In: Accounting
Heraklion Co is a manufacturer of footballs and is a new audit client for your firm. You are an audit supervisor of Spinalonga & Co. and are currently preparing for the forthcoming interim and final audit for the year ending 31 October 2016. You are required to document and assess the sales system, recommend control improvements to deal with a specific fraud issue as well as undertake substantive testing of revenue.
Sales ordering, goods dispatched and invoicing
Heraklion Co sells footballs to a range of large and small sports equipment retailers in several countries. Sales are ma de through a network of sales staff employed by Heraklion Co, but new customer leads are generated through a third party company. Sales staff are responsible for assessing new customers' creditworthiness and proposing a credit limit which is then authorized by the sales director. The sales staff have monthly sales targets and are able to use their discretion in granting sales discounts up to a maximum of 10%. They then record any discount granted in the customer master data file.
The sales staff visit customer sites personally and orders are completed using a two-part pre-printed order form. One copy is left with the customer and the other copy is retained by the sales person. The sales order number is based on the sales person's own identification (ID) number.
The company markets itself on being able to dispatch all orders within three working days. Once the order is taken, the sales person emails the finance department and warehouse dispatch team with the customer ID and the sales order details and from this a pick list is generated. Sequentially numbered goods dispatched notes are completed and filed in the warehouse.
Sequentially numbered invoices are generated using the pick lists for quantities and the customer master data file for prices. Standard credit terms for customers are 30 days and on a monthly basis sales invoices which are over 90 days outstanding are notified to the relevant sales person to chase payment directly with the customer.
Required:
(a) Describe TWO methods for documenting the sales system, and for each explain ONE advantage and ONE disadvantage of using this method.
(b) Identify and explain SEVEN deficiencies in the sales system of Heraklion Co and provide a recommendation to address each of these deficiencies.
Note: Prepare your answer using two columns headed Control deficiency and Control recommendation respectively.
(c) Describe substantive procedures the auditor should perform to obtain sufficient and appropriate audit evidence in relation to Heraklion Co's revenue.
There're various methods that can be adopted for documenting the sales system of Heraklion Co.
1) Narrative Notes
Narrative Notes refers to the running description of the sales system and it contains step by step detailed procedures of the complete process.
Advantage: It covers each & every step of the complete process in narration form.
Disadvantage: It might be too cumbersome especially in case of long & complex procedures of large enterprises which might not be too useful or user-friendly for the auditor.
2) Questionaires
They're also referred as Internal Control Questionaires (ICQs) or Internal Control Evaluation Questionaires (ICEQs).
ICQs majorly contain a list of questions and the same are answered to assess whether the controls exist or not whereas the ICEQs are used to assess the effectiveness of those controls in place.
Advantage: They're quite short & crisp in nature due to their question-answer format and provide to the point details.
Disadvantage: Due to it's format, it might miss out the details for which the questions are not asked.
Sl. No. | Internal Control Deficiency | Control Recommendation |
1 | The credit worthiness of new customers is verified by the sales person who sets the credit limit, which is then authorized by the sales director. | Once the new customers complete their application, it should be verified by a credit agency with a credit limit proposed for the customer. The same should then be authorized by the Sales Director. |
2 | Sales Staff have discretion to provide sales discount upto 10%. This might have a risk of unreasonable discounts with chances of revenue leakage. | All discounts should be authorized by the management representative, i.e. Sales Director. |
3 | Sales Staff are able to make changes to Customer Master Data File for providing discount. | Sales Staff shouldn't have any access to provide discounts. |
4 | At the time of placing order, the Sales Staff doesn't check the inventory availability. This is specially when Heraklion Co. markets itself for shipping within 3 days. | Prior to placing customer's order, inventory availability should be checked for timely shipment |
5 | Customer orders are recorded in two-part form, one is left with customer and the other with salesperson. | Order form should be atleast four-part, one for customer, one for salesperson, one for warehouse and one for despatch. |
6 | Sequentially numbered GDNs are raised by the Warehouse Department. If the Finance Department doesn't receive a copy of GDN's, they'll never know when to raise Sales invoices. | Atleast a four part GDN should be created; one for warehouse department, one for customer, one for sales department and one for Finance to raise invoices. |
7 | The Sales person has the responsibility to chase customers whose dues are beyond 90 days. Company credit period is 30 days and this also raise the receivables ageing. | A dedicated person should be employed to collect receivables from customers and the same should be followed after 30 days once the credit period is over to improve collections. |
The substantive procedures that the auditor should perform to obtain sufficient & appropriate audit evidence that the revenue is assured are as follows: