13.

10 Last year the Diamond Manufacturing Company purchased over $10 million worth of
office equipment under its special ordering system, with individual orders ranging from
$5,000 to $30,000. Special orders are for low-volume items that have been included in a
department managers budget. The budget, which limits the types and dollar amounts of
office equipment a department head can requisition, is approved at the beginning of the
year by the board of directors. The special ordering system functions as follows:
Purchasing A purchase requisition form is prepared and sent to the purchasing
department. Upon receiving a purchase requisition, one of the five purchasing agents
(buyers) verifies that the requester is indeed a department head. The buyer next selects
the appropriate supplier by searching the various catalogs on file. The buyer then phones
the supplier, requests a price quote, and places a verbal order. A prenumbered purchase
order is processed, with the original sent to the supplier and copies to the department
head, receiving, and accounts payable. One copy is also filed in the open-requisition file.
When the receiving department verbally informs the buyer that the item has been
received, the purchase order is transferred from the open to the filled file. Once a month,
the buyer reviews the unfilled file to follow up on open orders.
Receiving
The receiving department gets a copy of each purchase order. When
equipment is received, that copy of the purchase order is stamped with the date and, if
applicable, any differences between the quantity ordered and the quantity received are
noted in red ink. The receiving clerk then forwards the stamped purchase order and
equipment to the requisitioning department head and verbally notifies the purchasing
department that the goods were received.
Accounts Payable Upon receipt of a purchase order, the accounts payable clerk files it in
the open purchase order file. When a vendor invoice is received, it is matched with the
applicable purchase order, and a payable is created by debiting the requisitioning
departments equipment account. Unpaid invoices are filed by due date. On the due date,
a check is prepared and forwarded to the treasurer for signature. The invoice and
purchase order are then filed by purchase order number in the paid invoice file.
Treasurer
Checks received daily from the accounts payable department are sorted into
two groups: those over and those under $10,000. Checks for less than $10,000 are machine
signed. The cashier maintains the check signature machines key and signature plate and
monitors its use. Both the cashier and the treasurer sign all checks over $10,000.
a. Describe the weaknesses relating to purchases and payments of special orders by the
Diamond Manufacturing Company.
b. Recommend control procedures that must be added to overcome weaknesses identified
in part a.
c. Describe how the control procedures you recommended in part b should be modified if
Diamond reengineered its expenditure cycle activities to make maximum use of
current IT (e.g., EDI, EFT, bar-code scanning, and electronic forms in place of paper
documents).
(CPA Examination, adapted)
Weakness
1. Buyer does not verify that
the department heads request
is within budget.
2. No procedures established
to ensure the best price is
obtained.

Control
Compare requested amounts
to total budget and YTD
expenditures.
Solicit quotes/bids for large
orders.

Effect of new IT
System can automatically compare the
requested amount to the remaining
budget.
EDI and Internet can be used to solicit
bids.

3. Buyer does not check

vendors past performance.
4. Blind counts not made by
receiving.

5. Written notice of
equipment receipt not sent to
purchasing.
6. Written notice of
equipment receipt not sent to
accounts payable
7. Mathematical accuracy of
vendor invoice is not verified.
8. Invoice quantity not
compared to receiving report
quantity.
9. Notification of
acceptability of equipment
from requesting department
not obtained prior to
recording payable.
10. Voucher package not sent
to Treasurer.

11. Voucher package not

cancelled when invoice paid.
12. No mention of bank
reconciliation.

Prepare a vendor performance

report and use it when
selecting vendors.
Black out quantities ordered
on copy of Purchase Order
sent to receiving
Provide incentives if
discrepancies between
packing slip and actual
delivery are detected.
Send written notice of
equipment receipt to
purchasing.
Send written notice of
equipment receipt to accounts
payable
Verify mathematical accuracy
of vendor invoice.
Compare/verify invoiced
quantity with quantity
received.
Obtain confirmation from
requisitioner of the
acceptability of equipment
ordered prior to recording
payable.
Send voucher package
(purchase order and receiving
report) to Treasurer along
with approved invoice.
Treasurer should mark
voucher package as PAID
when check is signed.
Bank account should be
reconciled by someone other
than Accounts Payable or the
treasurer.

Vendor performance ratings can be

updated automatically and made
available to buyer.
Do not permit receiving clerks to access
quantities on purchase orders.
Request bar coding or RFID tagging of
all items and use readers to check in all
deliveries.
Still provide incentives to detect
discrepancies.
Receiving data and comments entered
via on-line terminals and routed to
purchasing.
Configure system to notify accounts
payable automatically of equipment
receipt.
Automatic verification of mathematical
accuracy of vendor invoice.
System verifies invoice quantity with
quantity received.
Configure system to require confirmation
of equipment acceptability prior to
approving invoice for payment.

Configure system to match invoices

automatically with supporting
documents.
Configure system to mark supporting
documents as used when invoice is paid.
Bank account should be reconciled by
someone other than Accounts Payable or
the treasurer.

10.8

(CMA Examination, adapted)

a. O'Brien Corporation: Internal control weaknesses and recommended improvements:
Weaknesses and Potential Problem(s)

Recommendation(s) to Correct Weaknesses

1. Orders received over the telephone are

not confirmed by customers in writing.
This could result in errors or in filling
bogus orders.

Require a written customer purchase order

as confirmation of telephone orders.

2. Customer credit histories are not

checked before approving orders. This is
resulting in excessive late collections and
uncollectible accounts.

Customers credit should be checked and

no sales should be made to those that do
not meet credit standards.

3. Sales orders are filed by date in the

Marketing Department. This leads to
difficulty in handling customer questions
and complaints.

