Topic-27 - Internal- Control Purchases- Cycle PDF

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CPA P1 Auditing

TOPIC 27: INTERNAL CONTROL: PURCHASES CYCLE To understand the need for controls, it is helpful to break down the purchase process into its component stages. Bear in mind that a sale (see previous topic) is simply a purchase viewed from the other party‘s perspective, and hence much of the documentation (and many of the controls) is a mirror of the purchases process. The table shows the various stages of the purchases cycle, together with:

 What could go wrong  Control procedures to meet the control objectives (that things don‘t go wrong!)

It is essential that you understand the difference between:

 OBJECTIVES – what the company wants to achieve (or avoid)  PROCEDURES – what the company does to address its objectives

Stage in Cycle

Risks/Objectives

Requisition made and order

1. Order may be forgotten

Control Activity 1. All outstanding order kept on file

placed

for chasing

2. Goods not for business use

2. All orders authorised by manager

3. Goods not required

3. Inventory levels checked before 1

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order is placed

4. May miss out on bulk discounts

4. Separate ordering department , who plan orders to take account of discounts

5. Most competitive prices and quality may not be acquired with new suppliers Goods Received (or service

1. Wrong items arrive

enjoyed)

5. All new suppliers chosen by tender process based on quality and price 1. Warehouse staff agree goods received against GRN, and sign if correct

2. Poor Quality items arrive

2. Warehouse staff inspect all goods for minimum quality standards, prior to accepting goods

3. Goods are being stolen

3. Goods arrival area kept secure

Invoice Received

1. Invoice contains the wrong items/prices

1. Invoice agreed to GRN and Purchase Order and invoice calculations checked.

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2. Errors in posting to the

2. Payables Ledger

Nominal Ledger which is

Control A/c

the basis for Trial

reconciled regularly

Balance

to Payables Listing

3. Errors in posting to the

3. Payables Ledger

Personal Payables

Control A/c

Ledger

reconciled regularly to Payables Listing and sequence check from GRN’s to Invoices to ensure complete posting

Payment Made, or….

1.

Errors in posting

1.

Payables Ledger

payment to the

Control A/c reconciled

Payables Control A/c

regularly to Payables Listing

2.

Payment is stolen

2.

Where possible, all

payments are made by bank transfer and all cheques signed by Director, who sees supporting documents

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3.

Errors in posting to

3.

Payables listing per

the Personal Payables

Personal Payables

Ledger

Ledger, regularly reconciled to supplier statements

4. 4.

Planning of

Settlement discounts

payments, to ensure

missed

cash available and discounts taken.

Credit Received

1. Credit not accounted for

1. All credit notes sequenced and regular check that sequence complete in accounting records

2. Returned goods are

2. Any goods returned

accounted for as

to suppliers are

despatches, and hence

marked as “returns”,

sales

to ensure GDN is not prepared

3. Credit note agreed 3. Wrong Amount of Credit Received

back to original supplier invoice

CPA P1 Auditing NOTES  All documents should be pre-numbered in a sequence, so that completeness and validity are easy to verify

 All documents should be cross-referenced, so that it is easy to trace from the original order through to the Accounts

Internal Control Checklists For The Purchases Cycle. As noted in the previous topic, auditors need to establish what controls are in operation, document the system, and then test that controls are operating properly. We also saw that one method of documenting controls was to use some form of internal control questionnaire/checklist. For purchases, an Internal Control Questionnaire (ICQ) would be a checklist of questions to establish which controls were in operation. For example: ICQ – PURCHASE ORDERS PLACED Q1 Are all orders made from suppliers who have been checked for quality and price (preferred suppliers)? Q2 Are all purchase orders made in writing on standard, pre-numbered forms?

If the auditor is using an Internal Control Evaluation Questionnaire (ICEQ), the layout would be slightly different:

ICEQ – PURCHASE ORDER RECEIVED

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Q1 Could the company buy poor quality goods? (important to auditors as it impacts on inventory valuation, and possibly on the need for a provision for warranty costs) Answer – no, because of the following controls:  All new suppliers are asked for samples before any agreement to purchase is made.  All new supply needs are put out to tender before a supplier is chosen  Quality is checked as goods arrive, and any problems fed back to suppliers

TESTS OF CONTROL OF PURCHASES If you can come up with control procedures, then tests of control are easy – simply ask yourself how you would find out if a particular control procedure had taken place? What evidence might exist? With some controls, the easiest form of evidence may be to observe the control in operation (one of the reasons auditors like to attend a client‘s inventory count). For those controls that have operated in the past, inspection of documents showing that the control took place (e.g. a signature to evidence authorisation) might be suitable.

CONTROL TESTS  For a sample of suppliers, obtain the supplier file and inspect written copy of the last tender process, together with agreements with supplier on how quality will be measured and maintained.

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

On a random date, observe the goods-in process, noting quality checks carried out.

 Select a sample of GRNs from the prior period and inspect for a signature confirming that quality checks took place.

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