TOPIC 27: INTERNAL CONTROL: PURCHASES CYCLE

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Albert Floyd
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1 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 Control Activity Requisition made and order placed 1. Order may be forgotten 1. All outstanding order kept on file for chasing 2. Goods not for business use 2. All orders authorised by manager 3. Goods not required 3. Inventory levels checked before 1

2 order is placed 4. May miss out on bulk discounts 4. Separate ordering department, who plan orders to take account of discounts Goods Received (or service enjoyed) 5. Most competitive prices and quality may not be acquired with new suppliers 1. Wrong items arrive 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.

3 2. Errors in posting to the Nominal Ledger which is the basis for Trial Balance 2. Payables Ledger Control A/c reconciled regularly to Payables Listing 3. Errors in posting to the Personal Payables Ledger 3. Payables Ledger Control A/c reconciled regularly to Payables Listing and sequence check from GRN s to Invoices to ensure complete posting Payment Made, or. 1. Errors in posting payment to the Payables Control A/c 1. Payables Ledger Control A/c reconciled 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 3

4 3. Errors in posting to the Personal Payables Ledger 3. Payables listing per Personal Payables Ledger, regularly reconciled to supplier statements 4. Settlement discounts missed 4. Planning of payments, to ensure 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 accounted for as despatches, and hence sales 2. Any goods returned to suppliers are marked as returns, to ensure GDN is not prepared 3. Wrong Amount of Credit Received 3. Credit note agreed back to original supplier invoice

5 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 5

6 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.

7 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. 7

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