You are an internal auditor at Motor Spares Limited, a large retailer in motorcar spares. The company's internal control is weak and you have reported this finding to management for a number of years.

The managing director has, however been unwilling to take any steps to improve the internal control, as he believes he is sufficiently close to the business to be aware of any irregularities taking place. In addition, the company has employed the majority of the accounting personnel for quite some time and the director considers them trustworthy.

The company's major supplier is Spares Wholesalers Limited. The arrangements that have been agreed with this supplier are that purchases will be invoiced every seven to fourteen days, depending on the level of purchases. Settlements against invoices will be made within seven days, in return for which Spares Wholesalers Limited will grant generous discounts. To assess that discounts are not lost due to postal delays, it is the practice of Motor Spares Limited to issue cheques in favour of their bank for the invoiced amounts, with a request that the bank transfers the funds telegraphically to Spares Wholesalers Limited's nominated bank account.

During the course of your engagement for the current year you are unable to find a supporting invoice or any other document in respect of one such cheque made payable to the bank. Further investigation reveals several similar cheques for which there are no supporting documents. In due course, it is established that the accountant, Mr Fiddler, had been embezzling company funds for several years by the following means:

He would remove a recent, already paid, Spares Wholesalers Limited invoice from the company's files, together with the supporting delivery notes. These are the only documents that support purchase transactions and payment to creditors.

He would subsequently request that the cashier issue a cheque, payable to the bank, for the invoice removed from the file. He would also ask her to complete the bank's standard form requesting them to transfer the funds to Spares Wholesalers Limited's account.

He would then take the cheque, bank form, invoice and delivery note to the managing director, or in his absence, the financial director, and request that the cheque be signed. The cheque signatory would glance at the supporting documentation and verify the amount of the cheque against the supporting invoice before signing the cheque. He would only examine the supporting documentation in detail, if time permitted.

The signed cheque and supporting documentation would then be returned to Mr Fiddler who would replace the invoice and delivery note in the file from which he had extracted them. He would destroy the form requesting the bank to transfer the funds to Spares Wholesalers Ltd, and complete another form requesting the bank to transfer the funds to a fictitious company, Auto Spares Limited, in which name Mr Fiddler himself operated a bank account. This form, together with the cheque would then be forwarded to the bank.

He informed the bank that purchases were being made from this company and that similar payment arrangements had been made with them. Accordingly, he would arrange for the bank to transfer the funds to Auto Spares Limited.

After the discovery of the defalcation, the managing director requested that you advise him of the weaknesses in the system that facilitated this fraud and recommend changes in procedure to overcome the weaknesses.

REQUIRED Marks

2.1

Draft a report to the managing director setting out the weaknesses in the internal control system and your recommendations for improvements.[20]

2.2

Compile audit procedures for the accounts payable.[15]