KPMG: The Internal Controls Practical Guide - Essay Example

?Answer to 9.28 (a) Based on the flowchart depicted, Office Supplies Ltd has divided the activities involved in the sales cycle among four units i.e.order entry, shipping, invoicing and accounting. The key controls that could be relied on for these four divisions are as follows: Order Entry – In order to test the existence of the order, the key control that needs to primarily be relied upon is the source document which has been used as evidence of the placement of order by the customer. In this scenario it could be a telephonic conversation, a faxed or emailed request, or a signed order received from the customer. Since the flowchart depicts the preparation of the sales order as a manual procedure, the second key control that needs to be assessed is whether the company follows a four-eye principle when it comes to processing documents such as sales orders. Supervisory control is vital in ensuring that sales orders have been reviewed by two parties at the very least. According to the KPMG guide for internal controls, it is important that an organization adopt a culture where internal control is inherent in terms of accountability and operations, to ensure effectiveness of controls (Stock 1999, 24). Shipping – In order to determine the occurrence of the shipment, the key area of control that could be relied on is the bill of lading. A bill of lading would act as a legal contract between Office Supplies Ltd and the carrier of goods (Lawyers and Legal Services Australia 2011) and will suffice as evidence that the shipment has been effected as per the sales order. Moreover, if a banking institution is involved, then the acceptance of a bill of lading and other shipping documents can also act as proof that the shipment has been received by the recipients that have been billed for it, as per the sales order and invoices. Invoicing – This is another manually conducted process hence internal controls in terms of accountability and hierarchy need to be relied upon here. Besides the internally prepared invoice document, the source document such as the sales order would be required for reconciliation purposes. An added source of comfort would be provided by the Bill of Lading, which would contain the relevant information of the goods shipped or the reference to the sales order. In this regard, the bill of lading is an important document since the invoice can be reconciled against the shipping documents to ensure that the customer was billed for the goods shipped, which were shipped as per the order placed etc. Accounting – For the purpose of testing the correctness in terms of classification here, the journal entries would be a reliable key control, if accompanied by supporting vouchers or other source documents such as the sales order, invoice etc. One may rely on the net balances of accounts receivables, cash collected and outstanding debts to ensure that there are no miscalculated entries, but without a thorough entry-wise check, there is no certainty with which one can conclude that the accounting entries have been accurate. A trial balance may run accurate but be prone to inherent errors in terms of application of accounting fundamentals etc. Answer to 9.28 (b) From the viewpoint of an auditor, the controls that need to be tested must incorporate as much information from external parties as possible. This specially applies to the case of Office Supplies Ltd, wherein most of the documents such as sales orders, invoices, bill of lading etc involve manual entries and are subject to human error. A possible road map to follow when testing for controls for Office Supplies Ltd is as follows: -Gather evidence for the proper division of duties between the units as depicted in the flowchart. The responsibilities should be separate in terms of hierarchy. Moreover, extent of supervisory control should be looked into. This would ensure accountability and hence effectiveness of internal controls. -Since invoices, sales order etc are prepared manually, a separate check should be taken to ensure that all documents are properly numbered and in order. Hence, archiving by ‘customer’ only may not be effective for such purposes, and a separate record keeping mechanism should be in place to ensure that all numbered documents are in place. -A sample of transactions would be selected from each month to ensure uniformity in practices all year round (My CA Site 2009). It may happen that diligence required by the personnel responsible for the relevant activities may be lacking based on motivation levels, or seasonality, for example the Christmas season. The sample of transactions should be reviewed to deduce whether the data entered has been verified by a second party. Care must be taken to ensure that not only are samples distributed evenly across the year, but also across the customer base and size of orders. -Transactions would be verified and validated from the starting point in history. Does the sales order prepared comply with the customer’s specifications? If yes, are customer details archived under the appropriate category, i.e. is the correct master file being used for retrieval and archival of data? Are the sales orders numbered accurately? - The bill of lading is a critical document which should act as evidence of shipment here, and ensure occurrence of the seller’s role in the transaction. Has the bill of lading been acknowledged by the customer or the banking institution involved, if any? -Timeliness should be verified by ensuring that the invoices and bill of lading, along with journal entries correspond to the dates of the sales order. -Inquiries can be made about whether the personnel in charge of cash collection is the same as personnel in charge for recording of accounts receivables. -Since accounts receivables are being recorded and the company is effecting shipments on credit basis, inquiries should be made about the company’s credit control process. This would help provide information about the existence of any controls in place. For example, how many approving authorities exist when it comes to granting credit period to customers as opposed to cash based sales? How much autonomy does the personnel in charge of execution of sales orders have? -Reconciliation records must be inspected. For example, have invoices been reconciled with sales orders? Have bills of lading been reconciled with sales orders or invoices? The same rule applies to accounts receivables. Other questions to ask when reviewing the invoicing process are as follows. Has the customer been billed for the exact order as specified? How many copies of the invoices have been prepared? Have the invoices been numbered accordingly? Has the customer acknowledged receipt of invoice? Does the payment received correspond to the amount billed to the client? Does the date of the invoice match the time of the shipment? Does the invoice include not just the amount billed but the details of the goods shipped? -Account classification must be inspected. Are the proper laws of accrual accounting being applied when recording receivables? Are accounts receivable entries corresponding to the correct customers in terms of names and amounts? What are the source documents attached with the journal for verification of entries? Do sales journal balance the account receivables at any given point in time, accounting for credit/cash sales accordingly? Bank statements may be reviewed to reconcile the days when the accounts receivables entries have been cancelled out with cash collection. A major issue to account for here is the archiving of records by customer. Since the duties are segregated in the company, record keeping does not match the hierarchy defined. The invoicing unit must archive their records which may be sorted by invoice numbers and cross referenced to the master customer file, etc. While there may be some duplication and overlapping of information, this method allows for accountability in the divisions. The method outlined above would ensure that all documents are numbered in order to ensure that no piece of document goes missing. Plus, cross referencing will ensure that if in case a document is missing due to human error, it could easily be traced through a separate file altogether. Also, it helps to maintain chronological records to ensure cutoff times are in place and all activities have been carried out on the correct dates. As mentioned earlier, the more important documents when it comes to testing controls to are external documents. Therefore any communication with the customer with regard to orders is critical. The bill of lading, acknowledged by the carrier is also of prime importance as that acts as evidence that the shipment has been effected as per the customer’s order. Bank statements, if necessary are also crucial to determine whether the credit period allows matches the cash inflows of the company. Internally prepared documents, if reconciled with these external sources will hence be less prone to human error. Through the above methods, we have addressed the company’s record-keeping practices, credit approval policies, existence of supervisory control, extent of segregation of duties, application of accounting laws, reconciliation exercises, year-round uniformity in practices, and timeliness. In conclusion, the above methods may help establish the presence of controls, and the thoroughness in completion and accuracy of the documentation would determine whether the controls are effective. Works Cited "Bill of Lading | Lawyers and Legal Services Australia." Legal Lawyers - Solicitors and Barristers for Legal Advice and Assistance. http://www.legallawyers.com.au/legal-topics/admiralty-and-shipping-law/bill-of-lading/ (accessed September 3, 2011). Stock, Mark. "KPMG Internal Controls Practical Guide." European Corporate Governance Institute. www.ecgi.org/codes/documents/kpmg_internal_control_practical_guide.pdf (accessed September 3, 2011). "Test of Controls." 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