ACA 412

Case: Auditing the Expenditure Cycle

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

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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. (20 points)
b. Describe three areas where management information could be distorted due to
weaknesses in the procedures, and recommend improvements to correct these
weaknesses. (20 points)
c. Identify three strengths in the procedures described and explain why they are strengths.
(10 points)

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