Question

Part A
The following are internal control procedures found in the purchases and payment process of your auditee, Integrated Measurement Systems Inc.

Required:
For each control procedure:
a. Explain the type of control that is being applied.
b. Identify the control objective(s) that the control procedure meets.
c. Describe in detail one test of controls the auditor could perform to test the effectiveness of the control.

Control 1
Purchase requests from operating departments are authorized by the appropriate person in the requesting department.

Control 2
The purchasing clerk verifies that there is a signature on the purchase request (PR) and then issues a pre-numbered purchase order (PO) for the items required. The purchasing clerk retains copies of the PR and the PO and files them by PO number.

Control 3
The purchasing manager reviews the PO to see whether the purchase request is authorized, and, if so, approves it and forwards it to the buyer.

Control 4
The Buyer must select a vendor from a pre-approved list for all POs over $5000. For POs under $5000 the Buyer can select any vendor.

Control 5
The Receiver who accepts the goods into the warehouse verifies that the quantity received matches the bill of lading (BL), and signs on behalf of Integrated Measurement
Systems for receipt of the goods listed on the BL. If there is a discrepancy in the quantity received, the receiver does not sign the BL; the BL is sent to the Buyer to resolve the problem with the vendor.

Control 6
The purchasing clerk matches the signed BL with the filed copies of the PO and PR.

Part B
The following are internal control weaknesses found in the purchases and payment process of your auditee, Integrated Measurement Systems.

Required:
For each control weakness:
d. Describe the control risk that exists because of the weakness—what could go wrong?
e. Explain whether a monetary financial statement misstatement could result because of the weakness, and, if so, what it would be.
f. Describe in detail the impact the weakness will have on your other audit procedures.

Control Weakness 1
The purchasing clerk does not verify that the PRs are authorized by an appropriate person in the operating department, but only checks that there is a signature on the document.

Control Weakness 2
Access to the warehouse is not controlled and anyone can enter and leave anytime.

Control Weakness 3
The receiver does not match the BL to an authorized PO.

Answer 1

Part A

a. b. c.

 

 

Control 1

Purchase Requests from operating departments are authorized by the appropriate person in the requesting department.

 

Type:                            

Authorization procedures

 

Objective:                    

Authorization

 

Test:                             

Examine the PR documents to verify they have been signed

 

Control 2

The Purchasing Clerk verifies that there is a signature on the Purchase Request and then issues a pre-numbered Purchase Order for the items required. The Purchasing Clerk retains copies of the PR and the PO and files them by PO number.

 

Type:                           

Documentation and records created to support transaction

 

Objective:                   

Completeness, accuracy

 

Test:                            

Examine the PR/PO documents to verify they match test numerical continuity,

 

Control 3

The Purchasing Manager reviews Purchase Order to see whether the Purchase Request is authorized, and if so, approves it and forwards it to the Buyer.

 

Type:                           

Authorization is verified independently by segregation of duties

 

Objective:                  

Authorization

 

Test:                            

Examine the PR documents to verify they have been approved by purchasing Manager

 

Control 4

The Buyer must select a vendor from a pre-approved list for all Purchase Orders over $5,000. For POs under $5,000 the Buyer can select any vendor.

 

Type:                       

Authorization control procedure to ensure company is receiving the best price and suppliers are at arm’s length from Buyer

 

Objective:              

Authorization, validity

 

Test:                       

Examine the PO documents to verify those over $5000 are sent to a preauthorized vendor, scrutinize POs for signs the Buyer is sending these disproportionately to certain vendors, enquire of Purchasing Manager and Buyer about preauthorized vendors to assess their validity

 

Control 5

The Receiver who accepts the goods into the warehouse verifies that the quantity received matches the Bill of Lading, and signs on behalf of IMS for receipt of the goods listed on the Bill of Lading. If there is a discrepancy in the quantity received, the receiver does not sign the Bill of Lading; the Bill of Lading is sent to the Buyer to resolve the problem with the vendor.

 

Type:                           

Documents and records are used to record transaction information and allow for independent verification

 

Objective:                    

Accuracy, completeness

 

Test:                            

Examine the BL documents for evidence of quantities being verified; follow up of documents showing discrepancies to verify they have been signed for approval

 

Control 6

The Purchasing Clerk matches the signed BL with the filed copies of the PO and PR

 

Type:                           

Documents and records to allow independent verification of details

 

Objective:                  

Accuracy, completeness

 

Test:                            

Examine the PO/PR documents to verify they agree to BL.

 

Part B

d. e. f.

 

 

Control Weakness 1

The Purchasing Clerk does not verify that the Purchase Requests are authorized by an appropriate person in the operating department, but only checks that there is a signature on the document.

 

Risk:                            

Unauthorized expenses may not be detected

 

Possible error:         

None in the financial statements (This is a subtle point, but if even if expenses are improper, as long as they are correctly recorded as debits in the income statement accounts the net income is still correctly stated - effectively, these are a cost of doing business and should be recorded as such. This can, however, be seen as a type of misclassification misstatement in that the improper expenses should be shown as such in the income statement, not buried in with properly classified expenses. If improper expenses are detected by the auditor, this would indicate a fraud risk that needs to be followed up.), but management’s control objective of safeguarding company assets is not being met

 

Impact on audit:          

Inform management of internal control weakness, and potential fraud risk.

 

Control Weakness 2

Access to the warehouse is not controlled and anyone can enter and leave anytime.

 

Risk:                                   

 Theft of goods after received

 

Possible error:              

If inventory is recorded then stolen, perpetual inventory will be overstated. The inventory count should pick up and record any shrinkage, so the year-end financial statements would be corrected (This point is subject to the same consideration as noted above for Control Weakness 1 - the ‘loss’ due to theft is real cost to the business so needs to be recorded, but it should not be classified as part of Cost of Sales, and the implications for the auditor’s assessed risk of fraud need to be followed up.), but management’s control objective of safeguarding assets is not being met.

 

Impact on audit:          

Do not rely on perpetual inventory records. Increase substantive tests of inventory completeness. Inform management of weakness.

 

Control Weakness 3

The receiver does not match the BL to an authorized PO.

 

Risks: 1)                     

Unauthorized goods or incorrect quantities may be accepted, increase possibility of errors in recording accounts payable and purchases

 

Possible error:             

Incorrect purchases and account payable recorded (as above, if unauthorized inventory is then stolen, it will be a cost of doing business and not an error if loss is picked up by inventory count and adjustment for shrinkage)

 

 

Impact on audit:         

Increase substantive tests of payables, purchases, and expenses. Inform management of control weakness.