Background

Spyglass is the 10th largest company in the security services industry. Spyglass is a publicly traded company. The company's current annual revenues are $150 million. Elvis McGraw became the company's Chief Executive Officer (CEO) eight years ago. Mr. McGraw is a "hands-on" executive who was eventually given the additional title of Chairman of the Board. Branch operations are conducted in all states east of the Mississippi.

The company's philosophy is primarily one of decentralization. However, corporate accounting, accounts payable and payroll systems represent exceptions to this overall philosophy since they are centralized at the corporate office in Chicago, Illinois. Spyglass's annual purchase volume approximates $40 million. Forty-five thousand (45,000) checks are processed annually. The accounts payable function handles all cash payments.

Even though Mr. McGraw considers internal auditors "bean counters," an internal audit function was finally established a year ago. Given Mr. McGraw's doubts about internal audit, the department is working very hard to build credibility. Initially the CAE decided to perform financial audits and then expand into more complex audit engagements.

Internal auditing recently completed an audit engagement covering accounts payable. The information gathered during the audit is summarized below.

Information Gathered During Audit

1. Purchasing at the branch level is not standardized and thus may or may not involve a formal purchase order. Approximately 20% of the invoices processed do not have a purchase order and receiving report. These invoices are processed based on an authorized approver list.

2. A local software company recently installed a new automated accounts payable system at Spyglass. Although the installation was based on a standard software package, it was modified extensively under the direction of an outside consultant.

3. Turnover among Spyglass employees, including those in the accounting department, has been excessive. This condition, however, is not unusual in Spyglass's industry. The company has employed each of the five accounts payable clerks for fourteen to nineteen months.

4. There is a job rotation process in place whereby each clerk is assigned to a different function every 12 months.

5. Accounts payable clerks can only access the purchasing level requiring the lowest authority in the software package. The application audit log showed seventeen rejected access attempts to add a new vendor over a two-day period. During this time period, the accounts payable supervisor, who normally performs this function, was on vacation. The person(s) trying to execute the transaction to add a new vendor was already logged into the application. The invalid access attempts are included on a security report sent daily to the accounts payable supervisor.

6. The wages of one of the accounts payable clerks are being garnished as a result of a federal government collection action involving a student loan. During her employment interview, the applicant told the HR interviewer that she had no debts. This clerk has been responsible for processing employee expense checks and cash account transfers.

7. The accounts payable supervisor assigns vendor codes whenever an accounts payable clerk needs a check and no-account number code has been previously established for that vendor. If time permits the supervisor may do some checking, but mostly he relies on the approval appearing on the invoice as the basis for issuing the number. Purchasing has no responsibility for assigning vendor codes or providing information to accounts payable to set up a vendor code.

8. When the system was first established, each "active" vendor was assigned a code number, regardless of whether there was a balance due that vendor. One quarter of all vendors currently have zero balances due. Review of the vendor master files shows that many records are incomplete.

9. For vendors with whom business is being conducted on a one-time basis, without any expectation of a continuing business relationship, vendor codes are not added to the vendor master. A special procedure in the new application is used to c r e a t e a vendor number to process the invoice for payment.

10. The accounts payable clerks establish batch control totals prior to processing. Each clerk subsequently compares his/her batch totals with computer-generated totals after processing.

11. After checks are signed, the checks are returned to the accounts payable clerks for distribution to payees (assuming no request for "direct deposit").

12. Any reconciliations of monthly statements from vendors are done by corporate accounting.

13. There are written policies but virtually no written procedures for the accounts payable department.

I need some assistance writing a memo commenting on the various deficiencies based on the info above. With respect to each deficiency, can material errors occur?; if so, what is the nature of the error; if not, why?. For each deficiency, what corrective actions can be suggested?.