, these types of risks can damage the longevity and success of your business.

A properly conducted AP audit is critical for the financial health of your business and the performance of your accounts payable department. Using the right procedures ensures your organization’s finances are transparent, accurate, and free from fraudsters. 

The Future of Accounts Payable Audits

The future of accounts payable audits lies in technology. The laws will continue to change and expectations will keep on rising. The more industries and companies that adopt automation, the more governments will come to expect it.

It’s important to get on board now with the proper tools needed to prepare. With a strong AP department and the right software, there’s no need to fear accounting procedures any longer.

Going digital makes the auditing process faster, easier, and cheaper. More importantly, it gives a business more space to pursue a progressive strategy and plan for future endeavors.