Auditing Inventory and Receivables: Identifying Risks and Implementing Controls, Exercises of Auditing

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Unit 1: Revenue and Receipts Cycle

Learning Outcomes

• Explain the accounting system for revenue and receipts
• Understand how the various control activities within the cycle operate to reduce the risk of material misstatement and their direct effect on the substantive audit procedures to be performed
• Demonstrate a comprehensive understanding of the specific processes involved
• Explain the various stages involved in the cycle
• Understand the different types of fraud that could occur in the cycle
• Design and implementation of substantive procedures to address risk of material misstatements

Question 1 – General Knowledge Revenue and Receipts System

(d) (i) Customer order: external document sent by the customer which details the goods the customer wishes to purchase. (ii) Delivery note: records date, description and quantity of goods despatched to the customer and is signed by the customer to acknowledge the receipt of the goods. (iii) Back-order note: contains details of goods that could not be supplied when ordered by a customer as there was no invertor available; reviewed to establish whether an order has been placed with a supplier for the outstanding goods. (iv) Credit note: an internal document sent to the customer to acknowledge that the customer‟s account has been reduced (credited) for some reason other than for a payment received, e.g. goods have been returned by the customer. (v) Goods-returned voucher: document made out by the company itself that is used to record the details of goods that have been returned by a customer.

(e) 1. To ensure that completeness testing can take place to identify missing documents;

2. To provide each document within a document type e.g. each invoice, with a unique identity; and
3. To facilitate cross-referencing.

Question 2 – Stages of the sales cycle

Greenbox (Pty) Ltd is a large wholesaler of garden equipment. The company‟s revenue and receipts cycle is well staffed and is divided into clearly defined functions, namely receiving of orders, warehousing (picking, despatch, invoicing, recording of sales, mailroom and receipting/ cashier. It also has a „goods returned‟ function which handles the return of goods by customers and a credit management section. The following control procedures take place in the day-to-day running of the company.

Note: These procedures are in random order.

1. Jonny Greenfingers follows up on trade references supplied by prospective customers seeking credit.
2. Carl Camelion checks the detail on all internal sales orders prepared by the six order clerks.
3. Walter Weed, one of the warehouse clerks, makes out a back-order note for an items which is ordered but is not „in stock‟.
4. The gate controller counts the number of boxes on the company‟s delivery truck and agrees it to the delivery notes held by the driver.
5. Themba Treetops compares the goods to be delivered to the picking slip and delivery note as they are packed into boxes for delivery.

6. Harriet Hedge phones all debtors who have exceeded their credit terms every 48 hours to establish when Greenbox (Pty) Ltd can expect payment.
7. When customers collect goods they have ordered, they sign a delivery note and retain a copy.
8. Benji Berry checks the sequence of the invoices entered in the sales journal to identify missing invoices.
9. Gustav Glass compares prices on the invoice to the official price list and reperforms the VAT calculation.
10. Petrus Prunus regularly reviews bank deposits from customers made by EFT.
11. Lolly Lupin makes out credit notes for defective goods which are sold and returned by customers. Before doing so, she obtains the authority of Petrus Prunus to issue a credit note.
12. Daisy Dumisa goes through the „back orders‟ file weekly to ascertain the status of the backorder.
13. Petrus Prunus reviews the general journal frequently and follows up on any journal entries pertaining to debtors, such as bad debts written off.
14. Internal sales orders sent to the accounting department are filed in numerical sequence.
15. Themba Treetops goes through the day‟s picking slips at the end of each day to confirm that they have all been acted upon.

You are required to:

Indicate the function under which each of the control procedures (1-15) is most likely to occur at Greenbox (Pty) Ltd.

(Source: Graded Questions on Auditing, 2023, Q.8.2)

Suggested Solution

1. Credit management.
2. Order Department (receiving customer orders and sales authorisation).
3. Warehousing.
4. Despatch.
5. Despatch.
6. Credit management.
7. Despatch.
8. Recording of sales.
9. Invoicing.
10. Mailroom receipting/cashier.

The customer automatically receives an SMS-notification, indicating that the order is ready for despatch, and is also given a PIN (personal identification number). The company‟s delivery driver then scans the barcode when the goods are loaded onto the delivery vehicle as acknowledgement of taking custody of the goods. Once the driver arrives at the customer, the customer provides the PIN to the driver, who enters the PIN into a smartphone application. If the PIN is accepted by the application, the driver releases the goods to the customer. Once the goods have been released (via the PIN confirmation), the system automatically sends out an e- mail invoice to the customer.

