!

.rry t
i$3
f;

,ll 'qs :
r
x *?.
:-s,. :L.
ti
'i i!$$, 1

iln *t ii- i
a
I
tl J

CHAPTER 7

Purchases system

lntroduction
Examination context
Topic List
1 Ordering
2 Goods inward and recording of invoices
3 Payment
4 Deficiencies
Summary and Selftest
Answers to lnteractive questions
Answers to Self{est

113
 lntroduction

Learning objectives
o ldentify risks in a purchases system
. ldentify relevant controls to mitigate risk
o ldentify tests of those controls
. Recognise weaknesses in a purchases system

Specific syllabus references for this chapter are:2f , g, h, 3f,

Syllabus links
You will have learnt about the various books of record in the purchases system in Accounting

Examination context
As purchases is another important practical area, your assessment might well include scenario internal controls
questions in this area. The sample paper contained one such scenario question looking at consequences of
given weaknesses in a purchases system.

ln the assessment, candidates may be required to:

. Show how specific internal controls in a purchases system mitigate risk and state their limitations
. ldentify internal controls for an organisation in a given scenario
. ldentify internal control strengths and weaknesses in a given scenario
. Determine the extent to which tests of controls should be used in a given set of circumstances

114 Assurance
 1 Ordering

1.1 Risks and control objectives

When considering purchase orders, a company might recognise one or both of the following risks:
v
. Unauthorised purchases may be made for personal use
n
. Goods and services might not be obtained on the most advantageous terms
A
The controls put into place will be designed to mitigate these risks. Hence the objectives of the controls will be r
to prevent these risks from occurring. Here are the control objectives which might arise from the risks noted T
above: E
. All orders for goods and services are properly authorised and duly processed. All orders are for goods R
and services actually required by the company
. Orders are only made with authorised suppliers
7
. Orders are made at competitive prices

1.2 Controls
Once the company has identified the risks which exist in the purchases system, it will try and create controls
which mitigate those risks (that is, meet the control objectives outlined above). What controls will be put into
place depend on the nature of the company and the specific risks associated with the way it operates, but the
following controls can be used as examples of how the above risks can be mitigated.
. Segregation of duties; requisition and ordering
f;+.
o Gentral policy for choice of suppliers
r Evidence required of requirements for purchase before purchase authorised (pre-set re-order quantities
and re-order levels)
. Order forms prepared only when a pre-numbered purchase requisition has been received
. Authorisation of order forms
o Pre-numbered order forms
. Safeguarding of blank order forms
r Review for outstanding orders
. Monitoring of supplier terms and taking advantage of favourable conditions (bulk order and prompt
payment discounts)

Worked example: Controls over ordering

Truman Limited buys 'Drox'frequently. Drox is highly marketable and easily portable and the company has a
history of theft of inventories of Drox. ln order to make sure that only Drox required for business use is
purchased in the first place, the directors have decided to put the following controls into operation:
. Simon Radinski, the stores manager, will be in charge of purchase requisitions, which will be made when
inventories of Drox have fallen to a pre-set level.
r Orders will only be raised in respect of purchase requisitions made by Simon Radinski, except in periods
of Simon's absence, when requisitions may be made by his deputy Cathy Lewis.

Purchases system 115

 . Orders will be authorised by Linda Fairburn, the purchases director.

. Random, occasional spot checks will be carried out by Linda Fairburn on the level of Drox when the
requisition is^raised.
. Purchase orders will be kept in a locked office in the purchase department.
ln addition, in order to control inventories, Drox will only be kept in a locked cupboard in the warehouse.

