Question

Greg Norman is the auditor in charge of the Rogers Pharmaceutical Company audit. In assessing the internal controls for the company, Greg finds that the company bills customers and receives payments at three offices in three separate states using three different and incompatible software systems for tracking payments. Rogers’s terms of sale varies with the customer and varies from 30 days to 90 days. Open invoices are aged based on when they were booked to the receivables, but cash, chargebacks, or rebates are aged based on when they were applied to the account. Thus, a credit could be posted to the customer’s account when it was received, but the related invoice(s) remains open as a receivable and continues to age. Chargebacks are significant and linked to batch of product rather than invoice. Most similar companies have credit limits or credit checks but Rogers’s does not because all wholesalers are board certified M.D.’s, like the company’s founder.

Rogers’s total accounts receivable was $25,276,025.

Rogers’s total accounts receivable past due over 61 days was $17,434,500.

Rogers’s past top-five wholesalers had accounts receivable of $13,457,516.

Rogers’s top-five wholesale customers had $5,428,850 past due over 61 days.

Rogers’s allowance for doubtful accounts of $266,000 did not include any estimates for the top-five wholesale customers because it was management’s belief at the time that the top-five wholesalers did not present a collection risk.

Required:

Based on these control issues and findings, explain some of the most likely sources of misstatement that exist.

Answer 1

Following controls & system should be implemented for effective internal control:

Software System: Most important requirement is to have similar software at all offices. If feasible, they shall be linked to one another or atleast head office so that there can be regular updates available at head office where all accounting is done.

Compatible Software: Compatible software is extreme requirement for proper working of any organization. Unless system is compatible, proper and complete accounting cannot be guaranteed.

Chargebacks: Chargebacks shall be accounted monthly and proportionate credits shall be given to customers account so that accurate outstanding from particular customers can be ascertained.

Credit checks is must: Even though wholesalers are board certified, it may be very harmful for any organisation to not have a credit check as it can increase risk of fraud & dishonesty. Organisation can decide to have sampling check or easy check system as compared to credit check which is laid on other customers but in any case credit check is double must for every source of receipt.

Invoice accounting: Payment received from customers shall be cleared against respective invoices so that such invoices will be removed from outstanding amount of sales. Thereby organisation will come to know true position of outstanding amount.

Allowance for doubtful accounts: On belief of management, organisation does not provide for allowance for doubtful accounts on top five wholesale customers. It is critical for any organisation to work on sentiments hence it shall frame policy based on facts and experience rather than beliefs. So whether / not provision for doubtful accounts shall be created on top five wholesale customers shall be decided upon their past performance.

Sale diversification: Top five wholesale customers accounts for more than 50% sale of total sales ($13457516 / $ 25276025 = 53.24%) which is very high. Management shall consider the possibility to increase other customers base too, so that organisation does not remain dependent on these top five customers in case of any adverse circumstances that can occur.