Chapter 10

Auditing the Expenditure Cycle

Review Questions:

1. Differentiate between a purchase requisition and a purchase order.

Response: A purchase requisition is completed by the inventory control department when
a need for inventory items is detected. Purchase requisitions for office supplies and other
materials may also be completed by staff departments, such as marketing, finance, accounting,
and personnel. The purchasing department receives the purchase requisitions and, if necessary,
determines the appropriate vendor. If various departments have requisitioned the same order, the
purchasing department may consolidate all requests into one order so that any quantity discounts
and lower freight charges may be taken. In any case, the purchasing department prepares the
purchase order, which is sent to the vendor, accounts payable department, and the receiving
department (blind copy).

2. What purpose does a purchasing department serve?

Response: A purchasing department is able to research the quality and pricing of various
vendors. Its job is to monitor various supply sources and choose the highest quality good for a
given price, with reliable delivery. The purchasing department may also take advantage of
quantity discounts, especially when two or more manufacturing facilities are involved.

3. Distinguish between an accounts payable file and a vouchers payable file.

Response: An accounts payable file contains all source documents, including invoices,
organized by payment date. As the due dates come close to the current date, the invoices are
pulled from the file and paid. Under the voucher system, the accounts payable clerk prepares a
cash disbursements voucher upon receipt of all source documents. Each cash disbursements
voucher represents payment to one vendor. Multiple invoices may be paid with one voucher. The
voucher system allows better control over cash disbursements because cash vouchers are assigned
and tracked.

4. What are the logical steps of the cash disbursements system?

Response: The three logical steps of the cash disbursements system are
1. Identify liabilities due
2.Prepare case disbursement
3. Update accounts payable record
4. Post to the general ledger

5. What general ledger journal entries are triggered by the purchases system?
Response:
Accounts Payable:
Inventory Control Debit
Accounts Payable Credit

Cash Disbursements:
Accounts Payable Debit
Cash Credit

6. What two types of exposure can close supervision of the receiving department reduce?
Response: Large quantities of valuable assets flow through the receiving department on
their way to the warehouse. Close supervision here reduces the chances of two types of exposure:
failure to properly inspect the assets and the theft of assets.

7. What steps of independent verification does the general ledger department perform?
Response: The general ledger department receives journal vouchers from inventory
control, accounts payable, and cash disbursements. With these summary figures, the general
ledger clerk verifies that
a. total obligations recorded equal total inventories received.
b. total reductions in accounts payable equal total disbursements of cash.

8. What is (are) the purpose(s) of maintaining a valid vendor file?

Response: As a control against unauthorized payments, comparing the vendor number on
the voucher with a valid vendor file validates all entries in the voucher file. If the vendor number
is not on file, the record is presumed to be invalid and is diverted to an error file for management
review.

9. What is the purpose of the blind copy of the purchase order?

Response: A blind purchase order has all the relevant information about the goods being
received except for the quantities and prices. To obtain the information on quantities, which is
needed for the receiving report, the receiving personnel are forced to physically count and inspect
the goods. If receiving clerks were provided with quantity information through formal
documentation (i.e., the purchase order), they may be tempted to transfer this information to the
receiving report without performing a physical count.

10. Give one advantage of using a vouchers payable system?

Response: Vouchers provide improved control over cash disbursement, and they allow
firms to consolidate several payments to the same supplier on a single voucher, thus reducing the
number of checks written.

11. How do computerized purchasing systems help to reduce the risk of purchasing bottlenecks?
Response: Routine purchases can be automated, reducing the time lag between order,
arrival and recording of inventory. By freeing purchasing agents from routine work, such as
preparing purchase orders and mailing them to the vendors, attention can be focused on problem
orders (such as special items or those in short supply).
12. Which document is used by cost accounting to allocate direct labor charges to work-in-
process?
Response: Job tickets capture the time spent on each job during the day and are used to
allocate the labor charges to the work-in-process accounts.
13. Which department authorizes changes in employee pay rates?
Response: The personnel department, through the personnel action form authorizes
changes to employee pay rates.

14. Why should the employee’s supervisor not distribute paychecks?

Response: A form of payroll fraud involves a supervisor submitting fraudulent time
cards for nonexistent employees. The resulting paychecks, when given to the supervisor are
then cashed by the supervisor. This type of fraud can be reduced or eliminated by using a
paymaster to distribute paychecks to employees in person. Any uncollected paychecks are
then returned to payroll.

15. Why should employee paychecks be drawn against a special checking account?
Response: A separate imprest account is established for the exact amount of the
payroll based on the payroll summary. When the paychecks are cashed, this account should
clear leaving a zero balance. Any errors in checks (additional checks or abnormal amounts)
would result in a non-zero balance in the imprest account and/or some paycheck would not
clear. This will alert management to the problem so corrective action can be taken.

16. Why should employees clocking on and off the job be supervised?
Response: A form of payroll fraud involves employees clocking the time cards of
absent employees. By supervising the clocking in and out process, this fraud can be reduced
or eliminated.

17. What is a personnel action form?

Response: The advantages of a batch system with direct access files are increased
efficiency since master files (such as the general ledger) need not be recreated with each
update thus permitting more frequent reconciliation. The disadvantage is the need to take
extra measures to ensure the back-up and data integrity within the system.

18. What tasks does a payroll clerk perform upon receipt of hours-worked data from the
production department?

The payroll then performs the following tasks.

1. Prepares the payroll register showing gross pay, deductions, overtime
pay, and net pay.
2. Enters the above information into the employee payroll records.
3. Prepares employee paychecks .
4. Sends the paychecks to the paymaster or other distribute-paycheck function.
5. Files the time cards, personnel action form, and copy of the payroll register (not
shown).

19. What documents constitute the audit trail for payroll?

Response: Timecards, personnel action forms, job tickets, labor distribution
summary.

Discussion Questions

1. What is the importance of the job ticket? Illustrate the flow of this document and its
information from inception to impact on the financial statements.
Response: The job ticket is used to allocate each labor hour of work to specific WIP
accounts. These job tickets are very important for cost accounting. The job tickets are completed
by production workers as they capture the total amount of time that they spend on each
production job. Upon completion, these are routed to the cost accountants who use them to post
the labor costs to specific WIP accounts such as direct labor, indirect labor, and overhead. The
cost accountant prepares a labor distribution summary that contains the information for the
general ledger clerk to make the necessary entries to the general ledger accounts.

2. What documents support the payment of an invoice? Discuss where these documents originate
and the resulting control implications.
Response: The payment of an invoice may be supported by the purchase requisition,
purchase order, and receiving report (in addition to the invoice itself). The purchase requisition
originates from inventory control and represents the inventory requirements. The purchase order
originates from the purchasing department and represents an order placed. The receiving report
originates from the receiving department and represents the quantity and types of goods received.
Thus, the accounts payable must determine (a) that the goods ordered were requested by some
department (i.e., inventory control) other than purchasing, (b) that purchasing ordered the goods
from a valid vendor, and (c) that the goods were actually received. If all three of the conditions
are met, then and only then should the invoice be paid. Further, payments should be made for
only those goods received in good shape.

