Keystone Computers and Networks - Case Study Example

Keystone Computers and Networks, Inc. This report covers different auditing aspects to be considered while auditing Keystone Computers and Networks, Inc. based on the tasks assigned. Appendix 11 A Problems 11A-1(A) Controls Error or Fraud Controls (1) Applications controls are applied when customer orders are entered by sales order clerk. Application control would ensure that the correct data field has been entered in the system and the all the relevant records have been entered correctly. (2) The computer assigns number to the sales invoices when they are prepared. This control removes the chances of any invoice number being entered twice. In the absence of this, there are chances that the single invoice being processed more than one time. With the implementation this control a unique record of every transaction would be produced that can also be used in the reconciliation. (3) Monthly statements are mailed to customers. This control ensures that the balance in the company’s book of account and in the customer’s books is the same and if there are differences they are resolved in a timely basis through inquiries. (B) Controls over Cash Receipts Controls Error or Fraud Controls Cash receipts are prelisted by the receptionist This control would ensure that all the receipts are entered in the system properly and chances of forgery would be minimized. The accounting manager reconciles control totals generated by the account receivable control program. These controls ensure that all the record is being entered in the system and they are recorded at the correct value. So the completeness and accuracy are met. The computer summaries of cash collections and cash sales are reconciled top prelisting of cash receipts and cash deposited by accounts manager. Again this control would guarantee completeness and accuracy of the rerecord, since all the cash collections are matched with the cash receipts. Reconciliation would reveal any error made at the data processing stage. 11A-2 (1) When sales invoices are prepared and sent to the client before the actual delivery of the good, there is a greater risk that the sales and receivable balance is overstated because the company is not yet entitle to record the revenue and receivable against it. If the deliver is cancelled due to any reason there is a risk that the correction may not have been made to the above-mentioned accounts. (2) If proper provision has not been made to the account receivable, there is always a risk that some of the receivables may not be recoverable and the actual figure is overstated. Another risk associated with this is, that the profit for the year is also overstated because if the proper provision is created, it is charged to the statement of comprehensive income. 11A-3(a) As far as the test of controls is concerned, the auditors are mainly concerned with incorrect conclusions. Controls should be effective enough to prevent, detect, and correct all the errors or frauds. In the absence of effective controls, it will not be possible for the auditors to use audit sample since there is a greater risk of error or fraud not been detect by ineffective control (Alan). If the design of the internal control is effective to prevent, detect and correct the error and fraud, then the auditor also perform a test on the operation of the internal controls. If the design is not good, operations are automatically thought to be ineffective. If both the design and operation of the internal control is effective then audit sampling can be used to draw conclusion about the whole population. 11A-3(b) As mentioned in the working paper the control assessment document on page 489 that the sample size is 55 out of the population where the tolerable deviation rate is 7% and expected deviation is 1%. However, in the given scenario, tolerable deviation is if 15% so the auditor has an extra margin of safety. In addition to this, control risk is assessed to be 5%, which is very low. In these circumstances, the auditor is comfortable to choose a small sample size, because there are remote chances of significant errors. A minimum sample size of 15 to 30 would be suitable in these conditions but it is also dependent on the professional judgment of the auditor 11A-3(c) While comparing the sales invoices with the delivery notes, following tests of controls will be performed: 1. All the items of the sales invoices will be checked with the delivery notes. All the items mentioned in sales invoices shall be derived from the delivery notes. The rate and quantity should also be compared so that over or under invoicing is not done. 2. The sales invoice should refer to the delivery note by its unique number. This will reduce the risk of aging issues. It is possible that there are identical items mentioned in two different delivery notes; for instance Delivery note A and B. It is possible that the invoice that is paid related to Delivery note A rather than B. Such weak connection between delivery note and sales invoices will hurt the aging system as prior goods sent may appear as receivable. 