Reference no: EM13326326
1. To demonstrate the different phrases of an audit.
2. To illustrate specific audit techniques.
3. To work as an audit team in discussing issues and solving problems
OBJECTIVES:
On completion of this case study, you should be able to:
1. Evaluate audit risks exposure.
2. Critically analyse situations which will impact on the audit process.
3. Analyse strengths/weaknesses in internal controls.
4. Evaluate audit evidence.
5. Document audit findings.
Mt Hood Furniture Ltd - Mini Audit
The group project is worth 40% of the total mark for this paper. Students are required to complete the requirements of the following questions:
QUESTIONS Group Marks Due dates
Question 1: New client acceptance & Risk assessment
Question 2: Assessment of internal controls in sales cycle
Question 3: Accounts receivable confirmations and allowance for doubtful debts
QUESTION 1: NEW CLIENT ACCEPTANCE & RISK ASSESSMENT
a. Referring to the background information on the company, relevant auditing standards and professional ethical standards, discuss the key factors impacting acceptance of Mt Hood as an audit client. Use the following format for your discussions.
Present your answers in the table format below:
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Factors affecting client acceptance
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Explain your concerns regarding the factors identified
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For issues of concern, possible solutions or possible resolutions (if any)
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Etc.
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b. At the bottom of the working paper, draw an overall conclusion regarding accepting or rejecting the client.
c. Perform risk assessment on audit of Mt Hood Furniture. In your answer (1) identify the risk factors for the company, (2) explain the impact of the risk factors on the company's financial statement, and (3) outline how you may address the risk factors in the audit. You also need to include your concerns raised from performing analytical procedures. (This is where the auditor begins to define the risk of whether an account balance is misstated and the likely nature and direction of the misstatement, and to determine audit strategy). Use this format to report your risk assessments.
Present your answers in the table format below:
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(1) Audit risk factors identified
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(2) The impact on financial statements
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(3) How the risk factor influence the audit
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Etc.
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QUESTION 2: ASSESSMENT OF INTERNAL CONTROLS IN SALES CYCLE
Computer aspects of accounting system
Mt. Hood Furniture owns its own computer and computer software for sales, inventory management, purchases, payroll, general ledger, and other accounting applications. None of the accounting processing is outsourced. Geoff Cheng, the IT manager heads the Mt Hood's computer operations. Mr Cheng is relatively new to Mt. Hood. Geoff also has taken on the responsibility for security administration. Mr. Cheng recently hired Julie Macbeth as head of Systems Development. Ms. Macbeth has focused most of her attention on the development of a new system which will be implemented next year, and has kept changes to existing systems to a minimum.
John Rufner is head of computer operations and is responsible for the day-to-day operations of existing computer systems, as well as installing hardware and operating system software associated with the new system which will come on line in 20x4. Keith Brown serves as an assistant to the CFO and also is responsible for the data control function. Keith reconciles computer output every morning and is responsible for following-up on exception reports generated by the computer system.
Mt. Hood's accounting and inventory management are supported by a network of personal computers (PCs) with units at locations in the offices and warehouse and a central server to handle all accounting and inventory files. Printers are located in areas in which printed documents or records are routinely needed. The computer is used to control and process most transactions, to print documents, prepare accounting records, and prepare periodic financial statements.
The company uses a network housed on a HP 9000 server. Access is controlled by passwords. However, passwords are not changed regularly and are controlled informally. Only employees with jobs requiring computer data entry or access to file information and reports are given passwords.
Passwords are required to enter the system and specific applications within the system. Once on the application, employees have access to most programs and can enter relevant data. All entered data are processed by batch processing at the end of the day. Data is stored on transaction files in a traditional file system of organization. Normal data entry takes place via the software, which subject any input to various logical and numerical tests. Most input is backed up by paper trails of source documents and other business papers. The client has strong backup capabilities and no hardware malfunctions have resulted in the loss of data.
Initiating Sales and Delivering Goods
The company sells its office furniture products to independent dealers in major cities and towns, several national chains, and warehouse-club chains. The office cabinetry line offers custom orders for on-site installation.
Customers include major hotels, professional, and corporate offices. The company also produces a catalogue and has an information web site with an order link. Most sales orders are taken by company sales staff that visits the dealers and buyers for national chains (with the exception of orders that are taken from the order link on the Company's web site).
Approved prices are modified quarterly based on quantities in inventory, recent production costs, and competitive forces in the marketplace. Prices are determined at a meeting involving Conrad Saws, James Medlin and Emma Henderson. Emma Henderson is responsible for updating the master price file, which is reviewed by the entire team once new prices have been entered into the computer.
Finished products are shipped FOB from the warehouse or picked up by the customer. Sales terms on all office furniture and custom cabinetry are F.O.B net 30, and interest is charged on all receivables over 30 days at a rate of prime plus one percent.
The company does not ship any inventory on consignment, but office furniture inventory has been shipped to new dealers with terms on an initial shipment of net 120 days, before interest is charged.
