Deck 12: Audit Testing for the Supply Chain and Production Process

Question 1

With respect to purchases, what are the key internal controls related to financial reporting?

Answer 1

The critical internal controls for supply chain management address the proper selection of suppliers, authorization of purchases, and completeness of liabilities. Key internal controls related to financial reporting include the following:
i) A careful review of operational and financial historical performance of alternative potential suppliers is needed before selecting suppliers. Supplier evaluation and selection should be segregated. Only appropriate purchases of materials should be made, and disbursements should reflect the terms of an approved acquisition. Purchases from unauthorized vendors must be appropriate approved and a review should occur periodically off all purchases from such vendors.
ii) Proper valuation is facilitated by timely completion of a pre-numbered receiving report. The vendor's invoice should be verified by comparison with receiving reports and other supporting documents.
iii) Timing is important because liabilities may not be recorded until a vendor's invoice is received. The most important control in this respect is the timely preparation of a voucher. In electronic data interchange systems, the opposite might occur, goods are not yet received yet the supplier triggers an electronic payment.
iv) Because of the large number of expense and asset accounts that can be affected by procurement, classification is important. A formal policy to separate assets from expenses assists in proper classification of expenditures.
v) The reliability of transaction processing can be increased by independent review of account classifications for reasonableness, the use of check digits or hash totals, and the use of computerized posting

Question 2

Describe the accounts affected by the supply chain and production process.

Answer 2

a. Cash and short term investments: Cash payments
b. Inventory: Purchases, purchase returns and allowances, purchase discounts, freight in, production, inventory valuation
c. Accounts payable: Vendor payables
d. Accrued liabilities: Indirect overhead costs
e. Cost of goods sold: Cost of production, cost allocation
f. Purchase commitments, waste and spoilage

Question 3

How does the auditor look for unrecorded liabilities?

Answer 3

a. Understatement of liabilities and expense is a key concern in this area. Consequently, the search for unrecorded liabilities which addresses the completeness objective is especially important. In the search for unrecorded liabilities, one might:
i) review subsequent cash disbursements for understatement, search unpaid bills for overstatement
ii) trace receiving reports to vendor invoices. If goods were received, the purchase should be recorded in Accounts Payable.
iii) review vendors' monthly statements
iv) confirm balances of suppliers who now have zero or small balances but once were active suppliers.
b. The search for unrecorded liabilities is a common substantive test for accounts payable. This is a form of cutoff test. The auditor chooses a sample of disbursements made since the end of the fiscal year, examines the supporting documentation, determines if the payment is for a liability that existed at year end, and then determines if an actual liability had been recorded for the item. The auditor proposes adjustments to the account balance for any unrecorded liabilities that are detected. The size of the transactions tested after year end will depend on the auditor's assessment of the risk of material misstatement for liability assertions.

Question 4

With respect to inventory, what are the key internal controls related to financial reporting?

Question 5

What processing controls might be effective for reducing risks related to supply chain and production management?

Question 6

Is the auditor interested in all the controls within an audit-sensitive process? Why or why not?

Question 7

What physical controls might be effective for reducing risks related to supply chain and production management?

Question 8

With respect to disbursements, what are the key internal controls related to financial reporting?

Question 9

What segregation of duties controls might be effective for reducing risks related to supply chain and production management?

Question 10

Describe five of the obvious potential risks the supply chain and production process. For each risk, also identify relevant performance indicators that could be used to monitor the risks.

Question 11

With regard to production transactions, what is most important to the accounting function?

Question 12

Describe three indirect process risks in the supply chain and production process.

Question 13

Describe the primary substantive tests for purchases and payables.

Question 14

Describe the key event in the purchasing process and any significant issues of timing/recognition the auditor must consider.

Question 15

Describe the process objectives for the supply chain and production process.

Question 16

Describe examples of people risks in the supply chain and production process.

Question 17

Are risks tied to multiple causes? What does that mean to the auditor?

Question 18

What performance reviews/monitoring controls might be effective for reducing risks related to supply chain and production management?

Question 19

Describe two direct process risks in the supply chain and production process.

Question 20

What substantive analytical procedures that are especially useful for testing expense accounts that result from procurement activities are frequently used by auditors?

Question 21

You are involved in the audit of a medium-sized manufacturer of furniture. What tests of controls can be used to investigate segregation of duties in the supply chain and production management process?

Question 22

Describe three basic approaches the auditor may use for determining if existing purchasing policies are being properly applied.