Auditing Homeware Central Pty Limited: Conclusions, Key Accounts At Risk, And Internal Controls

Conclusions about Homeware Central Pty Limited’s future

Part (a)

As we see the company’s profit margin is falling from last two years and company is planning to improve it by taking some steps such as they are planning to keep their cost low so that they can cover their overhead costs by increasing the level of sales. They also planned to improve their working capital by reducing the levels of inventory and accounts receivable. They also expect to lower down the debt level to balance the cash flow (Dalkin, J. R. 2010). By this information we can predict that company will show a hike in its profit margin as compared to previous years although they will not reach the benchmark of the industry but they will try harder to improve the net profit figures.

Company’s current ratio will decrease slightly in future as they are reducing the level of their inventory and accounts receivable. This will also impact the quick ratio (Gray & Manson, 2007). The times interest earned ratio will also fall as the debts will be repaid by the company in near future. Net sales of the company will increase in the coming years as company wants to cover its overhead costs and improve the profit figures. In short company’s position will improve in near future.

Part (b)

The three account balances that could be at risk of material misstatement and needs peer review at the time of audit are:

1. Cost (Overhead Cost)
2. Inventory
3. Debts/ Loan

The company is trying to keep its costs in control so the auditor will critically review its cost accounts as the cost figures will decrease as compared to previous years that will surely draw the attention of the auditor. The company is planning to keep its costs down so that sales will recover the cost and profit figures will increase. Hence, there is chance of risk of material misstatement in company’s cost accounts and the cost can be overstated by the company to get rid of the tax liability (Bonner, 1990).

Company is planning to lower down the level of inventory and realise the cash to repay its liabilities so the auditor will physically verify the inventory count as there is chance to manipulate the inventory figures. The method for valuation of inventory directly affects the cost of goods sold that’s why auditor needs to evaluate the inventory figures as their valuation is done as per the guidelines. There is possibility of overstatement of the inventory balance at the year end. 

Key accounts at risk of material misstatement

Company is planning to repay its debt and decrease the level of debt to improve its working capital management. There is need to review the level of debt and the flow of cash the source of repayment of debt. The debts can be understated by the company to show a better financial position without its actual repayment. This shows the credibility and liquidity of the company.

Part (c)

The key assertions at risk in these three accounts namely:

Cost (Overhead Cost)

The cost records are dully maintained by the company or not as per the guiding principles of the company. The methods used for calculating the costs are in line with the standards prescribed. Any cost is understated/ overstated needs proper disclosure and the method followed to determine the amount needs to be described.

Inventory

The physical verification of inventory has been done by management at reasonable interval. At the time of physical verification any material discrepancy has been noticed and that discrepancy has been dealt in the books of accounts. The valuation of inventory is done as per the method stated in its books of accounts and the closing inventory is valued using the method company follows from year to year. Inventory is recognized in the books of accounts at lower of the cost or net realisable value.

Debts/ Loan

The repayment of debt is done by appropriate sources and timely repayment is done or not. The interest is properly calculated any paid on time any overdue will be paid with the payment of the debt. The loans are raised by authorised sources and are in line with the regulatory requirements (Schneider & Church, 2008).

Part (d)

The assessment of company’s financial condition is done through ratio analysis but many verifications and valuations are necessary to be done at the auditor’s end. The company’s revenue account and balance sheet will make the assessment easier and clear with this the turnover and profit stability will also be assessed. Management report is a major part to assess the financial condition of the company as their analysis and their comments plays a major role in auditing the financial statements. The internal controls followed by the company are also analysed that represents the true and fair view of the financial statements of the company. The company’s annual returns and reports would be useful to know as if company has duly complied with all the rules and regulations and no penalty is imposed on the company. Physical verification of Fixed Assets and inventory is very necessary to know the correctness of the value stated by the company in its financial statements. It is obligatory for the company to present its bill book and cash ledger or passbook to cross verify the cash balance and turnover figure of the company. The auditor should ask for the letter of allotment of the property owned by the company to assess the ownership and allotment is done legally or not. The working capital condition and requirements and liquidity is also assessed by the auditor to know the creditworthiness of the company. The auditor should know the maturity of all the loans taken by the company and ensure their proper repayment avoiding any over-dues and interest payment 

Internal control activities in Pure Water’s sales and receivables

Part (a) 

The three internal control activities in Pure Water’s sales and receivables are:

Segregation of duties:

The sales orders are prepared by the sales clerk, one copy of sales order is sent to shipping department and Shipping clerk will get the items from warehouse once he receives the sales order and prepares a shipping note in duplicate. The shipping clerk transfers the information from shipping note to delivery docket, which is in triplicate. Two copies of the delivery docket are given to the carrier. One of them is retained by the customer and anther one is sent to invoicing department. The invoicing department matches the sales order with the delivery docket and then prepares a sales invoice which is then sent to the customer (Altamuro & Beatty, 2010). The customer then makes the payment via cheque and sends the cheque through mail two staff members are assigned the duty to check the payment one of them opens the mails and records the cheque details and another one takes the custody of the cheque.

The complete process is in order and subsequently all tasks are assigned to the defined departments which will not give any chance for material misstatement. This is a complete flow process from placing the order to its payment which prevents the material misstatement to occur.

Preparation of sales order:

The customer places the order through phone or by mail. Once the sales clerk receives the customer’s request a sales order is prepared by him in triplicate. The order is then placed by the shipping clerk.

The process is in its flow as from receiving the customer’s request to placing the order every person is duly assigned to perform his task. This control activity will easily detect the material misstatements as there are 3 copies of the order generated which can be cross verified at any time. 