When orders are received they are routed directly to the warehouse, where prospective customers are compared with an approved customer list. If the customer is not on the approved customer list the order is routed to Keith Brown, assistant to the CFO, who reviews the prospective customer's credit background and prepares a report for Emma Anderson. Emma puts her written approval or disapproval on the credit report. If credit is not approved, Mr. Brown contacts the company directly and asks if the company is prepared to accept goods shipped C.O.D. If they will accept goods shipped C.O.D. the customer is put on the approved customer list with notation to ship only on a C.O.D. basis. If credit is approved, the customer is added to the approved customer list and the warehouse is notified so that it can ship goods. Emma Henderson and Keith Brown are the only individuals with authority to update the approved customer master file, which includes information on whether goods can be shipped on credit or C.O.D.
The warehouse prepares a shipment for customers that are on the approved order list, and goods are shipped the same day or the next day for goods that are in stock. Goods not in stock are put on a back-order list that is shared with production. Using the computer, a warehouse clerk prepares printed copies of both packing slips and bills of lading. The computer does not allow the preparation of a packing slip or a bill of lading for companies not on the approved customer list. At the end of every day packages of packing slips and bill of lading, signed by the freight carrier or customer, are sent to accounting.
Recording Sales
Sales invoices are prepared every night based on the information entered in shipping. The computer calculates an invoice based on the customer information, the information on goods shipped, and the pricing information from the master price file. The company also grants a 1% discount to dealers for orders over $50,000. Once the transaction file is updated it is merged with the accounts receivable master file. The computer performs the following control procedures:
- The computer program checks internal file labels to ascertain that it is processing the sales transaction file.
- The computer checks to see that the following fields have appropriate alpha or numeric information before the invoice is processed:
- Customer information
- Quantities ordered for each stock number
- Quantities shipped for each stock number
- Prices are checked against the master price list
- Bill of lading number
- The computer performs a reasonableness test on the amount of the sale invoice based on the customer number and customer sales history. A transaction is not processed without further approval if the calculated sales invoice is greater than 120% of the largest sale to the customer in the last two years.
Transactions that result in an error report are not processed and are printed on an error report. Keith Brown is responsible for clearing all exceptions the next day, including approving sales that exceed the reasonableness test. When the transaction file is merged with the accounts receivable master file the following computer controls are performed:
- A total of customer numbers is checked to ascertain that the complete master file is about to be processed.
- Run to run totals are calculated for total receivables comparing beginning receivables, plus sales, with the new receivable balance.
If these controls surface errors, the routine is not processed and Keith Brown needs to follow-up and determine the errors and ensure that the run is correctly processed the next day. A report is also run comparing the number of items shipped with the number of items billed. This report also goes to Keith Brown for review and follow-up if necessary.
Cash Collections
All cash receipts are routed to the cashier, Megan Rogers, who prepares a prelisting of cash receipts and the bank deposit. Megan is also responsible for depositing cash and returning the validated deposit slip to Emma Anderson, the CFO. The prelisting of cash receipts is forwarded to Erin Riley in accounts receivable. Erin is responsible for entering cash receipts in the computer. The cash receipts program is run every evening. When the transaction file is processed, the computer checks for appropriate alpha or numeric information in customer number and cash receipt fields before the cash receipt is processed. If these controls find errors, the routine is not processed. Keith Brown needs to follow-up and make a determination on the errors and needs to ensure that the run is correctly processed the next day. A report is also run preparing a listing of cash received that is forwarded to Emma Henderson for comparison with the bank deposit.
When the transaction file is merged with the accounts receivable master file the following computer controls are performed:
- A hash total of customer numbers is checked to ascertain that the complete master file is about to be processed.
- Run to run totals are calculated for total receivables comparing beginning receivables, less cash receipts, with the new receivable balance.
If these controls find errors, the routine is not processed. Keith Brown needs to follow-up and determine the errors and ensure that the run is correctly processed the next day. In addition, a reasonableness test compares the cash receipts with the balance due. A separate report is printed of all customers whose balance results in a credit balance in accounts receivable. This report also goes to Keith Brown for review and follow-up if necessary.
Other Procedures
Keith Brown prepares a monthly bank reconciliation which is reviewed by Emma Henderson by the 10th of every month. Emma Henderson reviews an aging of accounts receivable weekly. She and Keith Brown follow-up on past due accounts. Emma Henderson prepares any journal entries to write-off accounts receivable. These reports are reviewed and approved by Conrad Saws.
Complete the following requirements based on the information on Mt. Hood Manufacturing provided above.
a. Evaluate the strengths and weaknesses in the sales cycle for Mt. Hood Furniture. Organize your evaluation by audit objective. For each audit objective, describe the relevant internal control strength or weakness, and cross-reference to the flowchart. For each strength, describe how you would test the control and then discuss the audit implications for other tests if the tests of controls show that the control is strong. For each weakness, discuss the implications of the weakness and recommend an appropriate improvement in internal controls.