3. Discuss the time lags between realizing and recognizing economic events in the purchase and
payroll systems. What is the accounting profession’s view on this matter as it pertains to these
two systems?
Response: For accounts payable, a time lag exists between the time the good that is
purchased is received and the recording of the liability to the vendor. The receipt of an invoice is
the event that usually causes the liability to the vendor to be recorded. The time lag may range
from virtually nothing for fully integrated EDI systems to a few days. Thus, during this slight lag
in the recording process, liabilities are understated.
For payroll costs, wages to workers accrue each minute, hour, or day that they work.
However, these costs are not recorded as a liability during the time between when the workers
earn their wages and when they are paid. These time lags typically average from half a week to a
week.
Neither of these time lags are of concern unless the firm is closing its books or preparing
interim financial statements. At these points, however, estimates or accruals of the amounts owed
should be made and the books adjusted.

4. Discuss the importance of supervision controls in the receiving department and the reasons
behind blind fields on the receiving report, such as quantity and price.
Response: The receiving clerks have access to many of the firm’s assets: its inventory.
Two exposures potentially exist: (a) the clerk failing to perform his or her duty and (b) the clerk
pilfering or stealing the inventory. Thus, the copy of the purchase order used for this inspection
should have the quantities and amounts covered so that they may not be read. If the quantity is
printed on the receiving clerk’s copy of the purchase order, he or she may be tempted to skip the
physical inspection and the company may pay for inventory it did not receive or that is damaged.
A supervisor must remove the packing slip that contains quantity information to make sure the
receiving clerk actually inspects the goods. If the value of the inventory is listed, the employee
may be tempted to steal some of the inventory. Close supervision should deter employees from
stealing.

5. How does the procedure for determining inventory requirements differ between a basic batch
processing system and batch processing with real-time data input of sales and receipts of
inventory?
Response: A system that employs real-time data entry of sales will have the inventory
levels updated more frequently. Thus, when a sale depletes the inventory level to the reorder
point, the system will flag it for reorder more quickly than if it had to wait for a batch update of
the inventory records. The sooner the item is ordered, the sooner it will be received. With respect
to the real-time receipt of inventory, the inventory will be updated immediately to show the
accurate amount that is on hand. A customer wishing to know how soon an item will be shipped
will receive more accurate information regarding the status of the firm’s inventory levels. Thus,
the customer benefits from better stocking of inventory and better information regarding the
inventory levels.

6. What advantages are achieved in choosing:

a. a basic batch computer system over a manual system?
b. a batch system with real-time data input over a basic batch system?

Response:
a. The basic batch system provides the following benefits over a manual system: improved
inventory control, better cash management, reduction in time lag of inventory entries, increases in
the efficiency of the purchasing department, and a reduction in paper documentation.
b. The real-time data input system provides the following benefits over a batch system:
reduction in the time lag in record keeping, elimination of routine manual procedures, and an
even greater reduction in paper documentation.

7. Discuss the major control implications of batch systems with real-time data input. What
compensating procedures are available?
Response: The first control implication is that a fundamental separation between
authorization and transaction processing no longer exists. The computer programs both authorize
and process the orders and issue checks to the vendors. The compensating control is to provide
transaction listings and summary reports that describe the automated activities taken by the
system to management. In order for these controls to work, the managers must take the time to
carefully review these reports.
The second control implication is that the accounting records as well as the computer
programs reside on magnetic disks. These disks should not be accessed by any individuals not
authorized to access them in any fashion. The compensating control is to employ hardware,
software, and procedural controls over the data stores.

8. Discuss some specific examples of how information systems can reduce time lags that
positively affect an organization.
Response: One example is by reducing the time it takes to record the receipt of inventory
into the inventory records that are used to inform customers whether or not their requested item is
available. Also, the inventory levels are also reduced more quickly for those inventories that are
being shipped. With a reduced time lag, the risk of promising to ship an item to another customer
when it is not available is greatly reduced. Further, the automated system will be less likely to pay
an invoice too early, while at the same time not missing the discount period. Thus, cash
management is improved.

9. Discuss some service industries that may require their workers to use job tickets.
Response: Law firms require their employees to log the amount of time spent on each
client for billing purposes. Accounting firms also require their employees to keep job tickets for
the time they spend on each client. Car repair shops are another example. The mechanic must
keep track of how much time she or he spends working on each automobile.

10. Payroll is often used as a good example of batch processing using sequential files. Explain
why.
Response: Sequential files are appropriate because most if not all payroll records on the
master payroll file are updated during the payroll processing run.

Multiple Choice

1. B
2. B
3. C
4. B
5. D
6. C
7. B
8. D
9. C
10. C
11. B
12. A
13. C
14. C
15. C

Problems

1. Payroll Fraud
John Smith worked in the stockyard of a large building supply company. One day he
unexpectedly and without notice left for California never to return. His foreman seized the
opportunity to continue to submit timecards for John to the payroll department. Each week, as
part of his normal duties, the foreman received the employee paychecks from payroll and
distributed them to the workers on his shift. Because John Smith was not present to collect his
paycheck, the foreman forged John’s name and cashed it.

Required:
Describe two control techniques to prevent or detect this fraud scheme.

Response:
a. An employee action report from the personnel department should list all current
employees. Time cards for terminated or nonexistent employees should be identified when
reconciled with the personnel report.
b. An independent paymaster should distribute the paychecks to the employees. If an
employee is not present to receive the paycheck, it should be returned to the payroll department.

2. Payroll Controls
Refer to the Problem 2 flowchart in the text.
Required:
a. What risks are associated with the payroll procedures depicted in the flowchart?
b. Discuss two control techniques that will reduce or eliminate the risks.

Response:
a. The payroll department has no independent information as to changes in an employee’s
status. For example, the foreman may continue to submit timecards for terminated employees.
Because the foreman also distributes paychecks, he could steal and forge the uncollected checks.
b. i. An employee action report from the personnel department should list all current
employees. Timecards for terminated or nonexistent employees should be identified when
reconciled with the personnel report.
ii. An independent paymaster should distribute the paychecks to the employees. If an
employee is not present to receive the paycheck, it will be returned to the payroll department.

3. Payroll Controls
Sherman Company employs 400 production, maintenance, and janitorial workers in eight
separate departments. In addition to supervising operations, the supervisors of the departments
are responsible for recruiting, hiring, and firing workers within their areas of responsibility. The
organization attracts casual labor and experiences a 20 to 30 percent turnover rate in employees
per year. A portion of Sherman Company’s payroll procedures are as follows:
Employees clock on and off the job each day to record their attendance timecards. Each
department has its own clock machine that is located in an unattended room away from the main
production area. Each week, the supervisors gather the timecards, review them for accuracy, and
sign and submit them to the payroll department for processing. In addition, the supervisors submit
personnel action forms to reflect newly hired and terminated employees. From these documents,
the payroll clerk prepares payroll checks and updates the employee records. The supervisor of the
payroll department signs the paychecks and sends them to the department supervisors for
distribution to the employees. A payroll register is sent to accounts payable for approval. Based
on this approval, the cash disbursements clerk transfers funds into a payroll clearing account.

Required:
Discuss the risks for payroll fraud in the Sherman Company payroll system. What controls would
you implement to reduce the risks? Use the SAS 78 framework of control activities to organize
your response.

Response:
a. Risks
 Department supervisors have too much control over human resources. They are responsible
for recruiting, hiring, and firing.
 The high degree of casual labor creates an environment that lends itself to abuse.
 High employee turnover rate makes identifying absent or nonexistent employees difficult.
 Clock machines are unsupervised and located in nonprominent areas.
 Department supervisors submit personnel action forms.
 Department supervisors distribute the paychecks to the employees; checks written for
nonexistent employees could be kept and cashed by the supervisors.
b. Controls
 Authorization: A separated personnel function should be established to account for
employees and to authorize their payment
 Segregation of Duties: The department supervisors should not distribute the paychecks to
 employees. This should be the task of a paymaster.
 Supervision: The clocking in and out process should be supervised.

