Question

1. Audit Planning - Purchases Transaction Cycle

The internal auditor of Book Worm has just completed the annual planning meeting of the Audit Committee and has agreed to the following objectives for the following financial year:

1. To coordinate a review of the Purchasing and Accounts Payable functions, which will complement the external auditor's review of trade creditors and accrued charges.
2. To perform an operational audit of the Purchasing function.
3. To perform a review of inventory levels and the identification of the extent of any slow moving and obsolete inventory holdings
4. To review the levels of risk relevant to the inventory levels in each store and the warehouse.

The purchasing department consists of the following:

• A supply manager, reporting to the managing director.
• A purchasing officer, reporting to the supply manager.
• An administrative support supervisor, who reports to the purchasing officer.
• Two administrative support officers, reporting to the administrative support supervisor.

Required:

1. Describe the organisation of the Purchasing function and draw an organisation chart.

2. Develop the audit plan for the operational audit of the Purchasing and Accounts Payable functions.
3. Develop the audit plan to expand the operational audit into a financial audit that would meet the relevant external audit assertions for their audit of the financial reports.
4. Develop a plan to identify slow moving inventory items and the procedures to be followed.

Answer 1

Ans a

Purchasing Department Org Structure

Purchasing is responsible for the procurement process. This means it ensures the supply of goods, production materials and equipment so that a smooth production and sales process can take place. For this, goods must be procured at the right time, in the right quantity, and of the right quantity. If the purchasing process falls down, there's a risk that the business will not be able to manufacture products or keep the shelves stocked with sufficient volume to meet customer demand.

All businesses need specific goods, materials and equipment to manufacture products, offer goods for sale to customers, or perform the services they are selling. Someone has to ensure that these goods are bought into the company, in the right volume and at the right time, to meet the company's requirements. That role falls to the purchasing, or purchase, department.

The role itself is a broad one, covering such areas as market analysis, negotiations with suppliers and producers, transport, storage options, procurement technologies and order times to ensure that goods are bought as economically and time-efficiently as possible. Specific functions include:

• Identifying requirements for goods, materials and services.
• Identifying reliable suppliers.
• Price negotiations.
• Comparison of delivery terms.
• Establishing order quantities.
• Writing requests for bids and awarding supply contracts.
• Coordinating delivery with the warehouse against storage capacities.
• Product testing and quality control.
• Managing budgets and payments.

Ans a, b (Audit plan for Operational & financial audit of Purchasing and Accounts payable function)

In general, Purchasing and accounts payable audit is conducted in four distinct steps:

1. Planning
2. Fieldwork
3. Audit Reporting
4. Follow-up/Audit Review

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

  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 authorises 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 authorised 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.

Fieldwork

• 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 scrutinised, 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.

Audit Reporting

• 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.

Follow-up/Audit 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 organisation 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 favour. 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, centralised 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

Ans C (Identifying of Slow moving procedures)

Slow moving inventory are inventoried items (both raw materials and finished goods) that have minimal customer demand based on the quantity on hand for a period of typically six months or greater.

Product performance varies within inventory-based businesses, so it is important to have the right tools to manage inventory overall with the ability to identify, prevent and manage the outliers, including slow moving inventory.

Consider product performance in relation to the general idea of the Pareto principle (also known as the 80/20 rule). The gist of the rule is that most things in life are unevenly distributed, therefore the majority (80%) of something is caused by a smaller percentage (20%) of something.

Businesses need to be able to uncover potential issues with the right metrics based on well-maintained product history and current performance to identify slow moving product as it continues to sit on warehouse shelves, tie up capital, lose value to customers, and veers into becoming obsolete.

Identifying the culprits requires knowing the age and demand of each product.

• What is the average time an item remained in stock before being shipped?
• How much of the product has been purchased during a given period as compared to its historical and forecasted demand?

These metrics can reveal inventory turnover, which is how quickly products are moving from the warehouse to the customer and then being replenished. Low turnover is a red flag for slow moving inventory as it identifies product that is stagnant in the warehouse for a prolonged duration before being sold. Access to accurate data for analysis is vital and more efficient when provided by an inventory management system.

Prevent slow moving inventory

Slow moving inventory can occur for different reasons, such as the introduction of new products, the start of the year, improper phasing out of previous product versions, or the end of seasons. But with the ability to identify such inventory, ebusinesses can prevent the situation by better facilitating their purchasing and sales processes.

Manage slow moving inventory

There are instances where slow moving products can be removed without the need to further manage them in stock.

• With products that move slowly due to being out of season, businesses will often run clearance sales.
• Consider selling the inventory at a low profit margin or a loss to be able to replace shelf space with fast moving products that are proven to produce profit.
• Strategies can also be implemented to better sell product, such as with bundling. Slow moving product can be bundled with faster moving products that complement each other or multiple quantities of the same product can be packaged together to sell more for less.

Better allocation can be implemented for slow moving items that still must be sold to meet customer needs. The products can be sold, but not occupy physical warehouse space, by utilizing dropshipping and not affect demand forecasting of stocked items with special order purchasing.