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Module 8: Marketing, purchasing, and production functions

Overview
To provide you with realistic and challenging opportunities to apply internal auditing concepts and methodologies developed in earlier modules, Modules 8 and 9 address six major functions typical of many organizations: (1) marketing, (2) purchasing, (3) production, (4) human resources, (5) treasury, and (6) strategic planning. Module 8 covers the first three functions; Module 9 covers the last three. To help you gain the technical knowledge and professional skills related to these functions, the modules explain the internal auditors role, the main management and operational activities, and the risks of each function. Internal audit program extracts designed for a fictional organization, Nut Case, Inc., are used to illustrate the internal audit approach to these six common, yet important, functions. Although each function has its unique disciplines, sound risk management and control systems and practices can, and should, be applied to all. The practical illustrations of concepts and analytical methods will help you approach the design and performance of internal audits of less familiar activities such as aerospace engineering, nuclear energy generation, correctional services programming, health care, or education. The internal auditor should always focus on the potential contribution of each of the functions toward achieving the organizations strategic, operational, and financial goals. Each function has risks that could prevent the goals from being achieved. It is managements responsibility to identify, assess, and control risks, and to establish a framework of control systems and practices to increase the likelihood that goals are achieved. Through the application of an evaluative methodology and expertise in risk management, control systems, and practices, the internal auditor is able to identify opportunities to improve operations and enhance organizational achievement. The internal auditor also identifies the strengths of managements control systems and practices that should be maintained and built on. In your study and work so far, you have probably used only pre-written audit programs. By the end of this course, you should be able to prepare effective internal audit programs that are appropriate to any circumstance you encounter in practice, thereby avoiding the need to memorize audit programs authored by others.

Test your knowledge

Begin your work on this module with a set of test-your-knowledge questions designed to help you gauge the depth of study required.

Learning objectives
8.1 Marketing Explain the role, main activities, and risks of the marketing function in an organization. (Level 2) Marketing audit Case study Develop an audit program for a risk-based internal audit of the marketing function. (Level 1) Marketing audit Data analysis Use ACL to analyze the data compiled from a sales and marketing audit program. (Level 2) Purchasing Explain the role, main activities, and risks of the purchasing function in an organization. (Level 2) Purchasing audit Case study Develop an audit program for a risk-based internal audit of the purchasing function. (Level 1) Production

8.2

8.3

8.4

8.5

8.6

Determine the role, main activities, and risks of the production function in an organization. (Level 2) 8.7 Production audit Case study Develop an audit program for a risk-based internal audit of the production function. (Level 1) Module summary Print this module

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MU1 Module 8: Test your knowledge

1. In designing internal audit procedures, which of the following internal audit procedures with respect to purchasing is most appropriately written? a. b. c. d. Find out whether the planning and monitoring processes in place are working well. Select a sample of purchases for the month of October. Review procedures used in issuing requests for proposals to potential vendors. Find out whether the competitive bidding procedures are working well.

2. Management has requested an audit of promotional expenses. The sales department has been giving away expensive items in conjunction with new product sales to stimulate demand. The promotion seems successful, but management believes the cost may be too high. Which of the following audit procedures would be the least useful to determine the effectiveness of the promotion? a. A comparison of product sales during the promotion period with sales during a similar non-promotion period b. A comparison of the unit cost of the products sold before and during the promotion period c. An analysis of marginal revenue and marginal cost for the promotional period, compared to the period before the promotion d. A review of the sales departments reasons for believing that the promotion has been successful 3. A production manager for a moderate-sized manufacturing company began ordering excessive raw materials and had them delivered to a wholesale company that the manager was running as a side business. The manager falsified receiving documents and approved the invoices for payment. Which of the following audit procedures would most likely detect this fraud? a. Take a sample of cash disbursements; compare purchase orders, receiving reports, invoices, and check copies. b. Take a sample of cash disbursements and confirm the amount purchased, purchase price, and date of shipment with the vendors. c. Observe the receiving dock and count materials received; compare the counts with receiving reports completed by receiving personnel. d. Perform analytical tests, comparing production, materials purchased, and raw materials inventory levels; investigate differences. 4. Which of the following describes a control weakness? a. Purchasing procedures are well designed and are followed unless directed otherwise by the purchasing supervisor. b. Prenumbered blank purchase orders are secured within the purchasing department. c. Normal operational purchases fall in the range from $500 to $1,000 with two signatures required for purchases over $1,000. d. The purchasing agent invests in a publicly-traded mutual fund that lists the stock of one of the companys suppliers in its portfolio.

Solutions

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MU1 Module 8: Test your knowledge solutions

1. a. Incorrect. This is an audit objective. b. Correct. This procedure outlines a specific audit technique and specifies which account will be involved. c. Incorrect. This is an audit objective. d. Incorrect. This is an audit objective. 2. a. Incorrect. Sales comparisons determine the effectiveness of the promotion by stimulating demand. b. Correct. The change in unit costs of the product sold is unrelated to the audit objective. c. Incorrect. The promotion will be successful if the marginal revenue exceeds marginal cost because it would show the extent of additional revenue versus cost. d. Incorrect. The sales department may have useful information about new customers and repeat purchases. a. Incorrect. Since documents have been falsified, supporting documents exist for each cash disbursement. b. Incorrect. The vendors will confirm all transactions. c. Incorrect. Improper orders are shipped to another location; thus, observing the receiving dock will not detect the fraud. d. Correct. The analytical procedures should identify an unexplained increase in materials used. a. Correct. The possibility of management override is an inherent limitation of internal control. b. Incorrect. Use of prenumbered blank purchase orders secured within the purchasing department is a common control. c. Incorrect. Requiring a more stringent authorization procedure for larger purchases is an appropriate control as long as documentation supports all purchases. d. Incorrect. The purchasing agents mutual fund investment should not be a conflict of interest since the relationship is very weak between return on investment and any possible action by the agent to favour the supplier.

3.

4.