4. Flowchart Analysis
Examine the Problem 4 diagram presented in the text and indicate any incorrect initiation and/or
transfer of documentation. What problems could this cause?
Response: The purchase requisition should originate from the inventory control
department after someone has reviewed the records to determine if and how much of an inventory
item needs to be ordered. If purchasing agents are allowed to authorize purchase requisitions,
they might be tempted to buy items not needed in order to reap benefits and/or kickbacks from
the vendor. The purchase order that is sent to receiving is not said to be a blind copy, and this
might cause employees to either shirk their responsibilities and not count the inventory or to steal
some units because they know their value. Further, receiving should retain a copy of the receiving
report in its files along with the purchase order and packing slip. The inventory control
department should not prepare a journal voucher to send to the general ledger department; rather
it should prepare summary information that the general ledger department can use to reconcile the
inventory control account with inventory subsidiary summary. The accounts payable department
needs to post the liability to the accounts payable subsidiary ledger. The subsidiary accounts
payable ledger will not balance with the control account in the general ledger if these postings are
not made.

5. Accounting Records and Files

Indicate which department—accounts payable, cash disbursements, data processing, purchasing,
inventory, or receiving—has ownership over the following files and registers:

a. Open Purchase Order file

b. Purchase Requisition file
c. Open Purchase Requisition file
d. Closed Purchase Requisition file
e. Inventory file
f. Closed Purchase Order file
g. Valid Vendor file
h. Voucher register
i. Open Vouchers payable file
j. Receiving Report file
k. Closed Voucher file
l. Check register (cash disbursements journal)

Response:
a. purchasing
b. inventory control
c. inventory control
d. inventory control
e. inventory control
f. purchasing
g. accounts payable
h. accounts payable
i. accounts payable
j. receiving
k. accounts payable
 l. cash disbursements

6. Source Documents Identification

Refer to the Problem 6 figure presented in the text, which shows typical expenditure cycle files
and attributes. Explain, in detail, the process by which these data are obtained and used in the
requisition, purchase, and payment to inventory.

Response: First, the Inventory Master file is searched to determine if the Quantity on Hand is
less than or equal to the Reorder Point, which is a predetermined point at which the firm orders
more inventory. If it is less than or equal to the reorder point and the Quantity on Order is not
flagged as true, then the EOQ (a predetermined optimal order amount) is used to order the
Inventory Number item, which is an assigned number and described by the Description field.
The item is ordered from a specified Vendor in the Vendor file, and this information is stored in
the Inventory Master file. A purchase requisition is filled out and a Purchase Requisition
Number is assigned to the requisition. The Inventory Number, Quantity on Order, Vendor
Number, and Unit Standard Cost are recorded. The vendor Address, Terms of Trade, and
Lead Time are obtained from the Vendor file. If the Lead Time is too long, a different vendor
may need to be chosen or the price paid may be higher than the predetermined Standard Cost for
the item. At this point, the Date of Last Order field in the vendor file is updated.
The purchasing department then completes a purchase order and places it into the Open
Purchase Order file until the order is completed. First, the purchasing clerk assigns a
Purchase Order Number and fills in the corresponding Purchase Order Number. The
following information is also copied to the purchase order file from the above-mentioned records:
Purchase Requisition Number, Inventory Number, Quantity on Order, Vendor Number,
Vendor Address, and Standard Cost. The Expected Invoice Amount is determined by
multiplying the expected price times the quantity ordered.
When the inventory is received, the Inventory Master File is updated: the Quantity on
Hand is increased by the number of units received, and the Total Inventory Cost is updated. In
the Open Purchase Order file, the field Rec Flag is checked to indicate that the goods have been
received.
When the vendor’s invoice is received, the Invoice Flag field in the Open Purchase
Order file is checked to indicate that the invoice has been received. Further, the accounts payable
department adds a new record to the Voucher Register. This voucher register record is assigned a
Voucher Number, and the following information is recorded in it: Purchase Order Number,
Purchase Requisition Number, Inventory Number, Quantity on Order, Vendor Number,
Address, Standard Cost, and Expected Invoice Amount. The invoice Due Date is also noted
so that the disbursement may be made as close to the due date as possible without missing any
discounts offered.

7. Internal Control
Using the flowchart of a purchases system presented in Problem 7 of the text, identify six major
control weaknesses in the system. Discuss and classify each weakness in accordance with SAS
78.

Response:
 Authorization: The purchases function is not authorized from inventory control.
 Accounting Records: Inventory records are updated based on the purchase order rather
than the receiving report or invoice.
 Accounting Records: The accounts payable subsidiary ledger is updated based only on the
invoice. There is no reconciliation with supporting documents.
  Accounting Records: There is no cash disbursements journal or check register in use.
 Accounting Records/Segregation of Functions: The receiving department prepares the
receiving report directly from the packing slip. A blind copy of the purchase order should
go to the receiving clerk to control this activity. A supervisor should take possession of
the packing slip that contains relevant data and oversee the inspection process.
 Accounting Records/Independent Verification: The general ledger department should
receive journal vouchers or batch totals from inventory control, cash disbursements, and
accounts payable. These are used to keep the general ledger control accounts current and
to verify the overall accounting accuracy of the process.

8. Purchase Discounts Lost

Estimate the money that could be saved by the accounts payable and cash disbursements
departments if a basic batch processing system were implemented. Assume that the clerical
workers cost the firm $12 per hour, and that 13,000 vouchers are prepared, and that 5,000 checks
are written per year. Assume that total cash disbursements to vendors amount to $5 million per
year. Due to sloppy bookkeeping, the current system takes advantage of only about 25 percent of
the discounts offered by vendors for timely payments. The average discount is 2 percent if
payment is made within 10 days. Payments are currently made on about the 15th day after the
invoice is received. Make your own assumptions (and state them) regarding how long specific
tasks will take. Also discuss any intangible benefits of the system. (Don’t worry about excessive
paper documentation costs.)

Response: This firm processes approximately 52 vouchers per day and 20 checks per day. At a
minimum, the firm would benefit from the purchase discounts that would not be lost due to
sloppy bookkeeping: $5,000,000 × 75% = $3,750,000 × 2% discount = $75,000 savings per
year Even after deducting for any interest lost at 5 percent on the funds that remain in the bank
the extra 5 days: ($3,750,000 × 5%)(5/365) = $2,569. Thus, the net savings would be $72,431.
An added benefit may be that one less worker is needed. If this is true, the savings would be
approximately $25,000 before considering employee payroll taxes and costs of benefits.
Other benefits would include fewer errors, and thus fewer vendor complaints and better
control and reports over cash disbursements.

9. Data Processing Output

Using the information provided in Problem 8 present in the text, discuss all transaction listings
and summary reports that would be necessary for a batch system with real-time input of data.

