Analysis of Internal Control Weaknesses in Adam & Co.'s Expenditure Cycle

The report analyzes the expenditure cycle of Perth-based wholesaler Adam & Co. and identifies internal control weaknesses in the purchase, cash disbursement, and payroll systems. The report also highlights the risks associated with these weaknesses and emphasizes the importance of conducting audits.

Running head: ACCOUNTING INFORMATION SYSTEMS
Accounting Information Systems
By Name of the Student
Group Number
Module Name

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ACCOUNTING INFORMATION SYSTEMS
Executive Summary
The study relates to Perth-based wholesaler Adam & Co. The main business of the company
is to sell industrial supplies after sourcing its inventory from countries such as Vietnam,
China and Thailand. The report has generated an analysis of the expenditure cycle of the
company. The findings of this evaluation have revealed that the company follows a
centralised accounting system. However, in the purchase system the ARC, APC and the PC
completely overlooks the process of checking the inventory in order to update accounts and
preparing receiving reports and forwarding the same to the cash disbursement department.
Additionally, the assigned clerks in the PD and AP department completely overlooks their
duties. A critical analysis has been able to identify is weaknesses and risks such as reputation
loss, financial loss and increased debt burden.

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Table of Contents
Introduction................................................................................................................................3
System Flowchart of purchase systems......................................................................................4
Purchase system’s internal control weakness............................................................................5
Risk associated with Purchase system’s weakness....................................................................6
System Flowchart of cash disbursement system........................................................................7
Cash disbursement system’s internal control weakness.............................................................8
Risk associated with cash disbursement system’s weakness.....................................................8
System Flowchart of payroll system........................................................................................10
Payroll system’s internal control weakness.............................................................................11
Risk associated with payroll system’s weakness.....................................................................11
Conclusion................................................................................................................................12
References................................................................................................................................13

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ACCOUNTING INFORMATION SYSTEMS
Introduction
The first section of the report reviews the existing literature of existing systems,
thereby putting emphasis on internal control and usefulness of conducting audits. In the
subsequent sections, the report has depicted the weakness in Adam & Co.’s internal control
and risks related to the identified weaknesses. According to DeFond and Lennox (2017),
internal control ensures that the financial statements of an entity are prepared as per the
relevant international standard. The study also illustrates how internal control can be stated as
the process brought by the entity’s board of director and other personnel for guaranteeing
achieving the desired objectives. Based on the several types of other research studies, it has
been discerned that only a handful of large private companies is mandated to conduct audits
(Vanstraelen and Schelleman 2017). However, this research has emphasized on the benefit of
voluntarily conducting audits in an organization. Furthermore, auditing has a pivotal role
towards the accuracy of the financial statement corporate accountability and governance
mechanism (Lisic et al. 2019). As stated by Knecheland Salterio (2016), more than 37%
firms in the US conduct audit on a voluntary basis. These entities were seen to have a
remarkably low loan default ratio compared to an audit firm. This study emphasizes on the
importance in auditing of the “payroll functions”, “purchase systems” and “disbursement
of cash” of Adam & Co. along with the risks in each process.

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Purchases Vendor Received Warehouse Accounts
Payable (AP)
Checking the
Inventory
Details of
Product
required
Creating
Digital
Purchase
order (PO)
Printing two
hard copies
PO 1 PO 2
File
Selecting
Vendor
Packing Slip
Vendor
Selected
Reconciliation
and preparing
two hard copies
of receiving
report (X1 &
X2)
X 1 X 2
X2 + Goods
Updating of
inventory
Temporary
filing of
receiving
report
Invoice
Invoice
PO
PO
X1, X2
Reconcile
PO
Invoice
X1, X2
Disbursing
Cash
Updating
accounts
System Flowchart of purchase systems
Figure 1: System Flowchart of purchase systems
(Source: As created by the author)

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ACCOUNTING INFORMATION SYSTEMS
Purchase system’s internal control weakness
In supply chain management, monitoring successful delivery is a part of the
purchasing process which is able to verify that the administrative work has been conducted
appropriately (Logisticsbureau.com 2019). The process of purchasing also ensures whether
the inventory was able to be maintained safely before and after performing a purchase
activity. The internal control weaknesses in the purchase system of Adam & Co. can be seen
in the following areas:
 Lack of authority approving the purchase- In the purchase system of Adam & Co. the
lack of purchasing authority to approve the orders can lead to unnecessary personal
purchases by the “purchasing clerk (PC)”.
 Non-segregation of purchase authorization based on cost of purchase-As per the case
study, it can be further inferred that there was no segregation made from the authorizing
purchases related to the cost of purchase. In addition to this, a complete lack in the
approving authority is a grave fault in the purchase system (Spina et al. 2016).
 Lack of research about new vendors providing competitive prices- There is no
evidence that the company searched for better vendors who provided similar service at a
more competitive price combined with shorter delivery time and better quality.
 Several activities in the supervision of APC- As per the given facts of the case study,
there are a number of activities which are under the control and supervision of the
“Accounts Payable clerk (APC)” which are to be exercised by the “goods receiving
clerk”. In general, “accounts receivable clerk (ARC)” is responsible for selection of
vendor, order placement, invoice update and filing, updating of subsidiary ledger of AP
and managing control account of inventory (Nickerson and Hall 2017). On the other
hand, receiving clerk inspects the commodities, provides reconciliation for the items
against the information provided in the digital purchase order, preparation of the

