Auditing the Purchasing Process

Overview of the Lecture

• Discussion on auditing the purchasing process.
• Steps covered so far:
  1. Understanding the purchasing process.
  2. Identifying significant accounts and relevant assertions.
  3. Assessing risk and material misstatement.
  4. Evaluating the design of internal controls.

Walkthrough of the Purchasing Process

• Purpose: To map out the purchasing process and understand internal controls in place.
• Steps covered in the walkthrough:
  • Initial request for goods and services
  • Purchase order creation
  • Receiving report generation
  • Cash disbursement and accounting records updating.

Internal Controls Evaluation

• At each step, ask:
  • Has an internal control been designed to prevent or detect material misstatement?
• Currently focused on identifying internal controls before testing their effectiveness in the next step.

Entity Level Controls

• Importance of entity-level controls in the purchasing process.
• Key points to evaluate:
  • Active role of the audit committee (e.g., regular meetings, concerns about internal controls).
  • Existence of written policies and procedures for purchase authorization.
  • Requirement of authorized signatures for purchase requisition and orders.
  • Dollar limits for purchases for various managerial levels.
  • Monitoring of days payable outstanding.

Internal Controls Related to Management Assertions

• Key internal controls include:
  • Three-way match of purchase order, receiving report, and vendor invoice.
    • Validates occurrence and existence assertions.
  • Using pre-numbered documents to support completeness assertion.
  • Ensuring segregation of duties to mitigate fraud risk.

Importance of Segregation of Duties

• Avoiding overlap of responsibilities among employees to prevent fraud.
• Example: One employee should not handle purchase requisitions, purchasing, and receiving goods.
• Custody of assets and documents must be restricted.
  • Prevent unauthorized access to blank forms (e.g., purchase orders, checks).

Specific Internal Controls for Purchase Transactions

• Assertions and corresponding internal controls include:
  • Occurrence: Verify that purchases occurred (three-way match).
  • Completeness: Ensure all purchases are recorded (pre-numbered documents).
  • Authorization: Verify purchases are authorized and from approved vendors.
  • Accuracy: Check that prices and quantities are correct.
  • Cut-off: Ensure liabilities are recorded in the correct period (timely forwarding of receiving reports).
  • Classification: Properly classify purchases using a chart of accounts.

Cash Disbursement Transactions Internal Controls

• Internal controls for cash disbursements include:
  • Monthly bank reconciliations to verify occurrence assertion.
  • Maintaining segregation of duties.

Accounts Payable Internal Controls

• Assertions and internal controls for accounts payable:
  • Existence: Verify that liabilities are real obligations (approved vendor list, three-way match).
  • Completeness: Ensure all liabilities are recorded (using pre-numbered documents).
  • Cut-off: Check liabilities are recorded in the correct period by reviewing incoming payables post-year-end.

Next Steps

• The next lecture will focus on testing the effectiveness of the internal controls identified during the walkthrough.