Cookies and Crumbs (Pty) Ltd makes use of internet and email monitoring software.

You are required to:

a) Explain the business risks with which a Cookies and Crumbs (Pty) Ltd is faced relating to selling of its products over the internet. b) Provide examples of what internet and email monitoring software do. c) Identify the business risks related to the order, picking and despatch function of Cookies and Crumbs (Pty) Ltd. d) Indicate which controls you would expect to be present over the picking and despatch function of Cookies and Crumbs (Pty) Ltd.

(Source: Graded Questions on Auditing, 2023, Q.8.5)

Suggested Solution

(a) There is a risk  of the company‟s not complying with the Electronic Communications and Transactions Act which may result in the company facing liability;  in connecting to the internet, of unauthorised access to the company‟s computer system, which could lead to service disruption, virus contamination, data destruction or corruption and the loss of confidential information;  that information keyed in by customers may be inaccurate or incomplete, resulting in orders that cannot be filled, leading to customer dissatisfaction and loss of sales;  of unauthorised disclosure of confidential customer information (by hacking/eavesdropping or loss of data integrity) once the transmission of the transaction is underway;  of potential customer loss or reputational damage if customers are not satisfied with the website security;  of loss of customers or reputational damage due to any lack of availability or functioning of the online site, resulting in loss of sales;  of incorrect online pricing; and  that an inadequate audit trail may hinder the company‟s ability to defend itself against legitimate or fictitious claims or queries pertaining to a transaction (e.g. customers who deny placing orders or customers that claim they have placed orders that were not filled).

(b) These products can

 log the sites on the WWW that have been accessed by employees (which will dissuade staff form accessing illegal or unacceptable sites from the office);  prevent users form accessing certain websites;  control the addresses, length and content of emails, by monitoring the email protocol (thus, emails to or from certain specified addresses or over a certain length or containing attachments may not be allowed to pass);  pass all incoming files through a virus scanner;  encrypt emails that are sent to specific sites; and  control the delivery of messages to specific PCs.

(c)  Orders may be accepted for which payment has not been received.  Orders may not be acted on timeously or at all, resulting in a loss of sales and customer goodwill.  Inaccurate or incomplete order details may be recorded, that will result in incorrect deliveries, returns and customer dissatisfaction.  „Out of stock‟ items may not be identified resulting in the loss of the sale and customer goodwill.  Valid picking slips may not be acted on.  Goods may be removed for inventory for fictitious/unauthorised sales.  Incorrect items and quantities may be picked.  Inaccurate and incomplete delivery notes may be made out, resulting in a loss of revenue.  Theft may be facilitated by uncontrolled despatch.  Incorrect goods or quantities may be despatched.  Goods may be delivered to the wrong customer.  Customers may deny receiving goods.  Goods released from the warehouse may never be despatched or not despatched timeously.

(d)  Access to the order file should be restricted (specific terminals, password controls and least privileged access).  The order selected should automatically be transferred from the order file to the picking slip file (in effect the sales order should „become‟ the picking slip).  A code should be allocated to the order indicating the status of the order and preventing the order from being selected again for picking.  The screen should be formatted as a picking slip.  The goods picked should be ticked off by the picker against the quantity field on the picking slip, or a number should be entered into a designated field.  Should the quantity not be available, the actual quantity picked should be entered.  The picker should electronically sign the picking slip.  Different persons should be responsible for picking of the goods (picker) and doing the final checking of the quantity picked against the picking slip (picking control clerk) (segregation of duties).  The picking control clerk should check the physical goods picked against the picking slip to ensure that there are no differences between the quantity picked and the quantity indicated as picked on the picking slip.  The picking control clerk should be able to select the number of the picking slip from a drop-down menu.  The picking control clerk must electronically sign the picking slip.  Access to the picking slip should be restricted (restricting the fields which can be changed, password controls and least privileged access).  All quantity adjustments should be logged.  There should be control over the use of the barcode scanners (physical control over its use and password authorisation on the system when scanned.)

d) Providing Reg Park with examples of the controls over a debtors master file and over amendments to the master file.

(Source: Graded Questions on Auditing, 2023, Q.8.6)

Suggested Solution

(a)

1. Order department

Employees honest, but careless and not control aware.