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receiving reports, packing slip and updating subsidiary ledgers of inventory (Recruiting
Resources 2016). However, at Adam & co. an APC performs similar duties like an ARC.
Risk associated with Purchase system’s weakness
 Risk of financial theft - The purchase system provides complete authority to the ARC
for approving the orders. As there is no segregation of purchase authorization based on
cost of purchase ARC may misuse this power for ordering commodities for personal use
or even carry out a theft by faking purchasing of a product. Such a weakness in the
purchase system poses the risk of financial theft driven by excessive and improper
allocation of cost (Holmes 2018).
 Favoritism or collusion brought by lack of research about new vendors- As the
company does not make any initiative to find more information about vendors providing a
competitive price, it may lead to collusion or favoritism from the supplier pertaining to
continuous orders.
 Risk of approving poor quality product- The organization clearly lacks specialized
personnel for approving the quality of the commodities received. It is also worth
mentioning that a copy of the receiving report is collected by the APC who further files
the report in the department. This has a lot of scope for fraud at each step being carried
out by either clerk. It can further lead to approving the poor quality or quantity of
products provided by the vendor in return for gifts or bribes. There clearly needs to be a
segregation of duties for reviewing the purchase process (Zepeda, Nyaga and Young
2016).

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ACCOUNTING INFORMATION SYSTEMS
Accounts
Receivable
Disbursement of
Cash Treasurer Vendor
PO
X1, X2
Invoice
Completed the
filing as per
clearance date
Preparing the
cheque
Update accounts
Due Date
Signature
ChequeCopy
PO
X1, X2
Invoice
Copy
Close File
System Flowchart of cash disbursement system
Figure 2: System Flowchart of cash disbursement system
(Source: As created by the author)

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ACCOUNTING INFORMATION SYSTEMS
Cash disbursement system’s internal control weakness
The cash disbursement procedure relates to process the cash and cash equivalents
pertaining to procurement operations. The importance of a “cash distribution system” allows
an organization to process the payments accurately in the AP department whenever it is due
(Ellis 2018). It is customary for the AP department to notify any corrections which are to be
made for properly maintaining the vendor accounts required for the disbursement of the cash.
The weakness in the cash disbursement procedure of Adam & co. has been discussed in the
subsequent sections.
 Lack of written confirmation of the documents from AP department - The main issue
with this system is associated to the clerk not signing of the documents from the AP
department. Due to this, there is no accountability of the actions within the department.
 Lack of counter checking and reviewing of the cheques- Based on the given facts of
the case study, the treasurer in Adam & Co. receives and prepares a check for signing
without being faced with any additional information in form of invoice, receiving report
or purchase order (Bemo et al. 2017).
 Lack of personnel - The “cash disbursement clerk” has the excessive burden with duties
such as filing invoice, writing checks, maintaining AP subsidiary ledger and updating the
cheque register. There is a lack of personnel to handle such burgeoning pressure of work.
Risk associated with cash disbursement system’s weakness
 Risk of error in reviewing documents-The “cash disbursement clerk” does not sign the
documents arriving from the AP. As the clerk cannot be held responsible, this may lead to
serious issues for the organization in the future with no trail to follow when reviewing the
documents in the department.

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ACCOUNTING INFORMATION SYSTEMS
 Risk of theft and financial loss - As the treasurer receives the cheques for signing
without any additional information, there is a possibility of theft in the Department. The
cash disbursement clerk can fill incorrect amount in cheques either deliberately or by
mistake steal money from the company resulted from collusion with the employees or
vendors of the company. In case the clerk fills incorrect amount lesser than the payable
amount, it may lead to strained relationship with the vendor. Moreover, Adam & Co.
may lose track of the errors as the clerk did not put his signature in the documents
received. In case the clerk fills a wrong amount by mistake which is higher than the
payable amount, it will lead to a financial loss for the company.
 Risk of error caused by cash disbursement clerk- The cash disbursement clerk has to
perform lots of duties which may lead to higher scope of error. There is a possibility that
the clerk forgets to update the accounts, thereby making the financial accounts incorrect,
confusing and chaotic. Additionally, there is no provision to review the activities
associated to the “cash disbursement clerk”. This has provided the clerk with the
opportunity for carrying out fraudulent activities.

