Question

Darwin Playtime Pty Ltd (DPPL) is a toy manufacturer. DPPL has factories across the country and its customer base includes retailers, as well as individuals, to whom direct sales are made through their website. You are an audit senior at Raul David & Associates and you are currently reviewing documentation of DPPL’s internal controls in preparation for the interim audit.

DPPL’s website allows individuals to order goods directly and full payment is taken in advance. Currently the website is not integrated into the inventory system and inventory levels are not checked at the time when orders are placed.

Goods are delivered via local couriers; however, the couriers do not always record customer signatures as proof that the customer has received the goods. Over the past year, there have been customer complaints about the delay between sales orders and receipt of goods. DPPL has investigated these complaints and found that, in each case, the sales order had been entered into the sales system correctly, but was not forwarded to the despatch department for fulfilling.

DPPL’s retail customers undergo credit checks prior to being accepted and credit limits are set accordingly by sales ledger clerks. Neither the sales area managers nor the sales director are involved with this process. These customers place their orders through one of the sales team, who decides on sales discount levels.

Raw materials are purchased from a wide range of suppliers. As a result of staff changes in the purchase ledger department, supplier statement reconciliations are no longer performed. Additionally, changes to existing supplier details or inclusion of new supplier details in the purchase ledger master file can be undertaken by purchase ledger clerks, as well as supervisors.

In the past six months, DPPL has changed part of its manufacturing process and as a result some new equipment has been purchased. However, there are now considerable levels of plant and equipment that are now surplus to requirement. Purchase requisitions for all new equipment have been authorised by production supervisors and little has been done to reduce the surplus of old equipment.

REQUIRED:

a) Identify five (5) deficiencies in the internal controls of DPPL. Explain how a business risk arises from each deficiency.

Answer 1

The following are the deficiencies in the internal controls of DPPL and the business risks arising out of it:

1. Deficiency in IC: The website is not integrated into the inventory system and inventory levels are not checked at the time when orders are placed.

Business risk: There might be instances when the items ordered are not available in the inventory and the same is being placed by the customers resulting in delay in delivery / cancellation and customer dissatisfaction.

1. Deficiency in IC: Goods are delivered via local couriers; and they do not always record customer signatures as proof that the customer has received the goods.

Business risk: It can result into theft / stealing by the local couriers as there is no evidence that the goods have been delivered to customers. Further, the customer can claim that they have not received the goods, which will result into double loss for the company as they will need to refund the amount received from customers.

1. Deficiency in IC: Delay in forwarding the sales order info i.e. the sales order had been entered into the sales system correctly, but is not being forwarded to the despatch department for fulfilling.

Business risk: It will increase the customer complaints which will lead to lower sales and bad customer reviews – resulting in damaging the brand name and reducing future demands.

1. Deficiency in IC: Fixation of credit limits by sales ledger clerks and not by sales managers / directors.

Business risk: It can result into increase in bad debts for the DPPL as clerks will not be having sufficient knowledge to analyse the credit worthiness of the customers.

1. Deficiency in IC: Non-performance of supplier statement reconciliations.

Business risk: It can result in wrong accounting of invoices by clerks which can lead to excess payments being made which will impact the cash flow and profitability of the Company in future.