SULTHAN HAKIM/ 145020308121003

International Undergraduate Program in Accounting of Brawijaya University

Course: Auditing Laboratory

AUDITING CASES: 6. AUDIT PROCEDURES AND AUDIT DOCUMENTATION:
TESTING THE INVENTORY PURCHASING SYSTEM

DISCUSSION QUESTIONS

1. In the brief description presented of Lakeside's inventory procurement system,
several specific control activities can be seen:

 the company maintains a perpetual inventory which provides significantly
greater control than does a periodic system;
 the case implies that the company uses preprinted forms so that
adequate information is captured whenever a document is prepared;
 all purchase requisitions are reviewed and authorized before
merchandise is ordered;
 incoming inventory is inspected for damage upon receipt;
 all invoices are matched with the appropriate purchase requisition
and receiving report before payment is approved;
 prices of every invoice are verified; and

2. Canceled checks are the last document in this system, while receiving reports
are one of the first. Whenever auditors select a final document such as a
canceled check and search for its documentation, they are seeking to
substantiate the validity of the balance being reported. All forms and documents
must be present to prove that the amount and the company's reporting were both
correct. Such testing also seeks to discover whether false transactions have
been entered into the system. For example, if a canceled check is found without
a corresponding receiving report or purchase requisition, the possibility exists
that money has been stolen from the company; a payment was made for
merchandise that was not ordered nor received.

Taking a beginning document such as a receiving report and tracing the impact
of the transaction through an entire system is intended to provide evidence of
completeness and that the system and its controls are working as designed.
Obviously, such testing will also provide evidence as to the validity of the account
balance, but this particular procedure is more often associated with the
completeness assertion and internal control evaluation.

3. How might Lakeside pay for goods that were received? The company could, as
an example, receive an invoice and not properly match it with the corresponding

4. Audit documentation. the audit documents as a whole must indicate that internal control was studied and evaluated. From the location of the initials. is designed to demonstrate that the auditor has obtained sufficient. All audit documents are the property of the auditor and are maintained by the auditor in order to support the opinion rendered by the auditor. Because of the great volume of audit documentation accumulated during an . The working paper should also specify any problems that were encountered and their resolution. Auditing literature places emphasis on the existence of appropriate supervisory policies and anticipates that practices will be used by a firm in each audit engagement to verify proper supervision. How might Lakeside fail to pay for goods that were not received? If either the receiving report or the invoice is lost. Furthermore. 5. The receiving report might state that 10 items were actually acquired while the invoice was for 20 or 100. As another possibility. Thus. A CPA firm must establish policies and procedures for the supervision of work at all organizational levels to provide reasonable assurance that the examination conforms to generally accepted auditing standards. One such procedure is to have staff members leave their initials to indicate the completion of a test or later review. competent evidence on which to base an opinion as to the fair presentation of the client's financial statements. some of the audit staff may lack an in-depth knowledge of the client or the client's industry. In addition. The individual doing the review may not notice the discrepancy and erroneously approve the invoice. also called a working paper. this individual might authorize an incorrect invoice in order to receive a kickback from the vendor. receiving report. the working paper shown in Exhibit 6-1 was originally produced by Art Heyman (AH) and subsequently reviewed by Carole Mitchell (CM). the documents will not match and payment cannot be made. thus increasing the possibility of incorrect judgments. the company may wait indefinitely for the other (lost) form before approving the cash disbursement. The working paper must demonstrate that this portion of the examination was properly planned and that all assistants were adequately supervised. Procedures for supervision are necessary to ensure that appropriate judgments and conclusions have been drawn from the work performed. this auditing firm must require acknowledgment at every point of audit judgment to indicate that the supervisors concur with the actions taken. Supervision by auditors having the necessary experience and expertise provides reasonable assurance that sufficient evidence and proper conclusions were obtained. the working paper indicates the testing that was performed and the evidence that was accumulated. Not every member of an audit team will have the expertise necessary to evaluate the handling of each accounting and auditing problem that arises. Thus. 6. and Wallace Andrews (WA). This policy enables the firm to monitor the degree of supervision in each area of the audit as well as to ensure that no critical problem will escape the attention of supervising auditors. Given that overall objective.

8. some firms have standardized audit procedures for use on all audits. by having to furnish this information. Abernethy and Chapman may be using a code in which the letter N refers to the inventory account. engagement. Indexing allows the auditor easier access to the various documents and expedites the review process. One of the purposes of audit documentation is to serve as an historical record of all audit testing performed by the CPA firm. Audit procedures are the steps that are required to test a particular control. Also. and this particular document presents the results of the second testing procedure performed on that account. To assure that the audit documents clearly reflect the procedures that were carried out and the evidence gathered. the staff auditor is more likely to understand the purpose of the procedures being applied. This documentation provides a guideline for future audits but. For quality control standards. transaction. or account. The "N-2" designation on this document is apparently part of an indexing system. However. and the conclusions reached be included in the documentation of each test. Some firms write procedures specifically designed for a particular audit client. . serves as evidence should the auditor's work ever come under question. more importantly. Furthermore. most firms use an indexing system to organize all materials. standardized procedures are preferable to ensure that all audits are performed in a like fashion. 7. many auditing firms require that the objective. these standardized procedures should be supplemented with procedures designed to meet the particular circumstances of each client. although no indication is given in the case as to the actual derivation of the symbols. the scope.

