The Temporary Clerk and a Control That Cannot Be Relied On
You are auditing the purchases and payables cycle of Marlowe Foods Ltd, a food wholesaler with £30m revenue. The purchase ledger clerk who normally performs the three-way match (purchase order, goods received note, supplier invoice) has been absent since July. From July to the December year end, the temporary clerk processed invoices but did not always match them to goods received notes; the warehouse manager signed invoices as 'approved' without checking quantities. Supplier statements are reconciled monthly by the financial controller, but the controller also has authority to set up new suppliers and to amend bank details. During testing, you find 12 invoices out of a sample of 60 with no goods received note attached, and one new supplier was set up and paid £48,000 within five days of being added, with bank details differing from the invoice.
1. Assess the control environment and control activities for purchases, and decide whether you can rely on controls for the December year end.
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Control environment. The absence of the experienced clerk and use of an unsupervised temporary clerk weakens the control environment. The warehouse manager approving invoices without checking quantities means the approval control is not operating as designed - approval has become a formality.
Segregation of duties. The financial controller both reconciles supplier statements and can set up suppliers and amend bank details. This is a serious segregation-of-duties failure: the person who could conceal a fraudulent supplier is also the person who performs the reconciliation that would detect it.
Control activities. The three-way match is the key control, and 12 of 60 invoices (20%) lack a goods received note. That is a high deviation rate, well above any tolerable rate, and indicates the control is not operating effectively throughout the period.
Conclusion. I cannot rely on the three-way match or the approval control for the period from July to December. I should test the controls for the earlier period if I wish to reduce substantive testing there, but for the majority of the year a substantive approach is required. The supplier set-up and bank-detail changes require specific substantive testing regardless.
2. Design the substantive procedures you would perform on payables and on the suspicious new supplier, and explain the audit risk you are addressing.
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Risk. The key risks are (a) fictitious suppliers and payments diverted to a fraudster (possibly involving the controller or an external party), and (b) understatement of liabilities because unmatched invoices were not recorded.
Procedures on the new supplier:
- Obtain the supplier master file change log and review all suppliers added in the year, especially those added by the controller.
- For the £48,000 supplier, obtain the purchase order, goods received note, invoice, and evidence of delivery; confirm directly with the supplier using an address obtained independently (not from the master file).
- Inspect the bank details change history and compare to the original supplier documentation; trace the payment to the bank statement and confirm the payee.
- Interview the warehouse manager and the temporary clerk; consider whether the matter should be reported to those charged with governance and, if fraud is suspected, to the relevant authorities.
Procedures on payables:
- Supplier statement reconciliations reviewed independently, with follow-up of reconciling items.
- Search for unrecorded liabilities: review goods received notes around the year end not matched to invoices, review after-date invoices and payments, and review the purchases cutoff.
- Analytical review of purchases and payables against prior year and expectations.
- Test the completeness of the supplier master file (e.g. compare to prior year and to the VAT return).