Question

The following information relating to Tedy Brown’s operations has been identified: Issue 1 Tedy Brown has an accounts receivable insurance policy that allows the company to claim for bad debts of up to $50 000 per annum. The amount covered under the policy has remained the same since 2012 (when the accounts receivable balance averaged $2 000 000). Since 2012, the average accounts receivable balance has increased to $3 800 000. Issue 2 Tedy Brown sales representatives are entitled to commission on sales above quarterly targets. Any commission earned is required to be paid in the month following the quarter. In the year ended 30 June 2015, on two occasions, the commissions were paid three months following the quarter. Issue 3 There were numerous occasions during the year where major debtors, representing 40 per cent of gross revenues, settled their accounts 45 days after the due date. These debtors have been longstanding and reliable customers. Issue 4 Tedy Brown does not enter into foreign exchange contracts to fix its exposure to foreign currency movements, as it has never previously suffered significant foreign currency losses. During the year ended 30 June 2015, Tedy Brown incurred foreign exchange losses representing 10 per cent of net profit before income tax. Required: (a) Identify which two (2) items are primarily relevant only to the head of internal audit. Justify your answer. (b) Identify which two (2) items are significant and direct concerns for both the external auditor and the head of internal audit. Justify your answer.

Answer 1

Internal Auditor is responsible for identifying the items which cause losses to the company as well responsible for providing solutions because of which expenses and losses can be reduced.

Thus two issues which are directly relates to head of internal auditor are -

ISSUE 1 - this issue relates to insurance policy for accounts receivable. The policy amount has remained same since 2012 though the accounts receivable amount has increased substantially.

The auditor should inform the management that the policy amount should also increase if not more atleast proportionally to keep the losses in check. This is primarily concerned with internal auditor as external auditor will not check this. The policy is nowhere wrong and hence external auditor will only check whether its correct or not.

But internal auditor should inform this to management to increase the insurance cover.

ISSUE 3 - this issue relates to accounts receivable days increasing to 45. Thus it takes 45 days to recover the amount from debtors. This again should be identified by internal auditor as it will help in reducing the interest and opportunity costs. Nowhere will the external auditor inform this. He will check the bad debts and whether amounts are being recovered.

Internal Auditor should inform the management to keep strict policy to recover the amount.

Now concerns which directly relate both to internal and external auditor are -

ISSUE 2 - the commissions are paid to sales man in following month of the quarter. Here the commission is paid in three months following the quarter. Hence it is very much possible that commission has been paid more. Also it may happen that commission has been twice on sales made. Thus internal and external auditor both are responsible to check that commission is paid according to policy of the company.

Excess commission is loss of cash as well as inflated expenses in Balance Sheet. Commission should be paid only four times in a year at end of each quarter. This should be checked and matched with sales made to make sure proper commission outflow is done.

Both auditors are responsible for this.

ISSUE 4 - the company does not have policy to hedge it foreign currencies contracts. The company has not faced any significant losses in this area and hence not aware. However, this year it has faced foreign exchanges losses to the tune of 10% of profit before taxes. This is a huge amount. The company should be informed both by internal and external auditor to hedge the contracts to reduce the losses. Also, they should check whether losses reported are proper.

Their should be no inflation of losses under the head to avoid taxes.

In this way, both internal and external auditors are responsible for the duties.