Question

Adam is an auditor of Excellent & Partners for Colourful Facemasks Sdn Bhd. The

company has just appointed Excellent & Partners as its auditor for the current year.

Adam is in charge of auditing the sales and collection cycle for the company which is

a small facemask distributor in Peninsular Malaysia.

(Background)

(The company has been growing rapidly and is respected for its high quality

facemasks products. Adam found that the client has made some misstatements in

previous year audit which were not corrected. These misstatements relate to

recordings of sales invoices, cash receipts and subsidiary accounts receivable

ledgers.)

The company is also slow at improving its identified internal control

weaknesses in previous year audit. Adam discovers the followings:

-Starting this year, the client changes the recognition policy of revenue due to

changes in method of selling inventories as a result of Movement Control

Order, imposed by the government to overcome Covid-19 pandemic

-The company receives online orders from customers together with 90% to

100% payments and it immediately recognizes them as sales revenue. The

management claims that all of the company’s facemasks are essential items

especially in current pandemic situation. Thus, it is very unlikely that the

orders are canceled by customers.)

-The company’s factory has been working 24/7 to fulfill the customers’ orders,

as the company promises delivery of goods within 3 weeks’ time. Adam found

that there is only 1% backlog of orders (out of total orders received)

throughout the current year.

-The inventories are shipped to customers once they are ready. A copy of the

shipping document is filed with the sales invoice and sales order, but there is

no thorough review done on the documents by supervisors.)

-The company employs two staffs, one is handling the customer orders and

the shipping of inventories and the other staff is handling the issuing of sales

invoices, receipt of cash from customers, and updates of general and

subsidiary ledgers of accounts receivable

(In previous years, the response from clients of Colourful Facemasks to confirmation

requests has been frustrating at best. The response rate has been extremely low,

and those who did respond did not know the purpose of the confirmations or their

correct outstanding balance. Excellent & Partners have had the same experience in

confirming receivables with other similar organisations.)

Required:

1.Identify the four (4) internal control weaknesses in sales, cash receipts, and

trade receivables items, affecting audit risk of Colourful Facemasks Sdn Bhd.)

2. For each of the internal control weaknesses in (ii) suggest the improvement

that can be implemented by Colourful Facemasks Sdn Bhd.)

3.Based on the identified internal control weaknesses, state three (3) important

audit objectives in the above case.)

4.Describe four (4) audit procedures except external confirmations (two (2) for

each test of control and substantive tests) for sales, cash receipts, and

trade receivables items that must be performed by the auditor

5. Since the response rate for external confirmations of accounts receivable

balance is extremely low, in what ways that the external confirmations can be

improved before Adam chooses other audit procedures?

Answer 1

A) Internal weakness include:-

1) Change in revenue recognition to cash method may overstate revenues.

2) Incomplete review of shipping documents may result in incorrect shipments.

3) Receipt of cash and updating the GL being maintained by the same employee gives scope for fraud.

4) No review of sales orders and fulfilment by a second person/team gives rise to fraud opportunities.

B) The changes can include:-

1) Change the method of accounting to Accrual method and recognize revenue when goods are shipped.

2) The activities need to be segregated between the different teams so as to ensure that a single person does a single activity/or activities that are not complementary.