Question

Required
Audit Manager Sharon Gallagher and Audit Senior Josh Thomas previously met with the
Cloud 9 Ltd. Finance Director, David Collier, to gain an understanding of the internal controls
at the entity level. Based on their interview, they have assessed those controls as being
effective. Therefore, at a high level, the company demonstrates an environment where
potential misstatements are prevented or detected.
You have been assigned the task of documenting the understanding of the process
for recording sales, accounts receivable, and cash receipts for wholesale customers.
In your absence, Josh met with the Cloud 9 Ltd. Financial Controller, Carla Johnson,
and received permission to tape the interview, which is provided as a transcript (see
Appendix 3).

Using this interview transcript, you are now asked to:
Prepare a flowchart or narrative documenting your understanding of the sales to cash
receipts process for wholesale sales. Document your understanding in working paper A4–1
and A4–2 (if needed) on pages 14 and 15.
Identify any follow-up questions you would like to ask the client if aspects of the process
are not adequately explained. Also identify any weaknesses in the internal controls over the
sales and cash receipts. Document these in working paper A4–3 on page 16.
For the follow-up points and control weaknesses, describe any potential misstatements that
could occur in the financial statements in A4–3.

Appendix:

JT: Thanks for seeing me, Carla.
CJ: You’re welcome, Josh. What can I do for you?
JT: I need to ask you some questions around Cloud 9’s process for recording
wholesale revenue transactions, including the trade receivables and cash
receipts aspects. After I understand the process, I’ll need to select a sample
transaction to confirm my understanding of the process as you have
explained.
CJ: Well, I can tell you what should be happening, but you may want to go and speak to
the sales manager or warehouse managers to confirm they do what the company
policy and procedures say.
JT: Good point, I’ll make appointments to see them. Thanks. So let’s start at the
beginning—how does a sale transaction get initiated?
CJ: We’ve got a pretty complex inventory management software system called Swift. It
was designed by some of our tech guys. It tracks and does everything!
JT: Sounds impressive!
CJ: Anyway, the customers—let’s say the Myer store in Toronto—complete a purchase
order on-line through a site that is linked to Swift.
JT: How do the customers decide the quantity and know the price?
CJ: Swift is linked (don’t ask me how) to their store inventory records and sends them an
alert when their inventory balance of our products gets below the predetermined limit
they set with us. They can select the quantity based on their needs, but the prices
are set in the system. They get sent price lists from the sales manager so they know
the current prices.
JT: How often are prices changed?
CJ: Depends on the market, really. I don’t think they change too frequently.
JT: What if you don’t have the products?
CJ: The system doesn’t allow them to place an order greater than our current inventory
levels. If they need more, they need to fill out a separate request form that gets
e-mailed to our warehouse manager so he can place the order with China.
JT: OK, so they complete a purchase order, then what?
CJ: The submitted purchase order goes through a credit check and then becomes a
sales order. The sales order documents the quantity required, the selling price, and
the shipping terms. That’s all done behind the scenes in the system. We really don’t
see anything on our side until the sales order stage.
JT: Guess that saves a lot of time and trees!
CJ: Yeah, there’s so much that we rely on the system to do for us, it’s scary. If we were
hit by an electrical storm, we’d be in trouble.
JT: What happens to the sales orders—how do they get filled?
CJ: Every day, the warehouse manager downloads the outstanding sales orders to
these little hand-held computer/scanner thingies. It’s very Star Trek. Warehouse
personnel use these to select the items off the shelves onto pallets. The pallets are
taken to a staging area where each product is then scanned. This establishes the
shipping in Swift, which then gets printed for the delivery.
JT: Are the shipping documents approved before the goods go out the door? How
do you know that what got sent is what was ordered?
CJ: Swift matches the quantities and products on the shipping document to the sales
order. Once they match, the approval box is activated and the shipping supervisor
can enter his pass code. This officially approves the shipping document and it gets
printed.
JT: How many orders do you fill in a day? It sounds like a lot for one person to do.
CJ: We probably complete about 50 orders a day. Shoes aren’t perishable items, you
know, so it’s not like we are sending products to every store, every day. We’re trying
out the “pit crew” concept where there are two shipping supervisors with about four
to five warehouse employees in their crew team. So they are in the staging area with
them and do it right there with the hand-held devices. They like to have little contests
on who can do it the fastest. You should go down there; it’s quite a lively group.
David encourages it and it’s been great for productivity and morale.
JT: Sounds like a great working environment. Better than being stuck in a broom
closet sifting through invoices!
CJ: Ah, the life of an auditor. I remember the good old days . . .
JT: And the goods are sent out on your own trucks?
CJ: That’s right. We’ve bought our own trucks and vans rather than rely on couriers. The
drivers pick up their loads in the morning and bring back anything undelivered.
Because shoes are an easy product to off-load, we have to be careful about theft. So
nothing can be left in the back of a truck at the end of the day. It comes back here
and gets locked up in the shipping cage till it can be delivered again.
JT: Why would goods be undelivered?
CJ: Sometimes the drivers get behind or the store is closed unexpectedly. So there are
occasions when all the goods won’t get delivered in the day.
JT: OK, so now the goods are delivered to the customer, how do you bill them?
CJ: The drivers have the customers sign for the goods upon receipt and then give us the
signed copy of the shipping document. We go in to the billing system and pull up the
draft invoice that was generated when the shipping document was approved. We
match the quantities in the invoice against the signed shipping document and
confirm the customer sign-off. This way, we only bill for those goods that were
actually received by the customer.
At 4 p.m., we do a batch run of the day’s invoices, which are printed in duplicate, and
mailed out. The copy is stapled to the signed shipping document and put on file. The
running of the batch posts the invoices to the sales journal and accounts receivable
subledger.
JT: Does finance ever go back to the sales order?
CJ: No, since the shipping document can’t get generated unless it agrees to the sales
order, we don’t go back that far into the process. Why, do you think we have to?
JT: I wouldn’t say so at this stage. But you’d have to be sure to have some tight
controls around Swift given that it seems to do everything.
CJ: Like I said, it does everything.
JT: What is the cash receipts process?
CJ: We get most payments via EFT, so my AR clerk downloads the previous day’s
receipts from on-line banking. She then goes into the subledger to post the receipts
against the customer accounts. When she’s finished posting each entry, she runs a
batch report of all postings and reconciles it back to the bank statement. I review that
reconciliation and signoff.
JT: Are bank reconciliations done in a timely manner?
CJ: I do bank recs each month for the operating and savings accounts. David reviews
and approves them. Keep in mind, what I just explained is for the wholesale
transactions. We have separate procedures for the store regarding daily cash
balance reconciliations to the deposits in the operating bank account.
JT: Yes, our graduate will be handling the store side of the sales to cash receipts
process. They will probably come talk to you in a day or two. Well, I think that
should do it for now. I may have some follow-up questions for you as I start
getting my head around all of this.
CJ: Door’s always open.
JT: Thanks for your time.

Answer 1

After interviewing ~ Cloud 9 Ltd.; Financial Controller, Carla Johnson; I understand that process of internal controls for of the process for recording sales, accounts receivable, and cash receipts for wholesale customers is very effective.

Entire Process have very cooperative electronic control of internal tailor made application Swift. Which has effective API between internal & external platform.

I don’t see any issue from finance side subject to actual check.

Further I need to interview sales & warehouse manager to understand their process.

I have put it in below process chart