C12 1 (LO 1, 3, 4, 6, 7) Understanding internal control, fraud risk assessment, and substantive tests Analysis and evaluation Evaluate the effectiveness of the CIRI's control environment You may evaluate each individual component of the control environment but then develop an overall conclusion regarding the control environment and its influence on other aspects of internal control Analysis and evaluation Using the table below, evaluate the factors associated with the risk of fraud and the effectiveness of control activities with respect to the occurrence assertion for purchases and payables associated with the EDI purchasing system Analysis Identify internal control deficiencies that you find in the EDI purchasing system Fraud Risk Factors Assertion Incentives Pressures Opportunity Attitude and Rationalization Control Activities Possible Misstatements Occurrence purchases and payables Evaluation Prepare a letter with the two most important internal control recommendations that you have for management Each specific recommendation should describe the current system, explain the risk involved, and make specific recommendations for improvement Focus on issues raised by the new system and not on issues that have been raised in prior audits Phase II Substantive Testing When obtaining an understanding of the accounting system, you looked at the file containing the exception reports reviewed by Dennis Brewer (e g , for items billed but not received) While these reports are printed daily, often only three or four reports would be present for a given week Dennis said that he really pays attention to the reports primarily on Wednesday and Thursday and that he often does not keep the reports from earlier in the week Subsequently, you pulled a sample of 30 transactions from the EDI system to perform substantive tests of transactions and test the accuracy of recorded transactions that are processed through the system Of the 30 transactions selected at random, 19 represented transactions shipped directly to stores, and 11 represented drop shipments The following table summarizes the nature of this sample of 30 $ BV of Popn of Transactions Sample Size $ BV of Sample Drop shipments $ 5,756,077 1,391 11 $ 80,530 Shipped to stores 10,615,018 1,737 19 188,455 Purchases through the EDI system $ 16,371,095 3,128 30 $ 268,985 You noted the following issues among the 30 transactions You find one item that shipped directly to the stores with an invoice total of $9,775, for which the price on the invoice per the purchase order was $67 per unit but was billed at $76 per unit The company purchased 100 units of the SKU number on that invoice and paid the invoice in full as billed The company was closed from Thursday, June 30, 2022, through Monday, July 4, 2022 Inventory was taken on Thursday, June 30, 2022 During the inventory count, a truck came in with a shipment from CWS The value of the invoice was $9,875 The units were segregated from the rest of the inventory and not counted At the end of the inventory, the shipment was added to the overall value of the inventory During the closing of the books after July 4, the purchase was recorded as an account payable in the amount of $9,875 with a date of June 30, 2022 Auditing drop shipments has been a problem in past audits, as CIRI has not always had receiving documents to support deliveries to construction sites However, your firm has been able to verify that shipments had been billed to customers and subsequently cash was received associated with these deliveries In the current year, not only did you verify that the item was supported by electronic receiving reports, but you also followed up to find that they were billed to customers who paid for the goods All 11 of the electronic invoices from CWS for drop shipments included in the sample were supported by electronic receiving reports and they were paid in the correct amounts and on time However, Dennis could not show where one transaction with an invoice amount of $4,323 had been billed to, and had been paid by, customers He suggested two possibilities First, he suggested that some customers had prepaid for the shipments Second, he complained that he often had to follow up with the stores about filing receiving reports because someone at the store level failed to file a shipping report However, his primary responsibility was only for the purchasing system, not the billing system and ensuring that vendors were paid on time He could not verify what caused the problem with this transaction Further follow up failed to identify the underlying sales invoice for this transaction

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C12.1 (LO 1, 3, 4, 6, 7) Understanding internal control, fraud risk assessment, and substantive tests Analysis and evaluation: Evaluate the effectiveness of the CIRI's

C12.1 (LO 1, 3, 4, 6, 7) Understanding internal control, fraud risk assessment, and substantive tests

Analysis and evaluation: Evaluate the effectiveness of the CIRI's control environment. You may evaluate each individual component of the control environment but then develop an overall conclusion regarding the control environment and its influence on other aspects of internal control.

Analysis and evaluation: Using the table below, evaluate the factors associated with the risk of fraud and the effectiveness of control activities with respect to the occurrence assertion for purchases and payables associated with the EDI purchasing system.

Analysis: Identify internal control deficiencies that you find in the EDI purchasing system.

	Fraud Risk Factors
Assertion	Incentives/ Pressures	Opportunity	Attitude and Rationalization	Control Activities	Possible Misstatements
Occurrence purchases and payables

Evaluation: Prepare a letter with the two most important internal control recommendations that you have for management. Each specific recommendation should describe the current system, explain the risk involved, and make specific recommendations for improvement. Focus on issues raised by the new system and not on issues that have been raised in prior audits.

Phase II: Substantive Testing

When obtaining an understanding of the accounting system, you looked at the file containing the exception reports reviewed by Dennis Brewer (e.g., for items billed but not received). While these reports are printed daily, often only three or four reports would be present for a given week. Dennis said that he really pays attention to the reports primarily on Wednesday and Thursday and that he often does not keep the reports from earlier in the week.

Subsequently, you pulled a sample of 30 transactions from the EDI system to perform substantive tests of transactions and test the accuracy of recorded transactions that are processed through the system. Of the 30 transactions selected at random, 19 represented transactions shipped directly to stores, and 11 represented drop shipments. The following table summarizes the nature of this sample of 30.

	$ BV of Popn.	# of Transactions	Sample Size	$ BV of Sample
Drop shipments	$ 5,756,077	1,391	11	$ 80,530
Shipped to stores	10,615,018	1,737	19	188,455
Purchases through the EDI system	$ 16,371,095	3,128	30	$ 268,985

You noted the following issues among the 30 transactions.

You find one item that shipped directly to the stores with an invoice total of $9,775, for which the price on the invoice per the purchase order was $67 per unit but was billed at $76 per unit. The company purchased 100 units of the SKU number on that invoice and paid the invoice in full as billed.
The company was closed from Thursday, June 30, 2022, through Monday, July 4, 2022. Inventory was taken on Thursday, June 30, 2022. During the inventory count, a truck came in with a shipment from CWS. The value of the invoice was $9,875. The units were segregated from the rest of the inventory and not counted. At the end of the inventory, the shipment was added to the overall value of the inventory. During the closing of the books after July 4, the purchase was recorded as an account payable in the amount of $9,875 with a date of June 30, 2022.
Auditing drop shipments has been a problem in past audits, as CIRI has not always had receiving documents to support deliveries to construction sites. However, your firm has been able to verify that shipments had been billed to customers and subsequently cash was received associated with these deliveries. In the current year, not only did you verify that the item was supported by electronic receiving reports, but you also followed up to find that they were billed to customers who paid for the goods. All 11 of the electronic invoices from CWS for drop shipments included in the sample were supported by electronic receiving reports and they were paid in the correct amounts and on time. However, Dennis could not show where one transaction with an invoice amount of $4,323 had been billed to, and had been paid by, customers. He suggested two possibilities. First, he suggested that some customers had prepaid for the shipments. Second, he complained that he often had to follow up with the stores about filing receiving reports because someone at the store level failed to file a shipping report. However, his primary responsibility was only for the purchasing system, not the billing system and ensuring that vendors were paid on time. He could not verify what caused the problem with this transaction. Further follow-up failed to identify the underlying sales invoice for this transaction.