Manufacturing Concerns Of Acquisition And Payment Process - Term Paper Example

Manufacturing Concerns Of Acquisition And Payment Process 1. For any manufacturing concern, purchasing and payables forms a significant portion of its business cycle. Purchasing and payables process is broadly divided into two categories i.e. acquisition and payments. These processes forms an integral part of the supply chain management which are supervised by their respective department heads. Various accounts heads, appearing in the general ledger of the company, are involved in the procurement process. These account heads include Purchases, Cost of goods sold, Inventory (stock in hand) and accounts payable. Purchases account head represents the raw material acquired in the normal course of business. The purchases department ensures that the transactions are authorized and complies with predefined criteria. Accounts payables or creditors are the other account affected by the acquisition of raw material. Whenever a purchase of raw material is made, the accounts payable account is credited with the net amount payable to the supplier of the raw material. When the amount is actually paid, the affect is incorporated in the cash ledger. Cost of goods sold balance represents the book value of the finished goods sold during the financial period. The other impact of the selling of finished goods is recorded in the sales ledger which is credited by the selling price of the sold good. The difference between the cost of goods sold balance and sales appears in the company’s income statement as the gross profit. Inventory account acts as a sub-ledger to the purchases ledger. The balance in the inventory account represents the value of inventory present in the warehouse at the end of the financial year. The inventory management department keeps on assessing the net realizable of the stock in hand, as according to accounting principles, the stock must be valued at lower of cost or net realizable value. 2. Manufacturing concerns all around the globe are now focusing more and more on making its acquisition and payment process efficient and effective. Several business functions are involved in the acquisition and payment cycle such as Planning and forecasting, material management department, warehouse supervision department, quality control department and accounts department. All of the mentioned business functions are integrated with each other and with other business functions so that the company is able to utilize its resources aptly. The cycle of acquisition and payments starts with the planning department which prepares annual forecasts in consultation with the Marketing Department. These forecasts are based on the demand for the company’s products and are subject to revision on a monthly basis. The forecasts are forwarded to the Materials Management Department (MMD). The MMD considers factors such as the total quantity of finished goods to be produced taking into account the standard consumption of raw materials, the quantity of required raw materials on hand and minimum inventory levels to be maintained (buffer stock), when deciding on the quantity of raw materials to be purchased. Further consideration is given to factors such as availability of the item on a continuing basis, any bulk discounts etc. Several documents are also generated throughout the process. The first and foremost document generated for the acquisition of raw material is the purchase order. Purchase Order (PO) is system generated as per basis of Material Procurement Requisition (MPR). It is usually raised by Procurement dept and is computer numbered. One copy is sent to supplier, second to accounts dept, third copy retained by procurement and fourth sent to bank in case of imports. It is normally sent through fax. The procurement or the purchasing department ensures that the prices, as mentioned in the purchase order, is competitive and agreed with the suppliers. When goods are received at the warehouse, the Warehouse Incharge compares the item description and quantity as per the supplier’s Delivery Note (DN) with the respective PO, and if it is satisfactory, the system generates a Goods Inward Receipt (GIR), which has two, parts i.e. a receiving part and an approval part. The Warehouse Incharge signs only the receiving part of the GIR along with the DN, acknowledging the receipt of the goods. The quality control department on satisfaction as to the quality of the goods only enters the quantity into the system on the basis of the GIR. Valuation is done by the Accounts Department at month end. Accounts records the purchases in the General Ledger at every month end on the basis of the purchase summary, which is also system generated. The accounts department is also responsible for the cash disbursement to the suppliers. The department ensures that the disbursement is to the correct payee and vendor, the input for amount payable was of performed correctly, disbursement is recorded in the correct period and payments made are for goods or services actually ordered or rendered and received. 3. An organization maintains internal control in order to govern the management functions and to ensure that they are being carried out according to the predefined standard, established by the management itself or the relevant authorities. There is a direct relationship between the entity’s objective and the stability of the internal control that it maintains. The internal control environment depends on several factors such as the size of the entity, complexity and diversity of the entity’s operation and the applicable legal and regulatory environment. From the auditor perspective, it is imperative to obtain understanding of the client’s internal control environment and to ensure whether they are implemented appropriately. Purchasing and payment cycle acts as the corner stone for any manufacturing concern, and in order to operate effectively, the management must establish strong controls over it. For ordering, which is a sub process, the primary control is to ensure that the purchase transactions are approved. The material purchase requisition must be approved by head of material management department and all purchases are approved by the designated persons. In order to ensure that only valid purchase orders are input for processing completely, the management must ensure that all purchase orders are system generated and sequentially numbered to ensure that orders are not duplicated. Apart, from the mentioned, the management must also ensure that only authorized personnel have right to enter purchase orders and access vendor information and change or add new vendors. For the ordering sub-process, the control that POs are approved by the relevant personnel, can be tested by selecting, on random basis, few POs are ensuring that they were signed by the authorized signatories. The authorized signatory is usually the finance director or the head of supply chain management. Furthermore, controls on the processing of only valid purchase orders can be tested by checking 3 POs for three months and ensuring that PO number for