Use the following format.
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Audit objective
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Describe strength or weakness
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Describe tests of control for strengths or describe implications of weakness
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Describe influence of strength on audit strategy or describe recommended improvement for weakness
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Validity
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Etc
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QUESTION 3: ACCOUNTS RECEIVABLE CONFIRMATIONS AND ALLOWANCE FOR DOUBTFUL DEBTS
a. Based on the previous work completed for Question 2, and the following information, complete the following requirements related to the confirmation of receivables for Mt. Hood Furniture. You confirmed account receivable as at November 30, 20X3 when the book value of accounts receivable was $6,741,725. You may assume that except for the following, you received confirmations from customers that showed no exceptions. Determine whether the following conditions represent errors for purposes of your evaluation and evaluate the result of confirming accounts receivable.
1. Dealer No. 129 disputed receivables in the amount of $30,500, as they were not received until December 2, 20x3. Further investigation showed that the dealer ordered the goods on November 30, 20x3, and they were not counted in inventory when the inventory was taken on that date. The freight carrier came by late in the day and picked up the goods, even though the warehouse was normally shut down for inventory on November 30, 20x3. Cash in the amount of $30,500 was received on December 29, 20x3. The book value of the receivable for dealer No. 129 at November 30, 20x3 was $30,500.
2. Dealer No. 65 disputed receivables in the amount of $25,750, as it had been paid on November 30, 20x3. A cheque from dealer No. 65 was received and deposited on December 1, 20x3. The book value of the receivable for dealer No. 65 at November 30 20x3 was $25,750.
3. No response was received from dealer No. 41. A review of the cash receipts journal showed that a check for $44,000 was deposited on December 24, 20x3. The book value of the receivable for dealer No. 41 at November 30, 20x3 was $44,000.
4. Dealer No. 78 disputed receivables in the amount of $755 claiming that they did not receive an appropriate volume discount on purchases over $50,000. The book value of the receivables for dealer No. 78 at November 30, 20x3 was $75,500.
5. Dealer No. 130 disputed the price on stock number 11205 which was priced at $1,500 per unit and should have been priced at $1,200 per unit on 3 units. Mt. Hood furniture issued a credit memo for $900 on December 7, 20x4. The book value of the receivable for dealer No. 130 at November 30, 20x3 was $30,500.
6. No response was received from custom cabinet customer No. 29. A review of the cash receipts journal showed that a cheque for $30,250 was deposited on December 16, 20x3. The book value of the receivable for this dealer at November 30, 20x3 was $30,250.
7. Discount Chain No. 1 disputed the price on stock number 11205 which was priced at $1,485 per unit and should have been priced at $1,188 per unit on 10 units. Mt. Hood furniture issued a credit memo for $2,970 on December 10, 20x3. The book value of the receivable for this dealer at November 30, 20x3 was $457,800.
8. Dealer No. 85 disputed the balance on the confirmation of $35,700 in its entirety. Further investigation showed that the balance was charged to the wrong customer. Goods were shipped to dealer No. 58. On December 3, 20x3 the error was discovered. A credit memo was issued to dealer No. 85 and an invoice was sent to dealer No. 58, which was paid in full on December 27, 20x3.
b. Allowance/Provision for Doubtful Debts
Based on the following information, evaluate the fair presentation of the allowance for doubtful accounts.
Following is a summary of the activity in accounts receivable and in the allowance for doubtful accounts for the last two years. Also, included below is the aging of accounts receivable at 12/31/x3. Discussion with Emma Henderson indicates that the company has followed a practice of providing for bad debts at a rate of approximately one-half of one percent of sales. The company has aggressively pushed to increase sales in the last few years. An important aspect of recent sales growth has been the addition of two discount chains as customers. The company's profit margins have been reduced by selling to these customers, but they have been faithful about paying on time. Emma also made the following comments about specific dealers:
- Dealers No. 29 and No. 49 are notoriously slow payers, but the company has not had to write-off receivables from these dealers in the past. If the economy slows down, that could be a different story.
- Dealer No. 55 is having financial difficulty and the Company may have to write-off its receivable.
- Dealer No. 122 has been turned over to a collection agency.
- Custom Cabinet Customer No. 4 is relatively new to the company and has been very slow to Pay.
Note: An Excel spreadsheet with debtors ageing analysis is available on AUTonline.
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Accounts receivable
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Allowance
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Balance 12/31/X1
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$4,928,290
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$47,850
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Sales
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$27,558,375
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Provision for doubtful debts
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$137,792
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Write of accounts receivable
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-$136,450
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-$136,450
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Cash collections
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-$26,969,303
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Balance 12/31/x2
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$5,380,712
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$49,192
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Sales
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$35,274,720
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Provision for doubtful accounts
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$176,374
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Write off accounts receivable
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-$180,500
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-$180,500
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Cash collections
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-$33,492,009
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Balance 12/31/x3
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$6,982,923
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$45,065
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Attachment:- Receivable Ageing schedule.xlsx