the instructor should be aware that this question was developed with several educational objectives in mind: . in the seventh procedure. Also. signatures. other than comments A and B. dates. if so. The staff auditor does not indicate whether the $200 and the $360 amounts are over or under the current list price. Thomas' explanation is apparently accepted without further question or testing. what testing could be performed. Exception (B) is also vague and poorly written. By reviewing the steps of the audit program listed in this case. 2. although they do contain some problems. but in a small company such as Lakeside. Stating that "the difference represents monthly purchases from Cypress at different prices than shown in current price list" indicates nothing about the reason for the change. A great amount of variety exists in format. The comment does not indicate the amount of the differences that are involved in this replacement. no indication is given as to the purpose of verifying the account code. judging the materiality of the items will be quite difficult for the audit supervisors. Exception (A) is poorly written. An auditor would prefer to see this policy in an official Lakeside manual rather than accepting oral evidence. For example. do not require additional testing. concurrence appears to exist with this evaluation. This reconciliation is not clearly stated. Once again. The auditor should adjust the flowchart and memorandum for this system to include this discovery. with this explanation (and the actual testing procedure) is that Thomas' word is accepted as an adequate explanation for the discrepancy. and payee. In reviewing this audit document with students. Since all of the supervisors have added their initials. Additionally. the fifth procedure states that the auditor "examined canceled checks for amounts. students can see that Heyman has performed the audit procedures designed by Mitchell. the auditor is not just physically examining this information but is confirming the data against some other document (the invoice). thus. On the whole. Students may want to discuss whether these two discrepancies warrant further examination and. Attached is one example of an audit document that could be produced by carrying out the prescribed auditing procedures. that may not be possible. The audit procedures seem generally clear. Therefore. the explanation for the discrepancies is vague. though. endorsements. Exception (C) seems relatively clear. The major problem. The assumption has apparently been made through the comment "Pass Further Work" that the differences are immaterial and.EXERCISES 1. this working paper appears to be clear and comprehensive. and students ought to be evaluated on the clarity and understandability of their approach rather than on the development of a particular structure." Obviously. The auditor provides no information that any further testing has been carried out to verify these amounts.

so that his documentation is adequate. some are meaningless. as a discussion question. If this question is approached.  To assist students in developing the ability to discover and evaluate control problems. a number of problems exist. In this case. while some are quite significant. at least partially. He should do only enough work at this point to fully understand the nature of the inconsistency. . one or more of the students' efforts can be chosen and presented to the class as a whole or in small groups for a technical critique.  To aid students in developing audit document construction techniques. As in a previous case. 3. In conversations with Mitchell further work may be developed. If Art Heyman found inconsistencies in this part of the audit his primary responsibility is to document the items.  To introduce students to the types of testing procedures performed by auditors in verifying the operating efficiency of a company's control policies and procedures. student ideas as to the meaning and importance of each problem can be quite interesting.

P. Scope: Population: All receiving reports prepared during the period under audit. Audit Procedures:  Review receiving reports. recomputing 3% discount. and footed by Lakeside employees. t Inspected canceled checks and compared them to invoice amounts. Lakeside Company W. All agreed except B and C. randomly starting with #3918.  Invoices reviewed for compliance to see if they were checked. and paid. All complete and signed by inspectors. Pulled reports sequentially. except A. All agreed except E.  Compared receiving report to purchase requisition for quantity and description. All agreed except E. extended. All were except D. received.  Compared receiving report with purchase invoice for quantity and description. . Comments: See W/P N-3 page 2. Audit Conclusion: Further testing necessary because of exceptions noted. No. Sample: Judgmentally selected 12 receiving reports from inventory department file. All requisitions approved by Rogers or Miller.  Compared invoice prices with Cypress Master Price List. All agreed except B. N-3 Tests of Receiving Reports and Cash Disbursements 1 12/31/09 Accountant: AH Date: 12/3/09 Audit Procedures Date Receiving Invoice Check Report Number Number Number     t G 8/20/09 3918 711 3091      t G 8/21/09 3919 802 3121      t GC 8/24/09 3920 991 3164      t EF 8/27/09 3921 1261 3203      t GBD 8/28/09 3922 1313 3251      t G 9/2/09 3923 1406 3310      t E 9/3/09 3924 1510 3345      t A 9/7/09 3925 1616 3397      t GB 9/7/09 3926 1691 3425      t GC 9/14/09 3927 1812 3451      t G E 9/16/09 3928 2072 3471      t GC 9/21/09 3929 2149 3510  Audit Objective: To verify that items received were properly ordered.

or extensions were verified. R. N-3 Tests of Receiving Reports and Cash Disbursement (cont. System is functioning properly. Other invoices show initials and tick marks. F One invoice was reduced by a 4% discount. invoice prices were less than the Master Price List. This reflects a serious problem with both the Lakeside and Cypress systems. G In virtually all cases. Lakeside has paid for goods ordered.R. #3927.R. while R. Lakeside Company W. instead of 3%. #2923 indicates Lakeside's acceptance of a replacement but no indication in connection with R. B On two invoices Cypress billed Lakeside for items different from those received. E In a number of cases. #3927 has an item that is less expensive than the one billed. the scope of testing may need to be expanded.R. Further inquiry is required to determine if Lakeside still has a liability for these amounts. No. footing. but Lakeside took the discount in every case. Lakeside.) 2 12/31/09 Accountant: AH Date: 12/3/09 Comments A Receiving report not in file.P. . Unless it is accounted for.R. however. not those received. but more evidence is needed. #3923 shows an item that is more expensive than the one billed. checks were issued 2 or 3 days after the 20-day deadline for taking discounts. not goods received. Further inquiry required to determine reason. C Some receiving reports indicate receiving a different amount of goods than ordered. The purchase requisition for R. D No indication on this invoice that pricing. Requisitions indicate that goods have been backordered in both cases. There seems to be a discount on special items. In both cases the bill was for the items ordered. Failure to comply with the system in this one case. paid only for goods received. Client should be asked to find it or provide a reason for its absence.