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ACC311 Fundamentals of Auditing Assignment 2 Solution Spring 2014

Ali is an auditor having satisfactory quality control review (QCR) rating issued by ICAP. He has been appointed as an auditor of Model Manufacturing Limited. He has started his audit work, understanding the entity’s internal control environment and obtains various assertions from different executives and employees of the entity. After going through a preliminary assessment of the entity’s environment, Ali feels that there is a problem in the working of internal control system in handling the sales & debtors and payroll departments. Now, he is planning to check the internal control system of sales and payroll departments of the entity.

Describe various appropriate internal control procedures and tests of control, Ali may apply to determine the strength of internal control measures over the client’s:

Internal controls are the methods and procedures designed by management to safeguard assets and to manage resources. It’s the system of checks and balances. A system of internal control serves to minimize errors in the accounting records and to deter fraud, embezzlement and theft by employees, customers and vendors. The system of internal control provides reasonable assurance of the following:

  • Reliable financial and operational reports
  • Efficient and effective operations
  • Compliance with applicable state and federal laws and/or regulations and university policies and procedures

As department head, you are responsible for setting the “tone at the top” of your department’s control environment and ensuring that adequate controls are included in your daily operations. In plain language, a system of internal controls is essentially a system of checks and balances. This system of checks and balances over financial transactions is needed for much the same reasons why such systems are needed for democratic governments: absolute power leads to undesirable results. In government, absolute power can result in despotism; total control by one person over financial transactions can result in theft or fraud.

(i) Sales & debtors (2.5 + 2.5 Marks)

There are a large number of controls that may be required in the sales cycle due to the importance of this area in any business and the possible opportunities that exist for diverting sales and cash receipts away from the business
Typical control procedures at key stages of the sales cycle are:
1. Orders
2. Dispatch
3. Invoicing and credit notes
4. Returns inwards
5. Receivables
6. Bad Debts
(a) Orders
(i) Existing customers should be allocated a credit limit and it should be ascertained whether this limit is to be exceeded if the new order is accepted. If so the matter should be referred to credit control.
(ii) Any new customer should be referred to the credit control department before the order is accepted.
(iii) All orders received should be recorded on pre-numbered sales order documents so that a check can be made that all orders have been dealt with -a completeness check.
(iv) All orders should be authorized before any goods are dispatched.
(v) The sales order document should be used to produce a dispatch note for the goods outwards department. No goods may be dispatched without a dispatch note.
(c)  Dispatch
(i) Dispatch notes should be pre-numbered and a register kept of them to enable them to be matched
with relate to sales invoices and customer orders.
(ii) Dispatch notes should be authorized before goods leave the company.
(iii) Regular checks should be made to ensure that all dispatches have been invoiced.
(d) Invoicing and credit notes
(i) Sales invoices should be authorized by a responsible official and matched with the authorized order
and dispatch note.
(ii) All invoices and credit notes shouldbe entered In daybook records, the sales ledger, and sales ledger control account. Batch totals should be maintained for this purpose.
(e) Returns
(i)
Any goods returned by the customer should be checked for obvious damage and, when accepted. a
document should be raised.
(ii)
All goods returned should be used to prepare appropriate credit notes
(f) Receivables/Debtors
(i) A receivables ledger control account should be prepared regularly and checked to individual sales
ledger balances by an Independent official.
(ii) Receivables ledger personnel should be independent of dispatch and cash receipt functions.
(iii) Statements should be sent regularly to customers.
(iv) Formal procedures should exist for following up overdue debts which should be highlighted either
by the preparation of an aged list of balances or by the preparation of regular customer statements.
(v) Letters should be sent to customers for collection of overdue debts. A policy should be in place for
the Institution of legal proceeds where appropriate.
g) Bad debts
(i) The authority to write off a bad debt should be in writing. Appropriate adjustments should be
made to the sales ledger and the control account
(ii) The use of court action or the writing-off of a bad debt should be authorized by an official independent of the cash receipt function.

Payroll Internal Controls


General Payroll Controls

Consider using a selection of the following controls for nearly all payroll systems, irrespective of how timekeeping information is accumulated or how employees are paid:

  • Audit. Have either internal or external auditors conduct a periodic audit of the payroll function to verify whether payroll payments are being calculated correctly, employees being paid are still working for the company, time records are being accumulated properly, and so forth.
  • Change authorizations. Only allow a change to an employee’s marital status, withholding allowances, or deductions if the employee has submitted a written and signed request for the company to do so. Otherwise, there is no proof that the employee wanted a change to be made. The same control applies for any pay rate changes requested by a manager.
    • Change tracking log. If you are processing payroll in-house with a computerized payroll module, activate the change tracking log and make sure that access to it is only available through a password-protected interface. This log will track all changes made to the payroll system, which is very useful for tracking down erroneous or fraudulent entries.
    • Error-checking reports. Some types of payroll errors can be spotted by running reports that only show items that fall outside of the normal distribution of payroll results. These may not all indicate certain errors, but the probability of underlying errors is higher for the reported items. The payroll manager or a third party not involved in payroll activities should run and review these reports.
    • Expense trend lines. Look for fluctuations in payroll-related expenses in the financial statements, and then investigate the reasons for the fluctuations.
    • Issue payment report to supervisors. Send a list of payments to employees to each department supervisor, with a request to review it for correct payment amounts and unfamiliar names. They may identify payments being made to employees who no longer work for the company.
    • Restrict access to records. Lock up employee files and payroll records at all times when they are not in use, to prevent unauthorized access. Use password protection if these records are stored on line. This precaution is not just to keep someone from accessing the records of another employee, but also to prevent unauthorized changes to records (such as a pay rate).
    • Separation of duties. Have one person prepare the payroll, another authorize it, and another create payments, thereby reducing the risk of fraud unless multiple people collude in doing so. In smaller companies where there are not enough personnel for a proper separation of duties, at least insist on having someone review and authorize the payroll before payments are sent to employees.
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