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8.1 Marketing
Learning objective

Explain the role, main activities, and risks of the marketing function in an organization. (Level 2)
Required reading

Reading 8-1, Marketing activities and risks (Level 2)

LEVEL 2

Marketing role
Nearly all organizations profit or non-profit need to market their goods or services. Marketing is a process that identifies present and future opportunities in the marketplace, and then develops and implements strategies and plans to enable the organization to capitalize on these opportunities. An organizations scope of marketing activities may range from a single simple activity such as placing infrequent classified advertisements in local papers, to complex and extensive operations involving millions of dollars annually. In some organizations, such as manufacturers of soft drinks, soaps, and breakfast cereals, marketing is one of the largest areas of corporate expenditure. Although marketing success is of significant strategic interest to senior management, directors, and investors, internal auditors have historically tended to spend disproportionately fewer hours examining this function. Perhaps internal auditors are uneasy with attempting to evaluate creative, artistic disciplines, and marketing activities tend to present greater challenges for internal auditors trying to assess effectiveness, efficiency, and economy. Truly successful marketing is largely a creative undertaking, where precise impact is often hard to measure and even more difficult to attribute directly to efforts expended. For example, how would you evaluate the cost-effectiveness of a customer service department, or isolate the short-term impact on sales of increasing advertising expenditures by 10%? Despite these challenges, sound management systems and practices should still be applied to the marketing function, and feedback from an internal audit is important. In fact, the potential for internal auditors to identify opportunities for an organization to achieve more may be disproportionately higher in marketing than for more traditional areas of audit focus because of the rapid changes in the marketing environment. While you may not be familiar with the marketing function, when you first encounter it, keep in mind that internal auditors are also intent on identifying opportunities for an organization to achieve more, and are interested to see that appropriate goal-setting systems and practices (strategies and plans) are in place in all areas of the organization they work for.

Main marketing activities and risks

The marketing department surveys short-term and long-term customer needs that the organization could meet in order to achieve its goals, such as expanded market share, increased profitability, and improved share values. The marketing department then prepares a marketing strategy for each product, including decisions relating to price, distribution, and promotion, which should be integrated to create a cohesive marketing strategy for the firm as a whole. Products are researched, designed, and manufactured to meet identified customer needs and are introduced to markets through sales promotion, distribution, and customer service systems and practices. Reading 8-1 explains common marketing activities and the related significant risks.

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8.2 Marketing audit Case study

Learning objective

Develop an audit program for a risk-based internal audit of the marketing function. (Level 1)
Required reading

Reading 8-2, Nut Case, Inc. marketing audit program (Level 1)

LEVEL 1

This topic provides a sample marketing audit program using the audit program framework in Reading 5-1.

Case study 8.2-1: Nut Case, Inc., background information

The following background information will be used to provide a consistent setting for the case studies in Modules 8 and 9. Nut Case, Inc., is a medium-sized, privately-owned Canadian company whose primary business has been the production of high-quality suitcases, with sales all over North America. The owners are John Case and Mary Nut. Nut Cases manufacturing plant and head office is located in western Ontario. Ten regional sales offices are responsible to the vice-president, sales and marketing, at the head office. There are a total of 100 employees: 70 employed in manufacturing and warehousing, 15 in regional sales offices, and 15 in management, purchasing, and administration. When the company began business in 1980, sales rapidly expanded and controls were virtually non-existent. In recent years, sales have been levelling off and, as a result of excess plant capacity; the company branched into the manufacturing of briefcases and other lines of leather products. Sales for 2011 were over $24 million, gross profit was over $4 million, and net profit after taxes was $477,000. Here are some current challenges faced by the company: A new collective agreement signed by the company and the union representing Nut Case workers Competition from Nylon Case Inc., a manufacturer of nylon fabric suitcases, which has caused Nut Case to reduce prices on certain lines Declining world-wide sales in luxury travel products Increasing costs for raw materials On the recommendation of its external auditors, an experienced internal auditor and CGA, Eddie Tickbird, has been hired to provide more management control. Eddie reports administratively to the president and functionally to an audit committee, which is made up of outside directors. The audit committee was formed after Eddie gave the board a presentation on corporate governance and the role of internal audit and audit committees. The internal audit department has prepared a long-term risk-based audit plan, which involves the audit of six departments in two years. The audit programs for three of these audit engagements (marketing, purchasing, and production) are covered in this module, while the remaining three (human resources, treasury, and strategic planning) are covered in the next. There is also one ACL illustration in each module. Each of these audit programs is risk-based, which requires the auditor to consider the major objectives of the each process, the related risks, and controls to reduce those risks. As part of the audit planning, the auditor would also document best practices for key controls by referring to professional associations and other reference material. Then audit procedures would be developed to test the design and functioning of the controls. The following table would help in the development of the audit program for each audit engagement

Business process objective

Risks to achieving process objectives

Controls in place to Identified best mitigate the risks practices for controls

Walk-through (control design effectiveness)

Detailed testing (operational effectiveness)

In the audit programs provided in Modules 8 and 9, you can assume that the main activities, risks, and controls have been selected, based on an analysis of business objectives and risks.

Nut Case, Inc., marketing audit

Reading 8-2 is a sample audit program for an audit of the marketing function of Nut Case, Inc. This audit focuses on two of the key marketing activities: pricing and advertising. As you read through the audit program, remember that criteria must be established to achieve the objective(s) of the audit, and the audit procedures must be designed to obtain sufficient appropriate evidence as to whether the company is in compliance with the selected criteria.

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8.3 Marketing audit Data analysis

Learning objective

Use ACL to analyze the data compiled from a sales and marketing audit program. (Level 2)
Required reading

Online reading 8.3-1: Computer illustration 8-1: Sales and Marketing Analysis (Level 2)
LEVEL 2

In this topic, you will use ACL to analyze data compiled from a sales and marketing audit program. Go to Online reading 8.3-1 now, and perform the ACL analysis of sales and profit margins in Computer illustration 81.

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8.4 Purchasing
Learning objective

Explain the role, main activities, and risks of the purchasing function in an organization. (Level 2)
Required reading

Reading 8-3, Its all in the details: Align supply chain management with strategy (Level 2) Reading 8-4, Purchasing activities and risks (Level 2) Reading 8-5, A Supply Chain Unlinked (Level 2)
LEVEL 2

Purchasing role
Purchasing consists of procuring goods to be consumed, resold as is, or used as direct input to the production of goods for sale. The role of the purchasing department is to specify and acquire goods and services of the right quantity and quality, at the lowest price, and deploy them at the right time, to the right place, with a view to maximizing the value of the firm. The degree of importance of purchasing can depend on the nature of the organization. In a manufacturing company, for example, purchases of raw materials are often a significant percentage of the costs of manufactured products and are therefore significant in terms of financial statement materiality. Similarly, in a retail business, the cost of goods sold constitutes a large proportion of total costs. In the service industries, however, goods or services do not normally constitute a major cost factor in comparison to staffing, for example. When there is a large volume of purchases, management should take a keen interest in the appropriate design and effective implementation of effective controls to address the risks of the purchasing function. Purchasing has a significant ripple effect on related functions and activities. In a manufacturing company, for example, purchasing practices directly affect production: poor quality raw materials or delays in the delivery of parts needed for the manufacturing process can cause serious production problems; also, inappropriate or ineffective purchasing practices can create excessive inventory levels and tie up capital unnecessarily. The effectiveness of the purchasing function therefore affects costs of operation, earnings performance, and ultimately, the value of the firm. Purchasing is often an important area of the organization, making effective management of this department crucial to the success of the entire organization. The scope and function of the purchasing department must be clearly defined. Most organizations have a formal purchasing policy to specify the purpose and authority of the purchasing department. For example, the types of acquisition transactions that must go through purchasing and those that can be directly handled by user departments would be distinguished in such a policy. While user departments normally decide on goods and services required, the purchasing department supports users in determining their needs and ensures that purchase requests (requisitions) are approved in accordance with delegated authorities, consistent with the goals and policies of the organization, and reasonable overall. Although the purchasing department handles most purchases, it may sometimes be more efficient for the user to buy goods and services directly from suppliers. In light of the specialized knowledge and skills that are required, marketing departments, for example, often negotiate advertising contracts directly with advertising agencies, and are responsible for monitoring and evaluating the agencys performance. In the case of recurring small orders of similar goods or services, the purchasing department may choose to establish, through a competitive tendering process, vendor-of-record contracts or blanket purchase orders to enable users to directly contact suppliers for additional shipments of commonly required materials or supplies. In addition, arrangements can be made for staff to have access to a corporate credit card to make purchases of supplies within predetermined limits. A further approach is to allow staff to acquire small amounts of supplies and