Response: This answer assumes that the inventory and purchase order records are not on the
computer system. Upon receipt of an invoice, the clerk would reconcile the amount with the
purchase requisition, purchase order, and receiving report. A cash disbursements voucher would
be filled out and input immediately into the system; any input errors would require immediate
correction. Thus, all records in the voucher file would be clean records ready for processing. The
voucher records would be accumulated and processed together at the end of the day. A voucher
register would be generated and printed. The system will automatically update the accounts
payable subsidiary ledger and ensure that the debits and credits to the subsidiary ledger equal the
batch totals. A summary journal voucher will be prepared automatically for the general ledger
clerk.
As the system determines that an invoice needs to be paid, it will flag it for check writing
procedures. The checks will be prepared as well as a check register. The subsidiary ledger will be
updated, and a summary journal voucher will be prepared automatically for the general ledger
clerk.
10. Internal Control
Discuss any control weaknesses found in the Problem 10 flowchart presented in the text.
Recommend any necessary changes.

Response: The checks should be processed through accounts payable and the cash disbursement
departments. The payroll personnel should not have access to a bank account with funds. The
checks should be prepared, and the money should be transferred into the payroll account by the
cash disbursements department. The paychecks should not be handled by the payroll personnel
before being received by the paymaster because payroll personnel could withhold a dummy check
that was processed against a terminated employee. Actually, the personnel action forms (new
employees and terminated employees) should be processed by the personnel department rather
than the payroll department. The payroll department should use this master list to verify the
employees to whom checks are issued.

11. Internal Control (CMA 1288 5-3)

Lexsteel is a leading manufacturer of steel furniture. Although the company has manufacturing
plants and distribution facilities throughout the United States, the purchasing, accounting, and
treasury functions are centralized at corporate headquarters.
While discussing the management letter with the external auditors, Ray Lansdown,
controller of Lexsteel, became aware of potential problems with the accounts payable system.
The auditors had to perform additional audit procedures to attest to the validity of accounts
payable and cutoff procedures. The auditors have recommended that a detailed systems study be
made of the current procedures. Such a study would not only assess the exposure of the company
to potential embezzlement and fraud, but would also identify ways to improve management
controls.
Lansdown has assigned the study task to Dolores Smith, a relatively new accountant in the
department. Because Smith could not find adequate documentation of the accounts payable
procedures, she interviewed those employees involved and constructed a flowchart of the current
system. The Problem 11 flowchart is presented in the text, and a description of the current
procedures is presented below.

Computer Resources Available

The host computer mainframe is located at corporate headquarters with interactive, remote job-
entry terminals at each branch location. In general, data entry occurs at the source and is
transmitted to an integrated database maintained on the host computer. Data transmission is made
between the branch offices and the host computer over leased telephone lines. The software
allows flexibility for managing user access and editing data input.

Procedures for Purchasing Raw Materials

Production orders and appropriate bills of materials are generated by the host computer at
corporate headquarters. Based on these bills of materials, purchase orders for raw materials are
generated by the centralized purchasing function and mailed directly to the vendors.Each
purchase order instructs the vendor to ship the materials directly to the appropriate manufacturing
plant. Assuming that the necessary purchase orders have been issued, the manufacturing plants
proceed with the production orders received from corporate headquarters.
When goods are received, the manufacturing plant examines and verifies the count with the
packing slip and transmits the receiving data to accounts payable at corporate headquarters. In the
event that raw material deliveries fall behind production, each branch manager is given the
authority to order materials and issue emergency purchase orders directly to the vendors. Data
about the emergency orders and verification of materials receipt are transmitted via computer to
accounts payable at corporate headquarters. Because the company employs a computerized
perpetual inventory system, physical counts of raw materials are deemed not to be cost effective
and are not performed.

Accounts Payable Procedures

Vendor invoices are mailed directly to corporate headquarters and entered by accounts payable
personnel when received; this often occurs before the receiving data are transmitted from the
branch offices. The final day of the invoice term for payment is entered as the payment due date.
This due date must often be calculated by the data entry person using information listed on the
invoice.
Once a week, invoices due the following week are printed in chronological entry order on a
payment listing, and the corresponding checks are drawn. The checks and the payment listing are
sent to the treasurer’s office for signature and mailing to the payee. The check number is printed
by the computer and displayed on the check, and the payment listing is validated as the checks are
signed. After the checks are mailed, the payment listing is returned to accounts payable for filing.
When there is insufficient cash to pay all the invoices, certain checks and the payment listing are
retained by the treasurer until all checks can be paid. When the remaining checks are mailed, the
listing is then returned to accounts payable. Often, weekly check mailings include a few checks
from the previous week, but rarely are there more than two weekly listings involved.
When accounts payable receives the payment listing back from the treasurer’s office, the
expenses are distributed, coded, and posted to the appropriate plant or cost center accounts.
Weekly summary performance reports are processed by accounts payable for each cost center and
branch location reflecting all data entry to that point.

Required:
a. Identify and discuss three areas where Lexsteel Corporation may be exposed to fraud or
embezzlement due to weaknesses in the procedures described, and recommend improvements to
correct these weaknesses.
b. Describe three areas where management information could be distorted due to
weaknesses in the procedures, and recommend improvements to correct these thatweaknesses.
c. Identify three strengths in the procedures described and explain why they are strengths.

Response:
a. Three areas where Lexsteel Corporation may be exposed to fraud or embezzlement due
to weaknesses in its procedures, and the recommended improvements include the following.

Weakness
i. Branch managers are permitted to
issue purchase orders in emergencies
by dealing directly with the vendor,
avoiding purchasing controls. The
branch manager can decide when an
“emergency” exists and is permitted
to subjectively choose a vendor.
ii. Invoices are sent to and directly entered
accounts payable, without authorization
or verification documentation from
the purchasing or receiving departments.
Payments for undesired or unreceived
goods could be processed.
Recommendation
A procedure for expediting
orders should be developed
for the purchasing department.
Lexsteel should require proper
authorization and verification
documentation (i.e. purchase
order and receiving report)
prior to payment.
iii. Checks are prepared on invoices.
There is no supporting documentation
attached to the checks when they are
forwarded to the treasurer for payment.
The invoices cannot be cancelled after
payment, allowing the possibility of a
second payment of the same invoice.
Checks should be paid based on the
original invoice only after it has been
verified to the original purchase order
and receiving report. The invoices
should be cancelled after the checks
are signed.

b. Three areas where management information could be distorted due to weaknesses in the
procedures, and the recommended improvements include the following.
Weakness
i. Cash balances will be distorted
because all checks are drawn when
due but may be held for future
mailing when sufficient cash is
available. Cash management will
also be affected by inaccurate due
dates, lack of procedures for taking
vendor discounts, and inaccurate
information for EOQ calculations.
ii. Accounts payable information will
be distorted by drawing checks and
then holding for future payment, by
entering invoices without support-
ing documentation, and by inaccurate
receiving documentation. In addition,
inaccurate due dates could damage
vendor relations.
iii. Inventory balances are likely to
be misstated because of lack of physical
counts, poor receiving documentation,
and weak accounts payable procedures.
The lack of control over emergency
orders could distort inventory balances
and cause duplicate purchases.
Recommendation
Checks should be drawn only when
cash is available and mailed
immediately. Procedures should be
established for taking advantage of
vendor discounts when appropriate.
Invoices should not be entered into the
system until matched with supporting
documents, and receiving documents
should be matched against original
purchase orders. Due dates should be
calculated from the date goods are
received.
Procedures for cycle counting with
periodic reconciliation of book to
physical amount should be
implemented.

c. Strengths in the procedures described include the following:

i. The company has a centralized EDP system and database in place. This eliminates duplication
of effort and data redundancy while improving data integrity, efficiency, productivity, and timely
management information.
ii. Most purchase orders are issued by the centralized purchasing department from computerized
production orders or bills of material. This limits overstocking of materials inventory and
employs specialized expertise in the purchasing function.
iii. The functions of purchasing, production control, accounts payable, and cash disbursements
are centralized at the corporate headquarters. This improves management control and avoids a
duplication of efforts. The separated departments help maintain internal control by the
segregation of duties for authorization, payment, and coding.

