Internal Controls on Purchase of Material

Question: Discuss about theInternal Controls on Purchase of Material. Answer: Introduction Internal controls are designed to safeguard assets of the company and ensure reliable financial reporting (Arwinge, 2012). Internal controls in the areas of sales, purchase, fixed assets and stock are crucial to ensure accomplishment of the organizational goals. In the current case, internal controls in respect of stock of Fruito, which is retail sales shop, have been analyzed to find out risk factors and recommend checks and controls. The internal controls in relation to stock assume high importance in the organization engaged in retail sales business because of high volume movements (Arwinge, 2012). Identification of the Risk and its Impact The internal controls are placed on inward and outward movements and record maintenance of the stock so as to ensure that stock is safeguarded from misuse and theft (Johnstone, Gramling, Rittenberg, 2015). In the purchasing process there several risk factors that the management of Fruito should bear in mind while designing suitable controls. The first risk relates to authorization of the purchase transaction. The purchase orders need to be authorized by an appropriate authority such as purchase manager or head of the procurement department. If the purchase of material made without proper authorization, there would emanate a risk of buying material from unauthorized vendors at wrong prices and on terms which may be prejudicial to the company (Moeller, 2016). Further, in the absence of adequate controls, there remains a risk of excessive/short purchasing of material. It is customary for the companies engaged in the retails sales business to have estimations in regard to daily demand, supply, and buffer stock to be kept for emergency situations (Moeller, 2016). The company has to prescribe the reorder levels for material so that orders can be placed whenever stock reaches to the reorder level. In the absence of this mechanism, the company will be exposed to the risk of either falling short of material or pilling up inventory because of buying in excessive quantities. In either situation, the company will have to suffer. If the stock falls short, the company will not be able to meet out the demand, which may affect the customer base of the company. On the other hand, if the company buys in excess, it will lead to extra cost burden in the form of inventory handling and carrying costs (Moeller, 2016). Apart from the above, the controlling risks in relation to record maintenance are also crucial for the management of Fruito to take into consideration. In relation to purchase of material, it is essential that reliable and relevant records are maintained documenting all the necessary events in entire process of procurement (Moeller, 2016). The absence of adequate controls in this area would lead to manipulation and falsification of the book records. The employees of the company colluding with outsiders may take advantage of weak controls in the record maintenance and misuse the assets of the company for personal gains. Weak controlling in record maintenance may give rise to the risk of theft of material (Moeller, 2016). In addition to the above discussed risks, there remains a risk of reduction in the operational efficiency also. It is essential for every company to have properly structured and sell defined processes in every area of operations either it is material handling, procurement, or distribution. Lack of controls in the process of material procurement may lead to deterioration in the operational efficiency. Carrying out the processes with undefined steps and procedures always goes unplanned leading to delays and defects (Moeller, 2016). Recommendations for Internal Controls In order to counter the risks due to weak controls, the management of Fruito is advised to first define the processes such as order placing, authorization, and material checking on receipt. Further, each process should have an authority, which will be accountable for lapses or any kind of mistakes in the process (Delaney Whittington, 2010). The authorization process must be intact to ensure that all the transactions take place with the permission of the authorized person. In order to counter the risk of purchases from unauthorized suppliers on wrong prices and prejudicial terms, it is essential that the employees strictly adhere to the authorization process (Delaney Whittington, 2010). Further, the management of Fruito is advised to set the quantities of buffer/safety stock, reorder level, minimum level, and maximum level. The estimations in this regard got to be precise because mistakes would lead to financial loss to the company. There must be automation in record maintenance so that management could be made aware whenever inventory reaches to reorder level (Delaney Whittington, 2010). Further, high level checks should be implemented on the record maintenance to ensure that the transactions are recoded validly and timely. The management should ensure that the material in unloaded after proper physical counting and verification with the purchase order specifications (Delaney Whittington, 2010). In addition to the above, the management should have internal auditing function to check the book records and processes in respect of material procurement on adequate intervals (Delaney Whittington, 2010). The management should ensure proper segregation of duties that is to say that personnel who are responsible to carry out physical count should not take part in record maintenance. This will help in reducing the possibility of fraud through manipulation of the book records. Further, there should be caused verification of the stock by the third party at least once in a year so as to ensure that company holds in inventory what was purchased (Delaney Whittington, 2010). Summary In a nutshell, it could be analyzed that internal controls on material procurement are very important and particularly for the company engaged in retail sales business like Fruito. The major risks that could emanate due to weak controls in regard to Fruito have been identified as the risk of false book keeping, unauthorized purchase of material, and excessive/short inventory. In order to counter these risks, the management is advised to first take automation of the record maintenance process and define the standard operating procedures. In addition to this, accountability of the each personnel should be fixed and physical checks of stock should be implemented. References Arwinge, O. 2012. Internal Control: A Study of Concept and Themes. Springer Science Business Media. Delaney, P.R. Whittington, O.R. 2010. Wiley CPA Exam Review 2011, Auditing and Attestation. John Wiley Sons. Johnstone, K., Gramling, A., Rittenberg, L.E. 2015. Auditing: A Risk Based-Approach to Conducting a Quality Audit. Cengage Learning. Moeller, R.R. 2016. Brink's Modern Internal Auditing: A Common Body of Knowledge. John Wiley Sons.