Reference no: EM133492960

You are an audit supervisor of Rajin Sangat & Co and you are reviewing the documentation describing Read Book Habit Bhd.'s purchases and payables system in preparation for the interim and final audit for the year ending 30 September 2018. The company is a retailer of books and has ten stores and a central warehouse, which holds the majority of the company's inventory. 19 Your firm has audited Read Book Habit Bhd. for several years and as such, audit documentation is available from the previous year's files, including internal control flowcharts and detailed notes of purchases and payables system policies and procedures. As far as you are aware, Read Book Habit Bhd.'s system of internal control has not changed from last year. The audit manager is keen for the team to utilize existing system documentation to ensure audit efficiency. An extract from the existing system notes is provided below.

Extract of purchases and payables system (From Notes SD2017/1.2.3(ii))

Store managers are responsible for ordering books for their shops. It is not currently possible for store managers to request books from any of the other nine stores. Customers who wish to order books, which are not in stock at the branch visited, are told to contact other stores directly or visit the company website. As the inventory levels fall below the required level in a store, the store manager raises a purchase requisition, completed the form and sent to the purchase order clerk, Miss Lin, for processing. She sends any orders above RM1,000.00 for authorization from the purchasing director. Receipts of goods from suppliers are processed by the warehouse team, who agree to the delivery of the purchase order, check the quantity and quality of goods and complete a sequentially numbered goods received note (GRN). The GRNs are sent to the accounts department every two weeks for processing. On receipt of the purchase invoice from the supplier, an accounts clerk matches it to the GRN. The invoice is then sent to the purchase ordering clerk, Miss Lin who processes it for payment. The finance director is given the total amount of the purchase by Miss Lin for the signing of the cheque. Supplier statement reconciliations are not performed.

Required:

In respect of the purchases and payables system for Read Book Habit Bhd.:

I) Describe at least four (4) internal control deficiencies relating to the purchase and payable system of Read Book Habit Bhd. and recommend a control to address each of the deficiencies.

1) Deficiency: Store managers are solely responsible for ordering books for their respective shops, and there is no centralized purchasing authority. This decentralized approach can lead to inefficiencies, duplication of orders, and potential overstocking or stockouts.

Recommendation: Implement a centralized purchasing system where all purchase requisitions are consolidated and reviewed by a designated purchasing department. This department can ensure proper coordination, volume discounts, and better control over inventory levels.

2) Deficiency: Miss Lin, the purchase order clerk, is responsible for both processing purchase requisitions and authorizing orders above a certain threshold. This lack of segregation of duties creates a potential risk of unauthorized purchases or fraudulent activities.

Recommendation: Assign the authorization of purchase orders above the threshold to a different individual, preferably the purchasing director or an authorized manager, to establish segregation of duties and ensure proper checks and balances.

 

3) Deficiency: The company does not perform supplier statement reconciliations. This omission can lead to errors or discrepancies in recording and paying invoices, missed discounts, and potential duplicate payments.

Recommendation: Implement a regular supplier statement reconciliation process where the accounts department compares supplier statements with the recorded invoices and payments. This control will help identify and resolve any discrepancies promptly.

 

4) Deficiency: The accounts clerk matches the purchase invoice only to the goods received note (GRN) without additional review or verification. This limited review may result in incorrect or fraudulent invoices being processed for payment.

Recommendation: Introduce a secondary review process for purchase invoices where a designated employee compares the invoice details with supporting documents such as purchase orders, GRNs, and contractual agreements. This additional review will help detect and prevent erroneous or unauthorized payments.

 

II) For each of the internal control deficiencies identified above, identify four (4) tests of controls that you will perform to assess if each of these controls if implemented, is operating effectively to reduce the identified deficiency.

1.Test of Controls for the centralized purchasing system recommendation:

a) Requisition Review: Select a sample of purchase requisitions and verify if they are consolidated and reviewed by the designated purchasing department before orders are placed.

b) Coordination Check: Review a sample of purchase orders and assess if there is evidence of proper coordination among different store managers, such as consolidated orders, volume discounts, or bulk purchasing.

c) Inventory Control: Analyze the inventory levels of different stores and compare them to historical data to determine if there is improved control over stock levels, minimizing stockouts and overstocking.

d) Cost Analysis: Review the purchasing records and assess if there is evidence of cost savings through negotiated contracts, discounts, or improved supplier management.

2. Test of Controls for the segregation of duties recommendation:

a) Authorization Log: Examine a sample of purchase orders above the threshold and verify if they are authorized by a different individual, such as the purchasing director or an authorized manager, rather than the purchase order clerk.

b) Approval Limit Check: Review the policies and procedures related to purchase order authorization and compare them to actual practice to ensure that the authorization threshold is clearly defined and consistently applied.

c) Audit Trail Analysis: Analyze the system logs or transaction records to identify any unauthorized or suspicious purchase orders that may have been processed by the purchase order clerk.

d) Management Review: Interview the purchasing director or authorized manager to ascertain their involvement in the purchase order authorization process and their understanding of their responsibilities.

3.Test of Controls for the supplier statement reconciliation recommendation:

a) Reconciliation Procedure Review: Assess the documented procedures for supplier statement reconciliation and compare them to actual practice to determine if they are being followed consistently.

b) Reconciliation Sample: Select a sample of supplier statements and verify if they have been reconciled with recorded invoices and payments, ensuring that any discrepancies are identified and resolved.

c) Follow-up Actions: Review the documentation of supplier statement reconciliations and evaluate if there is evidence of appropriate actions taken to address discrepancies, such as contacting suppliers, making adjustments, or initiating investigations.

d) Training and Awareness: Interview accounts department personnel to gauge their understanding of the supplier statement reconciliation process and verify if they have received proper training on this control procedure.

4.Test of Controls for the secondary review process for purchase invoices recommendation:

a) Review Policy and Procedures: Examine the documented policies and procedures related to purchase invoice review and compare them to actual practice to ensure they are being followed consistently.

b) Invoice Review Sample: Select a sample of purchase invoices and verify if they have been subject to the secondary review process, where designated employees compare the invoice details with supporting documents.

c) Error Detection Rate: Analyze a sample of purchase invoices processed after the secondary review and determine the rate of detection of incorrect or fraudulent invoices compared to invoices processed without the secondary review.

d) Employee Interviews: Interview designated employees responsible for the secondary review process and assess their understanding of their responsibilities, the criteria for review, and their level of adherence to the control procedure.

III) For each of the internal control deficiencies identified above, describe the substantive audit procedures that must be performed by auditors.