Question

Budd's Retail is a small family owned retail business. Budd's sells its products to clients through via online internet sales and through a call centre. Most of the employees are casual staff employed during the busy seasons.

The company’s managers feel that on-the-job training is adequate for their needs and that the labour savings from using temporary staff are reflected in the profits Budd's has earned for the family each year.

When a customer order is received, either by phone or through the internet, the customer service representative (CSR) takes the order and checks that Budd's has the goods in stock and the correct price by checking an on-line database of inventory on hand. If the goods are available, the representative then personally phones the customer back to verify the order, including both quantity and price for each item and the extension for the entire order. The representative then prepares a sales invoice and faxes a copy to the customer.

The company has a shipping staff of 7 people and the shipping department will not ship any goods without a sales invoice initialled by the CSR. The shipping department is determined to reduce the number of shipping errors. This year, 12 shipments have occurred in which there was no sales invoice initialed and attached to the shipping bill. One of these turned out to be an urgent shipment to a long-time customer, sent on the manager’s verbal instructions.

Required:

Discuss five different types of deficiencies/problems in Budd's internal controls. Provide an example for each type of problem.

Control deficiencies may be evident from the lack of general controls, control objectives and/or from the limitation of internal controls that are discussed in CAS 315.

Answer 1

Answer:

Internal controls help companies to prevent errors and fraud through policies and procedures that companies inculcate in to the companies environment. The errors and fraud could be theft, favoritism, embezzlement or any clerical errors.

1. In small businesses like Budd’s Retail, the most common internal control deficiency found is the co-signers and Authorised signers. Due to the lack these place, there is a possibility of material misstatement.

It is important to have co-signers and Authorised signers in place in such small businesses is to prevent any one person taking sole discretion of any material decision making authority. For instance, in this not one person can take decision whether an urgent shipment can be made without an invoice or not. There has to be more than one authorizations in such situations.

2.Bank reconciliations: Small businesses maintain a general ledger to record payments and receipts of checks written, electronic cash received or paid, for company’s financial transactions. Bank reconciliation on a periodic intervals like monthly or quarterly help find any clerical errors or intentional misapplication of funds.

Hence from the above situation, mentioned it shows that Budd’s retails have still not considered the possibility of bank reconciliations to stop any kind of fraud or misappropriation of funds.

3. Segregation of work among employees for reducing the possibility of fraud. This is possible by segregating duties which are incompatible in nature. As per the IIA (Institute of Internal Auditors) confirms three categories of incompatible duties which can be listed down as a)custody of assets, b)recording and reporting and c) authorizations and approvals.

As per Budd’s retails there is no mention that managers of CSR and shipment departments are different and proper approvals are in place and which led to unrecorded unauthorized shipments.

Small business like Budd’s Retail with a tight hiring budget cannot always have the luxury of complete segregation of duties. Hence, its important for Budd’s retail to have unannounced spot check, periodical review of reports, rotating duties and conducting internal audits to have a good detective controls in place

4. Physical Audits of Assets: Physical audits to be undertaken and include tracking of inventory, material and tools. Physical counting is the best way to find any hidden discrepancies in balances in account and completely bypassing the electronic records.

5. Standardization of financial documents: Budd’s Retail should consider standardizing the documents used for any of the financial transactions like sales, cash expenses, receipt of inventory and shipments etc. Standardised documents make it easier to spot any discrepancy from the past records.

CAS 315 discusses about identifying and assessing the Risks of Material Misstatement through Understanding the Entity and its Environment

Risk Assessment procedures generally performed by auditors are listed as below:

Here, the objective of auditor is to identify and assess the risks of material misstatement, whether due to fraud or error, at the financial statement and assertion levels, through understanding the entity and its environment, including the entity’s internal control

• To identify and assess risks of material misstatement in the financial statements and at assertion levels (risk assessment do not provide sufficient appropriate evidence on their own to base an audit opinion) , the auditor needs to perform risk assessment procedures
• Risk assessment procedures include the following
  1. Inquiries of management and others within the entity
  2. Analytical procedures
  3. Observation and inspection
  4. Assessing information obtained from the auditor’s client acceptance or continuance process
  5. Assessing information obtained is relevant to identifying risks of material misstatement.
• Engagement partner and key engagement team members should discuss the susceptibility of the financial statements to material misstatement.