3. In case, delivery note is invoiced against two invoices, then a record should be maintained about the goods that are invoiced and the goods that are not. This will assist in reducing the double billing of the goods. Comparing the system-generated report of un-invoiced goods against delivery notes and the actual invoices could do this. Appendix 11B 11B-1 A detailed audit plan is designed to evaluate whether the sales revenue is free from material misstatements. Due to the materiality of this assertion, auditors take extra measures and design a reliable audit plan. The purpose of this plan is to evaluate the operating effective of the system in order to obtain sufficient appropriate audit evidence. Overall, the audit plan is good and sufficient tests have been included in it, to evaluate every important issue. This audit plan is very effective and sufficient that it will help auditors to highlight the risky areas. Following were the audit procedures that were performed by the auditor Client’s account receivable ageing was testes to ensure that all the balance is recoverable. Auditor has chosen some of the customers to send the confirmation of the balance and for those who did not reply to the first letter, another letter of reminder was sent. More tests were performed on those balances whose confirmation was not received within a reasonable time. These tests include examining the items which were subsequently paid reconciled the paid receipts with the sales invoices. Reviewed the customer credit file and all the balances above $150,000 were examined. All the suspicious account balances were examines and investigated properly. Substantive tests were also performed on the allowance for the uncollectable debts. These tests include reviewing the disputed amount as suggested by the confirmation letter. Analyzing the relationship between items such as revenue to receivables, allowance for uncollectable to account receivable balance and net sales to bad debt expense. The entire credit memorandum issued close to year was reviewed carefully to make any adjustments required. Performed analytical procedures to compare the changes between the current year and previous year. These procedures were performed to expose any extraordinary changes in the relationships between the gross profit to sales and salesman to monthly sales, receivable turnover, and advertising expense to sales. Management inquiries have regarding the amount owned by the client is owned by clients or related parties such as directors, shareholders, etc. 11B-2 Sales of Computer Sales of computer revealed the above-mentioned changes from one year to another. In the month July 20x4 sales were declined by more than 10% since the previous year. This may indicate the problem of under invoicing to evade taxes, or it may represent that the company had obsolete stock. In the year 20x5, March, April and October have more significant changes in the sales revenue of the month as compare to last year. Consulting Revenue 20X3-20X4 20X4-20X5 Month -2.901% -9.679% Jan -15.096% -5.414% Feb -0.210% -1.987% Mar 0.066% -10.505% Apr -5.275% -5.247% May 3.772% 4.122% Jun -11.763% -4.249% Jul 2.806% -7.620% Aug 0.720% 8.812% Sep -5.419% -4.903% Oct 1.640% -2.156% Nov 4.184% 8.771% Dec As far as consulting revenue is concerned, almost 12% change was noticed in July 20X4, since the previous year in the same months. There is a danger that the consulting revenue and receivables are understated. In February 20X4 revenue deviation was 15%. Some of the deviations continued to next year. Highest deviation is 10.5% in the month of April 20x5. Service Revenue 20X3-20X4 20X4-20X5 Month -0.134% -10.077% Jan 5.829% -10.826% Feb -0.785% 3.306% Mar 4.939% -8.011% Apr -2.598% -4.881% May 3.917% -6.283% Jun -1.349% -10.736% Jul -0.651% -4.881% Aug 0.263% 4.863% Sep -7.212% -5.637% Oct 1.258% -10.691% Nov -2.701% 0.687% Dec Service revenue is declining since last two years but it has declined sharply in 20X5. In Jan 20x5 there is risk that the revenue and receivable are understated. In February, there is even a greater risk sine the revenue in the same month in 20x4 was increased by 5% and 20x5 it was dropped by 11%. Similar is the situation in July 20x5 and November 20x5. (b) Auditor can perform the analytical procedure on sales and revenue. These may include comparing the sales of the month for every salesman to the last year in the same month, advertising expense to sales revenue of the month and salesman commission to the sales revenue. (c) Below mentioned substantive test would be suitable in the given situation, Inquiry forms the management regarding the decline in the sales revenue. These require main reveal extraordinary circumstance, which resulted adverse circumstances. Corroborative audit evidence can be obtained such as industry data can be compared with the company’s performance or the general economy conditions. Where there is a high risk of misstatement, the auditor can check all the delivery order for the month and check them against the sales invoices. This procedure would reveal any unrecorded revenue transaction. A balance inure can also be sent to customers to verify the balance for some particular month. 