recover the expenditure from the organizations petty cash fund, which the organization replenishes as an imprest account. In other situations, it is better for the purchasing department to engage directly in procurement activities because the departments professionally trained and experienced staff tend to have greater expertise (such as knowledge of markets, warranties, legal, and other ramifications of corporate acquisitions) and are normally able to negotiate optimal prices, terms, and conditions, such as volume discounts. A final consideration is that having transactions processed through the purchasing department creates an opportunity to formally segregate the incompatible duties of transaction initiation, approval, and recordkeeping.

Main purchasing activities and risks

Reading 8-3 explains how good supply chain management (purchasing), is important to competing in global markets. The article identifies points to consider when planning an internal audit of purchasing. Reading 8-4 describes the main purchasing activities and their accompanying risks. Clearly, where there is an opportunity to reduce risk through sound purchasing management systems and practices, there is an equivalent opportunity for internal auditors to improve the profitability of the firm and its value to investors by assessing such practices and making recommendations for improvement. Reading 8-5 describes the unexpected supply chain risks resulting from recent natural disasters, and discusses some implications for management and auditors to consider for supply chain risk management of large business operations.

Continuous auditing
One way of auditing accounting transactions such as purchases, payments, and receipts is through the process of continuous auditing. This technique was introduced in Topic 3.6. Trending data and/or comparing data from different operating units performing the same functions can help identify performance and efficiency concerns.

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8.5 Purchasing audit Case study

Learning objective

Develop an audit program for a risk-based internal audit of the purchasing function. (Level 1)
Required reading

Reading 8-6, Nut Case, Inc. purchasing audit program (Level 1)

LEVEL 1

This topic explains the design methodologies used to develop an audit program for the purchasing function and illustrates these methodologies with an audit program.

Nut Case, Inc., purchasing audit

Continuing with the Nut Case, Inc. case study, Reading 8-6 shows a sample audit program for the purchasing function. It focuses on selected key purchasing criteria and illustrates related audit procedures.

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8.6 Production
Learning objective

Determine the role, main activities, and risks of the production function in an organization. (Level 2)
Required reading

Reading 8-7, Production activities and risks (Level 2)

LEVEL 2

Production role
The main role of production is to manufacture the required quantity of a product of the required quality, within the budgeted time, at the lowest possible cost. Production is linked to purchasing and to product design and development a group that tries to find ways of improving quality and reducing costs. Production also provides information to marketing to assist marketing managers in planning inventory levels of finished products and to help set prices. Production has significant ripple effects on related functions and activities. In a manufacturing company, production systems and practices directly affect product quality, timeliness of product delivery to customers, and investment in product inventory. The effectiveness of the production function therefore affects costs of operation, earnings performance, and ultimately the value of the firm. In a manufacturing company, the costs of manufactured products are significant in terms of financial statement materiality. Production management should clearly take a keen interest in the appropriate design and effective implementation of appropriate control systems and practices.

Main production activities and risks

It is difficult to generalize about production because so many different products are made. Not only do production processes vary widely, but so do the risks and problems associated with each type of process. Metal cans, paper, cars, silicon chips, and airplanes are not made in the same way; some are produced through a job-order production process, whereas others are made through a production line or a continuous-process system. Sometimes raw materials are the most important cost, while in other cases, labour is the key cost to control. Each type of process is unique and has its own control requirements. There are, however, some characteristics common to all production processes. Each process must have inputs (labour, materials, or supplies), facilities, and equipment, and each combines these elements to create a product. Important activities are also carried out to support the production effort: purchasing, material handling, product design and development, engineering, plant and equipment maintenance, inspection and quality control, packaging, employee recruitment and training, plant safety, and so on. Considering the diverse nature of production, the main activities of a production environment are considered common and merit the attention of the internal auditor. The main activities include the following: Strategic positioning and evaluation Forecasting production demand Planning and scheduling production Production control Reading 8-7 describes these activities and the associated risks. Internal auditors can play an important role in assisting production management control overhead costs.

Cost control is exercised on a quantitative or physical basis on the manufacturing floor. Performance indicators such as number of units produced per labour hour, average quantity of raw materials used per unit of finished product, and percentage of defects per shift are widely used to control production activities. Ultimately, however, the total production activity must be evaluated through the use of costing systems that deal with the cost of producing the product. The cost accounting system is an important control device in a manufacturing organization, but assessing the quality of a cost accounting system is difficult because such systems serve different purposes: inventory valuation, operational control, and measurement of individual product cost. You may encounter two quality control systems in the workplace: Total Quality Management (TQM) and the 9000 series of quality management standards published by the International Organization for Standardization (ISO). Revised versions of the three key standards in the ISO 9000 series were published in December 2000. The most current versions, known as ISO 9000:2005, are now in effect and are well documented on the ISO website.
ISO 9000 and ISO 140001

Here is a concise overview of ISOs best known management system standards, and their impact on the world: The ISO 9000 and ISO 14000 families are among ISOs best known standards ever. ISO 9001:2008 and ISO 14001:2004 are implemented by over a million organizations in 175 countries.
ISO 9000 family

The ISO 9000 family addresses Quality management. This means it addresses what the organization undertakes in order to do the following: Fulfill the customers quality requirements. Fulfill applicable regulatory requirements. Enhance customer satisfaction. Achieve continual improvement of its performance in pursuit of these objectives.
ISO 14000 family

The ISO 14000 family addresses Environmental management. This means it addresses activities the organization undertakes to do the following: Minimize harmful effects on the environment caused by its activities. Achieve continual improvement of its environmental performance. More information can be found on the ISO website.