1.3 Tests of controls

The tests that the assurance providers carry out over such controls will obviously also depend on the exact
nature of the control and the business. However, again, some general ideas can be generated.

r Review list of suppliers and check a sample to orders made

o Check sequence of pre-numbered order forms
o Check orders are supported by a purchase requisition
o Review security arrangements over blank orders

Worked example: Tests of controls over orders

ru The directors of Truman Limited have requested that the auditors review that the new controls over the
purchase of Drox are operating effectively. The audit senior has therefore drafted the following plan:
o Spot check on security arrangements over purchase orders

. Request Linda Fairburn notifies the audit team of requisitions for Drox during the audit and attend spot
check on re-order level
a Observation of premises for evidence of Drox being stored elsewhere than the locked cupboard
a Review of sample of orders for Drox to ensure that purchase requisition exists and orders were made only
by Simon Radinski and were authorised by Linda Fairburn

a lf sampled requisitions were made by Cathy Lewis, check absence records for Simon Radinski.

lnteractive question 1: Ordering [Difficulty level: Exam standard]

m The directors of Lyton Limited (LL) have just uncovered a fraud being perpetrated by the stores manager. He
was in charge of ordering, had raised a number of false orders to non-existent suppliers, raised goods received
notes in respect of non-existent deliveries and forwarded an invoice to the accounts department, which was
then paid.
Which two of the following controls could have prevented this fraud?

Approved list of suppliers

Check of goods inward by person other than orderer
Pre-numbered order forms
Blank order forms locked in a safe

See Answer at the end of this chapter

2 Goods inward and recording of invoices

lB Section overview

Wt . are [Link] goods not [Link] accepting invoices for poor quatity goods.
. fisr.s
Controls include matching goods received with orders.

116 Assurance
2.1 Risks and control objectives
When considering goods inward and recording of invoices, a company might recognise all or some of the
following risks:
. Goods may be misappropriated for private use
. Goods may be accepted that have not been ordered
o lnvoices may not be recorded resulting in non-payment
o The company may not take advantage of the full period of credit extended
o The company may not record credit notes resulting in paying invoices unnecessarily
These risks lead to the following control objectives:
o All goods and services received are used for the company's purposes, and not private purposes
. Goods and services are only accepted if they have been ordered, and the order has been authorised l/

H
. All goods and services received are accurately recorded
A
. Liabilities are recognised for all goods and services that have been received ?
. T
All credits to which the company is entitled are claimed and received
E
o Receipt of goods and services is necessary for a Iiability to be recorded R
o All credit notes that are received are recorded in the nominal and payables ledgers
r All entries in the payables ledger are made to the correct payables ledger accounts 7
. Cut-off is applied correctly to the payables ledger

2.2 Controls
The following are types of controls which could be put in place to fulfil the above objectives.

. Examination of goods inwards

QualitY
- QuantitY
Condition

. Recording arrival and acceptance of goods (pre-numbered goods received notes)

o Comparison of goods received notes with purchase orders
o Referencing of supplier invoices; numerical sequence and supplier reference
o Ghecking of suppliers' invoices
Prices, quantities, accuracy of calculation
Comparison with order and goods received note
r Recording return of goods (pre-numbered goods returned notes)
. Procedures for obtaining credit notes from suppliers

. Segregation of duties: accounting and checking functions

. Prompt recording of purchases and purchase returns in day books and ledgers
. Regular maintenance of payables ledger
o Comparison of monthly statements of account balance from suppliers with payables ledger balances
o Review of classification of expenditure
o Reconciliation of payables ledger control account to total of payables Iedger balances
o Create a cut-off accrual of goods received notes not matched by invoices at year-end

Purchases system 117

 Worked example: Controls over goods inward

:b The production department at Manufacturing Company Limited (MCL) works on a just-in-time basis. Orders for
necessary materials are dispatched by computer according to pre-set re-order levels. Deliveries are made
within 12 hours by the suppliers, who invoice electronically when goods are dispatched. ltems are put into
production within hours of arriving at MCL's premises.

ln this example, it is crucial that controls over goods inward operate effectively. ln the first case, it is necessary
that the quality of goods being put into production immediately are of appropriate quality or production will be
held up. Therefore it is vital that goods inward are checked for quality and quantity on arrival at MCL's
premises.

It is also important that goods inwards are recorded, as with the goods being used so quickly it would be more
difficult to verify purchase invoices to goods being held in a warehouse.
Therefore MCL have a pre-printed, numbered goods received note (GRN) which contains a number of checks
in respect of quality and quantity and on which the warehouse staff note the relevant order number, the time of
delivery, and the quantity of goods delivered. A copy of this GRN is forwarded to the accounts department to be
matched with the supplier's electronic invoice.

