Auditing: Accounts Payable / Vendor Payments

Accounts Payable is one of the crucial area in audit. As it represents the monies owed by the organization to its creditors for supply of goods and services. Also for a fraudster who is looking to steal from the business, accounts payable is an easy target, if proper controls are not there.

Occupational fraud is a growing problem. According to ACFE’s “Report to the Nations 2016”, it is estimated that organizations loses 5% of revenues to fraud every year.

Following are the few methods, which can be used in auditing the accounts payable/vendor payments:

1. Benford Law test
Payments to vendors should be checked for conformance with benford law, to spot unusual trend in the data set. You can read more about using benford law in my previous post Benford Law in Analyzing Accounting Data.

2. Relative Size Factor (RSF) test
The Relative Size Factor test is an important tool for detecting errors. RSF test compares the top two amounts for each subset and calculates the RSF for each. The test identifies subsets where the largest amount is out of line with other amounts for that subset.

Relative Size factor = Largest record in the subset / Second largest record in the subset

3. Round Amount Payments
Most of the liabilities or payments are usually not round amounts (multiple of 100 or 1000’s). And since they also includes taxes it makes them more unusual to be round number. One can do analysis of those amounts which are multiples of hundreds, thousands or tens of thousands.

4. Same-Same-Same test
The purpose of Same-Same-Same test is to identify exact duplicates, which may indicate potential fraud. The test is called the same-same-same test regardless of how many fields are used to determine whether the records are duplicates.

5. Same-Same-Different test
Mark Nigrini states,” The same-same-different test is a powerful test for errors and fraud.” The test is called the same-same-different test regardless of how many fields are used to determine whether the records are near-duplicates. The usual test is run such that the different field is a subset field. Therefore it is looking for transactions that are linked to two different subsets.

6. Payments Without Purchase Orders test
If it is the policy of the organization to require purchase orders vendors before goods or services can be contracted, we can look for payments where there is no corresponding PO recorded. Some vendors have standing order contracts with the organization that are pre-approved so the cumbersome procurement process does not have to be done for each individual purchase.

7. Payments to vendors not in master (one time vendor)
To ensure that the organization deals with approved vendors, purchase orders and payments need to be from the vendor master file except in unusual circumstances or for low amount transactions. Payment to one time vendor without PO should be looked carefully, as it may be a potential fraudulent transaction.

8. Length of time between invoice and payment date test
This test may reveal unusually quick payments to certain vendors or slow payments that result in interest charges or early-payment discounts not taken.

9. Search for post office box
A common test is to look for the usage of postal box numbers as the mailing address of vendors. Usually legitimate vendors have physical locations and regular addresses. Vendors that use post office boxes raise red flag of potential fraud.

The above tests are not exhaustive, they are just few of the tests that you can perform to audit accounts payable. You cannot prevent 100% of the frauds from happening, but you can take steps to detect and minimize the impact of such frauds.