12. Human Resource Data Management

In a payroll system with real-time processing of human resource management data, control issues
become very important. List some items in this system that could be very sensitive or
controversial. Also describe what types of data must be carefully guarded to ensure that they are
not altered. Discuss some control procedures that might be put into place to guard against
unwanted changes to employee’s records.

Response: The data contained in a human resource management database are extremely
sensitive. Payroll employees should be able to verify that an employee has the status of an active
employee, but should not be able to change this status. The personnel employees, on the other
hand, should be able to activate new employees and change the status of an employee from active
to terminated. The personnel employees should not be able to submit timecards for employees.
This separation of tasks prevents either the payroll employees or the personnel employees from
processing paychecks for nonexistent or terminated employees.
The payroll employees should only be able to retrieve information that is necessary for
payroll. The human resource database will probably contain other information that the payroll
employees have no business viewing, such as performance evaluation data, health records,
pension plan balances, and injury claims. Thus, the central location of data needs good controls to
make sure that these sensitive data cannot be viewed or tampered with. Performance evaluation
data is very sensitive, and passwords should be necessary to access such information. Payroll rate
data are also very sensitive and should not be able to be tampered with.

13. Unrecorded Liabilities

You are auditing the financial statements of a New York City company that buys a product from
a manufacturer in Los Angeles. The buyer closes its books on June 30. Assume the following
details:
Terms of trade: FOB shipping point
June 10, buyer sends purchase order to seller
June 15, seller ships goods
July 5, buyer receives goods
July 10, buyer receives seller’s invoice

Required:
a. Could this transaction have resulted in an unrecorded liability in the buyer’s financial
statements?
b. If yes, what documents provide audit trail evidence of the liability?
c. On what date did the buyer realize the liability?
d. On what date did the buyer recognize the liability?
New assumption:
Terms of trade: free on board destination
e. Could this transaction have resulted in an unrecorded liability in the buyer’s financial
statements?
f. If yes, what documents provide audit trail evidence of the liability?
g. On what date did the buyer realize the liability?
h. On what date did the buyer recognize the liability?

Response:
Term FOB shipping point:
a. Yes
b. The best evidence is provided by the Purchase Order and Bill of Lading
Purchase Order—is evidence that the item was ordered, but does not indicate when it was
shipped.
Bill of Lading—reviewed post-period; will indicate when the goods were shipped
Receiving Report—prepared post-period; establishes possession but may not indicate when goods
were shipped
c. June 15
d. July 10
Term FOB destination:
e. No
f. N/A
g. July 5
h. July 15

14. Inventory Ordering Alternatives

Refer to Figure 10-2 in the text, which illustrates three alternative methods of ordering inventory.

Required:
a. Distinguish between a purchase requisition and a purchase order.
b. Discuss the primary advantage of alternative two over alternative one. Be specific.
c. Under what circumstances can you envision management using alternative one rather
than alternative two?

Response:
a. A purchase requisition is created when an item of inventory is needed (e.g., fallen
below the reorder point) and authorizes its purchase. A purchase order is created from
requisitions to the same vendor. Thus, one purchase order may contain many purchase
requisitions.
b. The system shown in alternative two expedites the ordering process by distributing the
purchase orders directly to the vendors and internal users, thus bypassing the purchasing
department completely. This shortens the time between recognizing the need for inventory and
mailing the PO to the vendor. Consequently, inventory safety stock levels can be reduced, thus
reducing inventory carrying costs.
c. Alternative one provides additional control over the ordering process. For example,
the purchasing agent could manually detect unusual order quantities or frequency caused by a
computer error. Managers whose systems lack reliable computer controls, and who wish to
compensate with human independent verification, may prefer this alternative. The price of this
added control is excessive inventory carrying costs.

15. Payroll Flowchart Analysis

Discuss the risks depicted by the payroll system flowchart for Problem 6 in the text. Describe the
internal control improvements to the system that are needed to reduce these risks.

Response:
Risks:
 Supervisor submits the personnel action form. This allows him/her to create nonexistent
employees.
 Supervisor distributes the paychecks to the employees. Checks written for nonexistent
employees can be kept and cashed by the supervisor.
 The appearance of control provided by accounts payable is deceiving. The review and
reconciliation of the payroll register is based on the presumption that the personnel action
form and time cards are legitimate and accurate. Since they are both prepared by the
supervisor, their integrity is brought into question.
Controls:
  Authorization: A separated personnel function should be established to prepare personnel
action forms and manage the human resource.
 Segregation of Duties. The supervisor should not distribute the paychecks to employees.
This should task should be performed by an independent paymaster.

Internal Control Cases:

1. Solution to Smith’s Market (Small Business Cash Sales Accounting System

a), b) See diagrams on the following pages.

c) Internal Control Weaknesses

1) Warehouse clerk has transaction authorization and purchasing responsibility.

2) Warehouse clerk has asset custody and recordkeeping responsibility. Blind PO is not
used to verify received inventory.

3) Accounting clerk approves invoice for payment without the benefit of a receiving
report or a purchase order. No three way match control.

4) Accounting clerk has account payable and cash disbursement responsibility.

 Smith’s Market
Invoi Exp Cycle DFD
Vend ce
or Revi
ew Revi
stoc ew File
k and
Prep File
are Sum
PO Jour
mary
Stoc Invoi
k ce Jour Updnal
Reco File nal ateVouc
Accoher
Pa rds Vouc
cki her unts
Invoi
ng ce Gene
Sli Pay ral
p Insp Chec Ledg
Ven
ect k er
dor
and Invoi
Upd ce Chec
ate k
Pa Stoc File
Regi
cki k ster Sum
ngFile Reco mary
Sli rds
p
 Ob Ware Accounti Treasury
ser house ng Clerk Clerk
ve Sto Vend Pur A
inv ck or cha
ent
ory
Rec seJou
ord Inv Surnal
On
s Re
oice mm Vou
HaRevie
nd w vi aryche Gener
e r
Stock Upda al
w
Prepar 3 te Ledge
1 an
e PO Acco
Acc r
d
Inv
Fil unts
oun
PO Pac Jou
kin oice
e trnal
g SuVou
Vend Slip Pay mm che
or Inspec Vend 4 aryr
t and or Jou
2 Update
Stock
and rnal
Recor Vou
Record Pur d in A
che
Pac s cha Inv Acco r
kin ses oice unts Check
g Su Che Regis
Slip mm ck ter
ary Vend
Smith’s A or
Market Exp
Cycle FC
2.
Solution to Spice is Right Imports (Standalone PC-based Accounting System)

a), b) see the following pages

c) Internal Control Weaknesses

1) Purchasing approves and executes purchases. The company needs an inventory control
function.

2) Purchasing updates inventory records for transactions that it previously approved and
executed.
3) Receiving clerk prepares receiving report from the packing slip. Should have a Blind
Copy of the PO.

4) Accounts Payable approves vendor payments based only on a PO and Invoice. They have
no evidence of inventory receipts and inspection. They need a receiving report as well.

5) AP approves liability and writes the check.

