1. Problem EP 12-9
Listed below is a selection of items from the internal control questionnaire on payables in Appendix 12A, Page 694.
Are invoices, receiving reports, and purchase orders reviewed by the cheque signer?
Are cheques dated in the cash payments (disbursements) journal with the date of the cheque?
Are the quantity and quality of goods received determined at the time of receipt by receiving personnel independent of the purchasing department?
Are suppliers’ invoices matched against purchase orders and receiving reports before a liability is recorded?
Required: For each item:
Identify the control objective to which it applies.
Specify one test of controls audit procedure an auditor could use to determine whether the control was operating effectively.
Using your business experience, your logic, your imagination, or all three, give an example of an error or fraud that could occur if the control were absent or ineffective.

2. Solution to EP 12-9
Payables internal control questionnaire items
1. a) Purchases and accounts payable are authorized according to company policy (proper authorization).
b) For a sample of cash disbursements, vouch to approval signatures on invoices, receiving reports and purchase orders.
c) Liabilities might be incurred in the company's name without the knowledge of responsible officers.
2. a) Cash disbursements are recorded in the proper period (proper period cutoff, completeness)
b) Select a sample of dated cash disbursements and vouch to cancelled cheques, comparing the dates.
c) Cash disbursements could be recorded late, thus temporarily overstating cash.
3. a) Valid liabilities are recorded and none omitted (sound error checking practices).
b) Observe auditee personnel making comparisons. Review correcting journal entries that result from the comparison.
c) Purchases or other liabilities may fail to be recorded and the error not detected by any other means.
4. a) Recorded liabilities and cash disbursements valid and documented (sound record keeping).
b) Select a sample of recorded supplier invoices, and vouch them to purchase orders and receiving reports for proper quantities and prices.
c) The company might record overstated or understated liabilities.

3. Problem DC 12-13
On January 11, at the beginning of your annual audit of Grover Manufacturing Company’s financial statements for the year just ended December 31, the company president confides to you that an employee is living on a scale in excess of that which his salary would support.
The employee has been a buyer in the purchasing department for six years and has charge of purchasing all raw materials and supplies. He is authorized to sign purchase orders for amounts up to $2,000. Purchase orders in excess of $2,000 require the countersignature of the general purchasing agent.
The president understands that the usual audit of financial statements is not designed to disclose immaterial fraud or conflicts of interest, although such events may be discovered. The president authorizes you, however, to expand your regular audit procedures and to apply additional audit procedures to determine whether there is any evidence that the buyer has been misappropriating company funds or has been engaged in activities that are a conflict of interest.
Required:
List the audit procedures that you would apply to the company records and documents in attempt to do the following:
Discover evidence within the purchasing department of defalcations being committed by the buyer. Give the purpose of each audit procedure.
Provide leads about possible collusion between the buyer and suppliers. Give the purpose of each audit procedure.

4. DC12-13 Grover Manufacturing - Purchasing defalcation
1. The following audit procedures may be applied to company records and documents to discover evidence of defalcations being committed by the buyer.
Make a detailed review of the internal controls relating to purchasing to ascertain whether there are any weaknesses that might permit the buyer to commit an irregularity. The review should include the determination that the controls are actually being observed and that approvals and countersignatures are not being given perfunctorily. The auditor's tests should then be concentrated in the areas of weakness.
Examine a representative sample of purchase orders issued by the buyer to determine that they have been prepared and issued in accordance with established company policy, particularly with respect to the countersignature of purchase orders over $200. Determine whether any orders for amounts in excess of $200 were split into two or more orders to evade the $200 limitations.
Compare the representative sample of purchase orders with their related approved requisitions to ascertain that the purchase orders issued were for goods and services required by the business and are supported by an authorized document originated outside of the purchasing department.
Test the authenticity of the suppliers by reference to telephone directors, purchasing directories, credit-rating publications, etc. This step will disclose any dummy or fictitious suppliers through which the buyer might later obtain funds.
Review the disbursing procedures and examine paid cheques, giving particular attention to the payee and the endorsement. This step will indicate whether the buyer has access to cheques and might reveal any irregularity in their negotiation.
2. To discover evidence indicating possible collusion between the buyer' and authentic suppliers, the following audit steps might be applied:
Note whether one supplier appears to be heavily favored over others for goods available from many suppliers.
Compare the prices on suppliers' invoices for like items.
Compare prices on purchase orders and invoices with suppliers' catalogs, price lists, etc.
Examine competitive bids received by the purchasing department. If necessary, arrange to have bids obtained directly from suppliers, including some not dealt with by the auditee.
If the review of pricing data reveals that certain suppliers offer quantity discounts, rebates, etc., ascertain that the company receives all such allowances to which it is entitled.
Inspect suppliers' invoices and receiving reports, and trace receipts to perpetual inventory records for assurance that the material was received.
Compare the perpetual inventory records and the materials on hand for agreement. Also review the results of the taking of the physical inventory. Determine if any shortages discovered resulted from nonreceipt of materials.
As an overall check on the purchasing function, compare the activity in the accounts recording the buyer's purchases with activity in prior periods and account for any unusual fluctuations. In addition, review the perpetual inventory records for evidence of unbalanced inventory or unnecessary accumulation of material.