3.4 Purchases, Payroll, and Inventory Cycle Controls
Key Takeaways
- The procurement cycle relies on the 'Three-Way Match' (matching Purchase Orders, Goods Received Notes / GRNs, and Vendor Invoices) prior to cash disbursement approval.
- Payroll controls require strict separation between HR record maintenance (creating employee profiles, altering wage rates) and payroll processing/disbursement.
- Inventory cycle controls mandate physical security safeguards, pre-numbered store requisitions, perpetual inventory accounting, and annual or perpetual inventory counts.
- In Bangladesh, payroll controls must ensure statutory compliance with the Bangladesh Labour Act 2006 regarding overtime calculation, festival bonuses, and Provident Fund deductions.
- Cut-off testing in purchases and inventory prevents understated liabilities and misstated stock by verifying GRNs generated near period-end against supplier invoice postings.
3.4 Purchases, Payroll, and Inventory Cycle Controls
Operational integrity across purchases, payroll, and inventory is essential for preventing asset misappropriation, fraud, and misstated cost of goods sold. For ICAB students, evaluating controls in these core transaction cycles requires mastering document matching, segregation of duties, and statutory payroll compliance.
Purchases & Expenditure Cycle Controls
The purchases cycle governs the acquisition of raw materials, goods, and services, culminating in cash disbursements to vendors. The cycle involves four main stages: requisitioning, ordering, receiving, and invoice processing.
Key Controls in Purchasing
- Authorized Requisitions: Purchase Requisitions (PR) must be approved by designated department heads within authorized spending limits.
- Competitive Bidding: Policies requiring three independent supplier quotes for purchases exceeding specified monetary thresholds (e.g., BDT 200,000).
- Approved Vendor List (AVL): Orders placed only with vetted vendors on the company's approved vendor database to prevent ghost vendor fraud.
- Sequential Pre-numbering: Purchase Orders (POs) and Goods Received Notes (GRNs) must be sequentially pre-numbered.
The Three-Way Match Control
Before releasing vendor payments, accounts payable staff must execute a Three-Way Match comparing:
- Purchase Order (PO): Verifies quantities, agreed unit prices, and authorized terms.
- Goods Received Note (GRN): Confirms actual receipt of goods, physical condition, and accepted quantities.
- Supplier Invoice: Verifies billed amounts, tax computations, and payment terms.
| Document Matched | Verifies Assertions | Fraud / Misstatement Risk Prevented |
|---|---|---|
| PO vs. Supplier Invoice | Accuracy, Authorization | Overbilling, unauthorized price increases, unapproved purchases |
| GRN vs. Supplier Invoice | Occurrence, Completeness | Paying for unreceived goods, duplicate billing |
| PO vs. GRN | Valuation, Accuracy | Accepting wrong specifications or excessive quantities |
Payroll Cycle Controls & Statutory Requirements
Payroll represents one of the largest expenditure items in many organizations. Weak controls expose entities to ghost employees, unauthorized wage rate increases, and inaccurate tax withholdings.
Essential Segregation of Duties in Payroll
To safeguard payroll, entities must segregate three core roles:
- Human Resources (HR): Responsible for hiring, firing, updating employee master files, and setting authorized pay rates.
- Payroll Processing: Calculates gross wages, overtime hours, tax withholdings, and net pay based on approved HR data and attendance records.
- Finance / Cashier: Approves bank transfer instructions and disburses net wages. Payroll processors should never have signatory power over payroll bank accounts.
Key Payroll Control Activities
- Attendance and Clocking Systems: Biometric or digital timekeeping systems to log working hours and overtime accurately.
- Independent Payroll Review: Senior finance managers review monthly payroll summaries against HR variance reports before signing bank transfer letters.
- Imprest Payroll Bank Account: Utilizing a dedicated payroll bank account funded with exact net payroll requirements each month.
Bangladesh Labour Act 2006 Statutory Compliance
In Bangladesh, payroll controls must integrate specific statutory mandates under the Bangladesh Labour Act 2006 (Amended 2013):
- Overtime Calculations: Statutory overtime pay rate is double the basic wage rate for hours worked beyond 8 hours a day / 48 hours a week.
- Festival Bonuses: Mandatory festival bonuses paid to workers based on continuous service history.
- Workers' Profit Participation Fund (WPPF): Transfer of 5% of net profit to WPPF, Welfare Fund, and Worker Welfare Foundation Fund.
- Provident Fund and Gratuity: Timely deduction and matching deposit of employee Provident Fund contributions.
Inventory Management & Safeguarding Controls
Inventory directly impacts balance sheet valuation and cost of sales in manufacturing and trading entities.
Core Inventory Controls
- Physical Security: Restricting warehouse access to authorized store personnel; installing CCTV surveillance.
- Store Requisitions: Goods issued from storehouses only upon presenting an authorized Store Requisition Slip signed by a production supervisor.
- Perpetual Inventory System: Maintaining real-time perpetual inventory records updated automatically via GRNs and store issue slips.
Physical Inventory Count (Stock Take) Procedures
Auditors evaluate management's annual physical inventory count procedures under ISA 501:
- Pre-count Instructions: Clear written instructions issued to counting teams detailing count procedures and warehouse zoning.
- Count Team Composition: Pairing a storekeeper (familiar with items) with an independent team member (unaffiliated with warehouse operations).
- Tagging and Sequence Checks: Utilizing pre-numbered count tags; recording damaged or obsolete stock separately.
- Reconciliation: Comparing physical count sheets against perpetual ledger records, investigating variances, and making authorized journal adjustments.
Summary of Key Controls & Assertions Across Cycles
| Cycle | Key Risk | Dominant Control Activity | Assertion Tested |
|---|---|---|---|
| Purchases | Payment for goods not received | Mandatory 3-Way Match before invoice posting | Occurrence / Completeness |
| Payroll | Fraudulent payments to fictitious 'ghost' workers | HR approval for employee creation & independent payroll review | Occurrence / Accuracy |
| Inventory | Stock theft, obsolete inventory valuation | Physical safeguards & periodic stock count reconciliations | Existence / Valuation |
Prior to authorizing a vendor payment, accounts payable staff perform a 'Three-Way Match'. Which three documents are cross-examined in this control?
To prevent the creation of fraudulent 'ghost employees' in the payroll system, which control procedure provides the strongest segregation of duties?
Under Bangladesh Labour Act 2006 provisions, how should overtime pay be calculated for factory workers working hours beyond the standard daily limit?