Question

REVENUE CASE 3

Aman & Afdal is the auditor of Warisan Sdn Bhd. He is in charge of auditing the sales and collection cycle for the company which is a small fish distributor in East Malaysia. The company is respected for its high-quality fish products, but its accounting office is perpetually neglected, and the sales department frequently makes errors in billing clients. In previous years, Aman & Afdal has found quite a few misstatements in billings, cash receipts, and accounts receivable. Like many companies, the largest assets are accounts receivable, inventory and fixed assets.

The company is also slow at improving its identified internal control weaknesses in the previous year’s audit. Among those weaknesses is shipment is made immediately whenever orders are received and no screening of credit approval is made by Warisan before shipping. Besides, a copy of the shipping document is filed with the sales invoice and sales order, but there is no thorough review done on the documents by supervisors. The accounts receivable general ledger account and the subsidiary ledger accounts are posted by the same person, and there is no independent periodic reconciliation between the control account and subsidiary ledger accounts.

Warisan has several large loans payable to local banks, and two banks have told management that they are reluctant to extend more credit, especially considering that a bigger and well-known fish distributor is moving into the area. In previous years, the response from clients of Warisan to confirmation requests has been frustrating at best. The response rate has been extremely low, and those who did respond did not know the purpose of the confirmations or their correct outstanding balance. Aman & Afdal have had the same experience in confirming receivables with other, similar organisations. Aman & Afdal concludes that control over cash is excellent and the likelihood of fraud is extremely small.

 

Required:

I) Identify the major factors affecting the audit risk of Warisan Sdn Bhd.

(6 Marks)

II) For each of the internal control weaknesses in Warisan Sdn Bhd, describe the tests of control and substantive audit procedures that must be performed to minimize the control risk.

(11 Marks)

III) Since the response rate for external confirmations of accounts receivable balance is extremely low, what alternative procedures would you suggest the auditor do?

(3 Marks)

(Total: 20 Marks)

Answer 1

I.

The neglection of the accounting department and the frequent errors made by the sales department signify that the auditor cannot rely on the company's internal control. This will increase the control risk in which requires the auditor to obtain more audit evidence.

The lack of efforts in improving its weaknesses shows that the management lacks integrity and ignorant towards their business operations, which give rise to inherent risk.

Warisan Sdn Bhd is a highly leveraged company as it owns several large loans payable. The fact that two banks have declined to extend their loan raises doubts over its liquidity in meeting the obligations and also over its capability to continue as a going concern.

II.

III.

Compare subsequent cash receipts to the year-end receivable balances.

Examine the subsequent cash receipts by matching such receipts amount with the actual amount of items that are being paid for, the shipping documents or other relevant client documentation.

Perform substantive analytical procedures by comparing the days sales outstanding to prior years and inquire management if there is any significant differences.

Refer answer detail