Term Project 2
Internal Control and Audit Program Case
Dr. Jahmani
November 15, 2012
Sweta Patel
1. Prepare a flowchart for the acquisition and the payment cycle for Johnson Machinery Company.
2. List the controls in existence for each of the six translation-related audit objectives for
acquisitions.
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Accuracy -- Purchasing department compare the invoice with the copy of purchasing
order for terms and price. Also, check footings, discounts on the vendor invoice and
extensions. The voucher section make sure that the checks was prepared
Completeness – When the purchasing department employee enters the approved
purchase requisition into the system, the system automatically generates a purchase
order in sequential order. The cashier uses pre-numbered checks to print checks for a
payment.
Classification – After receiving the approved invoices from the purchasing department,
the accounting department/voucher section codes the invoices for account distribution.
Occurrence – Purchasing department employee verifies whether there is a receiving
report and a purchase order for each invoice that is received from vendors before
approving the invoice for payment.
Timing – Date of receiving report is compared to invoice date.
3. For each control in part 2, list one test of control procedure for verifying its effectiveness.
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Accuracy -- Purchasing department compare the invoice with the copy of purchasing
order for terms and price. Also, check footings, discounts on the vendor invoice and
extensions. The voucher section make sure that the checks was prepared
o Test of Controls: Examine file of batch totals for initials of the clerk and compare
totals to summary reports.
Completeness – When the purchasing department employee enters the approved
purchase requisition into the system, the system automatically generates a purchase
order in sequential order. The cashier uses pre-numbered checks to print checks for a
payment.
o Test of Controls: Account for a sequence of purchase orders.
Classification – After receiving the approved invoices from the purchasing department,
the accounting department/voucher section codes the invoices for account distribution.
o Test of Controls: Examine documents for coding.
Occurrence – Purchasing department employee verifies whether there is a receiving
report and a purchase order for each invoice that is received from vendors before
approving the invoice for payment.
o Test of Controls: Examine documents in the voucher package to verify the
existence of the receiving report, purchase order and invoice.
Timing – Date of receiving report is compared to invoice date.
o Test of Controls: Check for unrecorded vendor invoices.
4. List the most important deficiencies in the acquisition and payment cycle.
Deficiencies in the Acquisition Cycle:
 Lack of proper authorization of activities and transactions
 Lack of adequate physical examination of assets
 Lack of adequate documents and records
 Lack of separation of IT duties from user departments
Deficiencies in the payment cycle:
 Lack of adequate separation of duties
 Lack of separation of the authorization of transactions from custody of related assets
 Lack of separation of the IT duties from user departments
 Lack of proper authorization of activities and transactions
 Lack of adequate monthly monitoring
5. Identify the most likely error or fraud that could result from each of the deficiencies listed in
part 4.
Deficiencies in the Acquisition Cycle:
 Lack of proper authorization of activities and transactions: It doesn’t seem that
Johnson Company has difficult inventory system. Ordering process is not automatic. It
seems very inefficient and it result in inventory being either high or low for the current
future. It can result in slower production.
 Lack of adequate physical examination of assets: Again, this could lead to an inventory
problem. It could be overstated or understated, which again could lead to valuation
problems. Also, these issues can affect net income, as cost of goods sold may be off.
 Lack of adequate documents and records: There are no records showing who requested
materials, when they were requested or who they were issued to. We do know that the
plant foreman is responsible for the purchase requisition and so perhaps it is up to him
or her to verify what is actually needed, however, with the loose inventory systems, the
plant employees could submit requests for all sorts of things that are not needed. Also,
I could see inventory theft occurring.
 Lack of separation of IT duties from user departments: The purchase order is created
automatically after the purchasing department inputs the purchase requisition from the
plant foreman. Although there is separation of duties here, as in the foreman isn’t the
one creating the purchase order, it doesn’t seem as if the purchasing department is
checking for fraud or for actual need; they just input the requisition into the purchasing
system.
Deficiencies in the payment cycle:
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Lack of separation of the authorization of transaction from assets: Where it seems the
biggest risk of fraud. There is no separation of responsibility. A purchasing employee
can create a fraudulent employee and could create fake vendor so he will submit
purchase order and create fake invoice, and then pay according to the fake invoice. Our
concern is that purchasing department can mistakenly not submit an invoice for
payment. This would be issue with company issuing following invoice.
