Question

Question 3                Understanding and Assessing Control Risks                  (Total 20 marks)

Assessing Control Risks
Quality Furniture NZ Ltd revealed the following through the enquiries and observations associated with understanding internal controls. The managing director Michael Jones has always placed a premium on the values of integrity and ethics.
For years, business has been conducted on a handshake, and commitments made by the company were always honoured. Integrity and ethics are also valued in employees, and this quality has been evidenced in any employee who has been with the company for more than a year or two. In recent years, as the company has directed resources to a new product line, and company revenues have grown, the company has actively sought out competent employees to fill out the management team by bringing in a new chief operating officer and a new chief financial officer (CFO).
Many accounting and information systems issues have been delegated to the CFO, Roma White, who has the responsibility for the company’s financing needs, accounting, and information systems. Roma almost immediately initiated a project to upgrade the company’s computerized accounting system. A new director of Information Systems (IT), Henry Smith, directly to Roma and oversees data control and systems security.
Key positions within IT include a director of computer operations and a programming director. Roma was hired because of her familiarity with benefits and risks of enterprise resource planning systems, and she reviews progress on the new system installation with the IT manager monthly. The IT manager is also responsible for managing the current system until the new system has been tested and is ready to use. Furthermore Roma recently hired Bill Roberts to act as an internal auditor. Bill reports directly to the CFO.
Currently the internal auditor is reconciling all bank accounts. The board of directors approved the hiring of an internal auditor, and, in the absence of an audit committee, Roma plans to discuss internal audit findings with the board of directors on an annual basis.
Roma is currently under pressure to produce financial statements within ten days after the end of the month. Michael Jones believes that this is essential to good business management. Once the financial are produced they are closely reviewed with managers of day-to-day operations to ensure that managers are held accountable for the resources which they are entrusted.
Other procedures performed to obtain an understanding of internal control revealed the following information:
A. Quality Furniture has identified a small group of office furniture dealers whose operations have deteriorated to the point that their ability to repay the company is doubtful. The company has decided to make additional shipments to these dealers on a COD basis. It is expected that a large allowance for doubtful debts may be necessary to reduce these accounts to estimated realizable value.
B. The tool inventory consists of accumulation of miscellaneous items, most of which are small quantities with very minor unit prices. This inventory totals $ 50,200.This is considered to be insignificant portion of the total inventories.
C. The purchased parts stockroom is separated from the production areas by a wire fence. While visiting the plant, you noted that the gate was open all day, and access to the stock room (which contains many valuable and easily concealed items) was available to any employee. The stockroom’s perpetual inventory records were formally checked by an employee who made periodic test counts. This employee has retired and has not been replaced. As a result, such counting has ceased. You expended your test in view of these situations and are satisfied that the perpetual records reasonably reflect the quantities on hand.
D. The board of directors just adopted a policy that will allow the company to invest excess funds in short term securities. The CFO will have sole authority for purchase and sale of the investments. Securities purchased will be credited to a company account at a local brokerage house. The securities are held in the company’s name. All correspondence relating to the investments is sent directly to the CFO. She in turn, forwards brokerages advices to her assistant for recording in the accounts.
E. A complete physical inventory of the company’s office furniture has recently been taken
Required:
Identify and explain any four control environment factors that affect the company’s internal control.                                                                                          (8 marks)
Describe two strengths and their implications for audit strategy in Quality Furniture NZ Ltd’s internal control.                                                                          (4 marks)                                                                                                                      
Describe four weaknesses and their implications for audit strategy in Quality Furniture NZ Ltd’s internal control.                                                          (8 marks)

Answer 1

Four control environment factors that affect company's internal control are :

1. Roma, the CFO is under pressure because she is handling a lot of work individually. In the question it is mentioned that the company has appointed one COO as well but there is no mention of the work assigned to that person. The company should distribute the excess workload of Roma to the COO so that both the employees can contribute according to their potential and efficiently contribute to company's growth.

2. The company should strictly scrutinize other groups of Furniture Dealers which have not paid the company for a long period of time. For this the company can do aging analysis of the debtors. Company should also put in place a mechanism whereby proper follow up should be made with the debtors & discounts can also be offered for early payment. Company should be conservative in making provisions for doubtful debts.

3. The company should install a scanning equipment preferably a bio-metric equipment which allows entry to the stock room only to the authorized persons. The company should appoint a new employee for carrying out periodic test checks of inventory in the stock room & ensure that checks are carried at regular intervals. Company should keep in mind that such employee should not be involved in maintaining the Stock register.

4. The CFO should be conscious while making investments in short term securities. The CFO should be well aware of the market conditions, new developments & should develop a well researched portfolio of securities so as to yield maximum benefit to the Company.