Purchase - Fraud Scenarios

Fraud scenarios in Purchase and Accounts Payable and methods to identify them:


1. In a case where amendments to purchase orders were not required to be approved in the System, an unauthorized amendment can be made to the purchase orders in favor of the vendor under a kick-back arrangement.
- Obtain log of amendments to purchase orders & compare with requisitions.

2. Where the responsibility of preparing / amending budget & ensuring procurement within budget limits is assigned to same individual, procurement in excess of budget can be concealed by unauthorized amendments to the budget.
- Check for frequent amendments to the budgets.

3. Where purchase invoices are passed without checking ‘goods received’ stamp affixed by stores, bills against which no material is received can be forwarded to the accounts payable team by purchase officer under a kick-back arrangement.
- Verify vendor bills for ‘goods received’ stamp. Compare log of goods receipt notes with vendor bills booked in ledger.

4. Where system of obtaining minimum number of quotations & preparation of comparative statements is not in place, the purchase officer may award order to vendors that charge higher than others without the management noticing.
- Compare rates of procurements with rates offered other vendors or market rates.

5. In case where access to vendor master is provided to personnel processing payments, unauthorized accounts can be created & payments can be made to such accounts without authorization. Further these accounts can be deleted later to conceal the unauthorized transactions.
- Check log of account creation & deletion. Also compare the log of goods receipt notes with vendor bills booked in ledger.

6. Where rights to access vendor master in System is not restricted, the database of vendors (including rates, terms etc.) can be downloaded & sold to competitors.
- Check if there is unrestricted access to the vendor master.

Purchase - Control Register

Following are the general controls that are applicable to all organizations. These may be used for evaluation during audit of purchase department. However, additional controls may be added depending on the business process & domestic regulations.

1. Appropriate segregation of duties should be ensured in a manner that requisitioning, vendor account creation, ordering, receipt, bill booking, bill passing & payment is done by different individuals & there is no conflict of interest.

2. Product wise & overall purchase budget should be prepared at the beginning of the year & month wise breakup should be made. Further, actual procurement cost should be compared with the monthly budgets to identify deviations & take corrective action.

3. Criteria should be defined for calculation of savings on procurement by the Company (e.g. benchmarking with peers & market). Further, targets should be defined for savings to be achieved by the Purchase department & actual achievement should be compared on a monthly basis.

4. Adequate analysis of financial records & operations of new vendors should be conducted before placing orders for regular items. This will ensure that the vendor will be able to meet company's long term requirements.

5. Appropriate System blocks (receiving blocks) should be incorporated in System to ensure that incoming material is accepted only against authorized purchase orders.

6. Appropriate Audit blocks should be applied in System to ensure that bills for incoming material is booked only against genuine goods receipt note & purchase orders. Further, the rates & terms of bill is matched with that in the purchase order. Further, processing of duplicate invoices against same purchase order or goods receipt note should be restricted in System.

7. System should restrict processing of incomplete purchase orders, similarly, it should restrict processing of duplicate purchase orders against same requisition.

8. System restrictions should be in place to ensure that purchase quantity is not more than requisitioned quantity (except in cases where minimum order quantity is more / less than the requisitioned quantity).

9. Open (old) purchase orders that are not utilized for significant period of time should be cancelled & material receipt against such order should be blocked to prevent unauthorized procurement.

10. Adequate quotations should be invited from approved vendors & a comparative statement should be prepared to ensure proper decision making & lowest cost.

11. Proper authorization of payments towards procurement should be ensured according to company's delegation of authority. Further, utilization of credit period should be ensured.

12. Scrutiny of vendor ledger accounts & purchase ledgers should be conducted on a periodic basis to identify any unwarranted entries & unauthorized activities.

13. Procurement rates should be benchmarked with peers & market to identify weaknesses in company's negotiation process & take corrective action.

14. Alternate vendors & products should be developed to prevent dependence on single vendors or products that may lead to stop-supply scenario.

Purchase - Risk Register

Following are the potential risks of a purchase department in a typical organization. There can be more specific risks depending on the environment of each company.

