Purchasing, Inventory, and Cash Disbursements: Common Frauds and Internal Controls

By Glenn Helms

Purchasing and cash disbursements are common targets for fraud in any entity's environment. Today, many practitioners, auditors, and management in industry are aware of the criticality of adequate internal controls, but may be uncertain whether existing controls in their organizations are adequate. It is important to understand common frauds and internal controls over the purchasing and cash disbursement cycle.

Topics discussed include:

• The acquisitions cycle: ordering, receiving, and warehousing
• Cash disbursements cycle
• Payroll and expense reimbursement frauds
• External auditing and forensic investigations: conceptual and procedural differences
• Controls and design

• Language: English
• Publisher: Wiley
• Release date: Mar 1, 2018
• ISBN: 9781119512288

Book preview

Title Page

Notice to Readers

Purchasing, Inventory, and Cash Disbursements: Common Frauds and Internal Controls is intended solely for use in continuing professional education and not as a reference. It does not represent an official position of the Association of International Certified Professional Accountants, and it is distributed with the understanding that the author and publisher are not rendering legal, accounting, or other professional services in the publication. This course is intended to be an overview of the topics discussed within, and the author has made every attempt to verify the completeness and accuracy of the information herein. However, neither the author nor publisher can guarantee the applicability of the information found herein. If legal advice or other expert assistance is required, the services of a competent professional should be sought.

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Course Code: 753337

CL4PCD GS-0417-0A

Revised: April 2017

TABLE OF CONTENTS

Chapter 1 The Acquisitions Cycle: Ordering, Receiving, and Warehousing

The Acquisitions Cycle

Ordering

Receiving and Warehousing

Variations of the Typical Acquisitions Cycle

Manufacturing Environment

Retail Environment

Services

Smaller Entity

Internal Controls in the Ordering, Receiving, and Warehousing Processes

Errors, Fraud, and Controls

Control Matrix

Summary

Practice Questions

Chapter 2 Cash Disbursements Cycle

Cash Disbursements

Typical Cash Disbursements System

Internal Controls in the Example Retail System

Errors, Fraud, and Controls

Control Matrix

Services

Electronic Data Interchange (EDI) Overview

Cash Disbursements Fraud Statistics

Cash Disbursement Frauds Other Than Billing

Cash Register Disbursement Frauds and Theft of Cash on Hand

Summary

Practice Questions

Chapter 3 Payroll and Expense Reimbursement Cycles

Payroll System

Internal Controls in the Example Payroll System

Additional Payroll System Controls

Control Matrix

Other Compensation Methods

Other Payroll Compensation Issues

Summary

Chapter 4 External Auditing and Forensic Investigations: Conceptual and Procedural Differences

Overview

Differences Between External Audit and Forensic Procedures and Principles

Summary

Glossary

Solutions

Chapter 1

Chapter 2

Chapter 3

Chapter 4

EULA

Chapter 1

THE ACQUISITIONS CYCLE: ORDERING, RECEIVING, AND WAREHOUSING

LEARNING OBJECTIVES

After completing this section, you should be able to do the following:

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Recall typical controls in the acquisitions cycle's ordering, receiving, and warehousing phases.

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Identify various forms (electronic or paper) used in the acquisitions cycle's ordering, receiving, and warehousing phases.

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Recall the processes in the acquisition cycle's ordering, receiving, and warehousing phases.

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Identify various types of errors or fraud that can occur if the acquisition cycle does not have adequate procedures or segregation of duties in the ordering, receiving, and warehousing phases.

The Acquisitions Cycle

The acquisitions cycle exists in all types of entities—government, not-for-profit, and for profit. Some of the most common ordering, receiving, and warehousing internal control objectives are

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authorization for the procurement of all goods and services at agreed-upon prices from approved vendors.

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all goods and services received are recorded and classified correctly and accurately.

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damaged or substandard goods are promptly identified and appropriate action is taken.

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payment is made for goods and services received and they have requisite quality.

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all goods are adequately safeguarded.

In many for profit entities, such as retail establishments and manufacturers, most transactions in the acquisitions cycle are for the procurement of either finished goods inventory for resale (retail establishments) or for raw materials inventory for production (manufacturers). These entities can also have a significant number of transactions for the procurement of services.

This section will address the ordering, receiving, and warehousing phases of a typical acquisitions cycle, noting where errors or fraud could occur, and presenting various types of internal controls to prevent and detect errors and irregularities. A control matrix will be presented to illustrate how controls can achieve relevant control objectives. Additionally, a fraud case is provided to illustrate this section's objectives.

Ordering

A typical acquisitions cycle's ordering, receiving, and warehousing phases are described as follows. Most entities will have variations to these examples within their own procurement processes, as it is appropriate to adjust controls to each entity's specific needs.

Assume that a large organization has numerous departments that use a variety of office supplies. A central purchasing department combines purchase requisitions from various departments in order to obtain quantity discounts on bulk purchases and also decrease the large amount of ordering and material handling costs that would be incurred if each department ordered its own supplies.

