Purchasing Operation - Review of Internal Control, Auditing and Secretarial Practice Video Lecture | Auditing and Secretarial Practice - B Com

this is our first lecture related to
chapter 11 which focuses on the
inventory and purchasing cycle keep in
mind that when we're working through the
inventory and purchasing cycle that
we're considering it from the
transactional perspective where we're
looking at internal controls and we're
also looking at account balances where
we are measuring monetary misstatement
as we consider these processes or these
cycles what we need to understand is
what are some of the accounts and what
are some of the transactions that we
need to consider as we are doing our
review from the perspective of an
auditor so what you see here are various
T accounts you notice that the primary
accounts are accounts payable and
inventory or inventory purchases you
notice that when we make the purchase
and we receive the goods is we have a
debit to inventory and we have a payable
to accounts payable when these items are
paid is we debit accounts payable and
the credit is going to cash so cash
payment is part of the transaction that
we're looking at depending upon whether
this is a merchandising inventory
situation or a manufacturing inventory
situation we may have accounts such as
factory overhead we may have cost of
goods sold and obviously we're going to
have expense accounts as these goods are
actually sold the cycle is critical to
our understanding of what internal
controls become important and as we
consider business cycles we need to
understand it from the beginning point
to the end point so what we have is the
payment cycle the purchase and payment
cycle as it relates to inventory and
accounts payable so you notice the very
first piece of this is the requisition
of goods and services and a well-run
organization this requisition is coming
from the department level the
requisition is based upon the
requirements for that specific
department but the department
is not actually ordering the goods the
requisition is going to the purchasing
department the purchasing department is
responsible for ordering the goods for
developing contracts with vendors for
identifying pricing for identifying
appropriate vendors and so forth the
purchasing department makes a purchase
requisition this purchase requisition
goes to the vendor and these goods are
actually ordered when they are received
they received by the receiving
department and we acknowledge the
receipt and account for these goods and
services essentially what we mean is
that the receiving dock will record and
count the items that have been received
and enter these into the computer system
the receipt of goods in most systems is
the starting point where we increase
inventory and create an Accounts Payable
so the next step of the process is the
actual approval for payment the approval
for payment comes from the accounts
payable department the accounts payable
department receives an invoice from the
vendor they then match this invoice with
what was received and what was purchased
based upon quantity goods as well as
pricing based upon this three-way match
if in fact it does match then accounts
payable approves for payment this
approval then goes to cash disbursement
where the payment is made and the
voucher that's been created by accounts
payable then is cancelled and the idea
we're cancelling the voucher is to make
sure that this item is not paid twice
when we're considering this what we want
to look at as to inventory as well as
accounts payable relates to how these
inventory balances match with these
management assertions keep in mind that
management assertion
are the explicit or implied statements
of management as they relate to
inventory balances or account balances
in the financial statement so the first
is existence when we're talking about
inventory clearly talking about
existence not occurrence that existence
is the inventory balance as of the
balance sheet date this is going to be
validated based upon an inventory count
eighty the next piece is completeness we
want to make sure that the inventory
balance represents all transactions that
have taken place during the period
rights to the inventory we want to make
sure that the inventory is there and we
have legal title to this inventory there
may be goods on consignment there may be
bill on hold situations there may be
situations beyond this that the
inventory is there but we don't have
legal title to it valuation clearly want
to record any underlying economic value
changes as we're considering inventory
we want to consider it from the
perspective of the lower of cost or
market and this becomes part of our
examination evaluation presentation and
disclosure we want to make sure that
it's presented correctly and classified
appropriately as we're considering the
next piece is we want to identify the
inherent risks related to inventory keep
in mind that inventory is a complex
accounting and auditing area it usually
includes material amount that are
material to the financial statements and
these are subject to manipulation large
number of inventory related frauds have
been perpetrated and it requires an
exercise of a high level of professional
skepticism from the auditor inventory is
prone to fraud we absolutely need to
understand fraud risks as it really
to inventory the primary issue related
to fraud is what we call inventory
shrinkage this is a term that's used
that basically reflects inventory that's
lost based upon its being stolen from
employees or other people that may have
access to the inventory employee schemes
involving fictitious vendors as a means
of transferring payments of themselves
is another risk and anytime we're
dealing with inventory and purchasing is
we need to understand that we are
consuming a tremendous amount of
resources within the organization and if
we don't have the appropriate controls
it's it's very possible that in fact
some sort of fraud is going to be
perpetrated you notice here related to
