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 manufacturing 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)