Question

In the audit of Andy, you have obtained the following information in relation to the client’s internal control over the sales and collection cycle.

Andy Pty Ltd (Andy) is operating in the retailing sector selling a wide range of electrical products, such as computers, headphones, smart televisions. All sales are for credit.

Customer orders are received in the order department by a clerk who is responsible for preparing three copies of pre-numbered sales order forms. After the sales order form has been completed, two copies of the sales order form are then passed to the credit department for credit approval. The approval of credit is made by the Head of the credit department who noted on both copies of the sales order form.

Next, one copy of approved sales order forms is passed to the shipping department where ordered products are shipped to customers. In the meantime, the other copy of approved sales order forms is used by a clerk in the billing department to generate customer’s invoices, which are not pre-numbered. The computer automatically determines the unit prices for the items from an approved list of billing price. The computer then automatically multiplies the number of items times the unit price and adds the extended amounts for the total amount of the invoice. Based on the invoice, an accountant records the transaction into the computerised accounting system.

Andy is currently sending statements to all customers every month.

Required:       Based on the information available above:

(a)         Critically evaluate the strength of the client’s internal control over the sales and collection cycle by identifying and explaining FOUR (4) internal control activities present in the system.  

Answer 1

Internal control accounting systems are the policies and procedures used to ensure accuracy and reliability across accounting reports to:

• Prevent fraud
• Control risk
• Proactively identify financial issues
• Protect resources (both tangible and intangible) from theft and waste
• Operate efficiently
• Generate timely, reliable reporting
• Measure progress towards business objectives and goals
• Comply with applicable laws and regulations
• Secure outside funding
• Reassure investors

The four internal control activities present in the system are:

1)Separation of Duties

Assigning specific duties to each employee that divides accounting responsibilities is a basic control system to ensure that the people responsible for financial reporting are separate from the people tasked with making cash deposits and asset purchases. Similarly, anyone conducting audits should be as far removed from financial duties as possible to ensure impartiality. The further apart these functions are in an organization, the lower the risk for fraud associated with each.

Here three copies of pre-numbered sales order are formed and are checked at there levels one at the ordering department and then at the credit department and then at the billing department and shipping department so proper separation of duties is done so as to minimize fewer chances of occurring fraud by checking for authorization at each level.

2)Access Controls

Access controls keep people out to keep value in the organization.

Setting permission levels to safeguard data and physical assets is one of the most routine controls businesses use because they are so easy to implement. In password-protected areas, secure passwords and two-step authentication procedures make it difficult for employees to use others’ login credentials. Additionally, changing passwords frequently enables access controls to remain steadfast over time.

Access controls can also be physical in nature allowing for more effective management of tangible assets, such as restricting badge access to employees who should not be allowed in certain areas.  

Here three copies of pre-numbered sales order are formed and are checked at there levels one at the ordering department and then at the credit department and then at the billing department and shipping department so proper separation of duties is done so as to minimize fewer chances of occurring fraud by checking for authorization at each level so, access controls have been established at three departments one at the ordering department and the other two at the billing and shipping department.So, one department cannot access the data of another department's data thereby implementing access controls.

3)Required Approvals

Designating managers to be responsible for transaction authorizations is an internal control function that funnels purchase decisions through the most trusted employees. Authorizations may be required for large payments, unusual expenses, and unexpected cost increases.

In larger organizations required approvals may follow a hierarchy, necessitating multiple layers of agreement before being finalized. The aim with this approach is to weed out unnecessary expenses at every level to minimize waste and reduce incidence of fraud.

In the above system,three copies of pre-numbered sales order are formed and are checked at there levels one at the ordering department and then at the credit department and then at the billing department and shipping department so at each level that is at the credit department level, shipping and billing department level all of them required approval of the respective departments for the sales order to be complete.

4)Templates

Standardizing financial documents creates consistency, which makes it easier during the auditing process. While some reports like a balance sheet or P&L statement have a standard format, other documents can vary substantially between business teams. Creating and using the same templates for estimates, invoices, purchase orders, funding requests, receipts, and expense reports creates comparability across like items during an audit. Streamlining these items is an important internal accounting control that businesses tend to overlook in the rush to implement more obvious control systems.

In the above system,three copies of pre-numbered sales order are formed and are checked at there levels one at the ordering department and then at the credit department and then at the billing department and shipping department so, proper invoicing and accounting of all the data has been made at each department including at the computerized accounting systems proper reports have been made which will make it easier to evaluate the entire process during the auditing process.