Posting the sales journal and accounts receivable ledger:

After placing the order and shipment the sales invoice is prepared by the sales clerk and sent to the accounting department the accounts clerk then post the sales entry in the sales and account receivables ledger immediately after receiving the sales invoice.

The posting is done by the accounts clerk and invoice is filed by the invoicing department as well which will prevent the material misstatement to happen as cross verification can be done after posting the entry.

Part (b)

The test of controls that can be taken to verify the effectiveness of the internal controls implemented by the company:

Segregation of duties:

This can be tested by checking the duties performed by:

Sales Department

Invoicing department

Shipping department

Sales Department

Warehouse Department

Accounts Department

By keeping a check on their work we can easily identify the biasness and verify the internal control easily (Rittenberg, Martens & Landes, 2007).

Preparation of sales order:

The order book can be verified its serial no. and can be cross checked as one copy is kept by the invoicing department. The delivery docket and sales order can be cross verified and then matched with the sales invoice.

Posting the sales journal and accounts receivable ledger:

The entries made by the accounts receivable clerk can be verified with the payment receipts and the sales invoice. The accuracy for invoice calculations can be seen by checking the order details. The accounts receivable and cheque collection needs to be separate so that two times the transaction will be automatically verified. The Account can be reconciled with the bank account and sales journal.

Part (c)

Three internal control weaknesses in Pure Water’s sales and processing system are:

The sales order and shipping notes are manually prepared:

The sales orders are prepared by sales clerk manually and pre numbered. There is no proper format to be followed by the clerk to make the sales order or there is no computerized system for preparing the order. The shipping clerk also manually make the shipping note which is pre numbered and this is prepared in duplicate but still there arises a chance of losing the note and chances of errors also arise as there is no proper format to be followed manually (Ashbaugh-Skaife, Collins & Kinney, 2007). 

All orders are in credit:

The orders are in credit which is very difficult to manage as this increases the work load as they need to record the same transaction thrice once in sales ledger and then in accounts receivables ledger and then in bank/ cash ledger (Doyle, Ge & McVay, 2007). The cheques are also retained by one of the staff member and there arises risk of losing the cheque by mistake.

Bank reconciliations are performed by accounting clerk:

The cheques are received by accounts receivable clerk the ledgers are posted by the accounts receivable clerk but the reconciliation is done by accounts clerk so their arises a chance to misinterpret any entry and the accounts clerk will take more time in reconciling the bank statements as he must not be having any clue about the payments (Hammersley, Myers & Shakespeare, 2008).

Part (d)

The account balances which are at risk of misstatement and the assertions at risk are:

Sales Account:

The sales orders and shipping notes are prepared manually because of which sales account will be affected and is exposed to risk of misstatement as manually there are more chances of errors to happen in the amount. The sales account will be effect as manually there are chances to repeat the last order number by mistake and same amount will be entered again which will misstate the sales account.

Accounts Receivables Account:

All sales are in credit and orders are taken via mails and telephone so there is possibility to post wrong entry in the accounts receivable ledger as the orders must be misinterpreted or wrongly numbered any type of error may arise because it is hard to manage the account and bad debs will not be recognised as all the sales are in credit.

Bank Account:

The reconciliation of bank account with the accounts receivable account is hard to be one as the books are maintained by the accounts receivables clerk and the reconciliation is done by the accounting clerk which will cause some errors at the time of reconciliation.

Part (e) 

The controls to be implemented to reduce the risk of material misstatement are:

1. To control the risk of sales account by manually preparing the sales order and shipping notes can be reduced by computerising the system and fixing a format for sales order which needs to be pre numbered and arranged date wise so that it will be easy to generate copies and to maintain proper files with monthly sales records (Lu, Richardson & Salterio, 2011).
2. To reduce the risk of banking error that too because of reconciliation the authority to reconcile the bank amounts with sales and account receivables will be given to the accounts receivable clerk. As the reconciliation must be done by the person who do know the flow of cash and manner of posting the same in the books of accounts. It is necessary to assign the same person the responsibility but it is to be given to the person who has knowledge of payments system. 

References:

Altamuro, J., & Beatty, A. (2010). How does internal control regulation affect financial reporting?. Journal of accounting and Economics, 49(1), 58-74.

Ashbaugh-Skaife, H., Collins, D. W., & Kinney, W. R. (2007). The discovery and reporting of internal control deficiencies prior to SOX-mandated audits. Journal of Accounting and Economics, 44(1), 166-192.

Bonner, S. E. (1990). Experience effects in auditing: The role of task-specific knowledge. Accounting Review, 72-92.

Dalkin, J. R. (2010). Financial Audit: Securities and Exchange Commission’s Financial Statements for Fiscal Years 2009 And 2008, DIANE Publishing.

Doyle, J., Ge, W., & McVay, S. (2007). Determinants of weaknesses in internal control over financial reporting. Journal of accounting and Economics, 44(1), 193-223.

Gray, I & Manson, S (2007). The Audit Process: Principles, Practice and Cases, Cengage Learning EMEA.

Hammersley, J. S., Myers, L. A., & Shakespeare, C. (2008). Market reactions to the disclosure of internal control weaknesses and to the characteristics of those weaknesses under Section 302 of the Sarbanes Oxley Act of 2002. Review of Accounting Studies, 13(1), 141-165.

Rittenberg, L. E., Martens, F., & Landes, C. E. (2007). Internal control guidance: Not just a small matter. Journal of accountancy, 203(3), 46.

Schneider, A., & Church, B. K. (2008). The effect of auditors’ internal control opinions on loan decisions. Journal of Accounting and Public Policy, 27(1), 1-18.