1 International Organization for Standardization, ISO 9000 Quality Management,

http://www.iso.org/iso/iso_catalogue/management_and_leadership_standards/quality_management.htm and ISO 14000 Environmental management, http://www.iso.org/iso/iso_catalogue/management_and_leadership_standards/environmental_management.htm.

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8.7 Production audit Case study

Learning objective

Develop an audit program for a risk-based internal audit of the production function. (Level 1)
Required reading

Reading 8-8, Nut Case, Inc. production audit program (Level 1)

LEVEL 1

Nut Case, Inc., production audit

Reading 8-8 presents the production audit program for Nut Case, Inc. It focuses on key criteria of the production function and illustrates related audit procedures. While this specific audit engagement covers all aspects of production, in many companies this would not be a practical approach, and separate engagements would be established to assess the risk management and control processes of specific aspects of production such as production planning, control of materials, control of labour, and so on.

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Module 8 summary
Marketing, purchasing, and production functions
This module provides examples of how the approach to internal auditing described in the first half of the course may be applied to three functional areas: marketing, purchasing, and production. The role, main activities, and risks of each area are described, followed by a sample audit program from each area. In addition, an ACL illustration from the marketing audit program is provided in detail. Although the example is from the marketing area, you will be expected to analyze data from any functional area.

Explain the role, main activities, and risks of the marketing function in an organization.
The role of marketing within the organization is to do the following: Identify present and future opportunities in the marketplace. Develop and implement strategies and plans for the organization to capitalize on these opportunities. The main activities of marketing are as follows: Market research Market strategies development Pricing Promotion Sales and distribution Customer service Issues facing marketing, which are potential risks for the organization, include the following: Loss of sales and market share due to incompetent or ineffective marketing efforts Loss of competitive advantage through failure to maintain confidentiality of sensitive marketing information Erosion of unit contribution margins because of inadequate pricing or cost management High marketing costs per unit sold Excessive inventories leading to high carrying costs and obsolescence

Develop an audit program for a risk-based internal audit of the marketing function.
A complete audit program is outlined for Nut Cases pricing and advertising. This follows the same format as outlined in Module 5: Audit objectives Audit criteria Audit procedures Planning Examination Reporting and monitoring

Use ACL to analyze the data compiled from a sales and marketing audit program.
This computer illustration is drawn from Nut Cases audit program for marketing. It analyzes sales data to assist

in making a decision about which sales offices to close. This illustration provides detailed instructions on how to do the analysis. Working through this example will assist you in mastering ACL.

Explain the role, main activities, and risks of the purchasing function in an organization.
The role of purchasing within the organization is to do the following: Specify and acquire goods and services of the right quantity and quality, at the right price. Deploy them at the right time, to the right place, with a view to maximizing the value of the firm. The main activities of purchasing are as follows: Strategic positioning and evaluation Determining needs Acquiring goods and services Monitoring Issues facing purchasing, which are potential risks for the organization, include the following: Loss of sales due to poor-quality raw materials, delays in their delivery, or frequent stockouts Excessive inventory levels and resulting high carrying costs caused by inappropriate or ineffective purchasing practices Failure of control information systems and technologies that support purchasing Opportunities for fraud and illegal acts Just-in-time manufacturing, which involves unexpected risks affecting the supply chain, including natural disasters

Develop an audit program for a risk-based internal audit of the purchasing function.
A complete audit program is outlined for Nut Cases purchasing function. This follows the same format as outlined in Module 5: Audit objectives Audit criteria Audit procedures Planning Examination Reporting and monitoring

Determine the role, main activities, and risks of the production function in an organization.
The role of production within the organization is to manufacture the required quantity of a product of the required quality, within the budgeted time, at the lowest possible cost. The main production activities are as follows: Strategic positioning and evaluations Forecasting production demand Planning and scheduling production Production control Issues facing production, which are potential risks for the organization, include the following: Potential for cost overruns Loss of sales due to manufacturing of defective products, missed deadlines, and stockouts of raw

materials or finished products Inappropriate or ineffective production practices resulting in excessive inventory levels

Develop an audit program for a risk-based internal audit of the production function.
A complete audit program is outlined for Nut Cases production function. This follows the same format as outlined in Module 5: Audit objectives Audit criteria Audit procedures Planning Examination Reporting and monitoring

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Module 8: Self-test
1. Computer question As internal auditor, you have scheduled an audit of economy and efficiency in the purchasing department of your organization. The company has been experiencing significant cost pressures, due to a combination of negotiated wage increases and a drop in sales in a prolonged recession. You are focusing on economy and efficiency because the president has been particularly interested in opportunities for cost savings in the companys administrative procedures. Your companys purchasing/payables process follows traditional procedures: a purchase order is required to initiate the purchase of goods or services, and a receiving report must be sent to accounting, where it is matched to a suppliers invoice and paid. The present policy is to require a purchase order for purchases over a minimum dollar limit of $200. For all purchases under $200, general cheque payments are used. These are prepared from a cheque requisition and are sent directly to accounting by each department. During your audit, you have asked about the dollar amount of purchase orders processed, and the processing staff has told you that they spend a lot of time processing small dollar value orders, but they have no specifics. You know that considerable amounts of overtime have been spent in recent months trying to cope with the volumes of processing. You want to use ACL to analyze the companys purchasing data and present analysis showing the volumes of orders processed in various dollar ranges. Based on this evidence, you will make recommendations to adjust the dollar limits required for purchase orders, which will save processing costs and still maintain a reasonable level of internal control over the companys purchasing activity.
Material provided

The project PURCH.ACL is linked to the dBASE table purch . The fields in this table are as follows:
RECORD_DELETED deleted record flag DATE VEND AMT PONUM DEPT date of order vendor number amount of order purchase order number department ordering

This table contains purchase order data for the year.

Required

On the basis of ACL commands previously illustrated, and available on the main menu, use ACL to answer the following questions (see Procedure). For each part, clearly specify the ACL command and output (if required) that you would use. a. Compute descriptive statistics on the AMT field and prepare several histograms to determine the population distribution, computing statistics for amounts less than $1,000. You may need to specify different ranges for the histograms in order to obtain a better picture of the distribution of purchase order amounts. b. Based on the histograms produced in part (a), what recommendations would you

make to management about raising the minimum dollar limits required for purchase orders and receiving reports? (The objective is to reduce processing volumes and still ensure that adequate controls are in place over the purchasing/payment process.) c. Prepare a stratification of the distribution of purchase order amounts by vendor and a histogram of vendors. d. Based on the analysis of volumes of purchases by vendor in part (c), what recommendations would you consider to increase the efficiency of processing purchases with certain vendors? e. As previously stated, for purchases under the minimum dollar limit, the company processes a cheque directly, without issuing a purchase order. However, there is a cost for this process. What ideas might you consider to reduce processing costs in this area? Explain in general terms the analysis you might gather to support a recommendation to management.
Procedure

1. 2. 3. 4.

