Pharmaceutical Company, a drug manufacturer, has the following internal controls for billing and recording accounts receivable:
1. An incoming customer’s purchase order is received in the order department by a clerk who enters the information into the sales management system. The system assigns an internal sequential number to the sales order. For existing customers, once the customer number has been entered, the information system automatically retrieves the customer's name and address and credit limit. The clerk visually compares this information to the purchase order, writes the customer number and internal sales order number on the customer purchase order form, then enters the item number and quantity ordered. The clerk then initials the purchase order as entered, and stamps the date entered on the purchase order. The sales management system multiplies the number of items by the unit price and adds the extended amounts to produce the total amount of the invoice. The clerk visually compares the total invoiced with the purchase order. If Meyer’s prices are less than the customer prices, the order is processed. If Meyer’s prices are higher, the clerk sets the order status as “Pending” and takes the purchase order to the sales department for follow-up. The clerk will release the order from the “Pending” status to credit check only when one of the sales supervisors has approved the order. For large differences (greater than $500), the customer is requested to initiate a revised purchase order.
2. The sales management system compares the sum of the new customer order plus existing accounts receivable for the customer with the credit limit for the customer. If the amount is less than the credit limit, then the order is accepted. If the amount exceeds the credit limit, a warning is displayed on the screen, and the order is not accepted but is given the status of “Pending.” All pending orders are listed on a report and printed daily for review by the credit department. Approval is granted only if credit limits are increased and authorized by the credit manager on a credit limit change form, after appropriate investigation.
3. The sales management system compares ordered amounts with inventory, and if items are in stock, prints a three-part sales order shipping document and bill of lading, which is sent to the shipping department. After the order has been shipped, two copies of the shipping document are given to the accounting department. The third copy of the sales order and bill of lading are sent with the goods to the customer.
4. An accounts receivable clerk retrieves the sales order using the sales order number, enters the quantities shipped, and generates the invoice. One copy of the shipping document goes with the invoice to the customer, and another copy is stapled to the company copy of the invoice and filed numerically. The sales order number is listed on the invoice.
5. Sales are recorded online, that is, as each invoice is prepared, it is posted against the customer master file. Each day, a daily sales journal is printed. The sales and accounts receivable posting is recorded by automatic journal entry at the end of each day, after the daily sales journal is printed. The journal entry is printed at the bottom of the daily sales journal.
REQUIRED
a. Flowchart the billing function as a means of understanding the system.
b. Identify the potential risks of misstatement (error or fraud) that could occur at Meyer’s.
c. For each risk identified in part (b), identify internal controls present at Meyer’s that could prevent or detect the potential misstatement. State the audit objectives associated with each internal control.
d. Have all of the transaction-related audit objectives for sales been covered in part (c)? If not, list internal controls over sales for the remaining transaction-related audit objectives.
e. For each of the internal controls in parts (c) and (d), list control to verify the effectiveness of control.
f. For each transaction-related audit objective for sales, list a useful test of the appropriate substantive tests, considering internal controls.