Question

Fox Industries Co (Fox) manufactures engineering parts. It has one operating site and a customer base spread across Europe. The company’s year-end was 30 April 20X3. Below is a description of the purchasing and payments system.

Purchasing system:

Whenever production materials are required, the relevant department sends a requisition form to the ordering department. An order clerk raises a purchase order and contacts a number of suppliers to see which can dispatch the goods first. This supplier is then chosen. The order clerk sends out the purchase order. This is not sequentially numbered and only orders above $5,000 require authorization.

Purchase invoices are input daily by the purchase ledger clerk, who has been in the role for many years and, as an experienced team member, he does not apply any application controls over the input process. Every week the purchase day book automatically updates the purchase ledger, the purchase ledger is then posted manually to the general ledger by the purchase ledger clerk.

Payments system:

Fox maintains a current account and a number of saving (deposit) accounts. The current account is reconciled weekly but the saving (deposit) accounts are only reconciled every two months.

In order to ma ximize their cash and bank balance, Fox has a policy of delaying payments to all suppliers for as long as possible. Suppliers are paid by a bank transfer. The finance director is given the total amount of the payments list, which he authorizes and then processes the bank payment.

Required:

(a) As the external auditors of Fox Industries Co, write a report to management in respect of the purchasing and payments system described above which:

(i)   Identifies and explains FIVE deficiencies in the system,and

(ii)   Provides a recommendation to address each deficiency. A covering letter IS required. ( it is not requested)

(b) Identify and explain THREE application controls that should be adopted by Fox Industries Co to ensure the completeness and accuracy of the input of purchase invoices.

(c) Describe substantive procedures the auditor should perform to confirm the bank and cash balance of Fox Industries Co at the year-end.

Answer 1

(A)(i)

	Appendix
Deficiency	Implication	Recommendation
When raising purchase orders, theclerks choose whichever supplier candespatch the goods the fastest.	This could result in fox ordering goodsat a much higher price or a lowerquality than they would like, as the onlyfactor considered was speed of delivery.it is important that goods aredespatched promptly, but this is justone of many criteria that should be used in deciding which supplier to use.	An approved supplier list should becompiled; this should take into accountthe price of goods, their quality and alsothe speed of delivery. once the list has been produced, allorders should only be placed withsuppliers on the approved list.
Purchase orders are not sequentiallynumbered.	Failing to sequentially number the orders means that fox’s ordering teamare unable to monitor if all orders arebeing fulfilled in a timely manner; thiscould result in stock outs. if the orders are numbered, then a sequence check can be performed forany unfulfilled orders.	All purchase orders should be sequentially numbered and on a regularbasis a sequence check of unfulfilledorders should be performed.
Purchase orders below $5,000 are notauthorised and are processed solely byan order clerk.	This can result in goods being purchased which are not required byfox. in addition, there is an increasedfraud risk as an order clerk could place orders for personal goods up to thevalue of $5,000, which is significant.	All purchase orders should be authorised by a responsible official.authorised signatories should be established with varying levels ofpurchase order authorisation.
Purchase invoices are input daily by the purchase ledger clerk and due to his experience, he does not utilise any application controls.	Without application controls there is a risk that invoices could be input into the system with inaccuracies or they may be missed out entirely. This could result in suppliers being paid incorrectly or not all, leading to a loss of supplier goodwill.	The purchase ledger clerk should input the invoices in batches and apply application controls, such as control totals, to ensure completeness and accuracy over the input of purchase invoices.
The purchase day book automatically updates with the purchase ledger but this ledger is manually posted to the general ledger.	Manually posting the amounts to the general ledger increases the risk of errors occurring. This could result in the payables balance in the financial statements being under or overstated.	The process should be updated so that on a regular basis the purchase ledger automatically updates the general ledger. A responsible official should then confirm through purchase ledger control account reconciliations that the update has occurred correctly.
Fox’s saving (deposit) bank accounts are only reconciled every two months.	If these accounts are only reconciled periodically, there is the risk that errors will not be spotted promptly. Also, this increases the risk of employees committing fraud. If they are aware that these accounts are not regularly reviewed, then they could use these cash sums fraudulently.	All bank accounts should be reconciled on a regular basis, and at least monthly, to identify any unusual or missing items. The reconciliations should be reviewed by a responsible official and they should evidence their review.

(ii)Report to management

Board of directors
Fox Industries Co
X Country

30 April 2013

Dear Sir,

Audit of Fox Industries Co (Fox) for the year ended 30 April 2013

Please find enclosed the report to management on deficiencies in internal controls identified during the audit for the year ended 30 April 2013. The appendix to this report considers deficiencies in the purchasing and payments system, the implications of those deficiencies and recommendations to address those deficiencies.

Please note that this report only addresses the deficiencies identified during the audit and if further testing had been performed, then more deficiencies may have been reported.

This report is solely for the use of management and if you have any further questions, then please do not hesitate to contact us.

Yours faithfully

An audit firm

B) Application controls
Document counts – the number of invoices to be input are counted, the invoices are then entered one by one, at the end the
number of invoices input is checked against the document count. This helps to ensure completeness of input.
Control totals – here the total of all the invoices, such as the gross value, is manually calculated. The invoices are input, the
system aggregates the total of the input invoices’ gross value and this is compared to the control total. This helps to ensure
completeness and accuracy of input.
One for one checking – the invoices entered into the system are manually agreed back one by one to the original purchase
invoices. This helps to ensure completeness and accuracy of input.
Review of output to expected value – an independent assessment is made of the value of purchase invoices to be input, this
is the expected value. The invoices are input and the total value of invoices is compared to the expected value. This helps to
ensure completeness of input.
Check digits – this control helps to reduce the risk of transposition errors. Mathematical calculations are performed by the
system on a particular data field, such as supplier number, a mathematical formula is run by the system, this checks that the
data entered into the system is accurate. This helps to ensure accuracy of input.

C) Substantive procedures over bank and cash balance of Fox Industries Co (Fox)
– Obtain Fox’s current bank account reconciliation and check the additions to ensure arithmetical accuracy.
– Obtain a bank confirmation letter from Fox’s bankers for all of its accounts.
– For the current account, agree the balance per the bank statement to an original year-end bank statement and also to the bank confirmation letter.
– Agree the reconciliation’s balance per the cash book to the year-end cash book.
– Trace all of the outstanding lodgements to the pre year-end cash book, post year-end bank statement and also to paying-in-book pre year end.
– Trace all unpresented cheques through to a pre year-end cash book and post year-end statement. For any unusual amounts or significant delays obtain explanations from management.
– Examine any old unpresented cheques to assess if they need to be written back into the purchase ledger as they are no longer valid to be presented.
– Agree all balances listed on the bank confirmation letter to Fox’s bank reconciliations or the trial balance to ensure completeness of bank balances.

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