Start CGA ACL. Open the project PURCH.ACL and retrieve the table purch in the Tables folder. Save all the required reports after using the appropriate ACL commands. Compare your answers to the solutions provided.

Hint : In solving this question, consider the following ACL commands, in addition to other ACL commands that you may use: Window > Show Command Line Analyze > Statistical > Statistics Analyze > Histogram Analyze > Stratify

Note : Should you experience difficulties when attempting to send output to screen (for example, if ACL system crashes), log back into ACL. If prompted, restore to the last-saved version of your file. Repeat the exercise, but before running the report, click Output > Print or Output > File to select that option. Solution 2. Multiple choice a. The markup applied to an organizations products varies between customers. Which of the following audit procedures is most likely to uncover this? 1. Checking to see if sales have been made to customers with inadequate credit ratings 2. Checking to see if salespeople were able to set prices without clearance from the central office 3. Determining if production costs have been excessive 4. Analyzing selling costs for excessiveness b. In an audit of travel expenses for salespeople, the auditor calculates average travel expenses per day travelled for all salespeople, and then examines detailed receipts for salespeople with high averages. Which types of audit evidence do these procedures represent? 1. Documentary and physical evidence

2. Analytical and physical evidence 3. Documentary and analytical evidence 4. Physical and testimonial evidence c. How does an organization minimize the risk that agents in the purchasing department will use their positions for personal gain? 1. Rotate purchasing agent assignments periodically. 2. Request internal auditors to confirm selected purchases and accounts payable. 3. Specify that all items purchased must pass value-per-unit-of-cost reviews. 4. Direct the purchasing department to maintain records on purchase prices paid, reviewing them every six months. d. Upon receipt of purchased goods, receiving department personnel match the quantity received with the packing slip quantity, and mark the retail price on the goods based on a master price list. The annotated packing slip is then forwarded to inventory control, and goods are automatically moved to the retail sales area. What is the most significant control strength of this activity? 1. 2. 3. 4. Immediately pricing goods for retail sales Matching quantity received with the packing slip Using a master price list for marking the sale price Automatically moving goods to the retail sales area

e. Which of the following is not likely to be included as an audit step when assessing vendor performance policies? 1. 2. 3. 4. Determine whether agreed-upon lot sizes were sent by vendors. Determine whether only authorized items were received from vendors. Determine whether the balances owed to vendors are correct. Determine whether the quality of the goods purchased from the vendors has been satisfactory.

Solution 3. CASE STUDY T8-1: Catco Ltd. From observations, inspection of various documents, and analytical procedures performed during your internal audit of the purchasing department of Catco Ltd., you have determined that the department is structured as a cost center, and that managers of the department are evaluated and annual cash bonuses determined based on purchase cost minimization. In recent years, bonuses and perquisites have been consistently high for purchasing department managers. At the same time, bonuses for managers in other functional areas such as production and marketing have been falling. Analytical review procedures have determined that spoilage, rework, inventory write-offs, returned sales, and warranty claims have all been rising in recent years. Furthermore, you are aware from trade magazines and interviews with directors and senior managers that the companys reputation as a manufacturer of high quality products seems to be eroding, and market share is being lost to Japanese and other Pacific Rim competitors, whose products consumers seem to view as more reliable. From interviews conducted with the treasurer, chief executive officer, and chairman of the board, it seems clear that the market price of the firms shares seems to vary, largely due to the investment communitys expectation of future cash flows. Sadly, the market value of the firms shares has been sliding steadily downwards for the last three years, against general market trends.

Required

a. Explain goal congruence and the potential for ethical dilemmas to arise for purchasing management. b. If purchasing department managers pursue cost minimization, with a view to maximizing their annual bonus, should they be chastised if the market price of the companys shares drops? c. Draft an appropriate audit finding (criteria, observation, cause, impact, and recommendation) for inclusion in the internal audit report. Solution 4. CASE STUDY T8-2: Celtic Enterprises Limited Celtic Enterprises Limited (CEL) is a Canadian corporation that produces and markets soft drinks in more than thirty countries. The corporate head office is located in Halifax. CEL has five divisions throughout the world. CEL has enjoyed considerable growth in the last ten years and is now an important player in the soft drink industry. Operating results for the current year, however, were below expectations. Budgeted and actual sales by division were as follows:
Division North America South America Europe Asia Africa TOTAL 255 145 182 73 75 730 Current year Actual Budget ($000,000s) 305 146 230 95 100 876 290 140 215 90 90 825 Actual Last year Budget ($000,000s) 285 140 210 95 92 822

The soft drink industry is highly competitive and global in its scope. Marketing activities, especially advertising, are critical to the success of the organization. The corporate head office marketing group is responsible for determining CELs overall marketing philosophy. Marketing groups in each division are then responsible for establishing local marketing strategies and managing their own marketing activities. All divisions use major advertising agencies for the design, delivery, and management of their advertising campaigns. The marketing groups negotiate advertising contracts. Finance departments in each division are responsible for making payments to agencies. Agencies are remunerated on a fixed amount plus a percentage of advertising expenditures managed. Advertising expenditures in all divisions are mainly for advertising in newspapers, magazines, radio, and television, and in recent years on the Web. Some divisions also sponsor sports events in some countries. Actual and budgeted advertising expenditures by division for the current year were as follows:
Division North America South America Europe 51 35 29 Actual ($000,000s) 45 34 25 Budget

Asia Africa TOTAL

10 14 139

11 12 127

Yesterday, Maxine Schultz, the president of CEL, confided to Hugh OBrien, chief audit executive, that she was not satisfied with the operating results for the year, that the companys market shares were declining in all divisions, and that she was concerned about the way advertising activities were managed by the divisions. Furthermore, it seems that the investment markets were beginning to discount the companys share price. Hugh was pleased to answer that advertising activities were planned for examination by the internal audit department in the coming months. Following Maxines comments, Hugh decided to expedite this audit and requested his audit manager, Larinda Thornley-Hall, to prepare a draft audit program for this project, to include at least the following elements: a. b. c. d. e.
Required

Audit objective Key areas to examine and rationale for selection Potential problems in each area High-level (general) audit criteria for each area Examples of audit procedures in each area

Assuming the role of Larinda, prepare the draft audit program requested by Hugh OBrien. Solution 5. CASE STUDY T8-3: Willon Manufacturing Company Willon Manufacturing Company (WMC) is one of the most important producers of carpets and floor coverings in Canada. It had sales of over $450 million last year and made a profit of $52 million. WMC operates six plants, each manufacturing different products. The president of the company, Yves Deschamps, called Rhonda Van Nus, the director of the internal audit department, into his office yesterday and told her the following:
Rhonda, I do not know whats going on in our Toronto plant. I reviewed their costing reports this morning, and they are seriously out of line with their targets. They seem to have major problems in controlling their use of raw materials. You know that labour costs are only 10% of total manufacturing costs and are not a concern. I also looked at their inventory reports, and they have enough raw materials for six months. We cannot afford to finance such waste. They put a new inventory management system in place last year, and I thought it was working well. I also spoke with Janet Grace, our vice-president of marketing, who informed me that she had recently received numerous complaints from customers about the poor quality of the products manufactured in Toronto. You know how competitive our industry is; we can easily lose customers for poor product quality. I want you and your audit team to fly to Toronto as soon as possible to identify the problems there in particular the poor control over use of raw material. But before you leave, please write me a memorandum outlining the possible causes of these problems and your proposed audit approach. This will enable me to understand the situation better while waiting for the results of your audit.

