Operational Auditing 825 Ill. Problems Problem 1 You are the director of internal auditing of a large municipal hospital. You receive monthly financial reports prepared by the accounting department, and your review of them has shown that total accounts receivable from patients have steadily and rapidly increased over the past eight months. Other information in the reports shows the following conditions: The number of available hosoital beds has not changed. The bed occupancy rate has not changed. Hospital billing rates have not changed significantly. The hospitalization insurance contracts have not changed since the last modification 12 months ago. Pei eee Your internal audit department performed a financial and operational audit of the accounts receivable accounting function ten months ago. The working paper file for that assignment contains financial information, a record of the Preliminary survey, documentation of the study, evaluation of controls, documentation of the procedures used to produce evidence about the validity and collectibility of the accounts, and a copy of your report that commented favorably on the controls and collectibility of the receivables. However, the current increase in receivables has alerted you to the need for another audit. You remember new stories last year about the manager of the city water system who got into big trouble because his accounting department double-billed all the residential customers for three months. You plan to perform a preliminary survey of the problem, if indeed a problem exists. Required: 8. Write a memo to your senior auditor listing at least eight questions that should be used to guide and direct the preliminary survey. (Hint: The categories of questions used in the last preliminary survey were these: “Who does the accounts receivable accounting?” “What data processing procedures and policies are in effect?” and “How is the accounts receivable accounting done?” This time, you will use these categories826 Chapter 35 and add a fourth category of questions: “What financial or economic events have occurred in the past 10 months?”) b. Describe the phases of the audit that would be performed after the preliminary survey is completed. Problem 2 Silver Lily Company has a centralized purchasing department that is managed by Josie Francisco. Francisco has established policies and procedures to guide the clerical staff and purchasing agents in the day-to-day operation of the department. She is satisfied that these policies and procedures are in conformity with company objectives and believes there are no major problems in the regular operations of the purchasing department. Silver Lily’s internal audit department was assigned to perform an operational audit of the purchasing function. Their first task was to review the specific policies and procedures established by Francisco. The policies and procedures are as follows: ¢ All significant purchases are made on a competitive bid basis. The probability of timely delivery, reliability of vendor, and so forth, are taken into consideration on a subjective basis. © Detailed specifications of the minimum acceptable quality for ali goods purchased are provided to vendors. « Vendors’ adherence to the quality specifications is the responsibility of the materials manager to the inventory contro! department and not the purchasing department. The materials manager inspects the goods as they arrive to be sure that the quality meets the minimum standards and then sees that the goods are transferred from the receiving dock to the storeroom. ¢ All purchase requests are prepared by the materials manager based on the production schedule for a 4-month period. The internal audit staff then observed the operations of the purchasing function and gathered the following findings: « One vendor provides 90 percent of a critical raw material. This vendor has a good delivery record and is reliable. Furthermore, this vendor has been the low bidder over the past few years,Operational Auditing _827 « As production plans change, rush and expedite orders are made by production directly to the purchasing department. Materials ordered for cancelled production runs are stored for future use. The costs of these special requests are borne by the purchasing department. Francisco considers the additional costs associated with these special requests as “costs of being a good member of the corporate team.” * Materials to accomplish engineering changes are ordered by the purchasing department as soon as the changes are made by the engineering department. Francisco is proud of the quick response by the purchasing staff to product changes. Materials on hand are not reviewed before any orders are placed. + Partial shipments and advance shipments (that is, those received before the requested date of delivery) are accepted by the materials manager, who notifies the purchasing department of the receipt. The purchasing department is responsible for follow-up on partial shipments. No action is taken to discourage advance shipments. Required: Based on the purchasing department’s policies and procedures and the findings of Silver Lily’s internal audit staff, a, Identify weaknesses and/or inefficiencies in Silver Lily Company’s purchasing function. b. Make recommendations for those weaknesses / inefficiencies that you identify. Use the following format in preparing your response. Weaknesses / Inefficiencies Recommendations 1. iy