Establish customer files and file sales

orders by customers.

4. Only two copies of sales orders are

prepared. This is not enough to insure a
proper matching in the Billing Department.

Prepare, at a minimum, a three-part sales

order, sending one to Shipping and one to
Billing. Billing should match its copy with
a signed copy from Shipping before
preparing a sales invoice.

5. Items that are out of stock are merely

noted. Inaction in these cases could cause
lost sales.

Establish procedures to schedule

production for back orders and to ship and
bill the product once it is available.

6. There is no reconciliation of inventory

amounts shipped with billings. This could
result in undetected underbilling.

Billing and shipping records should be

integrated on the computer system to
provide for reconciliation of inventory
amounts shipped and billed.

7. The Receiving Department and the

Shipping Department share a computer
terminal. In addition, the personnel in both
departments have access to the physical
inventory and can update the perpetual
inventory records through the terminal.
This could result in theft of inventory with
no means of tracing the theft.

Each department should have its own

terminal and the terminals should be for
inquiry purposes only. The physical
custody and recordkeeping of inventory
should be separated (perpetual records
should be updated on the computer by
Purchasing/Accounts Payable and Billing).
Access to the physical inventory should be
limited to Receiving; it would add
incoming goods to the physical inventory
and select the goods from the warehouse
for shipping.

8. The Receiving Department does not

compare incoming deliveries to purchase
orders. This may lead to the acceptance of
unordered goods.

Copies of purchase orders without quantity

information should be sent to Receiving.
Receiving should match the shipment to the
purchase order and indicate the quantity
received.

9. A complete inventory listing is printed

only once a year. Errors in the perpetual
inventory records may remain undetected
for too long a time period.

Inventory listings should be printed

periodically throughout the year, and
physical counts compared to the listing on
a cycle basis.

b.

How O'Brien Corporation could use its new computer system to improve control and
efficiency:
Maintain an online master file for customer account and credit data in addition to
inventory data.
Use online terminals to enter sales order data into the system as orders are received.
Have the system check inventory availability as order data are entered; if the customer is
on the phone at this time, inventory availability may be confirmed directly to the
customer.
Have the system perform a credit check as order data are entered, and reject orders from
customers who are not credit-worthy.
Immediately following approval of a sales order, have the system (1) print or display a
shipping order for Shipping Department use, (2) print a packing slip and mailing label
for use in shipping the goods to the customer.
Once the order has been shipped, the system should generate a customer invoice.
Maintain order data online to facilitate response to customer inquiries re order status.
Use password access controls to restrict access to the customer and inventory files, and the

operations that can be performed on these files, to appropriate personnel.

12.7

OBrien Corporation is a midsize, privately owned, industrial instrument manufacturer

supplying precision equipment to manufacturers in the Midwest. The corporation is 10
years old and uses an integrated ERP system. The administrative offices are located in a
downtown building and the production, shipping, and receiving departments are housed
in a renovated warehouse a few blocks away.
Customers place orders on the companys website, by fax, or by telephone. All sales are on
credit, FOB destination. During the past year sales have increased dramatically, but 15%
of credit sales have had to written off as uncollectible, including several large online
orders to first-time customers who denied ordering or receiving the merchandise.
Customer orders are picked and sent to the warehouse, where they are placed near the
loading dock in alphabetical sequence by customer name. The loading dock is used both
for outgoing shipments to customers and to receive incoming deliveries. There are ten to
twenty incoming deliveries every day, from a variety of sources.
The increased volume of sales has resulted in a number of errors in which customers were
sent the wrong items. There have also been some delays in shipping because items that
supposedly were in stock could not be found in the warehouse. Although a perpetual
inventory is maintained, there has not been a physical count of inventory for two years.
When an item is missing, the warehouse staff writes the information down in log book.
Once a week, the warehouse staff uses the log book to update the inventory records.
The system is configured to prepare the sales invoice only after shipping employees enter
the actual quantities sent to a customer, thereby ensuring that customers are billed only
for items actually sent and not for anything on back order.

Identify at least three weaknesses in OBrien Corporations revenue cycle activities.

Describe the problem resulting from each weakness. Recommend control procedures that
should be added to the system to correct the weakness.
(CMA Examination, adapted)
Weaknesses and Potential Problem(s)

Recommendation(s) to Correct Weaknesses

1. Orders from new customers do not

require any form of validation, resulting in
several large shipments being sent and
never paid for.

Require digital signatures on all online

orders from new customers.

2. Customer credit histories are not

checked before approving orders, resulting
in excessive uncollectible accounts.

Customers credit should be checked and

no sales should be made to those that do
not meet credit standards.

3. Outgoing shipments are placed near the

loading dock door without any physical
security. The loading dock is also used to
receive incoming deliveries. This increases
the risk of theft, which may account for the
unexplained shortages in inventory.

Separate the shipping and receiving docks.

4. Physical counts of inventory are not

made at least annually. This probably
accounts for the inaccuracies in the
perpetual inventory records and may also
prevent timely detection of theft.

Physical counts of inventory should be

made at least once a year.

5. Shipments are not reconciled to sales

orders, resulting in sending customers the
wrong items.

The system should be configured to match

shipping information to sales orders and
alert the shipping employees of any
discrepancies.

6. The perpetual inventory records are only

updated weekly. This contributes to the
unanticipated shortages that result in
delays in filling customer orders.

The warehouse staff should enter

information about shortages as soon as
they are discovered.

Require a written customer purchase order

as confirmation of telephone and fax
orders.

Physically restrict access to the loading

dock area where customer orders are
placed.

Inventory records discrepancies should be

corrected and investigated.