1.1 Not all customer orders may be acted on, or orders may not be acted on timeously leading to customer dissatisfaction and loss of business.

1.2 Orders may be accepted from customers (non-account holders) who have not been subjected to credit worthiness testing.

1.3 Inadequate sales authorisation may take place. Orders may be taken from account holders who have exceeded their credit terms (increased risk that goods will never be paid for).

1.4 Inaccurate or incomplete order details may be recorded.

2. Warehouse

2.1 Goods may be incorrectly picked or not picked at all because of

• errors in compiling the ISO (picking slip);
• errors in actual picking (omissions, incorrect goods picked);
• no picking slip from the ordering department; and
• picking slip lost, mislaid or just forgotten about. leading to incorrect invoicing, customer dissatisfaction, returns etc.

2.2 „Out of stock‟ items may not be

• identified on the picking slip;
• communicated to the customer; or
• placed on backorder.

3. Despatch

3.1 Despatch errors may occur.

• Incorrect goods/quantities may be despatched although correctly picked.
• Goods picked may not be despatched at all.
• Goods may be delivered to the wrong customer.

3.2 Proof of delivery may not be obtained from customer and, as a result, not all goods delivered may be invoiced, or the customer may deny receiving the goods.

4. Invoicing and recording of sales

4.1 Invoices may be inaccurately prepared, e.g. incorrect prices, quantities, casts and extensions, invalid discounts given, VAT incorrectly calculated.

4.2 Goods despatched to customers may never be invoiced.

4.3 Invoices may not be entered (or may be inaccurately entered) in the sales journal, resulting in incorrect postings to debtors accounts (which will lead to queries, delayed payment from debtors, etc).

4.4 Invoices may not be timeously sent or not sent at all (resulting in same problems as in point 4.3).

5. Receipts and recording of receipts from debtors

5.1 EFT payments received may not be properly and accurately entered in the cash receipts journal (resulting in incorrect debtor records).

6. Goods returned by customers

6.1 The description and quantity of goods returned by customers may not be recorded correctly and incorrect credit notes may be passed.

6.2 Credit notes may be passed for goods not yet returned.

recording a fictitious credit to the debtors account, e.g. credit note, or bad debt write-off journal entry.

5.2 With a little bit of collusion, all employees in the cycle could set up a false business entity which sends an official order which is filled. The goods are delivered and either never „invoiced‟ or they are invoiced, and the debt is written off or a credit note is passed.

5.3 The other business entity may be a genuine business belonging to an employee or manager (or friend or family) at Crazytimes (Pty) Ltd:

• Extra items may be picked and despatched to the other business along with a genuine order and never charged.
• Goods may be invoiced at very low prices.
• An order may be filled and despatched, but the invoice deliberately not raised.
• Invalid adjustments can be made to the debtors account so that the debtor does not pay for goods purchased in the correct manner, i.e. proper order, correct goods picked and delivered etc. To settle or reduce the amount owed, invalid discounts may be given, false credit notes passed etc. in return for some „favour‟ from the debtor to the Crazytimes employee.

(c) Toxic combinations arise when a user profile or profiles have been identified to be unfavourable and may lead to segregation of duty conflicts. Toxic combinations may also be relevant for two or more user profiles where the risk of collusion or fraud may exist.

(d) Controls over a debtors’ master file and amendments thereof:

1. Record all master file amendments on a source document

1.1 All amendments to be recorded on hardcopy master file amendment forms (MAFs) (no verbal instructions).

1.2 MAFs to be pre-printed, sequenced and designed in terms of sound document design principles.

2. Authorise master file amendment forms

2.1 The MAFs should be  signed by two reasonably senior debtors section personnel, e.g. credit controller and senior assistant after they have agreed the details of the amendment to the supporting

documentation, e.g. the approved credit application document for the addition of a new customer; and  cross-referenced to the supporting documentation.

3. Enter only authorised master file amendments onto the system accurately and completely

3.1 Restrict write access to a specific member of the debtors section by the use of user ID and passwords.

3.2 All master file amendments should be automatically logged by the computer on sequenced logs and there should be no write access to the logs (this allows subsequent checking of the MAFs entered for authority).

