Question

Auditing Question:

Purchase and Payment System

You are provided with the following information about the internal control system for materials acquisitions for the ABC Company Limited, a medium-sized company that builds special machinery to order.

Material purchase acquisitions are first approved by the plant manager, who then sends them to the Purchasing Department. A prenumbered purchase order is prepared in three copies by one of several department staff. The department staff account for all purchase order numbers. The original copy is sent to the vendor. The Receiving Department is sent the second copy to use for a receiving report. The third copy is kept on file in the Purchasing Department along with the requisition.

Delivered materials are immediately sent to the Storeroom. The receiving report, which is a copy of the purchase order, is sent to the Purchasing Department. A copy of the receiving report is sent to the Storeroom. Materials are issued to factory employees subsequent to a verbal request by one of the foremen.

When the mailroom clerk receives vendors’ invoices, he forwards them to the Purchasing Department staff who placed the order. The invoice is compared with the purchase order on file for price and terms by the staff. The invoice quantity is compared with the Receiving Department’s report. After checking footings, extensions, and discounts, the staff indicates approval for payment by initiating the invoice. The invoice is then forwarded to the Accounting Department. Vendor name, date, gross and net invoice amounts, and account distribution are key-entered into the computer system for updating the acquisitions journal and accounts payable master file, and filed by payment date due. The vendor’s invoice is filed in the Accounting Department. The purchase order and receiving report are filed in the Purchasing Department.

The Accounting Department requests prenumbered checks from the Cashier. They are manually prepared and then returned to the Cashier, who puts them through the check-signing machine. After accounting for the sequence of numbers, the Cashier sends the checks to the Accounting Department, where they are key entered for recording cash disbursements and updating accounts payable. The checks are placed in envelopes and sent to the mailroom. At the end of each month, a listing of the accounts payable master file is printed and the total is compared with the general ledger balance. Any differences disclosed are investigated.

Requirement:

a) What are some of the limitations of any organization's internal control?

b) Explain the following six transaction-related audit objectives for acquisitions:
Occurrence

Completeness

Accuracy

Classification

Cut-off

Posting and Summarization

c) List the existing controls for each of the six transaction-related audit objectives

For acquisitions.

d) For each control in Part C, list one audit test of control procedure to verify its

Effectiveness.

e) List the most important internal control weaknesses for acquisitions and cash

   Disbursements.

Answer 1

(a) Limitations of an organizations Internal Control

1. Quality of the Accounting System.
2. Complexity of the underlying transactions and other events which may require using the work of an expert.
3. The completion of unusual and complex transactions particularly at or near year end.
4. Transactions not subjected to ordinary processing
5. Financial Statements are likely to be susceptible to misstatements. example: adjustments involving high degree of estimation.
6. Degree of judgement involved in determining account balances
7. Susceptibility of the assets to loss or misappropriation

(b)Explannation of transaction related audit objectives:

1. Occurance : Transactions and events that have been recorded have occured and pertain to the entity.
2. Completeness : All transactions and events that should have been recorded have been recorded.
3. Accuracy : Amounts and other data relating to recorded transactions have been recorded appropriately.
4. Classification : Transactions and events have been recorded in the proper accounts
5. Cut - off : Transactions and events have been recorded in the correct accounting period.
6. Posting and Summarization: Recorded transactions are correctly included in the master files and correctly summarized.

(c) Listing out the existing controls for the transaction related audit objective for acquisition:

1. Occurance & Accuracy: The purchasing department compared the vendor invoice with the purchase order for price and terms by the staff. The quantity mentioned in invoice is compared with the receiving departments report. This control ensures the occurace of the transaction recorded as well as the accuracy.
2. Completeness & Cut off : At the month end the listing of accounts payable report is compared with general ledger. Any differences are investigated into. This ensures that all the transactions that should have been recorded are appropriately recorded.
3. Classification & Posting and Summarization : All the departments are given a particular function which enable them to enter the transactions into the correct ledger. The review process at the month end also ensure the same.

(d) Audit Test of Control Procedure to verify its effectiveness

The auditor has to perform compliance procedures to verify if the control is effective. The auditor will have to perform a walk through the entire process with a live sample and undersatnd if the controls as mentioned above is being performed accurately. Auditor will have to select samples from the purchases ledger dump on the basis of the materiality and performance materiality and verify the supportings ( Purchase Order , Receiving Department Report, Invoice, Payment Details). Occurance, accuracy, cut off, classification, posting and sumarization assertion is tested by performing the above test. Some samples can be taken from the bank statement inorder to ensure the completeness assertion that all the purchases that should have been included is included.