6) AP clerk has access to the AP control account in the general ledger and the AP subsidiary
(Cash Disbursement voucher file).
 Purchase
Order
Review Purch Packin
Inventor ase Vendor Rec
g Slip Wareho
y Order Rept use
Prepare
PO
Update
Inventor Rec Inspect
y Close Rept Goods Reconcile
Invent and set
PO
ory up
Liability
PO
File Invoi
ce Purch
File ases
Review Journa
Chec Open Cash
l
k Items Disb
and Post Vouch
Vendor Check er
Gen
Copy Ledge
Check r
File Regist
er
 Re
Inve ce
Purchasi VeIReceivin Accounts
ivi
ngntor nd
Pang
Pu
Payable
A
y
Revi ng
Upd rc
Departm or
cks
Re
entSub
ew ate inp
ha
1 Ledg
Inve po
Inve se
ge
er
ntor rt
ntor 3 Ve Or
Sli
c
y y pt nd de
and and 2 In r T
or
Pu a
Re voReco
Prep PO Clos
rcPu n
ce Re ic ncile
are File e PO
ha rc
POPu Re d
ivi ce e , Set 4
ha
se rc ce V
ngivi Up
A e
Or seha ivi Reng Liabi
de Orse ng r
po Pur
lity,
if Re Cas
cha
rdeOr Re Wa
rt po
post
h
rdeVe po yreh tose
rt dis
rnd rt ou GLJou
or b
rnal
se Gen
Vou
Led
che
ger
r
Spice is Right
Expenditure Cycle
Flowchart (Page 1)
Accounts Payable
(Continued)

Ven
dor

Review
5
open Che
items ck Che
and ck
Post to Cop
Accoun Cash y
ts disb
Vouch
Check
er
Regist
Gener
er
al
Ledge 6
r

Spice is Right Expenditure Cycle

Flowchart (Page 2)
d) Flowchart of revised system

Student responses will vary for this part of the assignment. The following issues, however, need
to be addressed.
 Upgrade stand-alone computers to a networked environment
 The internal control problems already covered need to be corrected in the new system.
 A system configuration similar to figure 10-3 would be appropriate.

3. Solution to ABE Plumbing, Inc. (Centralized Small Business Accounting System)

ABE Plumbing Internal Control Problems

1) Purchasing agent authorizes and executes the purchase transaction.

2) Receiving clerk prepares receiving report from the packing slip. He should

receive a “blind” copy of the PO.

3) Warehouse clerk should not be updating the inventory subsidiary ledger. The

clerk has asset custody and record keeping responsibility.

4) Accounts Payable clerk should not be writing checks. The clerk has asset

custody and record keeping responsibility.

 ABE Plumbing, Inc. DFD Expenditure
Cycle
Purchase Order
Inventory
Vendor
Requirements
Review Inventory
Inventory
Records
Packing Slip
PO
Order Data

PO File Payment Data

Update AP
Receive Check
Inventory Receiving Number
Data RR CD Voucher

Quantity and Due Date

Hard Condition Receiving
Copy Post
Report
RR
Update AP
Check
Post
General Amount
Update ledger
Inventory

Post Check
Inventory Register
Quantity
Check
Vendor Purchasing Department Data Processing Receiving Department Warehouse

A
1 2
PO
B
Monitor / Packing
PO
Prepare PO Slip
Rec
Report
Purchases /
Prepare
AP System
Packing Rec Report 3
Slip
Accounts Pay
Update
Inventory
A Rec
Invoice PO File Report
Rec
Report
Invoice Inventory
Reconcile Sub Ledger
and Post
Rec Report
B File
4

Review and GL
Check
Write
Checks Open/Closed
Cash Disb

Check Reg ABE Plumbing Purchases / Cash

Disbursements System

This flowchart shows the receiving report being filed by the warehouse clerk, although

the problem description does not include this step.

d) Flowchart of revised system

Student responses will vary for this part of the assignment. The solution should address

the control issues identified in part C of the case.  

 
4. Solution to Walker Books, Inc. (Manual system with Minimal PC Support)

a), b), See diagrams on the following pages.

c) Internal Control Weaknesses

Walker Books Expenditure Internal Control Weaknesses

1) A separate inventory control department should authorize purchases.

2) Receiving should use ‘blind copy’ of the purchase order to force the clerk to count and
inspect the goods upon arrival.

3) Accounts payable should perform a three-way match between the PO, Receiving
Report, and the Supplier’s Invoice.

4) The Accounts Payable Department should not write checks.

5) The invoice should not be destroyed. This is an audit trail issue.

6) Signing and distribution of the check is done without the benefit of supporting
documents or a valid vendor file.
 Walker Books Data Flow Diagram for Purchasing System

Vendor
Vendor
Inventory

Inventory levels Invoice

7
1 2
Inventory P.O. Reconcile Posting
Review Prepare AP Subsidiary
requirements & info
records PO
Record AP

P.O. P.O. Journal

voucher

Goods and 4 5
8
Vendor packing slip Receive & Packing slip Reconcile Posting
Vendor Examine General Ledger
Unload PO & info
& Post
Goods Pack. Slip

P.O. & Packing

slip

6
Create
Receiving
Reports
 Walker Books Data Flow Diagram for Cash Disbursements System

AP Subsidiary Check Register

Posting info

1 2
Review Invoice due Prepare
open Check &
AP Update

Check

3 5
4
Examine Signed check Signed check & Send Signed check Vendor
Photocopy Vendor
Check Photocopy Check &
Check
& Sign Mark Copy

Marked check
photocopy

6
Create
Journal
Voucher

Journal
voucher

7
Posting
Examine General Ledger
info
& Post
 Walker Books Document Flowchart for Purchasing System (Original)

Purchasing Department Receiving Department Warehouse Accounts Payable Department

Purchase Vendor Receiving A

Monitor
Terminal Order Report
Goods &
Generate
POs
Purchase
Packing
Inventory Order
1 Slip File

Vendor
Reconcile

Purchase
Goods &
Documents
2 Temp.
File
Order

Purchase
A Invoice
Order
Receiving
Report

Vendor Record &

AP
Create
Subsidiary
Voucher
File
Journal
3
Receiving
File Voucher
Report
Purchase
Order
2A Invoice

Open
AP
 Walker Books Document Flowchart for Cash Disbursements System (Original)
Accounts Payable Department Cash Disbursements Department General Ledger

Open Review & Check

AP Create 4 1A
Check

Examine &
Sign
Check
Check 6 Journal
Voucher
Journal
Voucher
Invoice

Signed
Check
AP
Subsidiary Update
Records Terminal
Check
Photocopy
Register
Check

Check
General
Signed Ledger
Invoice Vendor
Check
5 Check
Copy

Trash
Bin Marked Mark “Paid” Journal
Check & Create Voucher
Copy Voucher

File

Revised System Walker Books System

Student responses will vary for this part of the assignment. Notwithstanding the internal
control issues already covered that need to be addressed, Walker Book’s new system
design could reflect features similar to those in figure 10-3.
5. Solution to AV Safety, Inc. (Manual and Standalone Computer Processing)

a), b), See diagrams on the following pages.

c) Internal Control Weaknesses

Purchases Procedures
1) The inventory clerk in the warehouse department has asset custody, transaction
authorization and record keeping responsibility.

2) The receiving clerk prepares the receiving report from the packing slip information.
The receiving department clerk should receive a ‘blind copy’ of the purchase order to
force the receiving clerk to count and inspect the items before preparing the receiving
report.

3) Accounts Payable does not verify that the good have been received via a receiving
report. Payment approval is based on a PO and invoice only.