Lack of separation of the IT duties from user departments: Whereas the company does
not seem to have a sophisticated inventory control system, they do have an automated
payment system for check disbursements. After the purchasing department OKs
invoices for payment, the accounting department enters them into the payment system.
The system then creates checks automatically and the cashiering department runs the
checks through the auto-signer. There is opportunity here for fraud, both by the
cashier, who could slip in a fraudulent check to be paid, or by the accounting
department, who could enter into the payment system a request for payment for a nonexistent invoice.
Lack of proper authorization of activities and transactions: We already discussed the
potential for fraud occurring in the payment cycle. Because of a lack of authorization,
the company could mistakenly pay an invoice twice or pay an invoice for the wrong
amount. While this may or may not be caught, it could occur as there doesn’t seem to
be adequate verification.
Lack of adequate monthly monitoring: This is a big oversight. There doesn’t seem to be
any reconciliation, which is the last phase where mistakes could be caught
(overpayment, dummy vendors, under payment, etc.). Also, a fraudulent vendor could
submit a duplicate invoice or improperly credit the plant’s account. With the loose
controls in place, this may or may not be caught by the purchasing department, who is
responsible for approving invoices.
6. Suggest a system alteration for JMC that would correct each of the deficiencies identified in
part 4. Be sure to keep cost/benefit in mind.
The deficiencies in the payment cycle could be easily rectified by having the IT
department create queries and increase the domain of individuals or departments access to
view data that is currently available in portions to the various departments. The department
information must be available to the various departments to allow closure and increase the
monitoring capability throughout the organization. The reports created by each department
would alleviate the monitoring issue and have concrete information for status updates and the
ability to verify actual spending versus projected spending. The Accounting department needs
to request from the IT department the ability to run a query report that would allow them to
rectify their information. The query report would include the ability to print a copy of the
purchase order, invoice and copy of check.
The information is in the system but access is not given to each department. Each
department requires the IT department to allow access to view only when that department is
not in charge of making changes to the information. This allows each department to monitor
without making changes to the data. The cost associated with this is minimal because it is a
matter of adding individuals to access different screens in the system. The creating of the
query reports is also a matter of creating the capability running different reports to analyze the
data and run edit reports to ensure proper billing and closure to the accounts. For example,
reports would be run to see if any checks were issued that were over the threshold of an
acceptable amount. The IT department needs the ability to link the purchase order from start to
finish. The link needs to be created for the purchase order, voucher, and payables. A query
report needs to be generated to allow the Purchasing department the ability to verify
completion of purchase order, items received, and payment received by vendor. If a check
needs to be reissued it needs to be documented.
7. Design an audit program to test internal control. The program should include, but not be
limited to, tests of controls from part 3 and procedures to compensate for the deficiencies in
part 4.
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Existence and Occurrence-Purchases and cash disbursements that have been recorded
have occurred and also pertain to the entity; Examine documents in voucher package
for existence; Examine supporting invoices, purchase orders, and receiving reports
containing the proper check number and date for each cash disbursement
Completeness-All purchases and cash disbursements that should have been recorded
have been recorded; Check to make sure purchase orders are in sequential order;
reconcile vendor statements to accounts payable listing
Accuracy-Purchases and cash disbursements have been recorded at the proper amount;
Compare price on invoice to approved price listing; Recalculate price extensions and
discounts; Recalculation of vendors' invoices; Obtain prices from purchasing department
and compare to vendors' invoices
Post and summarization-Acquisition transactions are properly included in the accounts
payable and inventory master files, and are properly summarized; Examine and compare
the transaction list to disbursement journal and examine initials for approval; Examine
initials on general ledger accounts indicating comparison; Foot subsidiary records and
compare to control account
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Classification-Purchases, Accounts payable and cash disbursements are recorded in the
proper accounts; observe use of chart of accounts and correct account classification;
Examine supporting invoice for reasonableness of accounting distribution
Timing- Acquisition and disbursement transactions are recorded on the correct dates;
examine the procedure to check and see if unrecorded vouchers exist; Perform search
for unrecorded liabilities