a) HKL is a manufacturer and distributor of printed stationery products that are sold in a wide variety of retail stores around the country. There are two divisions: Manufacturing and Distribution. A very large inventory is held in the distribution warehouse to cope with orders from retailers who expect delivery within 24 hours of placing an order.

HKLs management accountant for the Manufacturing division charges the Distribution division for all goods transferred at the standard cost of manufacture which is agreed by each division during the annual budget cycle. The Manufacturing division makes a 10% profit on the cost of production but absorbs all production variances. The goods transferred to Distribution are therefore at a known cost and physically checked by both the Manufacturing and the Distribution division staff at the time of transfer.

The customer order process for HKLs Distribution division is as follows:

i) HKLs customer service center receives orders by telephone, post, fax, email and through an online Internet ordering facility. The customer service center checks the creditworthiness of customers and bundles up orders several times each day to go to the Distribution division.

ii) All orders received by the Distribution division are input to HKLs computer system which checks stock availability and staff would then produce an invoice for the goods using another accounting system.

iii) Internet orders have been credit checked automatically and stock has been reserved as part of the order entry process carried out by the customer. Internet orders automatically result in an invoice being printed without additional input.

iv) The Distribution division uses a copy of the invoice to select goods from the warehouse, which are then assembled in the loading dock for delivery using HKLs own fleet of delivery vehicles.

v) When HKLs drivers deliver the goods to the customer, the customer signs for the receipt and the signed copy of the invoice is returned to the Distribution division and then to the account department.

vi) HKLs management accountant for the Distribution division produces monthly management reports based on the selling price of the goods less the standard cost of manufacture. The control for inventory is compared with the monthly inventory valuation report and while there are differences, these are mainly the result of write-offs of damaged or obsolete stock, which are recorded on journal entry forms by the Distribution division and sent to the account department.

Due to the size of inventory held, a physical stocktake is only taken once per annum by Distribution staff, at the end of the financial year. Besides, there is limited use of computerized system to keep track the movement of stocks; they rely on human power to check the stocks for delivery. As for this, this has always revealed some stock losses, although these have been at an acceptable level. Both internal and external auditors are present during the stocktake and check selected items of stock with the Distribution division staff. Due to the range of products held in the warehouse, the auditors rely on the Distribution division staff to identify the products held.

Identify and analyse the key weaknesses in the risk management approach that the directors of HKL should look into. Also, suggest the course of action that should be taken. Relevant examples or illustrations should be given. (13 marks)