On a monthly basis, the departments within the large organization determine what supplies are needed by having a responsible employee observe the types and quantity of supplies on hand in the departmental supply rooms. A numerically sequenced purchase requisition is prepared by this employee and approved by the departmental manager. A copy of the purchase requisition is filed numerically in the requesting department and another copy is sent to the purchasing department.1

The purchasing department accounts for the numerical sequence of purchase requisitions by department to provide assurance that no purchase requisitions are missing. All identical items that are requested by different departments are summarized. The purchasing department is the only department that can issue purchase orders, and purchase order forms are under the control of the purchasing department.

The purchasing department has a list of approved vendors for each item that is used by the various departments. This approved-vendors list is constructed based upon factors such as length of time from order to delivery, payment terms, prices, and the quality of goods provided.

Once a supplier has been identified, the purchasing department creates a four-part numerically sequenced purchase order. The purchase order is approved by an appropriate supervisory employee in the purchasing department and serves as a written authorization for the vendor to ship the requested goods to the customer. The purchase order is sent to the vendor, copies of the purchase order are distributed to accounts payable and receiving, and a copy is retained in the purchasing department.

Additionally, company policy prohibits purchasing personnel from receiving gifts or other types of remuneration from vendors. This company policy is distributed to all vendors each year. A review of a sample of the purchase prices paid by the purchasing department and quality of goods received is conducted by an individual outside of the purchasing department each month.

Some acquisitions systems in larger entities require purchase requisitions to be approved by management other than management in the department that requisitioned the goods or services. An alternative to this policy is to have purchase requisitions above a certain dollar amount be approved by management outside of the requisitioning department.

Larger entities also oftentimes rotate the purchasing agents and suppliers so that no one purchasing agent works consistently with the same supplier. There is oftentimes a policy whereby new vendors are investigated by personnel outside of the purchasing, receiving, warehousing, and accounts payable departments.

See exhibit 1-1 for a flowchart of ordering process, exhibit 1-2 for an example of a purchase requisition, and exhibit 1-3 for an example of a purchase order.2

Receiving and Warehousing

When goods are received, receiving department personnel complete a four-part sequentially numbered receiving report. The receiving report includes information as to the number and quality of goods actually received (the number of goods received could be different from what was ordered due to numerous reasons such as the vendor being low on stock, theft of goods during shipment, and more). Exhibit 1-4 contains an example of a receiving report used by the United States General Services Administration (GSA).3 The person who receives and inspects the goods compares the purchase order number on the vendor's packing slip with the internal purchase order copy to provide assurance that the goods were actually ordered by an authorized individual. If the purchase order numbers do not agree or if the received goods are different from what is indicated on the purchase order then management is notified to resolve this error. The receiver's inspection of the goods provides assurance that the quality of goods received meets the organization's standards. The name of the person inspecting the goods is included on the receiving report and this employee can be contacted in case there are problems with either the quality or the amount of the purchased goods. Note that the GSA form has an option for a second person to inspect the goods; this would provide added assurance as to the quantity and quality of goods received.

What if purchased goods are damaged? Many receiving reports allow the receiver or inspector to note if goods received were either damaged or substandard in quality. A debit memo (the buyer's accounts payable is reduced) is issued to the vendor for these goods and the vendor will issue the buyer a credit memo (the vendor's accounts receivable is reduced). A copy of the debit memo is attached to the goods that are sent to the shipping department as authorization to ship the goods back to the vendor. A copy is also sent to accounts payable to adjust the vendor's invoice for the damaged or substandard goods.

What if purchased goods are okay? A copy of the receiving report is sent to accounts payable, purchasing, and the warehouse. Also, a copy of the receiving report is maintained in the receiving department as evidence of goods received. Accounts payable will match the receiving report, purchase order, and vendor invoice before payment is made for the goods. The purchasing department receives a copy of the receiving report and the open order is changed to filled status because the ordered goods have been received. Purchasing periodically reviews the outstanding purchase orders and investigates any long-outstanding orders.

The warehouse provides intermediate storage for the purchased goods. The goods are sent from the receiving department to the warehouse and the goods are counted again by warehouse personnel. The goods received are compared with the receiving report copy and the goods are stored. If there is a discrepancy between the number of goods noted on the receiving report and the number counted by warehouse personnel, then management is notified and the reason for the discrepancy is investigated and resolved.

Access to the warehouse should be restricted to authorized employees and enforced by the use of locks and other physical safeguards. All employees should be issued identification cards that must be worn at all times. All employees should be required to pass through a security entrance where the employees' identification cards are either examined by security personnel or can be used to gain access to approved areas. Goods susceptible to theft should have additional physical access controls, such as being kept in a separate locked gated area of the warehouse. For example, a distributor of fine crystal and china may keep its more valuable items locked in a separate part of the warehouse that is under twenty-four hour camera surveillance. In addition, security guards may patrol the premises.

A physical inventory count of goods should be conducted at least annually and differences between the count and recorded amounts should be investigated promptly. The inventory process should be observed by personnel independent of the warehousing function and periodic test counts should be made by these

Reviews for Purchasing, Inventory, and Cash Disbursements

[Anand Raj · Rating: 5 out of 5 stars]

love it book as great exposure on fraud and control arnd risk