Purchasing, Inventory, and Cash Disbursements: Common Frauds and Internal Controls

• Chapter 1 - The Acquisitions Cycle: Ordering, Receiving, and Warehousing
  • Learning Objectives
  • The Acquisitions Cycle
  • Ordering
  • Receiving and Warehousing
  • Variations of the Typical Acquisitions Cycle
    • Evaluated Receipts Settlement
    • Damaged or Substandard Goods
  • Manufacturing Environment
  • Retail Environment
  • Services
  • Smaller Entity
  • Internal Controls in the Ordering, Receiving, and Warehousing Processes
    • Separation of Duties
    • Other Controls
  • Errors, Fraud, and Controls
  • Control Matrix
  • Summary
  • Exercises
• Chapter 2 - Cash Disbursements Cycle
  • Learning Objectives
  • Cash Disbursements
  • Typical Cash Disbursements System
    • Retail Store Example
  • Other Controls
  • Internal Controls in the Example Retail System
    • Separation of Duties
    • Other Controls
  • Errors, Fraud, and Controls
    • Separation of Duties
  • Control Matrix
  • Services
  • Electronic Data Interchange (EDI) Overview
  • Cash Disbursements Fraud Statistics
    • Cash Disbursement Frauds Other Than Billing
    • Check Tampering
    • Interesting Facts about Check Fraud
    • Check Fraud Case
    • What Is Positive Pay?
    • How Does Positive Pay Work?
  • Cash Register Disbursement Frauds and Theft of Cash on Hand
  • Summary
  • Exercises
• Chapter 3 - Payroll and Expense Reimbursement Frauds
  • Learning Objectives
  • Introduction
  • Payroll System
  • Internal Controls in the Example Payroll System
    • Separation of Duties
    • Other Controls in the Example Payroll System
  • Additional Payroll System Controls
    • Errors, Fraud, and Controls
    • Separation of Duties
    • Fraud/Errors Not Due to Inadequate Segregation of Duties
  • Control Matrix
  • Other Compensation Methods
    • Commissions
  • Other Payroll Compensation Issues
    • Payroll Outsourcing
    • Expense Reimbursement Frauds
  • Summary
  • Exercises
• Chapter 4 - External Auditing and Forensic Investigations: Conceptual and Procedural Differences
  • Learning Objectives
  • Overview
  • Differences between External Audit and Forensic Procedures and Principles
  • Summary
  • Exercises
• Chapter 5 - Latest Developments
• Appendix A - 2008 Report to the Nation on Occupational Fraud and Abuse

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Chapter 1 - The Acquisitions Cycle: Ordering, Receiving, and Warehousing

Learning Objectives

• Understand typical controls in the acquisitions cycle’s ordering, receiving, and warehousing phases.
• Be able to identify weaknesses in internal control in the acquisitions cycle’s ordering, receiving, and warehousing phases.
• Use a control matrix to understand how controls can mitigate numerous risks.
• Understand risks to reliable financial reporting in the acquisitions cycle’s ordering, receiving, and warehousing phases if adequate internal controls are not present.

The Acquisitions Cycle

The acquisitions cycle exists in all types of entities – government, nonprofit, and for profit. Some of the most common ordering, receiving, and warehousing internal control objectives are

• Authorization for the procurement of all goods and services at agreed-upon prices from approved vendors
• All goods and services received are recorded and classified correctly and accurately
• Damaged or substandard goods are promptly identified and appropriate action is taken
• Payment is made for goods and services appropriately
• All goods are adequately safeguarded

In many for profit entities, such as retail establishments and manufacturers, most transactions in the acquisitions cycle are for the procurement of either finished goods inventory for resale (retail establishments) or for raw materials inventory for production (manufacturers). These entities can also have a significant number of transactions for the procurement of services.

This chapter will address the ordering, receiving, and warehousing phases of a typical acquisitions cycle, noting where errors or fraud could occur, and presenting various types of internal controls to prevent and/or detect errors and/or irregularities. A control matrix will be presented to illustrate how controls can achieve relevant control objectives. Additionally, a fraud case is provided to illustrate this chapter’s objectives.

Ordering

A typical acquisitions cycle’s ordering, receiving, and warehousing phases are described below. Most entities will have variations to these examples within their own procurement processes, as it is appropriate to adjust controls to each entity’s specific needs.

Assume that a large organization has numerous departments that use a variety of office supplies. A central purchasing department combines purchase requisitions from various departments in order to obtain quantity discounts on bulk purchases and also decrease the large amount of ordering and material handling costs that would be incurred if each department ordered its own supplies.

On a monthly basis, the departments within the large organization determine what supplies are needed by having a responsible employee observe the types and quantity of supplies on hand in the departmental supply rooms. A numerically sequenced purchase requisition is prepared by this employee and approved by the departmental manager. A copy of the purchase requisition is filed numerically in the requesting department and another copy is sent to the purchasing department.¹

The purchasing department accounts for the numerical sequence of purchase requisitions by department to provide assurance that no purchase requisitions are missing. All identical items that are requested by different departments are summarized. The purchasing department is the only department that can issue purchase orders, and purchase order forms are under the control of the purchasing department.

The purchasing department has a list of approved vendors for each item that is used by the various departments. This approved-vendors list is constructed based upon factors such as length of time from order to delivery, payment terms, prices, and the quality of goods provided.

Once a supplier has been identified, the purchasing department creates a four-part numerically sequenced purchase order. The purchase order is approved by an appropriate supervisory employee in the purchasing department and serves as a written authorization for the vendor to ship the requested goods to the customer. The purchase order is sent to the vendor, copies of the purchase order are distributed to accounts payable and receiving, and a copy is retained in the purchasing department.

Additionally, company policy prohibits purchasing personnel from receiving gifts or other types of remuneration from vendors. This company policy is distributed to all vendors each year. A review of a sample of the purchase prices paid by the purchasing department and quality of goods received is conducted by an individual outside of the purchasing department each month.

Some acquisitions systems in lager entities require purchase requisitions to be approved by management other than management in the department that requisitioned the goods or services. An alternative to this policy is to have purchase requisitions above a certain dollar amount be approved by management outside of the requisitioning department.

Larger entities also oftentimes rotate the purchasing agents and suppliers so that no one purchasing agent works consistently with the same supplier. There is oftentimes a policy whereby new vendors are investigated by personnel outside of the purchasing, receiving, warehousing, and accounts payable departments.

See Exhibit 1-1 for a flowchart of ordering process, Exhibit 1-2 for an example of a purchase requisition, and Exhibit 1-3 for an example of a purchase order.²

1 The company has a budget for supplies by department and by type of supply (printer cartridges, paper, etc.).

2 The purchase requisition and purchase order forms are from a template provided with Microsoft office suite of products.

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