CASE 6

CASE 6TESTING THE INVENTORY PROCUREMENT SYSTEM

Recall:Audit Process

Lakesides Inventory Procurement SystemGenerated by DATA Processing Systems of Richmond, Virginia

UnderstandDocumentsProcess flowInternal controls

DocumentsPurchase requisitions - Request for purchase of goods or services by an authorized department or function Vendor Invoices - the bill that is received by the purchaser of goods or services from an outside supplier.Receiving Report - an internal document used to record what materials and inventory were received by the company.

ThreatsEventAffected AccountsPossible ManipulationsPurchase inventoryInventory, Accounts PayableUnder-record inventoryRecord in a later periodNot recordReturn inventory to supplierAccounts Payable, InventoryOverstate returnsRecord returns in an earlier periodInventory is soldCOGS, InventoryRecord at too law an amountNot RecordInventory becomes obsoleteLoss on write-down of inventory, InventoryNot write-offPeriodic count of inventory quantitiesInventory shrinkage, InventoryDouble counting

INHERENT RISKInventory is a complex accounting and auditing area.It is usually material, complex, and subject to manipulation

Other manipulations (Inventory)Empty boxes or hollow squares in stacked goods Mislabelled boxes containing scrap, obsolete items, or lower-value materials Consigned inventory, inventory that is rented, or traded-in items for which credits have not been issued Inventory diluted so it is less valuable

Controls (For Purchase)Approval of a contract with suppliers Restricted access to the inventoryMonitoring of inventory and purchase levels by management To avoid the risk of purchasing agents entering into kickback arrangements with vendors, controls include: Requiring competitive bids for large purchases Rotating purchase agents across product lines

Mandating vacations for employees can be a useful control in trying to prevent and detect fraud

Controls for Receipt of, and accounting for, goods and services Receiving department should make sure that: Only authorized goods are received Goods meet order specifications Accurate count of the goods received is taken Accountability is established to assure that all receipts are recorded

THREE-WAY MATCH: CONTROL FOR PAYMENT APPROVAL Purchase Order Receiving Information/ report Vendor invoice

Process flow chartLakesides Procurement System

Segregation of DutiesAuthorization Functions Approval of Purchase Requisitions by RogersAssigning / Appointing higher officials involve in the process( Inventory, Treasurer, Controller)Recordkeeping Functions:Controller Custody of Asset Functions:Inventory Department Internal Control

PSA 200 Overall Objectives of the Independent Auditor and the Conduct of an Audit in Accordance with PSAOwing to the inherent limitations of an audit, there is an unavoidable risk that some material misstatements will not be detected. The auditor should design audit procedures to obtain reasonable assurance that misstatements arising from fraud and error that are material to the FS taken as a whole are detected.

Audit programsAudit program are lists of audit procedures to be performed by audit staff in order to obtain sufficient appropriate evidence.

The individual procedures are determined after obtaining an understanding of the accounting system and determining the audit strategy to be followed.

The audit program reflect the understanding of the system and will incorporate a mix of compliance (test of control) and substantive tests that the auditor intend to perform.

The audit program is an important part of the auditors working papers and records a significant part of the audit evidence required to justify the audit opinion.

Purpose of Audit ProgramsA set of instructions to the audit team

Assist with planning and performance of the audit.

A means to control and record the proper execution of the audit work and also to review the audit work.

A record of the audit procedures to be adopted, the audit objectives, timing, sample size and basis of selection of each criteria.

Audit evidence to support the auditor opinion.