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Supervisors Payroll
Department (PD)
Accounts
payable (AP)
General
ledger (GL)
Time Cards Time Cards
Review Updating the
records
followed by
preparing the
pay checks
Pay cheques
Printing Payroll
register (two copies)
Y1 Y2
Time cards
Y1
File
Y2
Disbursement
voucher
Y2
Voucher
Imprest
account
cheque
Copy
File
Y2
Voucher
File
Time Cards
Pay cheques
Distribution
followed by
review
System Flowchart of payroll system
Figure 3: System Flowchart of payroll system
(Source: As created by the author)

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ACCOUNTING INFORMATION SYSTEMS
Payroll system’s internal control weakness
A payroll system is maintained for keeping track of the work duration of the
employees, no. of days worked, leave balance, computing wages, completion of direct
deposits and withholding taxes. The main purpose of such a system is to keep track of
relevant activities by which employers pay an employee (Asif and Webb 2015).
 Maintaining a manual timecard system- It is to be noted that Adam & Co. maintains a
manual timecard system where the employee’s record their work hours on a timecard.
The review of the timecard is performed manually by the supervisor and forwarded to the
respective payroll department during each week (Woo, Asiabase Technologies Ltd 2017).
 Insufficient segregation of duties- The payroll clerk has to perform several duties
relating to data entry in the timecard to the central payroll system, taking printout of pay
cheques, taking a printout of two hard copies of the payroll register, posting of digital
employee records, forwarding cheques to the supervisor and filing of time cards.
 Absence of payroll preview- The internal control lacks any system for previewing
payroll or “Human Resource Information Systems” where the data is processed for
checking the accuracy of total working hours, number of employees and leave balance of
an employee (Noe et al. 2017). This is a necessary initiative to be taken by the individual
departments for maintaining separate systems for payroll for better monitoring and
review.
Risk associated with payroll system’s weakness
 Risk of overpaying the employees and increased tax burdens- As the employee
attendance is maintained in a manual timecard system, there is a high possibility that

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employees may falsely mark their friend’s attendance, which is also known as buddy
punching. The risk of error in the manual timecard system even under the scrutiny of
supervisor is considerably higher as it causes overpaying the workers. This will further
have a negative impact on the liquidity as a result of increased tax burdens (Nathoo et al.
2018).
 Risk of fraud- The excessive burden on the payroll clerk led by insufficient segregation
of the duties poses a significant scope of fraudulent activities. These relate to paying
remuneration to the employees who have been terminated or non-existent in the first
place. This can not only lead to significant financial loss for the company, but also grave
repercussions such as spending jail time (Kelly and Deklepper 2016). A notable instance
of such a payroll practice can be traced from the incident that took place in San
Bernardino. In this case, four workers of a hospital in California were accused of payroll
fraud, as they falsely mark their attendance. This led to a financial loss for the company
amounting to $800,000, during August 2007 and March 2011. As an aftermath of this
incident, the California State controller’s office noticed payroll practice as the prime
reason behind such a fraud (Iaonline.theiia.org 2019). In addition to this, the lack of
payroll preview can lead to large amounts of money being stolen from the company
without any system to trace.
Conclusion
As per the given information on the case study, it can be discerned that a centralized
accounting system (AS) with network terminals situated at various locations is being carried
out for the expenditures at Adam & Co. Based on the regulations and policies of the
company, it follows elaborate systems as per “payroll functions”, “purchase systems” and
“disbursement of cash”. A closer evaluation of the processes, revealed that all the three AS

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functions had a significant issue in its internal control which was necessary to be removed by
conducting random audits on a regular basis. On a concluding note it can be stated that
reviewing the expenditure systems at Adam & Co., it was found that the company suffers
from several critical risks pertaining to internal control weaknesses. A delay in taking
appropriate action can lead to significant professional and financial loss for the company. The
auditing team of the company should look forward to create a balance among the internal
weaknesses and estimate the losses which have taken place due to poor expenditure practices
carried out in the company.

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internal control audits?. Journal of Accounting Research, 55(3), pp.591-627.
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Holmes, E.E., 2018. A Case by Case Analysis of FASB and its Public Accounting
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payroll risks can enable internal auditors to help their organizations save money and identify
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https://www.logisticsbureau.com/what-is-purchasing/ [Accessed 18 Sep. 2019].
Nathoo, A., Brady, J.C., Hollis, C. and Dunn, C.H., Square, Inc., 2018. Payroll correction.
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