ASSIGNMENT ON [INTERNAL CONTROL]

CASE 01:

PriceRight Electronics (PEI) is a small wholesale discount supplier of electronic instruments and parts. PEIs competitive advantage is its deep-discount, 3-day delivery guarantee, which allows retailers to order materials often to minimize in-store inventories. PEI processes its records with stand-alone, incompatible computer systems except for integrated enterprise resource planning (ERP) inventory and accounts receivable modules. PEI decided to finish integrating its operations with more ERP modules, but because of cash flow considerations, this needs to be accomplished on a step-by-step basis.

It was decided that the next function to be integrated should be sales order processing to enhance quick response to customer needs. PEI implemented and modified a commercially available software package to meet PEIs operations. In an effort to reduce the number of slow paying or delinquent customers, PEI installed web-based software that links to the website of a commercial credit rating agency to check customer credit at the time of purchase. The following are the new sales order processing system modules:

Sales. Sales orders are received by telephone, fax, e-mail, website entry, or standard mail. They are entered into the sales order system by the Sales department. If the order does not cause a customer to exceed his credit limit, the system generates multiple copies of the sales order.

Credit. When orders are received from new customers, the system automatically accesses the credit rating website and suggests an initial credit limit. On a daily basis, the credit manager reviews new customer applications for creditworthiness, reviews the suggested credit limits, and accepts or changes the credit limits in the customer database. On a monthly basis, the credit manager reviews the accountsreceivable aging report to identify slow-paying or delinquent accounts for potential revisions to or discontinuance of credit. As needed, the credit manager issues credit memos for merchandise returns based on requests from customers and forwards copies of the credit memos to Accounting for appropriate account receivable handling.

Warehousing. Warehouse personnel update the inventory master file for inventory purchases and sales, confirm availability of materials to fill sales orders, and establish back orders for sales orders that cannot be completed from stock on hand. Warehouse personnel gather and forward inventory to Shipping and Receiving along with the corresponding sales orders. They also update the inventory master file formerchandise returned to Receiving.

Shipping and receiving. Shipping and Receiving accepts inventory and sales orders from Warehousing, packs and ships the orders with a copy of the sales order as a packing slip, and forwards a copy of the sales order to Billing. Customer inventory returns are unpacked, sorted, inspected, and sent to Warehousing.

Accounting. Billing prices all sales orders received, which is done approximately 5 days after

the order ships. To spread the work effort throughout the month, customers are placed in one of six 30-day billing cycles. Monthly statements, prepared by Billing, are sent to customers during the cycle billing period. Outstanding carry-forward balances reported by Accounts Receivable and credit memos prepared by the credit manager are included on the monthly statement. Billing also prepares electronic sales and credit memos for each cycle. Electronic copies of invoices and credit memos are forwarded to Accounts Receivable for entry into the accounts receivable master file by customer account. An aging report is prepared at the end of each month and forwarded to the credit manager. The general accounting office staff access the accounts receivable master file that reflects total charges and credits processed through the accounts receivable system for each cycle. General accounting runs a query to compare this information to the electronicsales and credit memo and posts the changes to the general ledger master file.

REQUIREMENTS:

a. Identify the internal control strengths in PEIs system.

b. Identify the internal control weaknesses in PEIs system, and suggest ways to correct them.

CASE 2:

Consider the following two situations:

1. Many employees of a firm that manufactures small tools pocket some of the tools for their personal use. Because the quantities taken by any one employee are immaterial, the individual employees do not consider the act as fraudulent or detrimental to the company. The company is now large enough to hire an internal auditor. One of the first things she did was to compare the gross profit rates for industrial tools to the gross profit for personal tools. Noting a significant difference, she investigated and uncovered the employee theft.

2. A manufacturing firms controller created a fake subsidiary. He then ordered goods from the firms suppliers, told them to ship the goods to a warehouse he rented, and approved the vendor invoices for payment when they arrived. The controller later sold the diverted inventory items, and the proceeds were deposited to the controllers personal bank account. Auditors suspected something was wrong when they could not find any entries regarding this fake subsidiary office in the property, plant, and equipment ledgers or a title or lease for the office in the realestate records.

REQUIREMENTS:

For the situations presented, describe the recommendations the internal auditors should make to prevent similar problems in the future.