Worked example: Controls over purchase recording

ru Stibbe Limited have recently discovered that they have been paying invoices that had been credited because
the goods had been returned by the production quality controller due to poor quality.
ln order to prevent this occurring, Stibbe Limited should have put the following controls in place:

. Raising purchase return notes

. Copy purchase return notes sent to accounts department by production department
. Review of credit notes before payment run authorised
o Regular comparison of supplier statements with payables ledger accounts

2.3 Tests of controls

The following tests could be used in relation to the controls noted above.

. Check invoices for goods are:

Supported by goods received notes
Entered in inventory records
Priced correctly by checking to quotations, price lists to see the price is in order

- Properly referenced with a number and supplier code

- Correctly coded by type of expenditure

- Trace entry in record of goods returned etc and see credit note duly received from the supplier, for
invoices not passed due to defects or discrepancy
. For invoices of all types:

- Check calculations and additions

- Check entries in purchase day book and verify that they are correctly analysed
Check posting to payables ledger
. For credit notes:

- Verify the correctness of credit received with correspondence

- Check entries in inventory records
Check entries in record of returns
Check entries in purchase day book and verify that they are correctly analysed
Check posting to payables ledger

118 Assurance
 Check for returns that credit'notu. ur" Outy received from the suppliers

a Test numerical sequence and enquire into missing numbers of:

Purchase requisitions
- Goods received notes
Suppliers' invoices
Purchase orders
Goods returned notes
o Obtain explanations for items which have been outstanding for a long time:
Unmatched purchase requisitions
Unmatched purchase orders
Unmatched goods receivbd notes
Unrecorded invoices (,
. Verify that invoices and credit notes recorded in the purchase day book are:
H
A
lnitialled for prices, calculations and extensions ?
Cross-referenced to purchase orders, goods received notes etc T
Authorised for payment
E
. Check additions R
r Check postings to nominal ledger accounts and control account
. Check postings of entries to payables ledger 7
Payables ledger
o For a sample of accounts recorded in the payables ledger:

Test check entries back into books of prime entry

Test check additions and carried fonvard balances
Note and enquire into all contra entries
. Confirm control account reconciliation has been regularly carried out during the year
. Examine control account for unusual entries

Worked example: Tests of controls over goods inward and invoices

ru The auditor is verifying the controls over goods inward at MCL. He selects a sample of goods received notes
and checks that they are in sequence, enquiring into any missing numbers (spoilt copies should be retained)
and seeking evidence (initials of relevant staff) that the quality checks have been carried out. These goods
received notes would then be checked to purchase invoices to ensure that all invoices had an associated
goods received note and also to purchase orders to ensure that the goods were ordered properly.

lnteractive question 2: Goods inward and invoices [Difficutty tevet: Exam standard]
Weezy plc is a company that has a large number of deliveries daily.
Which one of the following internal controls is most likely to prevent Weezy plc paying for goods that have not
been received?

Locked stores

Matching of purchase invoices with goods received notes

Authorisation of invoice payment

Safeguarding of blank order documents

See Answer at the end of this chapter,

Purchases system
r
 lnteractive question 3: Purchase recording [Difficulty level: Exam standard]
Rhonda posts the invoices to the payables ledger.
Which two of the following would help prevent suppliers from being overpaid?

Posting invoices to the receivables ledger

Reconciliation of the payables ledger to the control account

Authorisation of payments

Bank reconciliations

See Answer at the end of this chapter

3 Payment

3.1 Risks and control objectives

The following risks arise at this stage of proceedings:

. False invoices are paid in error

. lnvoices are paid too soon
. Payment is not correctly recorded
. Credits are not correctly recorded
. Payments are not recorded in the right period
The key risk is that money might be paid out by the business inappropriately. The following objectives arise out
of the risks:

. All expenditure is for goods that are received

o All expenditure is authorised
r All expenditure that is made is recorded correctly in the nominal and payables ledgers
. Payments are not made twice for the same liability

120 Assurance
3.2 Controls
The anangements for controlling payments will depend to a great extent on the nature of business transacted,
the volume of payments involved and the size of the company.