1. Inaccurate planning leading to short/excess purchase. (high severity & low frequency)

2. Short purchase (of raw material) leading to loss of production hours & loss of sale. (high severity & medium frequency)

3. Excess purchase leading to accumulation of non-moving stock & blockage of funds. (high severity & medium frequency)

4. Purchase at higher rate leading to high cost of purchase. (medium severity & high frequency)

5. Price fluctuations leading to variance in purchase cost & inaccurate projections. (medium severity & high frequency)

6. Bad quality of goods purchased leading to bad quality finished goods & loss of production. (high severity & medium frequency)

7. Unauthorized purchases & kick back schemes. Biased vendor selection. (high severity & low frequency)

8. Infavourable terms of purchase leading to high cost & interest loss. (low severity & low frequency)

9. Non-monitoring of vendor performance leading to continued purchase at infavourable terms / of bad quality. This leads to heavy financial losses. (medium severity & medium frequency)

10. Unauthorized payments to vendors towards fraudulant/fake purchases. (medium severity & low frequency)

Modern Internal Audit

Lately I read some articles & discussions on internal audit on social networking community forums. I was surprised to read narrow thoughts & understanding on concepts of internal audit & SOX. One discussion forum read "internal auditing is generally financial auditing. SOX auditing tests the internal controls whereas internal auditing validates the financial statement." Opposite to this, modern internal auditing is about adding value to organization. This is achieved by evaluating the organization's control environment, risk management, control activity & governance process & by suggesting improvements in them. Internal audit is not just about financial control testing, but it also helps implement crucial controls in all business processes & functions in an organization. Internal audit is an independent & objective approach towards ensuring: 1. Reliability & integrity of financial & operational information 2. Effectiveness & efficiency of operations 3. Safeguarding of assets 4. Compliance with laws, regulations & contracts. The above aspects should be kept in mind for every internal audit engagement.

Top Internal Audit Firms follow these principles to the core.

Purchase Process

Purchase is a critical function in any organization. Purchase involves a large volume of cash outflow. Major risks involved with the purchase function are high cost of purchase, low quality/standards of goods purchased, unauthorized purchases, fraudulant payments to vendors, purchase from unapproved vendors etc.
In this article we will try to understand the basic activities in purchase function. Clarity of process is of great help is internal audit. Following is the process of purchase in brief:

1. Purchase planning: Planning process begins with estimation of sales and corresponding production figures. Based on the production plan, material requirement is drawn out. This plan is reviewed on a periodic basis, based on changes in sales and production plan. The purchase plan is approved by top management along with sales and production plan. Also at this stage market research is conducted for availability of alternative material, import substitute etc.

2. Procurement: Procurement involves the following activities:
-Identification of suppliers suitable to company’s requirement. Many companies use sources such as IMC, CII etc. for selecting suppliers, as genuineness of suppliers can be ensured from such sources. This is continues process to identify vendors for new items and also to find better rates, terms etc.
for the existing products purchased.
-Quotations are invited from suppliers and comparative quotation statement is prepared. Some companies follow a practice of obtaining quotations and preparing analysis statement for every single purchase although from same buyer. This suggests strict internal control. Written denial is obtained from vendors not willing to quote on request. In some companies a MOU is entered into with vendor for purchase of material at rates quoted on London Commodity Exchange. This helps in hedging the fluctuations in prices of materials. Similar practice can be implemented in other countries for purchase of material traded on regional commodity exchanges. In some companies the fuel procured for use in production is changed to low-carbon emission fuel to earn carbon credits. These carbon credits can be sold to developed countries that are required to maintain a mandatory level of carbon credits. This practice helps generate revenue, meet pollution control needs and increase goodwill of the company. At the time of comparing quotations, effects in price, pre & post applicability of tax needs to be considered. As no credit can be availed from sales tax, companies prefer to buy material locally where VAT is payable.
-At some companies a penalty clause is included in PO for non-performance or delayed delivery. This ensured proper recovery of damages from vendor for loss of production hours due to delayed or no supply. In some companies a Committee is formed (consisting officials from Accounts, Finance, Purchase & Production department) for approval of comparative statements. This helps in evaluation of comparative statements from finance and production point of view and also it reduces the chances of biased decisions on purchase.

3. Vendor development: Based on the previous purchases experience, a master list of vendors; suitable to companies requirement is prepared for future procurement. This list is updated on a periodic basis for inclusion of new products, for obtaining better rates or terms etc. At some companies vendor development is directly liked to KRA of purchase department officials.

4. Vendor evaluation: Evaluation of vendors is a requirement under ISO. A standard format is used for evaluation of vendors. Criteria like timely delivery, quality of product, credit terms etc. are rated to evaluate effectiveness against standards. At some companies audit of vendors was conducted by company for their evaluation. Also monthly meeting was conducted with vendors to discuss their ratings and areas were improvements are needed. Analysis of Dispatch Advice failure report and identification of reasons thereof is a part of vendor evaluation.

6. Bill Passing: Delegation matrix for bill passing is defined for approval of purchase bills. Credit limits are monitored to ensure non-stop supply. Trends in purchases need to be monitored to find out if there is any irregularity in purchases during particular months. Duplicate bills issued needs to be certified as issued in lieu of original.