succeeding month is not older than PO number of previous month. For the sub-process of goods receipt, the management must establish controls that receiving reports are input for processing completely and accurately. The control can be establish through pre numbering all good receipt reports and matching the goods received to the purchase orders upon receipt. From audit perspective, randomly select GIR on sample basis and compare them with the corresponding POs in order to ensure that the quantity of the goods matches. Segregation of duties must also be established in order to discourage fraud activities in the organization. Activities such as initiation and preparation of purchase orders, local and import purchases and recording of invoices and disbursement of cash, must all be separated from each other. While evaluating controls, all of the personnel involved in the afore mentioned activities must be interviewed by the auditors in order to ensure that proper segregation of duties are maintained. The next sub-process involved in the purchasing and payment cycle is the invoice processing. This is a very crucial process and the management must design immaculate controls in order to ensure that accounts department gets the correct information regarding the amount payable to the supplier. The information uploaded into the system from the purchase order must be compared by the data entry staff and any exception must be noted on invoice. For evaluating this control, a random transaction must be selected from the system and the amount must be compared with the purchase order and goods invoice receipt. In the system, while entering the particulars of invoice, supplier invoice number should be a required field in order to ensure that duplicate invoice numbers are not entered into the system. This control can be evaluated by a direct observation of the entering of invoice particulars into the system and observing whether the system prompts when a duplicate invoice is entered into the system. Reconciliation must be prepared by the management between inventory and payable reports by the finance function so that excess liability recorded on the basis of unapproved / not prepared GIRs, if any, can be reversed. In order to assess the reliability of this control, a copy of reconciliation must be obtained from the management and its accuracy must be assessed. Authority checks must also be maintained in the system in order to ensure that unauthorized access to the system is avoided. This control can be tested through direct observation. The last sub-process in the payment and acquisition process is the payment to the supplier. The foremost control objective for the management is to ensure that the disbursements are input for processing completely. Such controls can be designed which allow the cheques to be prepared electronically and after processing entry is posted in subsidiary ledger and cash book simultaneously. The ERP system must have the ability to automatically upload the information from the invoice thus ensuring that the disbursement input is for the correct amount. These controls can be evaluated through direct observation. Another significant control objective, in the payment sub-process, is to ensure that disbursement input is in the proper period. The system must have the ability to disallow any difference between the payment date and the date of the cheque. This control can be tested by checking any transaction and noting the date of payment from subsidiary ledger and comparing it with the cheque date. It must also be checked whether that entry in the subsidiary ledger is made simultaneously with the entry in cash book. 4. Fixed assets are the non-current asset of an entity and form a significant portion of the asset base of any manufacturing concern. Comfort over the accuracy of recording of fixed asset can be obtained through perform substantive analytical procedures and test of details. Substantive analytical procedure can be performed over the depreciation expense charged during the year. The analytics can be performed by multiplying the average depreciation rate with the book value of the fixed assets, and then comparing the depreciation charge for the year with the actual depreciation charge as per the books. If the actual depreciation charge as per the books and the expected depreciation charge as per the calculation differ significantly, inquire the management and obtain reasonable justification. Physical inspection of fixed asset is very important in order to verify their existence. The auditors must also ensure that all the assets are properly tagged. Other audit test over fixed assets include ensuring that routine repair and maintenance expenditures are expensed out and not capitalized, verifying the ownership of the fixed assets such land and buildings and identifying that fully depreciated assets appears at nil value. Prepaid expenses usually include prepaid rent and prepaid insurance. Rent agreements can be evaluated in order to calculate the prepaid rent for the period and comparing it with the balance appearing in the books. An expectation before conducting the test can be developed by comparing the current year figure with the corresponding of last year. The same test can be tailored for the prepaid insurance. For the audit of inventory, several procedures can be performed. It must be ensured that the inventory is recorded at the higher of cost or net realizable value (NRV). Test must be performed on obsolete inventory or such inventory the market price of which has been declining lately. Audit test must also be performed to check the adequacy of slow moving inventory. For checking the adequacy of provisioning, the ageing of the items must be established. Greater the age, higher will be the provision. Accrued liabilities include balances such as accrued salary, accrued overhead expenses, accrued mark-up expenses and payments related to other operating expenses. Cut-off testing must be performed on these balances to ensure that liability for the relevant financial period has been recorded. Comfort can be obtained by performing substantive analytical testing such as reasonableness testing. For accrued salary expenses, calculate the average monthly salary of all the employees and project the balance on 12 months. If the variation between the actual balance and the project balance exceeds the predefined threshold, investigation must be performed such as inquiring the management about whether any bonuses or increment were awarded during the period. Overhead expense can be linked with the production trend during the current year. If the production was higher during the current year, as compared to the previous, the accrued overhead expense is expected to be greater. For accrued mark-up expenses, average market rate of return must be applied on the long and short term credit facilities obtained by the management, and a comparison of the expected balance with the actual balance must be performed. Significant variation, if any, must be investigated. References [1] PricewaterhouseCoopers. PwC Audit Guide 2010. 2010. Print. Read More