Required

Assume the role of Rhonda Van Nus and prepare the memo requested by the president. For the purposes of this case, in your memo, list the possible causes of problems for raw material usage. Outline your audit scope and approach for raw material usage, and identify the systems and practices to be reviewed in this area. Solution

Solution 1

Self-test 8 Solution 1

Computer solution
a.

Retrieving the table purch and viewing its contents

1. Open the project PURCH.ACL. The status bar indicates that there are 499 records in the table.

Displaying descriptive statistics on amount (AMT) from the table

1. Choose Analyze > Statistical > Statistics to display the Statistics dialog box. 2. Click AMT in the Statistics On list view. 3. Click Output Select the option Screen and click OK.

As of: 03/15/2011 11:58:47 Command: STATISTICS ON AMT TO SCREEN NUMBER 5 Table: purch

AMT Range Positive Negative Zeros Totals Abs Value

Number -

Total 52,975

Average 2,453 0 2,453 -

499 1,224,012 0 0 0 -

499 1,224,012 - 1,224,012

Highest Lowest 53,129 52,677 52,054 45,247 44,848 154 157 158 161 162

Displaying a histogram for amount (AMT)

1. Select Analyze > Histogram to display the Histogram dialog box. 2. Click the drop-down arrow below the Histogram On button to display a list of fields. 3. Browse through the fields list and select AMT. Make sure Intervals is selected and in the text box beside it type 10. In the Minimum text box type 0, and in the Maximum text box type 1000. 4. Click Output click to select Screen and click OK. As of: 03/15/2011 12:03:58 Command: HISTOGRAM ON AMT MINIMUM 0 MAXIMUM 1000 INTERVALS 10 TO SCREEN Table: purch

Minimum encountered was 154 Maximum encountered was 53,129 Range 0 - 99 100 - 199 200 - 299 300 - 399 400 - 499 500 - 599 600 - 699 700 - 799 800 - 899 900 - 1,000 >1,000 Count 0 18 46 18 91 27 5 4 25 34 231

5. At the bottom of the Window click Graph to see the histogram as a graph.

Displaying a histogram for amount (AMT) from 200 to 800

Using steps similar to those described in the preceding section, display a histogram for AMT, setting the minimum to 200 and maximum to 800. As of: 03/15/2011 12:10:19 Command: HISTOGRAM ON AMT MINIMUM 200 MAXIMUM 800 INTERVALS 10 TO SCREEN Table: purch

Minimum encountered was 154 Maximum encountered was 53,129 Range <200 200 - 259 260 - 319 320 - 379 380 - 439 440 - 499 500 - 559 Count 18 27 23 11 17 77 27

560 - 619 620 - 679 680 - 739 740 - 800 >800

0 3 6 0 290

Displaying a histogram for amount (AMT) from 0 to 400

Using steps similar to those described in the preceding section, display a histogram for AMT, setting the minimum to 0 and maximum to 400. As of: 03/15/2011 12:12:51 Command: HISTOGRAM ON AMT MINIMUM 0 MAXIMUM 400 INTERVALS 10 TO SCREEN Table: purch

Minimum encountered was 154 Maximum encountered was 53,129 Range Count

0 - 39 40 - 79 80 - 119 120 - 159 160 - 199 200 - 239 240 - 279 280 - 319 320 - 359 360 - 400 >400

0 0 0 3 15 17 21 12 9 5 417

b. The analysis of the volumes of various dollar amounts of purchases, using the histogram command of ACL, should reveal that the company could raise the requirements for purchase orders, and receive reports, without compromising control over the majority of dollars spent. Clearly, the cutoff of $200 is not adequate because

very few P.O.s are less than $200. There is a range of acceptable recommendations here. You should recommend that the requirement for purchase orders be raised to anywhere from $400 to $600 or even $800. The actual amounts are not critical, only the principle that the limits should be raised just below the level where the larger dollars are involved. This maximizes the cost/benefit of control procedures to the organization. c.

Stratifying records for vendor (VEND)

1. Choose Analyze > Stratify to display the Stratify dialog box. 2. Click the drop-down arrow in the list view below the Stratify On button to display a list of fields. 3. Browse through the fields list and select VEND. Set Intervals to 25, in the Minimum text box type 146; in the Maximum text box type 180. 4. Click Output Choose Screen and click OK. As of: 03/15/2011 12:15:58 Command: STRATIFY ON VEND MINIMUM 146 MAXIMUM 180 INTERVALS 25 TO SCREEN Table: purch

Minimum encountered was 146 Maximum encountered was 180

VEND 146 - 147 148 - 148 149 - 150 151 - 151 152 - 152 153 - 154 155 - 155 156 - 156 157 - 158 159 - 159 160 - 160 161 - 162 163 - 163

Count Percent of Count Percent of Field VEND 43 0 28 25 0 37 38 0 44 0 11 24 8 8.62% 0% 5.61% 5.01% 0% 7.41% 7.62% 0% 8.82% 0% 2.2% 4.81% 1.6% 7.74% 0% 5.14% 4.65% 0% 7.01% 7.26% 0% 8.55% 0% 2.17% 4.77% 1.61% 6,278 0 4,172 3,775 0 5,684 5,890 0 6,940 0 1,760 3,873 1,304

164 - 165 166 - 166 167 - 167 168 - 169 170 - 170 171 - 171 172 - 173 174 - 174 175 - 175 176 - 177 178 - 178 179 - 180 Totals

19 16 13 24 10 30 31 29 0 25 31 13 499

3.81% 3.21% 2.61% 4.81% 2% 6.01% 6.21% 5.81% 0% 5.01% 6.21% 2.61% 100%

3.85% 3.27% 2.68% 4.98% 2.1% 6.32% 6.57% 6.22% 0% 5.42% 6.8% 2.88%

3,127 2,656 2,171 4,043 1,700 5,130 5,332 5,046 0 4,400 5,518 2,340

100% 81,139

Displaying a histogram for vendor (VEND)

1. Select Analyze > Histogram to display the Histogram dialog box. 2. Click the drop-down arrow below the Histogram On button to display a list of fields.