13B-3 1. As per reply of the confirmation letter the customer says that he has paid the balance on December 31, 20X5. The check of the same payment has been received on Jan 9. As the payment was already made before the year-end, so this account balance should be adjusted in the system and its value should be nil in the Financial statements of 20X5. (1) The company received returned printer at the end of the last year, so the balance of $330 should be adjusted against the sales revenue for the year ended 20x5. True balance of this account is $29,670(30,000-330). (2) True value of this account is $214,000, since by the end of the year the customer did nay pay the balance so, the whole of the amount would be included in the account receivable figure for the year ended 20x6. (3) In this case true value of this account balance is $120,000. $10,000 goods were dispatched after the year-end on January 3, 20x6 so it would be included in the revenue of 20X6. (4) Correct balance of this account is $540, because the discount allowed by the sales person was not in accordance with the terms of the contract. Although, the descant was subsequently approved by the company and afterwards it was credited. There was no such condition existing at the yearend date. (b) Probability Proportional to Size Sampling This is the method that takes the different sizes of the items within the population in selection of the audit sample. The population size is computed on the basis of population as well as risk of material misstatement. Sampling interval can be calculated as population/sample size (Foreman). The auditor is willing to accept up to 5% of the errors. On the basis of above sampling results there were only 10 exceptions were found and some of them are due to the different timings of the payment and recording. Selected sample size was 260 out of the population of 993 units. Sampling results are found to be satisfactory since the errors shown by the selected sample size are much below then the acceptable error level and there are remote chances of material mistaken because the auditor has already selected almost 19% (260 accounts from 993) of the item in sampling, which is a satisfactory figure. Appendix 14A 14A-1(a) Control Test of Control Computer matched information from vendor’s invoice with purchase order and receiving data. This control prevents the chances of wrong data being entered into the system and ensures the accuracy of the records. The computer assigns numbers to receiving reports This control ensures completeness as the reports and in sequence. Due to this it is easy to find the report in case they are missing. Checks are mailed by check signer. This control ensures that the right checks have been sent to the right people. It also assures accuracy since the signer of the check is mailing. 14A-1(B) Controls Errors controlled Computer matched information from vendor’s invoice with purchase order and receiving data. Auditor can check the effectiveness of this control by entering some fake entries in the system and see whether the computer is matching the vendor’s invoices with our chase order and receiving data. The computer assigns numbers to receiving reports Auditor can review the report in hard copies as well as in the system to ensure whether a proper number has been assigned to each receiving report. Checks are mailed by check signer. The auditor can check the details of the mails sent by the checks signers during the last month time for example. 14A-2 Internal control weaknesses and their implications As suggested by the working paper approved the purchasing manager selects vendors and he is also responsible for the purchase of the goods. There is no segregation of the duty and it is easy for the purchasing manager to make under the table deal. This weakness may result in the purchase of the required materials at the higher prices because there is no control on the authority of the purchasing manager, who has the liberty to choose any of the approved vendors. Another weakness mentioned on the working paper is that the vendor’s statements are not reconciled. This weakness may lead to create confusion regarding the vendor balances and the company may have to pay for the good that has not been taken by the company. In addition to this, vendor balance may be over or understated whack may lead to material misstatement. Audit Program for test of controls For each sample item selected for the tests of controls, following tests will be performed to ensure that all the controls are operating effectively: 1. To ensure that all the documents including purchase orders, delivery notes, vouchers and payment cherubs are signed by different personnel. Comparing the email correspondence of the employees and the signatures of the employees on above-mentioned documents could do this. 2. Check whether all the delivery notes, vouchers and purchase orders are sequentially generated by the system. This could be evidenced from the number printed on the relevant document. 3. To ensure that all the items invoiced by the vendor are included in the purchase orders. The amounts and quantity are as per the terms of purchase order. 4. To ensure that all the vouchers for payment are approved well before the payment. Comparing the dates of the voucher and the check could do this. The signatures on the vouchers could sight approval. 5. All the bank reconciliations should be checked. Ensure that at least 12 bank reconciliations are prepared on a monthly basis for one year. Establish from the identity and the signatures on the bank reconciliation that the prepared is an independent person. Works Cited Foreman, E.K. Survey Sampling Principles. New York: Marcel Dekker, 1991. Print. Alan, Trenerry. Principles of Internal Control. South Wales: niversity of new south well press Limited, 1999. Print. Read More