See pg. 781 (Cabrera)VouchingTracingAuditors ConcernOver-statement and Understatement of Accounts

Designing Audit ProceduresAudit terminology for procedureClient for documents/ roles/ processesBe specific in your description

MOST COMMONLY USED AUDIT PROCEDURESAUDIT PROCEDUREDefinitionAnalyzeTo identify and classify items for further study2. CompareTo observe similarities and differences between related items3. Confirm To communicate with outside parties to authenticate internal evidence4. CountTo enumerate a characteristic5. Examine To review critically6. Extend To multiply7. Foot To add a column8. InspectTo scrutinize or critically examine a document

MOST COMMONLY USED AUDIT PROCEDURESAUDIT PROCEDUREDefinition9. InterrelateTo show relationship10. ObserveTo watch or test a client11. ReconcileTo establish agreement between separate sources of information12. TestTo sample13. Trace To follow a transaction through the steps of the system14. Verify To prove accuracy of numbers or existence of amount15. Vouch To prove accuracy of accounting entries by tracing to supporting documents

Designing Audit ProceduresAudit terminology for procedureClient for documents/ roles/ processesBe specific in your description(see Exhibit 6-1)

Audit DocumentationAuditor need to record (document) all relevant audit matters from start till end of auditKeep PROPER DOCUMENTATION of ALL MATTERS pertaining to audit and justification of audit reports

Proper documentationWorking Papers (WP)Either: documents, information workings obtained from client.Past Fs, industry data, Trial balance, loan agreement of client, etc.Support audit conclusionOr: information produced by auditorsschedules, workings, audit programs, planning checklistSupport audit conclusionJustify audit report

Wp:Must be retained by CA for 5 yearsMust be kept confidentialCan be hard or soft (electronic media)Produced by CA must meet standard quality of good WPCan be filed in either -Permanent file-Current fileCan be used in court in cases of negligenceJustify that a professional and effective audit carried outRecord all info: -Client acceptance-planningAudit risksAudit programsTrial balanceAudit schedules................ Audit report.

ContentEach audit working paper must be headed with the following information: The name of the client. The period covered by the audit. The subject matter. The file reference. The initials (signature) of the member of staff who prepared the working paper, and the date on which it was prepared.

In the case of audit papers prepared by client staff, the date the working papers were received, and the initials of the audit team member who carried out the audit work. The initials of the member of staff who reviewed the working papers and the date which the review was carried out.

Some characteristics of a good working paperState a clear audit objective. State the name of client, subject matter, year/period end. State the full extent of the test or audit objective. Reference of linked documents. How sample size were determined. Clearly and objectively state the results of the test. The conclusions reached should be consistent with result of the test. Main reference. Signed and dated by preparer. Signed and date by reviewer.

Page reference is unclear Year is missingno signature objective is vague

number for testing is unclear

results of the test is unclear conclusion is not consistent with the results

Conclusion Working papers provide evidence that an effective, efficient, effective and economic audit has been carried out. They should therefore be prepared with care and skill. They should be sufficiently detailed and complete so that an auditor with no previous experience of that audit can understand the working papers in terms of the work completed, the conclusions reached and the reasoning behind these conclusions.

Heyman (Audit Procedures)Choose a date at random and, from the receiving report file located in the Inventory Department, select the next 12 receiving reports.

Review these documents for completeness and authorization. (see Receiving Reports)

Verify that each acquired item was properly recorded in the inventory purchases journal.

RCVRPT vs IPJ

Verify that each acquired item was properly recorded in the inventory purchases journal.

RCVRPT vs IPJ

Verify that each acquired item was properly recorded in the inventory purchases journal.

RCVRPT vs IPJ

For each of these receiving reports, locate the corresponding vendor invoice and purchase requisition filed in the Treasurers Office. Verify the agreement of these three documents as to quantity of goods and description of acquired merchandise.RECRPT vs VI vs PR

For each of these receiving reports, locate the corresponding vendor invoice and purchase requisition filed in the Treasurers Office. Verify the agreement of these three documents as to quantity of goods and description of acquired merchandise.RECRPT vs VI vs PR

v

Verify that the requisitions have each been approved by the proper company officials

v

Note the clients indication that prices have been checked, extended, and footed

Reconcile the prices on the invoice to the master price list found in the Controllers Division

Locate the cancelled check for each invoice, matching the dollar amounts and recomputing any appropriate discount.

Working Paper

-End of Report-DONT STOP TILL YOU GET TO THE TOP.

WHEN YOU GET TO THE TOP, DONT STOP.