Question

Evaluation and testing of controls at Hales Ltd

Tyrone has provided a narrative of controls over inventory at Hales Ltd and would like you to provide some advice on making the preliminary control risk assessment. Hales is a distributor of haircare products, including shampoos, conditioners and styling products throughout Australia. Hales uses an on-line ordering system. Hales does not manufacture any goods in house, instead, an inventory of raw materials is kept, with manufacturing being outsourced to other companies. Hales has around 35 suppliers and 15 manufacturers. These companies have proven to be reliable in the past. Tyrone has made the following notes about three particular elements of the inventory system.

Purchase of raw materials

Purchase orders are generated by the computer when the inventory level of a particular material falls below 75% of what was used in the previous month. Purchase orders include the date, the suppliers name and the raw material required. Three copies of the purchase order are created. The first copy goes to the warehouse where it is used to enable the following up of overdue orders. The second copy is filed by the accounts clerk by order of date and the third copy goes to the supplier. Upon receipt of materials, barcodes on the delivery packages are scanned into the computer system. A two part receiving report is then generated. The first part is matched to the purchase order by the warehouse manager. The second is sent to the accounts clerk who files it. If the scanning of barcodes does not match data on the master file then the process is stopped.

Procedures for finished goods

When finished goods fall below 65% of the previous months sales, production orders are triggered. Production orders include a date, the manufacturers name, the raw materials needed and the volume of finished goods required. Two copies of the production order are generated. The first copy is sent to the raw materials warehouse where it is used as a picking slip by the warehouse staff. It is then included with materials which are sent to the manufacturer. The second copy is filed by the production manager by order of date. When finished goods arrive at Hales, barcodes on the delivery packets are scanned. A two part receiving report is generated, with the first copy being matched to the production order by the production manager and the second copy being filed by the accounts clerk. As with materials purchases, if the scanning of barcodes does not match the codes on the master file then the process is stopped.

Changes to the master file

The inventory master file contains information on the volumes of inventory on hand including barcode information and locations within the warehouse. The master file also has details of approved suppliers and manufacturers. Orders can only be made to suppliers and manufacturers on the master file. Changes to the master file can be made by the production manager. This applies to both raw materials and finished goods. To make changes the production manager completes an amendment form which is then kept as a record of any changes made.

Other information

There are separate warehouses, staff and procedures in place for the raw materials and finished goods. The selection of suppliers of raw materials and manufacturers is done automatically by the computer based on the latest price as per the last invoice and delivery time. Password access to the computer permits the following:

• Raw materials store staff have access to purchase order printing and goods received notes printing for materials.

• Finished goods store staff have access to goods received notes printing for finished goods.

• The production manager has access to production order printing and master file changes.

• The acounts clerk has access to master file changes.

Question 4

In relation to Hales Ltd:

• The weaknesses in the internal controls for each of the three aspects of the inventory system identified (raw materials, finished goods and changes to the master file).

• An assessment of the implications of each of the weaknesses you have identified.

• Three tests of control JDM’s IT audit division could perform to assist Tyrone with verifying the effectiveness of the internal controls (assuming that JDM will be performing tests of control).

• Two Computer Assisted Audit Techniques (CAATs) that Tyrone could request the IT auditors run to assist him in testing the valuation of inventory.

Answer 1

Computer Assisted Auditing Techniques provide an automated approach to audit tests, replacing tests that would have been performed manually by the internal audit team. The completeness of manual tests is often limited by the completeness of the data that can be analyzed by an auditor through a reasonable effort and by a short time. It is obvious that the quality of audit consistently depends on the capability of auditors to obtain additional support and coverage for audit opinion at a low incremental cost.

The use of CAATs gives internal auditors an opportunity to reach their target by:

1.Addressing expectations

2.Improving audit quality

3.Reducing risks

4.Increasing productivity

5.Giving added value suggestions

6.Indentifying and extending services

7.Improving team technology and information systems skills.

CAAT Applications to Industries

This document gives a wide range of tests that are typically performed by internal auditors in several areas:

1.General Business Processes

2.Finance and Banking

3. Services and Distribution

4.Healthcare

5.Government

6. Manufacturing

7. Retail

The involvement of the MIS team in your planning will give you additional resources to indentify and evaluate EDP risks and to better chose the tests that will efficiently reach your objectives.

STOCK & INVENTORY CONTROL

1.Select items from perpetual stock for test reconciliation.

2.Use sampling command for physical reconciliation testing.

3.Reconcile selected physical counts to computed amounts.

4.Compare the value of physical counts to general ledger value.

5. Statistically analyze usage and ordering to improve turnover.

6. Report on stock and high value balances using any selection.

7. Test clerical accuracy of totals and extensions.

8. Summarize and stratify turnover by stock item in any order.

9. Test for duplicate parts, item numbers, prices or descriptions.

10. Segregate variances from standard pricing in peso amount order.

11. Identify obsolete inventory by sorted turnover analysis.

12. Quickly indentify items with yearly volume under on-hand quantity.

13. Isolate and analyze high value transactions by value, group, etc.

14. Identify starting and sending period balances by class or group.

15. Report on products in order of profitability (low-high, high-low).

16. Automatically summarize products by group, location, type, etc.

17. Calculate current inventory items based on LIFO value or pool.

18. Assess the financial viability of LIFO versus FIFO management.

19. Determine the percentage change in sales, price and/or cost levels.

20. Analyze the difference between standard costs and actual costs.

21. Isolate stock lines where the cost is greater than retail price.

22. Report unrealized profits by comparing standard vs. sales prices.

23. Extract products with zero quantities or zero prices.

24.Compare speed and accuracy of delivery by product and vendor.

25. Match stock receipts with vendor ledger and report variances.

26. Generate a stock status exception report for low stock needs.

27. Check product reordering volume by item, warehouse, vendor. and

28. Divide inventory into classes and compare percent investment.