Cheque and cash payments The cashier should generally not be concerned with keeping or
generally writing-up books of account other than those recording payments, nor
should he have access to, or be responsible for the custody of,
securities or title deeds belonging to the company.
The person responsible for preparing cheques should not himself be a
cheque signatory. Cheque signatories in turn should not be responsible
for recording payments.

Cheque and bank transfer o Cheque and bank transfer requisitions

payments
- Appropriate supporting documentation (for example, invoices) H
- Approval by appropriate staff
Presentation to cheque signatories (in case of cheques) ?
lnstigation of bank transfer by appropriate staff T
. Authority to sign cheques
R
Signatories should not also approve cheque requisitions
Limitations on authority to specific amounts
Number of signatories
Prohibitions over signing of blank cheques 7

o Prompt dispatch of signed cheques

o Obtaining of paid cheques from banks
. Payments recorded promptly in cash book and nominal and
payables ledgers
Cash payments . Authorisation of expenditure
. Cancellation of vouchers to ensure they cannot be paid twice
. Limits on payments
o Rules on cash advances to employees, lOUs and cheque cashing

Worked example: Gontrols over cash payments

W Build Co has a large number of suppliers and it takes deliveries most days. Deliveries are noted on goods
received notes which are matched with invoices when they arrive. lnvoices are entered to the payables ledger
system, which is programmed with the credit terms given by each supplier and produces a payment listing each
week when the computer prints all the necessary cheques.
Linda, the payments clerk, takes the cheques to the financial controller for authorisation and signature.

Purchases system
il
 3.3 Tests of controls
The following controls may be used

Payments cash book (authorisation) a For a sample of payments:

- Compare with paid cheques to ensure payee agrees

Check that cheques are signed by the persons authorised to
do so within their authority limits

Check that bank transfer was authorised and initiated by

appropriate person
Check to suppliers' invoices for goods and services. Verify
that supporting documents are signed as having been
checked and passed for payment and have been stamped
'paid'

- Check to suppliers' statements

Check to other documentary evidence, as appropriate
(agreements, authorised expense vouchers, petty cash books
etc)

Payments cash book (recording) a For a sample of weeks:

- Check the sequence of cheque numbers and enquire into

missing numbers
Trace transfers to other bank accounts, petty cash books or
other records, as aPProPriate
Check additions, including extensions, and balances fonvard
at the beginning and end of the months covering the periods
chosen
Check postings to the payables ledger

- Check postings to the nominal ledger, including the control

accounts

When checking that bank and cash are secure, assurance providers should consider the security
arrangements over blank cheques. Bank reconciliations are also a very important control and assurance
providers should carry out the following tests on these.

Area Tests of control

Bank reconciliations a For a period which includes a reconciliation date reperform

reconciliation (see Chapter 13)
a Verify that reconciliations have been prepared at regular intervals
throughout the year
a Scrutinise reconciliations for unusual items

Petty cash payments a For a sample of payments:

- Check to supporting vouchers

Check whether they are properly approved

- See that vouchers have been marked and initialled by the

cashier to prevent their re-use

122 Assurance
 Worked example: Tests of controls over cash payments

ru The auditors of Build Co have decided that it is important to check the computer control that ensures that
suppliers' credit terms are used and payments are made on time. To do this they will use a computer assisted
audit technique (CAAT). They will process a number of 'dummy' invoices from existing suppliers and check that
the computer processes the payments at the correct time. CAATs will be covered in more detail in Chapter '11.

lnteractive question 4: Cash payments

%
L*s
[Difficulty level; Exam standard]
Which two of the following control activities are most likely to reduce the risk of payments being made twice for
the same liability?
o
Stamping 'Paid' on invoices that have been paid H

Prompt dispatch of cheques

?
T
Authorisation of payments
E
Checking supplier statements before payments are made R

See Answer at the end of this chapter

4 Deficiencies

be abte to

Try the following question

Y)
L*.E
lnteractive question 5: Deficiencies of the purchases system
[Difficulty level: Exam standard]
The auditor of Sunny plc has identified that there is no procedure to track purchase invoice due dates.
Which one of the following is the most likely consequence which might arise as a result of that deficiency?

