Understanding and Auditing Purchasing Processes

Oct 3, 2024

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.