3.3 To enhance the accuracy and completeness of the keying in of master-file amendments and to detect invalid conditions, screen aids and program checks will be implemented. Screen aids and related features:

• minimum keying in of information, e.g. when amending existing debtor records, the user will only key in the debtors account number to bring up all the details of the debtor;
• screen formatting, screen dialogue; and
• new debtors account number automatically generated by the system. Program checks, e.g.
• verification/matching checks to validate a debtor account number against the debtors master file (invalid account number, no amendment);
• alphanumeric checks;
• range and/or limit/data approval checks on terms and credit limit field, e.g. credit limit must be between R5 000 and R75 000 (range) or cannot exceed R75 000 (limit), and terms can only be 30 days or 60 days (data approval);
• field size check and mandatory/missing data checks, e.g. credit limit and terms must be entered when adding a new debtor;
• sequence check on MAFs entered; and
• dependency check, e.g. the credit limit granted may depend on the credit terms granted, e.g. a debtor granted payment terms of 90 days may only be granted credit up to a limit of R2 000 (a relatively low amount).

4. Review master file amendments to confirm they occurred, were authorised and were accurately and completely processed

4.1 The logs should be reviewed regularly by a senior staff member, e.g. financial manager. The sequence of the logs themselves should be checked (for any missing logs).

5. The outlet is run by Greta Garbo. If the outlet gets too busy for her to handle, she calls one (or two) of the finished goods stores clerks to assist.
6. As sales are made only for cash, customers receive a receipt. TO prepare a receipt, Greta Garbo writes out details of the goods purchased on a blank piece of paper (using a sheet of carbon paper to make a duplicate), enters the sale details and stamps both copies with a Brandwear (Pty) Ltd stamp. The customer is then required to sign both copies of the receipt. Greta Garbo keeps the carbon copy in a file and the customer retains the „top copy‟. Receipts are only prepared by Greta Garbo, that is to say if she is being assisted by a stores clerk, the stores clerk is not authorized to make out a receipt.
7. Cash from customers is placed in a large metal cash box, which is kept under the counter. Only Greta Garbo and Vish Naidoo, one of the clerks in the accounting department, have keys to the cash box. At 4:30 p.m. each day Greta Garbo, or one of the store‟s clerks, drops off the locked cash box containing the day‟s takings with Vish Naidoo. At some stage prior to the commencement of business the following day, Vish Naidoo empties the cashbox, placing the cash in the company safe. At 7:30 a.m. each morning Greta Garbo collects the empty cashbox from Vish Naidoo.

Note: All items sold in Cashwear are priced in multiples of R5, for example R25, R30, R55. This works very effectively to reduce the need for Greta Garbo to keep a change float of more than R200.

8. The daily cash from sales in Cashwear is kept in the company safe as described above. On Friday morning Joe Phule, the factory administration clerk and senior wages supervisor, takes the money from the safe to make up the week‟s wages packets for factory workers who do not have bank accounts (the majority of employees are, however, paid their wages/ salaries by EFT). There is always enough cash from Cashwear sales to pay these cash wages and any extra cash from the week is left in the safe. At the end of each month, Joe Phule takes any excess cash which has accumulated and deposits it in the company‟s bank account.
9. At the end of each month, Greta Garbo and Joe Phule notify Otis Redding of the total amount of cash sales made (taken from the filed receipts) and the total amount of cash used for wages (taken from the wage records) respectively. The excess cash banked by Joe Phule every month is picked up by the cash book clerk.

Otis Redding passes the following journal entry, for example:

Dr Wages 4 593

Cr Cash Sales 4 593

Narration: Raising of wage expense and cash sales.

You are required to:

Identify and explain the weaknesses in internal control relating to Brandwear (Pty) Ltd‟s factory shop, Cashwear, evident from the information provided in points 1 to 9 above. (Ignore any VAT implications.)

(Source: Graded Questions on Auditing, 2023, Q.8.7)

