MyPet - Weaknesses in the Internal Controls Described, Computer Assisted Audit Techniques in Inventory Valuation - Case Study Example

Name: Tutor: Course: Date: CASE STUDY a. Weaknesses in the internal controls described From the internal control system described in the MyPet case the computer selects the supplier of both finished goods and raw materials based on the delivery time and the latest price from the recent invoice. This is a weakness of this system because the quality and reliability of the material or finished goods cannot be authenticated. The goods or the materials may have a fair price and have a short delivery time but it may not be the right material or goods needed by the company in terms of quality. Consequently the system can be compromised by unscrupulous workers when poor quality materials or goods are purchased at fair prices. Lead time and prices cannot be the only criteria for selecting finished goods or raw materials to be purchased. Substandard goods can be purchased. There is also a possibility that there can be multiple orders generated when the prices and delivery times of the suppliers match each other. There is need for further differentiation and a unique criterion of picking out the best supplier. There is no internal control system, regardless of how comprehensive and detailed it may be, it can on itself guarantee efficient administration and accurate and complete records, or come out as fool proof against fraud. This is challenging when those engaged hold position of authority or trust. MyPet inventory system has authorization codes or password assigned to different people like the stores staff, production controller, and the account clerk. It is possible that without an internal monitoring system, the various authorities like in the production and the account clerk can share information in order to unscrupulously have the purchase budget inflated for personal gains. Moreover, the account clerk is in charge of the Masterfile amendments and he could doctor information in order to steal from the company. This system, therefore, relies largely on the faithfulness and honesty of the people in charge of the authorization codes. The authorization controls tend to be misused by the person in charge and the top management has to be very vigilant in order to avoid rampant cases of fraud. The people in charge have to be respected persons with untainted profiles. Possibility of collusion in order to defraud the company cannot be wished away. The management has to be alive to the fact that such an incident cannot happen at MyPet Company. Financial statements are prepared from this data and there is high possibility some people in management position will want to use junior officers in charge to manipulate the data to their own personal advantage and at the expanse of the company and its stakeholders. The internal control system has been designed by human being and it cannot be free from errors in design, misjudgment or distraction, fatigue, carelessness, misunderstanding, and interpretation. Whereas the integrity and competence of the personnel operating and designing the system may be directed by training and selection, the qualities can be influenced by pressure from other agencies within the organization. Human factor is subject to error regardless of the competency or integrity of the personnel involved. Separate systems are maintained at MyPet in terms of warehouses and staff for both finished goods and raw materials. Purchase orders are generated automatically when the stock of any material goes below 70% of the previous month’s usage. On the other hand orders are generated automatically when finished goods fall below 60% as compared to the previous month’s sales. From this description there is a high possibility of there being an overstock or an under stock. The raw materials will automatically be turned into finished goods. The finished goods system may have warned of an under-stock but immediately after the order is delivered there are more goods produced as finished goods. There is no account for work-in-progress and how far is it from turning into finished goods. The parallel systems of the raw materials and finished goods can bring confusion, which may either lead to needs for creation of more warehouses or under-utilization of the existing ones. There should be a way of synchronization that will send signals when there is a possibility of overstocking or under-stocking. The cost of maintaining the inventory control system at MyPet may exceed the benefits drawn from the same system making the management to reduce the budget of the system. Any system has to be cost effective and some managers will compromise internal control systems where they require huge budgets to maintain them. Conflict of interest may arise when the person in charge of a certain section is required to prepare a report that is reliably used to make important decisions in the business. b. Two tests for controls for the inventory systems Test controls for inventory systems are not an end in themselves and they need validation to make sure that the objective of their creation is obtained. Testing for controls for inventory system is important for ensuring that they are reliable and the data provided is accurate and useful to the company. Therefore, the first test to be performed by the IT audit team should be to evaluate internal control exposure to risks, such as misuse of resources, falling short of the objectives of the program, and noncompliance with regulations, laws and policies of management. Secondly, the IT audit team should assess the effectiveness of internal control. This is essential since the correlation between internal control effectiveness and risk exposure determines the extent of evaluation/audit tests. c. Computer Assisted Audit Techniques (CAATs) in inventory valuation Computer assisted audit systems (CAATs) are used to analyze huge volumes of data and point out anomalies. Is easier to obtain data files and spot any unlatching files using the codes given. Large amounts of data can be analyzed within the shortest time possible. Any irregularities in the data provided can be spotted and rectified as early as possible. Integrity of data is very important in business and auditors make decision using data that is held in the information system. The two Computer Assisted Audit Techniques that IT auditors can use in testing valuation of inventory are Test data and online audit monitor. Online audit monitor This technique offers continuous audit by integration of audit program code into transactional application of the client. Its objective is monitoring transactions and making extractions if certain criterion has been set. Transactions can be sorted into high risk transactions, unusual transactions, or specific transactions. It is believed that new lines of program code need to be added into computer program of the client that enables the shift of control from customer’s program to audit code so as to offer integration of audit program code into accounting system. If a transaction meets the predefined criterion, normally embedded audit is activated and two possible procedures performed: transaction tagging and audit log creation (Dejan 11). Online audit technique is quite advantageous. It can be practiced with systems that process transactions immediately without interrupting the processing routines of the client. Therefore, with the use of this technique, any anomaly in the codes provided in MyPet inventory system can be easily spotted. Test Data This technique is based on the creation of input data by the auditor that has to be processed by the application of the client. Test data is composed of incorrect and correct data. If incorrect data is keyed into the system there is always a rejection. The outcomes of the input procedure are then compared with the anticipated behavior of the application in order to determine if the input controls are functioning (Dejan 10). In order to effectively employ the test data technique, the application of the technique should be undertaken by unexpected visit and copying of customer’s programs for future inspection. d. Tests on data produced by CAAT before being reliant After the IT auditors ran a CAAT on inventory data found in the accounts MyPet management, it is important for specific tests to be carried out to ensure that the data is reliable. Before the data is used in analytical procedures it has to be verified through authentic tests. The tests that can be used for verification is the tests of controls and substantive tests. Audit tests, such as tests of controls and substantive tests, are carried out on a sample basis on an existing set of transactions that are similar. The sampling methods can be non-statistical or statistical. Tests of controls are usually performed when the evaluation of material misstatement’s risk at the assertion level incorporates an anticipation that controls are effectively working. This therefore implies that tests of controls are usually performed if a system exists and if the system has controls. It is important to note that tests of controls are usually performed so as to determine whether the controls within the systems are really working effectively. This assists in determining if the controls can be relied upon (Chow 1). Substantive tests or procedure are tests developed to determine irregularities or errors that directly affect the data’s correctness. They are usually performed so as to detect misstatement of the material at the assertion level. Therefore, performing substantive tests is very essential since the tests assist in determining if dollar misstatements have really occurred (Chow, 2). Work cited Dejan Jeksic, Implementation of computer Assisted Audit Techniques in Application Controls Testing, Management of Information System, Vol. 4 (2009), 1, pp.009-012. Chow David, 2009, Analytical Procedures –A Powerful Tool for Auditors, < http://www.hkiaat.org/images/uploads/articles/Analytical.pdf> Read More