CASE 7: EXPENDITURE CYCLE

Lexsteel Corporation is a leading manufacturer of steel furniture. Although the firm has
manufacturing plants and distribution facilities throughout the United States, the
purchasing, accounting, and treasury functions are centralized at corporate
headquarters.
While discussing the management letter with the external auditors. Ray Landsdown,
controller of Lexsteel, became aware of potential problems with the accounts payable
system. The auditors had to perform additional audit procedures in order to attest to the
validity of accounts payable and cutoff procedures. The auditors have recommended that
a detailed systems study be made of the current procedures. Such a study would not only
assess the exposure of the firm to potential embezzlement and fraud, but would also
identify ways to improve management controls.
Landsdown has assigned the study task to Dolores Smith, a relatively new
accountant in the department. Because Smith could not find adequate documentation
of the accounts payable procedures, she interviewed those employees involved.
Descriptions of the current procedures are presented below.
The host computer mainframe is located at corporate headquarters with
interactive, remote job-entry terminals at each branch location. In general, data entry
occurs at the source and is transmitted to an integrated data base maintained on the
host computer. Data transmission is made between the branch offices and the host
computer over leased telephone lines. The software allows flexibility for managing user
access and editing data input.
Production orders and appropriate bills of material are generated by the host
computer at corporate headquarters. Based on these bills of material, purchase orders
for raw materials are generated by the centralized purchasing function and mailed
directly to the vendors. Each purchase order instructs the vendor to ship the materials
directly to the appropriate manufacturing plant. The manufacturing plants, assuming
that the necessary purchase orders have been issued, proceed with the production
orders received from corporate headquarters. When goods are received, the manufac-
turing plant examines and verifies the count to the packing slip and transmits the
receiving data to accounts payable at corporate headquarters. In the event that raw
material deliveries fall behind production, each branch manager is given the authority
to order materials and issue emergency purchase orders directly to the vendors. Data
about the emergency orders and verification of materials receipts are transmitted via
computer to accounts payable at corporate headquarters. Since the firm employs a
computerized perpetual inventory system, physical counts of raw materials are
deemed not to be cost effective and are not performed.
Vendor invoices are mailed directly to corporate headquarters and entered by
accounts payable personnel when received; this often occurs before the receiving data are
transmitted from the branch offices. The final day of the invoice term for payment is
entered as the payment due date. This due date must often be calculated by the data-
entry person using information listed on the invoice.
 Once a week, invoices due the following week are printed in chronological entry
order on a payment listing, and the corresponding checks are drawn. The checks and the
payment listing are sent to the treasurer's office for signature and mailing to the payee.
The check number is printed by the computer and displayed on the check and payment
listing and is validated as the checks are signed. After the checks are mailed, the payment
listing is returned to accounts payable for filing. When there is insufficient cash to pay all
the invoices, certain checks and the payment listing are retained by the treasurer until all
checks can be paid. When the remaining checks are mailed, the listing is then returned to
accounts payable. Often, weekly check mailings include a few checks from the previous
week, but rarely are there more than two weekly listings involved.
When accounts payable receives the payment listing back from the treasurer's
office, the expenses are distributed, coded, and posted to the appropriate plant/cost
center accounts. Weekly summary performance reports are processed by accounts
payable for each cost center and branch location, reflecting all data entry to that point.

Required
a. Identify and discuss three areas where Lexsteel Corporation may be exposed to fraud
or embezzlement due to weaknesses in the procedures described, and recommend
improvements to correct these weaknesses.
b. Describe three areas where management information could be distorted due to
weaknesses in the procedures described, and recommend improvements to correct
these weaknesses.
c. Identify three strengths in the procedures described and explain why they are
strengths.
(CMA adapted)