3. Browse through the fields list and select VEND. Set the Intervals to 25, in the Minimum text box type 146, in the Maximum text box type 180. 4. Click Output Select Screen and click OK As of: 03/15/2011 12:20:11 Command: HISTOGRAM ON VEND MINIMUM 146 MAXIMUM 180 INTERVALS 25 TO SCREEN Table: purch

Minimum encountered was 146 Maximum encountered was 180 Range 146 - 147 148 - 148 149 - 150 151 - 151 152 - 152 153 - 154 155 - 155 156 - 156 157 - 158 159 - 159 160 - 160 161 - 162 163 - 163 164 - 165 166 - 166 167 - 167 168 - 169 170 - 170 171 - 171 172 - 173 174 - 174 175 - 175 176 - 177 178 - 178 Count 43 0 28 25 0 37 38 0 44 0 11 24 8 19 16 13 24 10 30 31 29 0 25 31

179 - 180

13

7. Close all windows and exit ACL. If prompted to save the changes, choose No to close without saving the view.

d. The stratification and the histogram revealed that a relatively small number of vendors account for a large volume of the purchasing transactions. It would most likely be more efficient if blanket purchase orders were negotiated annually with these vendors. Departments would then be able to order directly over the telephone, thus saving the processing cost of individual purchase orders. e. This part of the question requires you to be creative and use your general business experience. The management auditor would likely perform some analysis, using sample departments, on the types and amounts of purchases under $200. You should discuss the use of petty cash funds, with proper procedures. The issue of standing purchase orders may also be relevant here, for certain departments that frequently require small purchases. Another consideration is the use of corporate credit cards.

Note:
You may use other ACL commands.

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Self-test 8 Solution 2
a. 1. Incorrect. The creditworthiness of customers does not affect markup. 2. Correct. This is the most likely reason for variance in pricing. 3. Incorrect. Production costs would affect pricing equally and would not vary by customer. 4. Incorrect. Selling costs would not affect product pricing and thus would not uncover the reason for variance in markups. b. 1. Incorrect. No physical evidence is involved. 2. Incorrect. No physical evidence is involved. 3. Correct. The travel expense receipts are documentary evidence. The calculations of average travel expenses are analytical evidence. 4. Incorrect. No physical evidence is involved. c. 1. Correct. The risk of favouritism is increased when buyers have long-term relationships with specific vendors. Periodic rotation of buyer assignments limits the opportunity to show favouritism. 2. Incorrect. Confirmation does not enable internal auditors to detect inappropriate benefits received by purchasing agents or deter long-term relationships. 3. Incorrect. Although value-per-unit-of-cost reviews are helpful in assuring value received for price paid, they do not directly focus on receipt of inappropriate benefits by purchasing agents. 4. Incorrect. Review of records every six months does not enable the organization to detect receipt of inappropriate amounts by an agent or deter relationships that could lead to such activity. d. 1. Incorrect. Timing is not as important as the accuracy of prices. 2. Incorrect. Matching quantity received with the packing slip does not ensure receipt of the quantity ordered. 3. Correct. Use of the master price list assures that the correct retail price is marked. 4. Incorrect. Goods may or may not be needed in retail sales. e. 1. Incorrect. Lot size, delivery of only authorized items, and quality of goods are directly related to vendor performance. 2. Incorrect. Lot size, delivery of only authorized items, and quality of goods are directly related to vendor performance. 3. Correct. Balances are confirmed to assess the accuracy of accounting records, not vendor performance. 4. Incorrect. Lot size, delivery of only authorized items, and quality of goods are directly related to vendor performance.

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Self-test 8 Solution 3
CASE STUDY T8-1: Catco Ltd.

a. Goal congruence is the alignment of the goals of investors, directors, and senior management with the goals of the organization. As an example, the focus on costs will bias purchasing managers to make decisions without reference to strategic goals such as share price maximization, operational goals such as quality, customer satisfaction, and market penetration or other financial objectives such as maximization of revenues, profits, or residual income. A shorter-term perspective rather than a long-term focus will be encouraged. Financial goals and information gathered to monitor and evaluate purchasing management performance are based on historic cost data, prepared on an accrual accounting model without reference to the likelihood or timing of future cash flows. This accountability model appears to be at odds with the investors interest in the expectation of future cash flows. Where the design of management control systems and practices encourage purchasing managers to pursue goals that are not consistent with (or not aligned with) the goals of investors, directors, and senior management, goal congruence is at risk and the potential for ethical dilemmas arising is increased. b. Purchasing managers who have pursued short-term goals of cost minimization with a view to maximizing their annual bonus should not be chastised for failing to achieve other objectives such as improvement of share value. These managers have behaved in a manner that is consistent with the design of the management control system, including its incentive program. Accountability for the failure of purchasing managers to pursue more long-term, value-oriented goals should rest with those managers who have designed and implemented a management control system that has failed to encourage the alignment of the goals of investors, directors, and senior management with the goals of the purchasing managers. The internal auditors report should focus on the opportunity to improve the design of the management control system rather than being critical of individual managers or groups of managers.

c. Criteria Managements control systems and practices should be designed to promote goal congruence between shareholders, directors, and managers. Observation Purchasing managers have been receiving favourable performance appraisals and high bonuses in recent years, at a time when spoilage, rework, inventory write-offs, returned sales, and warranty claims have been rising. Furthermore, the companys reputation as a manufacturer of high-quality products seems to be eroding, and market share is being lost to Japanese and other Pacific Rim competitors, whose products consumers seem to be viewed as more reliable. The value of the firms shares has been declining steadily. Cause Financial goals and information gathered to monitor and evaluate purchasing managers performance is based on historic cost data, prepared on an accrual accounting basis without reference to the likelihood or timing of future cash flows. This accountability model encourages a narrow and short-term perspective rather than a corporate long-term focus. For example, cost

reductions achieved with respect to raw materials purchases appear to be having unintended short-term outcomes such as increased spoilage, rework, inventory write-offs, returned sales, and warranty claims, as well as longer-term consequences for the companys reputation, market share, and value. The design of the incentive program to focus on short-term cost minimization has biased purchasing managers to make decisions without reference to strategic goals such as share price maximization; operational goals such as customer satisfaction and market share; or other financial objectives such as corporate maximization of revenues, profits, or residual income. The motivational impact of Catcos accountability model appears to be at odds with the investors interest in the expectation of future cash flows. Impact Where the design of management control systems and practices encourages purchasing managers to pursue goals that are not consistent with (or aligned with) the goals of investors, directors, and senior management, goal congruence is at risk and the potential for ethical dilemmas arising is increased. The value of the firm will not be maximized unless all managers pursue goals that are likely to have a combined positive impact on value. Recommendation Management control systems and practices should be redesigned to encourage managers of purchasing to pursue goals that are more consistent with the goals of investors, directors, and senior management with a view to achieving a greater degree of goal congruence. Purchasing managers should be evaluated on the achievement of a balanced blend of strategic, operational, and financial goals. For example, increased spoilage, rework, inventory write-offs, returned sales, and warranty claims should be monitored and charged to purchasing if the quality of raw material purchases is considered to be the cause.