control issues in the requisition
process and again when we talk about
inventory the purchase of inventory is
we need to continue this from the
perspective of the items are requested
there are then purchased and then they
receive then the payment is made now you
notice that there's a very specific
segregation of duties there so as we had
pointed out it's critical that the
requisition er is not the one that
actually purchases good it's very
important that the purchasing department
is in control and management of vendors
of pricing and the actual purchase of
goods and services from the entire
organization receiving is a separate
department from these other two
departments receiving is only
responsible for receiving and
acknowledging receipt of the goods from
vendors and then finally accounts
payable accounts payable separate
department and they are responsible for
approving payment this approval of
payment is based upon quantified
information from the purchase order and
receiving as well as from the invoice
but the issue related to inventory is
going to be different compared to
whether it's a manufacturing
organization a retail organization a
just-in-time manufacturing or where
we're considering supplies now the
difference between supplies and
inventory is inventory are the things
that we ultimately sell supplies are
these goods that we purchase where they
are consumed in the revenue process but
they're not actually sold to the
end-user
each of these have unique situations in
terms of controls clearly the difference
between a manufacturing organization and
a retail organization need to be
considered in manufacturing as we
develop inventory we're going to have
absorbed the cost from direct labor from
direct materials as well as overhead all
these items then flow through work in
process and finish goods we don't have
that in a retail organization but we do
have other unique situations that create
issues from a control perspective
controls related to the purchasing of
goods and services we've talked about a
number of these things clearly the
biggest control is the segregation of
duties absolutely critical that the
organization established specific
functions and roles within these
specific departments to control the
process we need to have approval of
contracts with suppliers we need to
identify who actually approves this in
most of the situations that I've worked
in is it's the purchasing department
that approves these contracts and is the
only group that has the ability to
actually enter in a new vendor or even
change information in any of the vendor
information which means that we need to
have restricted access to the computer
program this restricted access to the
computer program needs to be on a roll
based perspective in an ER
system the erp system is developed from
the perspective that the material or the
information that flows through the
information is within a is within and
crosses over various departments however
with role-based restricted access
receiving as an example only has the
ability to enter the amount of items of
that's been received purchasing only has
the ability to actually purchase goods
and manage the vendors accounts payable
only has the ability to approve based
upon these prescribed values of
purchased received and pricing to avoid
the risk of purchase agent entering into
kickback arrangements with vendors we
require competitive bids we rotate
purchasing agents across the product
lines so not only do we have the
segregation of duties between
departments we need to also consider the
controls within a very specific
department and so you notice here that
within the purchasing department we have
some very specific issues that we need
to contend with companies also need to
consider other controls such as the
maximum quantity that can be ordered
within a given period of time
most of the modern accounting systems
will keep track of quantities will keep
track of who's ordering what and
certainly from the requisition
perspective it's very important that the
requisition err which is coming from the
department level is the only way that a
purchase order can be initiated and this
requisition is going to be driven by a
restriction of what can be ordered the
actual quantity and a lot of this is
developed based upon the budget
constraints within the organization we
need to understand the Moonen minimum
amount of previous usage doing a
specific period of time and again as
we're going through this know
notice how the budget absolutely relates
to the controls related to the purchase
of goods and services we require a
review by purchase agents for accounts
or for some high dollar levels embedded
within the system there needs to be
controls that if an order goes over a
specific quantity or price that these
need to be approved at a higher level
and again as we're talking through this
keep in mind that we're talking about
the goods and services for the operation
of the organization we're not talking
specifically about the capital items
capital items are going to have a very
specific control process even though
they may be going through this standard
purchasing cycle of requisition
purchasing and so forth so we need to
understand that the capital items are
going to be treated a little bit
different or in fact they should be
treated different and if they're not
treated different it's very possible
that this is a control issue receipt of
goods the receiving department should
make sure that only authorized goods are
received goods meet order specifications
there is an accurate count and this out
accountability is established to assure
that all receipts are recording in a
well-run receiving department as items
come off the truck essentially what the
receiving department is going to do is
they're going to consider opening some
of the boxes sometimes that's not
appropriate but they're going to count
the items compare that to the packing
slip go to the purchase order within the
system and record the receipt of what
was actually received now receiving also
