8.45 Page 349 Fictitious Vendors, Theft, and Embezzlement. The following cases a

Question

8.45

Page 349

Fictitious Vendors, Theft, and Embezzlement. The following cases are designed like the ones in the chapter. Your assignment is to write the audit approach portion of the cases organized around these sections:

Objective. Express the objective in terms of the facts supposedly asserted in financial records, accounts, and statements.

Control. Write a brief explanation of desirable controls, missing controls, and especially the kinds of “deviations” that could arise from the situation described in the case.

Tests of controls. Write some procedures for getting evidence about existing controls, especially procedures that could discover deviations from controls. If there are no controls to test, then there are no procedures to perform; go to the next section. A “procedure” should instruct someone about the source(s) of evidence to tap and the work to do.

Audit of balance. Write some procedures for getting evidence about the existence, completeness, valuation or allocation, or rights and obligations assertions identified in your objective section.

Discovery summary. Write a short statement about the discovery you expect to accomplish with your procedures.

Purchasing Stars

Bailey Books Inc. is a retail distributor of upscale books, periodicals, and magazines. Bailey has 431 retail stores throughout the southeastern states. Three full-time purchasing agents work at corporate headquarters. They are responsible for purchasing all inventory at the best prices available from wholesale suppliers. They can purchase with or without obtaining competitive bids. The three purchasing agents are R. McGuire in charge of purchasing books, M. Garza in charge of purchasing magazines and periodicals, and L. Collins (manager of purchasing) in charge of ordering miscellaneous items such as paper products and store supplies.

One of the purchasing agents is suspected of taking kickbacks from vendors. In return, Bailey is thought to be paying inflated prices, which first are recorded in inventory and then in cost of goods sold and other expense accounts as the assets are sold or used.

The duties of Collins, the manager in charge, do not include audit or inspection of the performance of the other two purchasing agents. No one audits or reviews Collins's performance.

The purchasing system is computerized and detail records are retained. An extract from these records is in Exhibit 8.45.1.

EXHIBIT 8.45.1

This kickback scheme has been going on for two or three years. Bailey Books could have overpaid by several hundred thousand dollars.

EXHIBIT 8.45.1

Explanation / Answer

The following are the tests of control which are to be followed by the auditor of a company to ensure that the management is not responsible or aware about the fictitious vendors, theft and embezzlement.

A test of controls is an audit procedure to test the effectiveness of a control used by a client entity to prevent or detect material misstatements. Depending on the results of this test, auditors may choose to rely upon a client's system of controls as part of their auditing activities.

However, if the test reveals that controls are weak, the auditors will enhance their use of substantive testing, which usually increases the cost of an audit. The following are general classifications of tests of controls:

If the inspection approach is used, a test of controls is typically conducted for a sample of documents related to transactions that occurred throughout the year. Doing so provides evidence that the system of controls has operated in a reliable manner throughout the reporting period.

A test of controls is made irrespective of the dollar amount of the underlying business transaction. The main point of the test is to see if a control functions properly, so the dollar amount of a transaction is not of consequence to the goal of the test.

If the auditors encounter an error in a test of controls, they will expand the sample size and conduct further testing. If additional errors are found, they will consider whether there is a systematic controls problem that renders the controls ineffective, or if the errors appear to be isolated instances that do not reflect upon the overall effectiveness of the control in question.

Exisitng levels of control:

Bailey has 431 retail stores throughout the southeastern states. Three full-time purchasing agents work at corporate headquarters. They are responsible for purchasing all inventory at the best prices available from wholesale suppliers. They can purchase with or without obtaining competitive bids. The duties of Collins, the manager in charge, do not include audit or inspection of the performance of the other two purchasing agents. No one audits or reviews Collins's performance.

Desirable level of controls:

Bailey has 431 retail stores and only 3 agents have been appointed for the purchases, which is not adequate in comparison to the large number of stores. There must be atleast one agent appointed for each state or region. The procedure for selecting and buying the books by the agents is not right since they purchase from the suppliers without obtaining competitive bids. There must be a procedure to obtain bids from prospective suppliers and a procedure must be kept in place which should select the best supplier at the least cost. Collins being the manager in charge of purchasing should follow a procedure to check the processes followed by the other two agents and approve the suppliers selected by them. There also needs to be a higher level manager to check the performance of all three agents and approves of the processes followed by them for selection of suppliers. Monthly reports can be prepared by the agents and submit it to the higher level manager to keep a check on their processes. The inventory, cost of goods sold and expenses account needs to be selected on a sample basis and properly vouched for the authenticity of the transactions.

Audit of balance:

The following procedures can be adopted to get the evidence of existence or completeness of the procedures:

The auditor can get a balance confirmation from the suppliers on a monthly or weekly basis to match the same with the financials of the company. if there is a difference between the two, the auditor should ask the company to prepare a reconciliation for the difference. The company must follow these steps regularly to maintain uniformity in the balances of the suppliers and the company. A manager must be appointed to check whether the company has obtained the balance confirmations from the suppliers and reconciliation statement has been prepared before making the payment to the suppliers. The auditor should also do a thorough vouching of all the expense heads and check whether the transactions are supported by proper bills to ensure their veracity.

Discovery summary:

By following the above procedure, there will always be a check on the suppliers appointed and the agents will not be able to make excess payments to them as there would be monthly balance confirmation for the same and payments would be made only if the amounts in the confirmation matches with the balance in the financials of the company.

Related Questions

Navigate

• Browse (All)
• Browse 8
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.