4) A copy of the PO is sent to the General Ledger, presumably for updating purposes. Its
use, however, is unclear from the case. Only journal vouchers should be used to update
the GL accounts.

Cash Disbursements Procedures

5) The company may be paying for items not received. The cash disbursement voucher is
based on a flawed process to set up the AP. A proper 3-way match needs to be performed
prior to establishing the liability.

6) No valid vendor file is used to approve payment.

7) No formal Journal vouchers are used to update the General Ledger.

A&V Safety, Inc Expenditure Cycle DFD- Purchasing

Prepare
Supplier Purchase Low Inventory
Supplier Order Purchase Items list
Order

Invoice
Inventory Records

Receiving Report
Prepare Voucher
Reconcile
Accounts
Recd.
Payable

AP
Summary Information

Raw Materials Update

Report Receiving General GL Control A/c
Report Ledger

Raw Materials Update

Raw Materials Summary
Storeroom Inventory
Storeroom Report
Records
A&V Safety, Inc Expenditure Cycle DFD- Cash Disbursement

Supplier
Supplier

Checks Filed

Prepare Voucher
Prepare Receiving Report
Accounts
Check Checks AP
Payable
Review

Summary Information
Summary
Report

Update
General Post GL Control A/c
Ledger
A&V Safety, Inc. Expenditure Cycle Flowchart (Original) Page 1f 2o

Warehouse General Ledger Accounting Receiving Dept.

1 A Vendor

Purchase Purchases
Order Journal Purchase Packing
Order Slip
Prepare
Purchase
Order ??
Purchase 4 Confirm and
Order Signed PO Prepare RR
2
AP Subsidiary
Purchase
Purchase Order
Order Ledger

Review and

3
Vendor Update

Receiving
B Report
Receiving
Invoice Report
Vendor
Update
Program
B

Inventory File
Ledger
A&V Safety, Inc. Expenditure Cycle Flowchart (Original) Page 2f o2
Accounts Payable Cash Disbursements General Ledger

Review Inven
And Prepare AP Subsidiary
7 A
CD Vouch Ledger Prepare
Checks
Summary

5 6 Update
Program

Check
. Cash Register
Disbursement
Voucher General
Ledger

Checks
AP
Summary Update
Summary

Voucher
A Register

Approve
Checks
File
Confirm, update
AP Subsidiary AP File and post
Ledger Cash
Voucher Copy of
Disb’ment Check
Voucher

Cash
Copy of
Disb’ment
Check
Voucher
Copy of
File
Check

Check
File

Vendor

Revised AV Safety, Inc. System

 Student responses will vary for this part of the assignment. Notwithstanding the internal
control issues already covered that need to be addressed, AV Safety’s new system design
could reflect features similar to those in figure 10-3

6. Solution to Premier Sports Memorabilia Purchasing System (Networks Computer

System with Manual Procedures)

a), b) see the following pages

c) Internal Control Weaknesses

1) The receiving clerk should be provided with a blind copy of the purchase order.

2) The high degree redundant activities in the system are inefficient and may possibly
lead to errors in accounting records. Specifically:
 Inventory requisitions are downloaded from the system to produce hard copy
purchase orders manually
 Inventory is manually updated from a terminal
 General ledger entries are posted from manually produced hard copy journal
vouchers and summaries.

Pre mier Sports Me morabilia Purchasing System Data Flow Diagram

Inventory Inventory
Chec k Requirements Valid Vendor
Inventory
Vendor Inventory Levels
Levels
Vendor
Vendor Info

Purchase Order Purchase

Inventory
Goods
Shipped Vendor
Vendor
Purchase Order Invoice

Purchase Order &

Packing Slip
Receive
Goods
Prepare Accounts
Receiving A/P Payable
Prepare Report Post
Receiving
Report
Receiving
Report
A/P Voucher

Summary Update
Update
General
Inventory
Ledger

Post

Control
Inventory Accounts
 Premier Sports Memorabilia Purchasing System Document FlowchartPage 1/2 (Original)
Inventory Control Purchasing Dept Receiving Data Processing Dept

B Prepare
A Valid Vendor
Purchase Purchase
File
Order
Prepare PO Requisition
1
Inventory A

Purchase B
View and Update Open/Closed
Order
Vendor Requisition

C
Packing
Slip
Create
C Open Open/Closed
2 Purchase Purchase Purchases
Order Prepare
Purchase
Receiving
Order
Report
Purchase Close and
Receiving Order D Update Inventory
Report Receiving Inventory
Purchase Report
Order
Receiving
2 Purchase Report
Order Update AP Sub
1 Receiving E
2 AP Ledger
View and Update Report

D Vendor

Inventory Update General

F
Summary GL Ledger
End of day
Procedure

3
Premier Sports Memorabilia Purchasing System Document Flowchart Page 2/2 (Original)
Accounts Payable General Ledger & A/R

1 2

Purchase Receiving 3
Order Report
2
Inventory
A/P Summary
Voucher

Reconcile
Invoice
Reconcile and Post

F
Vendor Set Up AP E

A/P
End of Day Voucher
Procedure

d)
Revised System Premier Sports System

Student responses will vary for this part of the assignment. An operationally improved
system design should reflect features similar to those in figures 10-3
7. Solution to Bait ‘n Reel (Combination of Networked Computers and Manual System)

a), b), d) See diagrams on the following pages.

c) Internal Control Weaknesses

1) The inventory control department should submit a purchase requisition to the purchasing
department authorization of purchases.

2) The receiving department clerk should receive a ‘blind copy’ of the purchase order to force
the receiving clerk to count and inspect the items before preparing the receiving report.

3) Accounts payable department records the liability before the vendor’s invoice arrives. No
three-way match is performed.

4) The AP Clerk should not update both the AP subsidiary ledger and the general ledger AP
Control account.

5) Cash Disbursement clerk prepares check and updates the AP subsidiary and GL accounts. The
clerk could set up a fraudulent AP and pay it (vendor fraud).

6) Inventory control/Storage has asset custody and record keeping responsibility.

 Inventory Vendor
Records Records

Inventory
Bait ‘n Reel DFD 1 Requirements
2
Prepare Purchase Order Vendor
Review Vendor
Purchase
Records
Order

Electronic PO Electronic PO
Accounts
Payable
Goods
6 4
Record Reconcile
Post Receiving Report
Liability & Goods &
Prepare Order
Voucher

Receiving Goods & Receiving

Report Report

Inventory 5
7 Update
Control
Reconcile Inventory
Vendor Invoice &
Vendor & Post Records
PO Copy
Update
A/P
Accounts
Control Post
Invoice,
PO Copy,
RR Inventory
Subsidiary
9
Signed Prepare
Check Check
Cash
Account
Invoice,
PO Copy,
RR, Check Check
Register
12
Update
Post
Records General
& Sign Ledger
Check
Inventory
Control
Storage Purchasing Receiving Accounts Payable

A Receiving Electronic
Inv. Subsidiary Vendor List Electronic
Ledger PO Report 1 PO

Receiving
Report 2
6 Terminal
Terminal Update AP subsidiary
Terminal
1 Reconcile
& Prepare
RR 2 Receiving
Terminal
Receiving
Report 2
Review
Vendors &
Prepare
Report 1 3
PO A
Receiving
Report 2 File Vendor
Inv. Subsidiary
File Receiving
Purchase File Terminal Report 1
Ledger Order 2
Purchase Reconcile
Order 1 Terminal & Invoice
Purchase Record
Order PO
Copy
Save Order Update
& Notify Invoice
Vendor
Receiving
Report 1
PO
Inventory AP Copy
Control Control

