Question

INTERNAL   CONTROL   ANALYSIS  
  
A   company   that   produces   component   parts   for   automobile   manufacturers   has   grown   rapidly   since   its   incorporation   several   years   ago.   Management   is   concerned   about   internal   controls   over   the   purchasing   cycle   because   the   cost   of   goods   sold   percentage   has   continued   to   rise   even   though   it   seems   that   many   of   the   raw   materials   and   supplies   used   in   production   are   costing   less.   The   following   description   of   the   purchasing   process   is   available:      
  
   Pre-numbered   purchase   requisitions   are   used   to   order   most   goods,   except   when   a   critical   need   is   identified   (1).   If   an   urgent   order   must   be   placed,   the   production   department   personnel   can   call   it   in   directly   to   the   vendor,   usually   with   same-day   delivery   (2).   A   purchase   requisition   is   ordinarily   completed   when   the   supply   of   raw   materials   falls   to   a   certain   reorder   point   as   determined   by   a   mathematical   formula   (3).       Purchase   requisitions   are   forwarded   to   the   purchasing   department   where   vendors   are   selected,   terms   are   negotiated,   and   orders   are   placed   using   pre-numbered   purchase   orders   (4).   Although   there   is   no   formal   approved   vendor   list,   the   purchasing   department   tries   to   maximize   volume   discounts   and   prefers   to   sole-source   purchases   as   much   as   possible   (5).           Four-part   purchase   orders   are   created—the   original   that   is   mailed   to   the   vendor   and   three   copies   for,   respectively,   the   requisitioning   department,   accounts   payable,   and   receiving   (6).       Upon   receipt   of   the   goods,   the   receiving   department   matches   the   item   description,   quantity   ordered,   and   vendor   per   the   accompanying   packing   slip   with   the   receiving   department’s   copy   of   the   purchase   order   (7).   To   prevent   loss   or   theft,   the   goods   are   not   unpacked   until   they   are   moved   to   the   warehouse   where   they   are   placed   into   inventory   (8).   The   receiving   department   prepares   a   receiving   report   and   forwards   it   along   with   the   goods   to   the   warehouse   for   safekeeping   (9).       Vendors   send   invoices   directly   to   the   accounts   payable   department   where,   upon   receipt,   the   accounts   payable   clerk   reconciles   the   invoice   with   the   department’s   purchase   order   copy   (10).   Based   on   this   reconciliation,   the   accounts   payable   clerk   prepares   a   voucher   and   forwards   it   to   the   accounting   department   for   controller   approval   and   general   ledger   entry   (11).   Once   recorded,   the   approved   voucher   is   returned   to   accounts   payable   to   serve   as   the   basis   for   check   creation   and   eventual   vendor   payment   (12).  
  
Required—Identify   in   a   cross-referenced   list   any   three   (3)   internal   control   deficiencies   in   the   process   described   above,   making   sure   to   explain   why   each   would   be   considered   as   such.

Answer 1

Internal Control Analysis

Internal Control Deficiencies

Inadequate documentation

Proper documentation gives proof of the primary transaction. The documentation confirms that all the purchase transaction is pre-numbered with an objective guaranteeing that all the underlying transactions are documented and accounted for. The pre-number of transaction help to avert the organization from recording the transaction two times because there will no identical number in the system. Proper and adequate documentation of transaction will ease the process of preparing financial statements and records of the organization. For example the pre-numbered purchase requisitions used to order most goods must be used in all transactions of the company to avoid recording the transaction twice.

Lack of control with authorization of transactions

The authorization of purchase transaction plays a important role in confirming that those losses are disallowed and avoided. The level of authorization is important in excluding inappropriate spending by the company. Authorizing transactions before placing order gives a chance to managers to assess purchasing decisions before implementing. Also the authorizing purchasing enables the managers to make sure that the purchase transaction will support the objectives and the goals of the company. For example, the act of the production department to call indirectly the vendor and deliver the product in the same day in an urgent order may compromise the internal control hence deficiencies will be realized.

No formal ethical policies and procedures

This control may result in inadequacies and embezzlement of the resources of the company. In the purchase transaction, the vendor list must be formally improved. Lack of formal approval of list of vendors may place the company into the risk of embezzlement of the critical resources. The prescribed ethical policies and procedures provide rules on how the resource embezzlement may be aligned with the objectives of the company.