Prompt payment discounts may not be obtained

Goods not actually received may be paid for

lnferior goods may be purchased

Payments may be made to fictitious suppliers

See Answer at the end of this chapter

Purchases system 123

Summary and Self-test

Summary
Controls in the purchases system are focused on
the following key points of the cycle

Cash payments
Ordering

Goods inwards and recording of invoices

Risks: Risks: Risks:

Goods for personal Goods may be misaPProPriated - Payments made

- - inappropriately
use, - lnvoices may be'mislaid leading to non-Payment
Goods not on most - Blank cheques (and
- - lnvoices are paid at wrong time/amount
therefore cash)
advantageous terms Payments/credits not recorded
- stolen
- Record in wrong Period

Self-test
Answer the following questions.
1 For each of the following, state whether it is an objective relating to ordering, recording invoices or
payment:

(a) Orders are only made to authorised suppliers tl Ordering Recording invoices [l eayment

(b) Liabilities are recognised for all goods and Ordering ^frL
L I Recording invoices __.1
Payment
services received
(c) Orders are made at competitive prices Ordering fl necoroing invoices Payment

(d) All expenditure is authorised tr ordering [-l RecorOing invoices Payment

(e) Cut-off is correctlY aPPlied Ordering Recording invoices Payment

(0 Goods and services are only accepted if Ordering [-l Recoroins invoices tr Payment
there is an authorised order

2 List four examples clf purchase documentation on which numerical sequence should be checked

1 .............
2 .............
3 .............
4 .............

3 Why is numerical sequence on GRNs checked?

4 Give five examples of tests to be performed on the cash payments book

2
3
4
5

Now, go back to the Learning Objectives in the lntroduction. lf you are satisfied you have achieved these
objectives, please tick them off.

3 Assurance
Answers to lnteractive questions

Answer to lnteractive question 1

Approved list of suppliers.

Check of goods inward by person other than orderer.
Because the stores manager is entitled to make orders, pre-numbered order forms and safekeeping of order
forms would have made no difference in this case.
c
H
Answer to lnteractive question 2
A
Matching of purchase invoices with goods received notes. ?
T
Answer to lnteractive question 3 E
R
Reconciliation of the payables ledger to the control account.
Authorisation of payments.
7
Answer to lnteractive question 4
Stamping 'Paid' on invoices that have been paid.
Authorisation of payments.
Although checking supplier statements will help, the timing differences between the statement date and
payments made may mean that this method is not foolproof.

Answer to lnteractive question 5

Prompt payment discounts may not be obtained

Purchases system 12s

 Answers to Self-test

(a) Orders are only made to

authorised suppliers
a Ordering Recording invoices Payment

(b) Liabilities are recognised for all

goods and services received
tr ordering ,/ Recording invoices tr Payment

(c) Orders are made at competitive ,/ l

prices
Ordering l- Recoroing invoices tr Payment

(d) Allexpenditure is authorised ordering ,/

tr [-l Recoroing invoices Payment

(e) Culoff is correctly applied Ordering Recording invoices Payment

(0 Goods and services are only

tr ordering ,/ Recording invoices tr Payment
accepted if there is an
authorised order

2 Four from: (1) purchase requisitions, (2) purchase orders, (3) goods received notes, (4) goods returned
notes, (5) suppliers' invoices
3 Sequence provides a control that purchases are completely recorded. Missing documents should be
explained, or cancelled copies available othenrrrise the implication could be that goods have been received
but not matched with an invoice and the liability in respect of that invoice is being omitted.
4 For a sample of payments:

o Compare with paid cheques to ensure payee agrees

. Note that cheques are signed by the persons authorised to do so within their authority limits
. Check to suppliers' invoices for goods and services. Verify that supporting documents are signed
as having been checked and passed for payment and have been stamped 'paid'
. Check to suppliers' statements
. Check to other documentary evidence, as appropriate (agreements, authorised expense vouchers,
wages/salaries records, petty cash books etc)

126 Assurance