Auditing - Cotton Company - Case Study Example

Auditing: The Cotton Company Case Introduction Efficient internal controls in the Sales and Cash receipts are extremely important in any organization. It is through efficient internal control that an organization’s performance is enhanced because; internal control ensures order, direction and consistency. Sales and Cash Receipts represent a vital area in business, since it is associated with an organization’s revenue, which determines profitability. With this in mind, this report provides a summary of the existing controls in Sales and Cash Receipts in the Cotton Company, as analyzed by the internal audit department. The analysis includes identification and discussion of the controls for the Sales. In addition, the analysis identifies the controls for the Cash Receipts, which are also discussed in detail. The report identifies and discusses some of the possible deficiencies in the internal controls for Sales in the Cotton Company. In this report, some of the possible deficiencies in the internal controls for Cash Receipts are identified and discussed. The report also provides valid recommendations as to how the deficiencies identified in the internal controls for Sales and Cash Receipts can be rectified. These recommendations are expected to be of great significance to the internal audit department and the Cotton Company at large. The Cotton Company is expected to apply the recommendations in achieving its performance and profitability targets. It is also anticipated that the recommendations provided in this report will help the Cotton Company to prevent loss of resources, through fraudulent activities in the Sales and Cash Receipts department. Existing Controls for the Sales There are various controls for the sales in the Cotton Company. For instance, the pre-numbering of sales slips to ensure that a sales slip is not used and plucked off is an effective control for the company’s sales. When the slips are numbered, Sales-clerks cannot use them to record a sale, take cash for themselves and then pluck off the leaves to hide any recordings on the sale. Secondly, the sales slips come in three copies, all of which are colored differently. This means that a sales-clerk has to record all the three slips so that copies can be given to other personnel, while one copy can be retained for evidence of the transaction and future reference (Gomez, 2012). Therefore, Sales-clerks have to collaborate with the cashier such that copies of sales slips are shared between the cashier and the Sales-clerks. Another control on the sales in that the company’s store maintains a central cash register, which is under the authority of the store manager. Another control is the requirement that a cash sale should involve payment to the sales-clerk, and marking of the three copies of sales slips by the sales-clerk, in order to ensure that the money is then taken to the supervisor. Sales-clerks should not keep the money (Arens, Best, Shailer, & Fiedler, 2013). In addition, the store’s supervisor has the authority to countercheck the clerk’s calculations and then compare the sales tag figures of the sold clothing with the description on the invoice. Credit sales are not approved by Sales-clerks, but rather by the supervisor who qualifies for credit from the approved credit list. It is only the supervisor who compares the figures recorded in the sales-clerks’ sales books and the figures recorded in the cash register. The store’s selling procedure involves entry of all sales, either in cash or credit, by the supervisor in his cash register. Also, the copy of the invoice that is given to the customer has to be validated by the cash register (Hall, 2012). In addition, approval of larger credit sales that exceed $500 has to be done by Diab himself. Finally, the cashier and the sales-clerks are not allowed to receive or handle any cash from sales (Arens, Best, Shailer, & Fiedler, 2013). Existing Controls for the Cash Receipts The Cotton Company has various controls as far as cash receipts are concerned. For instance, it is only Diab or the supervisor who deposits the cash received through sales. By only allowing Diab or the supervisor to deposit the cash that is received from sales, the risk of misappropriation of cash receipts is eliminated (Long, 2009). This is further reinforced by the issue of Diab or the supervisor having to give all the deposit slips to the accounts receivable clerk. If both the supervisor and Diab were to be responsible for the keeping of the deposit slips, chances of fraud could be created. In addition to this, the copies of sales slips that Sales-clerks give to the cashier have to be given to the accounts receivables clerk for reconciliation, while he also receives a summary of the day’s receipts. This means that; only the accounts receivables clerk is in-charge of all the cash receipts. He is also the only employee who is responsible for entry of the sales invoice information into the firm’s computer, after reviewing the sales books and the cash register tape. To ensure that cash receipts are handled by authorized people, in order to avoid confusion, it is only the supervisor who receives all payments from Diab’s secretary, and adds it to the cash register for later deposit. This total is given to the accounts receivables clerk for recording of receipts and updating once again on the computer. The Cotton Company’s store further requires that the accounts receivables clerk has to compare deposit slips received from the bank against the cash receipts journal. To avoid misappropriations, it is only Diab who controls any write offs, and controls information pertaining to such issues. Possible Deficiencies in the Internal Controls for the Sales and Cash Receipts The following are some deficiencies are possible in the internal controls for the sales and cash receipts of the Cotton Company: The Sales-clerks are still allowed to pack the clothes for clients. This creates a loophole in that a sales-clerk may agree with clients to pack clothes of higher value or superior quality for them than what is recorded on the slips so that clients will give some cash to the Sales-clerks later. With these arrangements, the Sales-clerks can fraud the Cotton Company, if they decided