has the responsibility of delivering
these goods and services or goods we're
talking specifically about goods to the
to whatever user departments were using
or the inventory Depot wherever they go
the idea is the receipt of the goods and
at the loading dock needs to be
accounted for but also the receipt of
the goods at the end-user weather
department or the inventory Depot also
needs to be managed there's a term that
we use in accounts payable we call this
the three way match the three way match
is the purchase order the receiving
information what was received and the
vendors invoice purchase order basically
has the items that were ordered and the
price that these items were established
at the point of order the receiving dock
is entering what has been received the
vendors invoice when it comes in
essentially identifies what was shipped
and what and the quantity and pricing so
the three-way match is at accounts
payable accounts payable will consider
the purchase order the receiving
information compared this to the vendor
invoice and if there is the match then
this item can be approved for payment
discrepancies it needs to be reviewed
with the purchasing agent supporting
documentation and authorization are
presented to accounts payable for any
discrepancies before these items are
paid now keep in mind that in my
experience the biggest problem related
to this three-way match is going to be
the charge for shipping so there clearly
is going to be some sort of charge this
does create some problems in terms of
the three main way match but again the
complexities related to the three-way
match need to be addressed within
policies and procedures within the
organization it's very critical to make
sure that these items get resolved
appropriately because what may be
happening is the payment for the invoice
goes outside the process well the
problem with that is if the item was
received appropriately the receiving
essentially creates the liability
so we may still show a liability on the
financial statements when in fact that
item has already been paid because it's
been paid outside the system so when
there's discrepancies and the system is
not allowing you to make payment because
of this these discrepancies these need
to be resolved appropriately so that
there is no bad effect on the financial
statements I won't go through a lot of
these ratios these are in your books but
the idea is that as we're gaining an
understanding of analytical procedures
and keep in mind that we're talking
about analytical procedures here in the
planning stage so we're not using
analytical procedures at this point for
our substantive testing but you notice
that we have inventory ratios Accounts
Payable ratios and we're using these
essentially to identify things that have
changed from the last period and again
they may have changed for appropriate
reasons but as we're looking at changes
is this essentially is directing our
attention to what we need to look at as
we are assessing the risk of material
misstatement factors suggesting a
heightened risk of fraud in the
acquisition and the payment cycle so
we've talked a little bit about fraud
related to inventory now we're talking
about fraud as it relates to the
purchasing cycle as where you're
acquiring and paying for items an
unexpected increase in gross margin
inventory that's growing at a great
greater than sales expenses that are
either significantly above or below
industry standards unexpected increases
in the number of suppliers capital
assets that seem to grow faster than
than the business expense accounts that
have significant credit entries these
credit entries may in fact be some sort
of adjustment that we are essentially
negating some sort of fraud and in
travel and entertainment expenses no
question about it but that
one of the tasks that we have as
auditors is to examine travel and
entertainment this is the potential for
fraud especially in high level employees
within the organization as we respond to
these identified risks of material
misstatement we need to develop an audit
approach that includes tests of controls
substantive procedures tests of details
substantive political procedures and
identify this from up the perspective of
sufficiency for each relative relevant
assertion let's just take this just a
little step further just make sure that
we understand what we're talking about
tests of controls if applicable as we
are conducting our risk of material
misstatement
so as we're conducting our risk of
material misstatement we are considering
the risk from the inherent perspective
we're also considering the risk based
upon our tests of controls the tests of
controls and the inherent risk defines
our risk of material misstatement the
risk of material misstatement is then
used they determine the nature timing
and extent of our further procedures
some of these further procedures will be
additional tests of controls if in fact
we are conducting an integrated audit
relative to sarbanes-oxley 404 but if
we're only doing a financial statement
audit these further audit procedures are
our substantive procedures these
substantive procedures is where we are
measuring monetary in a statement we're
looking at the test of details related
to account balances and we are
considering substantive analytical
procedures when they're applicable again
the bottom line related to our
substantive procedures is we are
measuring monetary in a statement we
need to consider these appropriately and
determine if they're appropriate and
sufficient for each relative
and again as we're considering the
assertions we're considering these from
the perspective of these implied or
explicit statements related to financial
information that are embedded in the
financial statement and as we've talked
about the financial statements are the
responsibility of management okay
so we've started a very good beginning
related to our discussion related to
inventory and the purchasing cycle we
will continue this in the next lecture
thank you very much