BACK TO BASICS

Understanding Procurement Activities

Acquisition of
goods and services
constitutes one of the
organization's most basic
economic functions.
BY DAVID O'REGAN

ROCUREMENT ALSO CALLED "BUYing" or "purchasing" involves the

acquisition of goods and services for
an organization's direct benefit or use.
In most instances, much of the organization's tnonetary focus centers on
procurement activities, typically comprising one of the top two sources of
expenditure. Most auditors therefore
encounter procurement-related issues
frequently during their careers and
should develop an understanding of its
core principles to gain a solid grasp of
this important area.
The administrative details of procurement processes may be highly complex
in practice. In fact, some organizations'
procurement manuals resemble telephone
directories in size. The fundamentals of
procurement, however, can be distilled
to a core economic challenge, in which
competition plays a major role. An appreciation of the importance of competition
can illuminate several procedural and
internal control considerations in procurement activities.
THE CORE ECONOMIC CHALLENGE

lead to downward pressures on costs and

thereby yield the best value.
RESTRICTIONS ON COMPETITION

Internal auditors should be aware of circumstances in which competition related

to procurement actions can be reduced
severely, or even ehminated. In the most
obvious cases, a competitive market for
specific goods or services may not exist,
leaving no appropriate substitutes.
When the price of a good or service is
influenced or fixed outright by a
monopoly or cartel, an organization must
undertake procurement without meaningful scope for bringing competitive
forces into play.
Organizations are not only at the mercy
of external conditions, however. Valid
reasons may exist for management to
diminish the role of competition voluntarily in some of their procurement
actions. For example, organizations commonly standardize some aspects of their
operations, such as computer hardware,
for a defined period the procurement
of compatible equipment and services
can achieve significant efficiencies that
outweigh a reduction in competitive
procurement bidding for all available
brands. In addition, most organizations
are required by law or public opinion to
balance purely economic factors with sustainability considerations. Even without
adopting full-fledged "green procurement" or "ethical procurement" acti\aties,
organizations can still face noneconomic
factors that limit competition.

Procurement is an economic activity

that seeks to allocate scarce funds among
alternative uses. Organizational funds
are "scarce" in the sense that every dollar spent on a good or service is a dollar
that could have been spent on something
else, or not spent at all and invested in
a bank account. Reckless input of funds
to a procurement process without due
consideration of outcomes would serve
no positive end the scarcity of funds
therefore forces organizations to make A WORD ON FRAUD
sacrifices, economize, and seek best Fraud may be interpreted as a subvervalue for money in their procurement sion of the smooth economic functionactions. All other things being equal, ing of procurement processes, especially
maximizing competition among poten- their competitive elements. Examples of
tial vendors of goods and services should competition-diminishing fraud include
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BASICS

bidding rings among potential vendors

to fix prices and collusion between potential vendors and employees of a procuring
organization to favor specific vendors. To
reduce the risks of anti-competitive fraud
in procurement, an organization should
treat all potential vendors on an armslength and equal basis, and receive and
handle all vendor communications in a
rigorous, confidential, and transparent
manner. The internal auditor shoultl look
for any warning signs of fraud in correspondence between the organization and
potential vendors. Auditors could also
assess the appropriateness of accounts
payable and disbursement procedures,
the responsibilities for which should be
segregated adequately from the procurement function.
INTENSITY OF COMPETITION

Although competition is often diminished

in procurement actions, for both good and
bad reasons, competitive procurement
remains a best practice in the acquisition
of goods and services. Organizations
commonly establish cost thresholds that
trigger intensity levels for individual

transactions along three levels of competition low, medium, and high.

Low levels of competition tend to be
reserved for small items of expenditure, for
which the costs of administering competition outweigh any benefits. When organizations undertake "spot buying" using pcttj'
cash, for example, the competitive element
may consist of merely casting an eye over
prices displayed on a store's shelves.
With medium competitive intensity,
a procuring organization normally seeks
quotes trom potential vendors. This category of procurement tends to be associated with small to medium acquisitions
of goods and services. In a process sometimes referred to simply as "shopping," an
organization selects and obtains quotes
from two or more potential vendors.
The third and most intense category of
procurement competition applies to major
procurement actions, for which sealedbid tenders are common. An organization may solicit bids for a procurement
action from either pre-selected potential
vendors or on the basis of an open tender
advertized in the media. When potential
vendors submit sealed bids, the procuring

organization typically holds them in a

secure location until their formal opening
and recording. In some instances, organizations undertake auctions for large procurement actions. However, auctions are
relatively rare in organizational procurement, in part due to complicated logistical
requirements. In practice, auctions tend to
be used for homogeneous items such as
commodities and time-critical items like
perishable foods.
SELECTING VENDORS

The selection of potential vendors represents a crucial and sensitive part ofthe
procurement process. Internal auditors
should be aware ofthe risks arising from
the exclusion of specific vendors, through
carelessness or intent, which can materially impact the outcome of procurement activities. Most organizations maintain a database also called a "roster" or
"portfolio" of existing and potential
vendors. Before including vendors in the
database, a procurement fijnction should
screen vendors for their technical capabilities and fmancial stability, and any
amendments to the database should be

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subjected to strict control and authorization procedures.

Regular infusion of new potential
vendors into the procurement process is
essential to encourage fresh competition.
An organization may source new potential vendors through active solicitation,
either for specific procurement actions or
for general registration purposes. Some
organizations, such as the United Nations,
maintain procurement Web sites through
which vendors can register their interest
in future procurement activity. Internal
auditors should seek evidence that the
organization selects potential vendors on
a transparent and equitahle basis, to maximize the scope for competition.
SPECIFICATIONS AND COST

For se;iled-bid tenders, technical and economic evaluations underpin competitive

integrity, representing crucial steps in the
procurement process. Technical evaluations involve an assessment of whether
the specifications of a good or service
offered by a potential vendor meet the
organization's requirements. Only submissions from potential vendors that

pass the hurdle of technical acceptability

should proceed to an economic evaluation. Vendor selection therefore is normally made on the basis of the economic
evaluation of the best value for money
offered by technically acceptable offers.
The economic evaluation focuses on
the costs proposed by potential vendors,
alongside any other relevant costs and any
compelling nonfinancial considerations.
In practice, procurement functions often
fmd that there are degrees of technical
acceptability. Moreover, organizations
commonly use systems of weighted scores
that intermingle technical and economic
aspects. For example, an organization that
wishes to stress quality over cost for a procurement action may apply a weighting of
70 percent to the technical evaluation and
30 percent to the economic evaluation.
Auditors shoLild be aware of the way in
which scoring methods can influence the
outcome of a procurement action, and how
this area may be open to manipulation.
For complex procurement actions, especially in thefieldof emerging technologies,
potential vendors may be asked to contribute to the development of technical

BASICS

specifications. Technical negotiations

between the organization and potential
vendors complicate procurement transparency, and the auditor should assess that
safeguards are in place to encourage fair
and competitive negotiations.
TRANSPARENCY AND FAIRNESS

Although procurement processes comprise a range of fundamental procedures

and internal controls beyond the scope
covered here, the fundamental idea that
good competition tends to encourage
good procurement remains key to this
important activity. Internal auditors must
be sensitive to procedures and controls
designed to encourage transparency and
fairness and thereby safeguard the competitive elements of procurement.

DAVID O'REGAN, CIA, FCA, is author of

Auditing the Procurement Function, to be
published by The IIA later this year.
To submit a "Back lo Basics" article for
consideration, e-mail David O'Regan at
david.oregan@gmail.com.

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