to do so. Only the accounts receivables clerk is solely in charge of reconciling all the differences from the sales-clerk figures, credit sales and total sales figures. This is a deficiency because, the accounts receivables clerk may decide to inflate uncollectible debts and fraud the company. The accounts receivables clerk has online access to the firm’s bank account. This subjects the controls for the sales and cash receipts of the Cotton Company to deficiency (Whittington & Delaney, 2012). This is because, there are so many transactions that take place within a period of one month, such that even if the accounts receivables clerk paid ghost creditors or inflated amounts from the firm’s bank account, it would be difficult to make a follow up. The responsibility of preparation of monthly bank reconciliations and reconciliation of the accounts receivables trial balances is left to one employee only- the accounts receivables clerk. The accounts receivables clerk may fabricate figures, since he is the sole employee who is in charge of preparing monthly bank reconciliations and reconciliation of the accounts receivables trial balances. Recommendations on how to reduce Deficiencies in the Internal Controls This report provides the following recommendations to rectify the aforementioned deficiencies in the internal controls for the sales and cash receipts of the Cotton Company; Sales-clerks should not be allowed to pack the clothes for clients. Instead, only the supervisor or another employee under the direction of the supervisor should be allowed to do this work. This will reduce chances of clients and Sales-clerks collaborating to fraud the Cotton Company. The accounts receivables clerk should be given the responsibility of counterchecking and approving the reconciliations made on the differences from the sales-clerk figures, credit sales and total sales figures by another employee, probably his assistant. This will reduce chances of fraud, since two employees will be responsible for this sensitive task. Online payments through the firm’s bank account should be made in the presence of Diab so that he can verify that the amounts remitted are those agreed upon, monthly. To prevent the accounts receivables clerk from fabricating figures, he should not be solely in-charge of preparing monthly bank reconciliations and reconciliation of the accounts receivables trial balances, but should be assisted by his assistant so that he verifies and approves his assistant’s figures. It is imperative to note that efficient internal control helps a company to achieve its goals and avoid pitfalls (Pickett, 2013). For instance, the central operation of the Cotton Company’s store should have only one dispatch or sales outlet. The store should use an integrated computer system, which has terminal access of all functions. A hard copy output is given out whenever necessary. Only the supervisor and the manager should be the managers of the computer system. Corrections should be counter-checked by both the sales-clerk and the supervisor, but only approved by the supervisor and not the sales-clerk. Conclusion It has been established that an efficient control system is beneficial to any organization because it ensures order, direction and consistency. Particularly, an organization with efficient internal control achieves its performance and profitability targets (Tarantino, 2008; Naciri, 2013). Some of the controls for the sales and cash receipts in the Cotton Company include the use of different colored, three-copy sales slips that are pre-numbered. The company should also have a central cash register, with central authority. In addition, the company’s credit sales should be approved by the supervisor and not the sales-clerks. Cash is deposited by either Diab or the supervisor for the Cotton Company. The accounts receivables clerk has the sole responsibility of entry of the sales invoice information into the firm’s computer. Credit sales that exceed $500 are only approved by Diab himself, while the cashier is not allowed to receive or handle any cash from sales. However, some deficiencies are possible in the internal controls for sales and cash receipts. These include the authority given to the accounts receivables clerk to access the firm’s bank account online. He is also solely in charge of reconciling all the differences from the sales-clerk figures, credit sales and total sales figures. Additionally, the Sales-clerks are allowed toa pack the clothes for clients. To rectify these deficiencies online to the bank account of the Cotton Company should be limited, while the role of packing clothes for clients should not be for the Sales-clerks. However, each sales-clerk should be allowed to make independent sales. When each of the sales-clerks is allowed to make his or her valid sales records, sales can be calculated per sales-clerk to determine their reasonableness (Whittington, 2013). It is imperative that credit approval is done by an employee with authority because it is vital (Trenerry, 1998). References Arens, A. A., Best, P., Shailer, G., & Fiedler, B. (2013). Auditing, Assurance Services and Ethics in Australia. Frenchs Forest: Pearson Higher Education Australia Press. Gomez, C. (2012). Auditing and Assurance: Theory and Practice. New Delhi: PHI Learning Press. Hall, J. (2012). Accounting Information Systems. Mason: Cengage Learning Press. Long, M. L. (2009). Internal Controls for Small Businesses to Reduce the Risk of Fraud. Retrieved from http://longforsuccess.com/wordpress/wp-content/uploads/2010/09/Good-Internal-Controls.pdf Naciri, A. (2013). Internal and External Aspects of Corporate Governance. Abingdon: Routledge Publications. Pickett, K. H. (2013). The Internal Auditing Handbook. Hoboken: Wiley Press. Tarantino, A. (2008). Governance, Risk, and Compliance Handbook: Technology, Finance, Environmental, and International Guidance and Best Practices. Hoboken: John Wiley & Sons Press. Trenerry, A. (1998). Principles of Internal Control. Sydney: UNSW Press. Whittington, R. (2013). Wiley CPA Examination Review 2014. Auditing and Attestation. Hoboken: John Wiley & Sons Press. Whittington, R., & Delaney, P. R. (2012). Wiley CPA Exam Review 2012, Auditing and Attestation. Hoboken: John Wiley & Sons Press. Read More