Question

‘How to do it’ is a company which provides information and products for the DIY sector. It has grown significantly in the past few years and turnover has increased from around $3m to over $15m per annum.

The company was originally managed by the owners who, as it grew, hired staff from predominantly amongst people that they knew or were already known to other staff. Staff numbers had grown from less than 10 to over 60 during this period and many employees were married to, or in relationships with, others within the company.

Audits are conducted annually and the audit company is well regarded and has been doing the audits since the company began. The auditors are regarded as part of the team and attend the Christmas function each year.

At the most recent Christmas function one of the auditors, commented to the general manager, as an aside during a conversation, that he was surprised that given the increase in turnover that the yearly profits were not higher.

The general manager decided that during the Christmas break he would look at the auditor’s report and review the situation. The auditor’s report made no such statement but after examining the figures it was apparent that profits should have been higher.

When the office re-opened he requested the auditors to undertake an examination specifically to discover why it was so.

The auditors investigated and reported that the section manager responsible for major purchases had paid invoices to a company which he and his wife owned. The amount paid to the company was in excess of $500,000.

The section manager was responsible for signing off on work completed, or supplies received, and authorising payments. His wife was responsible for issuing the cheques. Both were signatories to the cheque account.

What breaches of internal control were there and what modifications to procedures would you implement? Prepare a 5 page report outlining your suggested course of action.

Answer 1

Breaches of Internal Control

1. The fraud scheme is most easily accomplished when one or few individuals maintain control over multiple functions and duties such as purchasing, selecting vendors, and receiving, and approving payments. Lack of adequate written cash disbursement procedures, such as requiring independent approval for disbursements over a particular amount, also heightens the risk of such scheme.

2. Third party vendor diligence was ignored. The vendors should be scrutinized before entering into contracts.

3. Same person/ Related persons should not have been allowed to authorize payments as well as for issuing cheques. Here the senior manager and his wife were responsible for authrosing payments and as well issuing cheques. This increases the chances of fraud schemes within the organisation.

Suggested modifications

1. An independent third party should periodically audit the database to ensure that the listed vendors are indeed still active and not being used to process fictitious invoices.

2. Once the new vendor has been approved, he or she should be entered into a master vendor database to which only a select few individuals have authority to enter into and change. These changes should be made in accordance with written procedures requiring proper authorization.

3. Once the company commences business with the vendor, an appropriate independent person should approve all purchase orders prior to being processed. In addition, adequate supporting documentation including an original invoice from the supplier, and a receipt to indicate that the product was delivered, should be requested and reviewed to support all cash disbursements.

4. The same person should not be able to both request and approve purchase orders.    Likewise, only designated check signers should be able to disburse payment.

5. Numerous disbursements approved by one particular employee to a particular vendor which are just below the employee’s spending authority or which are for large even amounts or which are made on unusual dates such as weekends and holidays should be reviewed.

Auditors should follow up fraud indicators by looking for:

• Transactions lacking all required supporting documentation;
• Numerous disbursements approved by one particular employee to a particular vendor which are just below the employee’s spending authority or which are for large even amounts or which are made on unusual dates such as weekends and holidays;
• Invoices which do not match with the original purchase order and if applicable the original sales contract;
• Excessive “soft expenses” such as consulting fees, sales commissions, and advertising where there are no tangible products attached to the payable, paid to the same vendor by the same or few employees;
• Checks made to “cash” or “bearer” for alleged services or products received;
• Suspect endorsements on checks; and
• Checks with more than one endorsement, checks payable to businesses or individuals that were cashed and not deposited and checks endorsed by individuals.