Suggested Solution

Weakness Explanation

1. There are insufficient physical access controls 1.1 between the finished goods store and the outlet – inventory is „conveniently transferred‟ from finished goods stores to the outlet, and employees can „come and go as they wish‟; 1.2 between the outlet and the street – customers (i.e. anyone) have „easy access‟ to the outlet. 1. As an additional uncontrolled „entry/exit‟ point has been created to the finished goods store, the increase in the risk of theft (unauthorised despatches) from the factory (and the outlet itself) has been increased significantly.
2. The physical layout and lack of security checks increase the risk of theft by the general public. 2. „Customers‟ can walk in off the street, steal goods and exit the outlet without having to pass through any security.
3. There is no check (division of duties) in respect of the effecting and recording of a sale by Greta Garbo, i.e. no security or „gate control‟ on whether goods leaving the outlet are supported by a receipt. 3. Because Greta Garbo is (normally) the only person involved in a sale, she is able to 3.1 undercharge on a particular item; or 3.2 not charge at all (friends etc.), thereby allowing goods (in effect) to be stolen.
4. Finished goods stores clerks assists on an „ad hoc‟ basis. 4. This reduces the isolation of responsibilities and gives the clerks the opportunity to sell goods (fraudulently) from the finished goods store.
5. The receipt made out to record a sale is inadequate as it is not 5.1 a standardised pre-printed multicopy document; 5.2 not pre-sequenced ; 5.3 not checked for correctness of prices, extensions casts and VAT.

5.1 A standardised pre-printed document would enhance the accuracy and completeness of recording the sale. 5.2 Because the receipts are not sequenced, there is no possibility of properly reconciling receipts with cash sales made. Although an „official‟ receipt has been

Weakness Explanation

7. No independent reconciliation of the sales recorded for the day to the cash on hand takes place.
8. When the cash is transferred between different parties (e.g. Greta Garbo and Vish Naidoo there is no acknowledgement of transfer isolation of responsibility).

7 & 8 Because of these weaknesses 7.1 there is no source total for cash sales to which subsequent reconciliations can be made, e.g. postings to the cash sales account in the ledger, cash banked; and 7.2 cash can be stolen by a number of parties e.g. Vish Naidoo, the store's clerk who sometimes drops off the cash (would need the key – easily obtained), Joe Phule, or anyone who has access to the company safe. Any amount stolen cannot be quantified (no source total) or pinpointed (isolated) to a particular individual.

9. There appears to be no reconciliation of cash sales to inventory movements including frequent counting (even daily) of inventory on hand. This combined with the other weaknesses means that inventory can be stolen (by a number of people, internal and external) and it will not be detected. 9. If proper records were kept of the movement of inventory, Greta Garbo could be held accountable by the reconciliation of the movement of inventory (say daily) with her cash on hand, e.g. for every item sold there should be the relevant amount of cash.
10. Excessive amounts of cash are held at the company and allowed to accumulate (not banked timeously). Inadequate risk assessment on the part of management.
    10. This increases the risk of armed robbery and endangers staff.
11. Cash from cash sales is used to pay wages (company should also insist that all employees are paid by EFT).
    11. This weakens the control over misappropriation of cash by unnecessarily complicating the reconciliation and audit trail of cash receipts and wages, by combining a cash-generating system and a cash expense system.
12. There appears to be no independent supervision or checking on what Joe Phule does
    12. He has access to the cash from the outlet. He uses some of it for a legitimate expense (wages) and banks

and there is an inadequate division of duties relative to his function.

the excess cash every month. As there is no independent reconciliation of what cash he received, how much he paid in wages and how much he banked, he could easily misappropriate some of the excess cash (see point 13 below).

13. There is inadequate control over the authorisation and accuracy of the journal entry passed by Otis Redding. He does not independently verify or reconcile the figures presented to him.

13.1 Greta Garbo can report any figure she likes for cash sales, and hence could easily cover up any misappropriations (she could also easily collude with Joe Phule to perpetrate larger fraud). 13.2 Because there is no reconciliation of actual cash on hand to theoretical cash on hand before the entry is passed, theft of cash by Joe Phule will not be detected.

14. Management does not appear to have created a strong control environment.
    14. The failure to implement suitable controls, e.g. division of duties, isolation of responsibilities, lack of supervision, particularly in respect of cash and the physical control of inventory and cash will result in misappropriation of company assets. Management appears not to be particularly control orientated.

Question 6 – Controls, weaknesses, debtors circularization,

assertion

PART A

Riley‟s Kitchen (Pty) Ltd is a small business that manufactures and sells homecooked meals from an online platform. Customers are required to create an account online before being able to make purchases. Customers select items that they want to purchase from a drop-down menu on Riley‟s Kitchen‟s website, and once they have confirmed their selection, the customer proceeds to a payment page. Customers have the option of paying via credit card at check-out or cash on delivery. When a customer has opted to pay with cash on delivery, the company‟s driver collects the cash from the customer. The driver keeps the cash on him until such a time that he has accumulated what he deems a large sum of money. The driver then hands the cash over, in a sealed