Bait
n Reel
‘ Purchases System (Original) 2A
 Cash Disbursements

1A

Invoice
Receiving
Report Invoice Invoice
PO Receiving Receiving
Copy Report Report
PO PO
Copy Copy
Review &
Prepare Check Terminal Check
Check

4 General Ledger
Review
& Check
Vendor
Sign

Check Update
Register

AP Invoice
Subsidiary
Receiving
5 Report
Check
Copy
PO
Copy

File

Bait ‘n Reel Cash Disbursements System (Original)

 Data Processing General
Purchasing (Inventory Control) Receiving Accounts Payable Ledger

Inventory Sub.
File Blind Purchase Vendor A
Transact. Copy Order 2
List

Prepare Vendor Vendor

Purchase Records Reconcile Invoice
Goods & Open Account
Open Purchase Orders File Summary
Order File Order AP
Review &
File
File
Blind
Copy Terminal/
Transact. Printer Printer
Transact. Reconcile
List
List Purchase Receiving Info
Order 2 Report
Purchase Receiving Account
Vendor Order 1 Report File Summary
File Terminal
File

File
Open Purchase
Order File Update
A/P File
& Close Inventory Sub.
Open PO File

Closed Purchase
Order File

Open AP
Update
File

General Ledger
Control Accounts

Account
Summary

Bait ‘n Reel Purchases System (Revised)

A
 General
Data Processing Accounts Payable Cash Disbursements Ledger

Open AP
File

Printer Printer Printer

Review
For
A/P Due
Transact. Transact. Account
Listing Listing Summary
Check
Due AP File
Information
File
File
Sign
Write Check
Checks &
Record

Vendor

Check Closed AP General Ledger

Register File Control Accounts

Bait ‘n Reel Cash Disbursement System (Revised)

8. Solution to Green Mountain Coffee Roasters, Inc. (Manual Procedures and
Standalone PCs)

a), b) see the following pages

c) The Following are the control weaknesses found in this Cash Disbursements System:

1) Warehouse authorizes and executes purchases of inventory. There should be an

independent inventory control function.

2) No formal receiving function and no receiving reports are prepared. A blind

copy of the Purchase Order should be used to count and inspect not a packing slip.

3) Warehouse has asset custody and maintains inventory records.

4) Accounts Payable approves liability with no evidence that goods were received. A
three-way match should include Purchase Order, Invoice, and Receiving Report

5) Account Payable has check writing responsibility and approves the liability and
maintains the accounting records.
DFD Green Mountain Purchases System
DFD Green Mountain Cash Disbursements System
Flowchart Green Mountain Purchases System Page 1

Warehouse

Inventory
Ledger

1
C

Open
PR

A A
2
D Packing
Slip
3

B
Packing
A Slip

E
 Flowchart Green Mountain Purchases System Page 2

E
C
4

AP Sub
Ledger
 Flowchart Green Mountain Cash Disbursements System
General Ledger

Journal
Voucher
Check Register

5
Update GL General
Ledger
Check
Check
Copy

Journal
Voucher Journal
Vendor Voucher

d)

Revised Green Mountain System

Student responses will vary for this part of the assignment. Notwithstanding the internal
control issues already covered that need to be addressed, Green Mountain’s new system
design could reflect features similar to those in figure 10-3
9. Solution to Holly Company –Payroll Systems (Small Company Uses Manual
Procedures with PC Support)

Employee
Information Employee
Records
Reviewed
Record Time Cards Review
Time Cards Prepare
Hours Time
Payroll
Worked Cards

File
Time Cards , Payroll
Register Copy
Hours Worked
Payroll Register

Print
Employees checks Payroll Register
and File
Update
Accounts

Signed Paychecks
Paychecks

Signed Paychecks
Sign
Distribute Checks
Checks

Holly Company Payroll System DFD

 Foremen Payroll Accounting
1
C. Employees
Control Weaknesses
Time Payroll
Register
1) Supervision – Timekeeping processcard
is unsupervised
Time
card
2) Segregation of Duties – Accounting Department
7 Prepares Paychecks
Print Checks
Prepare Update
3) Segregation of Duties – Accounting department
Payroll maintains both sub and GL accounts
Accounts
Review

4) Accounting Records – Payroll drawn on general cash account

Employee Subsidiary
Records Ledgers
2
5) Segregation of Duties – Accounting clerk prepares and signs paychecks
Employees
3
Time
Card Paychecks
6) Segregation of Duties – Foremen authorize Payroll
time cards and distribute paychecks General
Ledgers
Register
Payroll
7) Transaction verification
Distribute - Payroll clerk prepares paychecks without authorization
Register from a 4
6
Sign
personnel action form. Payroll
Register

5
Paychecks
Paychecks
D. Recommend Improvements

1. Provide supervision over

Holly timekeeping
Company Payroll Process
System Flowchart

2. Paychecks should be prepared by Payroll Department

3. Create separate GL function or provide access control to GL

4. Establish separate cash disbursement department

5. Establish an Impress account for payroll

6. Employ a paymaster to distribute paychecks to employees

7. Verify the status of employees before preparing paychecks.

10. Solution to A&V Safety, Inc. –Payroll Processing System (Manual Process)
Personnel
File
Employee
Reviewed
Record Time Cards Approve Information
Time Cards Prepare
Hours Time
Payroll Payroll
Worked Sheets
Register

Verified recipient File

Hours Worked Time Cards
Form

Paycheck Payroll
Employees
Register
Copy

Sign
Signed Paycheck Paychecks
Payroll Payroll
Summary Check
Update AP Ledger
AP Ledger
Verified
recipient
Form
Reconcile
and Post
GL
Summaries

AV Safety Payroll System DFD

Supervisor Payroll Accounts Payable

Employees Payroll
Time
Cards Register
Copy
Personnel
Time
6 File 3
Cards Prepare
Pay Update
Checks Payroll AP
register Ledger
Review
and Time
Add Pay Cards
1 rates Verified
AP Ledger
Payroll Recipients
Pay Payroll
register
Checks Summary
2 Copy

Pay 2 2 2
Checks

2 2

Distribute Payroll
Pay Reconcile
Pay register
Checks Checks
Copy

Employees Pay
Checks AV Safety Payroll System Flowchart
Copy
Page 1
Cash Disbursements General Ledger

1 1

5
Verified Payroll
Pay
Recipients Summary
Checks

Reconcile
Sign Pay Verified and Post
Checks Recipients
Verified
Recipients 4 AP Ledger

Pay
Pay
Checks
Checks
Copy
1

1 1

AV Safety Payroll System Flowchart Page 2

 C. Control Weaknesses

1) Segregation of duties – Supervisors assign pay rates for some employees

2) Segregation of Duties – Supervisors distribute check to employees

3) Transaction Authorization – Accounts Payable department should authorize cash

disbursements to issue a payroll check to cover the individual paychecks. An imprest

account should be employed.

4) Accounting Records – The verified recipient list does not verify who received the checks.

It verifies only that a check was written for an individual.

5) Independent Verification –The general ledger should receive an account summary from

the AP department.

6) Transaction verification - Payroll clerk prepares paychecks without authorization from a

personnel action form.

D. Flowcharts for this part of the case will vary. Solutions should address the issues

presented in part C of the case.