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Self-test 8 Solution 4
CASE STUDY T8-2: Celtic Enterprises Limited

Draft Audit Program a. Audit objectives You should define specific objectives for the audit project. Here is an example of an acceptable objective: To ensure that management control systems and practices are in place to optimize the effectiveness, efficiency, and economy of advertising expenditures

b. Key areas to examine and rationale for selection Given the problems at Celtic Enterprises Limited, you should identify the following areas to be examined and provide appropriate justification for their selection: Establishing objectives and strategies for advertising activities To determine if objectives have been set, are measurable and achievable, and if alternative strategies have been considered Preparation of financial budget and monitoring of variances for advertising expenditures To determine if specific advertising budgets are set for each product and if variances are monitored for necessary corrective action Control over contract advertising To determine whether competitive vendor selection practices are followed and payments made in strict observance of contractual terms and conditions Evaluation of the results of advertising activities To determine if advertising expenditures are having the intended impact on sales, market penetration, and so on c. Potential problems You should identify potential problems for each area selected. Examples follow: Establishing objectives and strategies for advertising activities Confusion arises because of unclear objectives and lack of specific strategies to meet the objectives. Advertising strategies are ineffective because they are not tailored to fit the needs of individual product lines, product mix optimization considerations, and local market circumstances. Objectives lack precision and measurability, precluding subsequent evaluation of performance. Preparation of financial budget and monitoring of variances for advertising

expenditures Financial goal setting is ineffective for the following reasons: Budget targets are not based on precise analysis of available cost information. Information systems do not provide sufficient budget performance information for analysis. Results of variance analysis are not incorporated into subsequent budget cycle goal setting. Control over contract advertising In the absence of competitive tendering systems and practices, the lowest possible contract prices are not being obtained. Quality of contractors performance is not monitored and evaluated as a basis of updating an approved vendor list. Payments are made for services that have not been rendered. Evaluation of the results of advertising activities Systems and practices are not in place to evaluate effectiveness of advertising expenditures, leading to ineffective management decision making. The results of effectiveness analysis are not incorporated into development and enhancement of future marketing strategies. d. Audit criteria The following are examples of acceptable criteria: Establishing objectives and strategies for advertising activities Specific and measurable objectives should be established for advertising activities. Marketing should evaluate alternative strategies, considering the costs and benefits of each. Preparation of financial budget and monitoring of variances for advertising expenditures Detailed budgets should be prepared for the implementation of established strategies. Actual expenditures should be monitored and compared to budgets. Budget variances should be analyzed and timely corrective action taken. Control over contract advertising The lowest possible contract prices should be obtained through competitive tendering systems and practices. The quality of contractors performance should be monitored and evaluated as a basis of updating an approved vendor list. Payments should only be made for services that have been satisfactorily rendered.

Evaluation of the results of advertising activities The organization should evaluate the results of advertising expenditures with a view to modifying future strategies. e. Audit procedures Audit procedures should be well written to give clear direction to the auditor who must execute the procedure. Clearly written audit procedures should preferably specify precise evidence gathering techniques, such as the following: Inspection Observation Enquiry (interview) Analysis Comparison Confirmation Computation Sample selection Less precise direction such as determine, review, assess, find out, when used without elaboration, should be avoided. Examples of acceptable internal audit procedures follow: Establishing objectives and strategies for advertising activities Inspect and analyze available documentation related to the marketing strategy, such as mission or vision statements, statements of priorities or key success factors, corporate strategic plans, minutes of board of directors, management performance contracts, and marketing policies. Inspect planning documents to determine marketings objectives and strategies. Inspect planning documents to determine whether specific and measurable objectives have been established for advertising campaigns. Interview selected staff and other individuals to determine how the marketing department develops and communicates its strategic direction, how well these systems and practices work, and whether interviewees have any suggestions to improve existing systems and practices. Obtain marketing strategies of leading organizations and perform benchmark comparisons with the auditees strategies. Compare marketings strategy for congruence with the strategic directions of the firm as a whole. Inspect planning documents to determine whether the marketing department evaluated alternative strategies, taking into account the costs and benefits of each. Preparation of financial budget and monitoring of variances for advertising expenditures Inspect financial planning documents to determine whether the organization has prepared detailed budgets for the implementation of established strategies. Through interviews with selected marketing managers and inspection of financial performance reports, determine whether the organization has controls in place to

monitor budget performance. Control over contract advertising Inspect marketing policies to determine that staff are directed to do the following: Select vendors through competitive procedures. Pay only for authorized services rendered at the contractually agreed price. Select a sample of invoices for advertising contracts and verify the following: Competitive practices governed the selection of the vendor. Invoices from advertising agencies were compared with supporting documentation (the contract, purchase orders, proof that services were rendered, and so on). The clerical accuracy of invoices was checked. Invoices were properly approved before payments were made. Evaluation of the results of advertising activities Interview selected marketing managers to determine whether the organization has systems and practices in place to evaluate the results of advertising expenditures. Inspect evaluation documentation and verify that appropriate modifications were made to advertising strategies as a consequence.

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Self-test 8 Solution 5
CASE STUDY T8-3: Willon Manufacturing Company

In your memo to the president, you should outline the potential causes of the problems identified at the Toronto plant and how the internal auditor will approach a review of these activities. Three main problems were identified in the presidents comments: Poor control over use of raw materials Excessive level of raw material inventories Poor quality of products manufactured You should identify the potential causes and determine how the internal auditor will approach the situation for raw material usage. Possible causes: Poor quality of raw materials used Inadequate inspection of raw materials before they are used in the production process Lack of monitoring of suppliers performance Inefficient production process Lack of care over raw materials in production process (waste, spoilage) Fraud Lack of control over use of raw materials (no raw materials standards) Inadequate standards You may also have other valid points. Audit approach: The auditor should perform an evaluation of internal control and reporting systems for the acquisition and use of raw materials. The following systems and practices should be examined and assessed: Systems and practices to determine the required quality of raw materials (specifications) Purchasing systems and practices to ensure that acquired materials meet company requirements Systems and practices for inspecting raw materials Systems and practices for monitoring suppliers performance Systems and practices for establishing and revising standards for the use of raw materials Systems and practices for monitoring actual use of raw materials Variance analysis reports for raw materials Physical security of raw materials before and during the production process Efficiency of production process regarding causes of waste and spoilage of raw materials You may also have other valid points.