Question
10% of total assessment You have been given another client, CTL Limited, to audit. CTL Limited (CTL) sells clay titles to the construction industry and has been in existence for the last four years. During this period, the financial controller has been refining the system of internal controls and informs you, at the planning stage of the current year's audit, that he has put together an internal control manual for the company. He has stated that this manual will create greater awareness of controls in the company, particularly with management which, in the past, has not been overly conscious of the need to implement and enforce effective internal controls.
Management staff receive bonuses based on certain agreed-upon target ratios which include measures such as targeted monthly sales volumes, variance of actual to budget departmental overheads and profit before interest and tax. The major shareholder takes an active interest in the performance of the company and is quick to request explanations on variances from the agreed- upon monthly budgets.
Two years ago, the company devoted significant time and resources to the development and implementation of a new IT system. All teething problems associated with the implementation phase have now been resolved, and the financial controller is satisfied that the automated controls in place are assisting in producing accurate and complete accounting records. The sales director also looks after the IT function as the position is not regarded by management as being a full-time job. Once application programs have been tested, strict password control exists over access to the programs. Passwords are not required for access to databases.
To assist in the planning for the current year's audit engagement, the audit manager has extracted the following information from a review of the systems notes in the permanent file and perusal of the new internal control manual:
I. Manual delivery notes for dispatch of tiles to customers are raised by the dispatch department from the sales order form. Where a delivery is only partially filled, the delivery note is marked 'hold for invoice' and placed on the incomplete deliveries file. At month end, the supervisor of the dispatch department is responsible for follow-up of the reasons why incomplete deliveries have been outstanding for greater than 30 days.
II. Returns of tiles by customers due to breakages, inferior quality, incorrect specifications or oversupply are received by the dispatch department where staff are required to check quantity and condition of the returned tiles. Details noted by the dispatch personnel, including the reason for the return, are recorded on a ‘goods returned' note. Once completed, this document is passed on to the trade receivables clerk who raises a credit note and sends it to the customer.
III. Once a delivery has occurred, the office copy manual delivery note is forwarded to the trade receivables clerk who is responsible for generating an invoice on the computer system. An invoice is raised by inputting the total quantity delivered (Note: this could be a number of partial deliveries) and the stock code which is also recorded on the delivery note. The computer then automatically retrieves the stock code price from the selling price master file. Posting to the debtors account occurs automatically once the trade receivables clerk has performed a screen check on the accuracy of the input of delivery details.
IV. For valued customers, discounts are applied in accordance with the company's volume rating system. The trade receivables clerk is responsible for updating the individual customer volume ratings every six months after preparing the 'sales volume analysis by customer' report. This report is authorised by the sales director prior to updating the customer discounts.
V. A sales journal summarising all sales invoices is prepared monthly by the computer system. This journal is then used by the trade receivables clerk for posting to the general ledger.
VI. Receipts from debtors are passed on to the trade receivables clerk after having been opened by the mail room. The trade receivables clerk lists all receipts from the debtors and then prepares a bank deposit slip. The list prepared by the trade receivables clerk is used to enter the debtors' payments on the computer system. The batch total of postings to the individual debtors' accounts is balanced to the bank deposit slip before processing occurs on the system. At each month end, the trade receivables clerk prepares a reconciliation of the trade receivables ledger to the debtors control account in the general ledger.
VII. The computer generates an aged analysis at month end based upon all invoices that have been processed onto the system for the period up until the last day of the month.
VIII. The financial controller obtains the latest trade receivables aged analysis at the end of each month and reviews all amounts out-standing for longer than 90 days. The trade receivables clerk is required to detail reasons for delays in payment by long outstanding debtors and the financial controller discusses items of concern with the clerk.
IX. Usually an action plan is agreed for follow-up; this may include involvement of debt collectors or the issuing of writs. Where necessary the financial controller records details of amounts that should be provided for as doubtful debtors. Whilst performing this re- view, the financial controller notes the level of individual debtors' balances and, in instances where he is uncomfortable with the level of this balance, he instructs the dispatch area to withhold any shipments until a minimum prescribed payment is received.
John your partner on the audit has mentioned to you that, in the past, a substantive approach had been adopted for the audit of CTL. He now feels that, with the improvements that the client claims to have made to the systems of internal control, an opportunity exists to place reliance on the internal controls and therefore reduce the extent of substantive work.
REQUIRED:
Prepare an additional report (excluding an executive summary) for John that outlines:
1. The internal controls in the system that are potentially effective, the risk that the control could mitigate and one ‘test of control' for each of the identified potentially effective controls.
2. The weaknesses in internal control for sales and trade receivables that you would bring to CTL management's notice in your management letter.
3. Your assessment of the reliance that can be placed on the internal controls covering the sales and accounts receivable cycles and the reasons for that assessment.