Evaluation and testing of controls at Hales Ltd

Tyrone has provided a narrative of controls over inventory at Hales Ltd and would like you to provide some advice on making the preliminary control risk assessment. Hales is a distributor of haircare products, including shampoos, conditioners and styling products throughout Australia. Hales uses an on-line ordering system. Hales does not manufacture any goods in house, instead, an inventory of raw materials is kept, with manufacturing being outsourced to other companies. Hales has around 35 suppliers and 15 manufacturers. These companies have proven to be reliable in the past. Tyrone has made the following notes about three particular elements of the inventory system.

Purchase of raw materials

Purchase orders are generated by the computer when the inventory level of a particular material falls below 75% of what was used in the previous month. Purchase orders include the date, the suppliers name and the raw material required. Three copies of the purchase order are created. The first copy goes to the warehouse where it is used to enable the following up of overdue orders. The second copy is filed by the accounts clerk by order of date and the third copy goes to the supplier. Upon receipt of materials, barcodes on the delivery packages are scanned into the computer system. A two part receiving report is then generated. The first part is matched to the purchase order by the warehouse manager. The second is sent to the accounts clerk who files it. If the scanning of barcodes does not match data on the master file then the process is stopped.

Procedures for finished goods

When finished goods fall below 65% of the previous months sales, production orders are triggered. Production orders include a date, the manufacturers name, the raw materials needed and the volume of finished goods required. Two copies of the production order are generated. The first copy is sent to the raw materials warehouse where it is used as a picking slip by the warehouse staff. It is then included with materials which are sent to the manufacturer. The second copy is filed by the production manager by order of date. When finished goods arrive at Hales, barcodes on the delivery packets are scanned. A two part receiving report is generated, with the first copy being matched to the production order by the production manager and the second copy being filed by the accounts clerk. As with materials purchases, if the scanning of barcodes does not match the codes on the master file then the process is stopped.

Changes to the master file

The inventory master file contains information on the volumes of inventory on hand including barcode information and locations within the warehouse. The master file also has details of approved suppliers and manufacturers. Orders can only be made to suppliers and manufacturers on the master file. Changes to the master file can be made by the production manager. This applies to both raw materials and finished goods. To make changes the production manager completes an amendment form which is then kept as a record of any changes made.

Other information

There are separate warehouses, staff and procedures in place for the raw materials and finished goods. The selection of suppliers of raw materials and manufacturers is done automatically by the computer based on the latest price as per the last invoice and delivery time. Password access to the computer permits the following:

• Raw materials store staff have access to purchase order printing and goods received notes printing for materials.
• Finished goods store staff have access to goods received notes printing for finished goods.
• The production manager has access to production order printing and master file changes.
• The acounts clerk has access to master file changes.

Substantive testing at Sooty Ltd

Lastly, Tyrone brings up the audit of Sooty Ltd. Sooty manufactures machine parts which are used for servicing heavy equipment in the mining industry throughout Australia. Tyrone informs you that during the planning stage of the audit of Sooty, it was found that one of Sooty's key suppliers had gone into administration which had led to major shortages of key materials. In order to circumvent this problem, Sooty secured the supply of materials through an alternative supplier, however Tyrone notes that the alternative supplier is new to the market and that some of Sooty's production staff have been complaining that the materials are of inferior quality. Tyrone says that Sooty has also suffered from cash flow problems recently as one of their debtors, Brown Ltd, has also been experiencing financial problems, taking up to 4 months to pay amounts which are normally due within 30 days. Tyrone notes that Brown makes up 35% of Sooty's sales and that management wish to maintain a good relationship with Brown. The resulting cash flow implications has meant that Sooty has been drawing on its lines of credit, which has subsequently caused it to temporarily violate the terms of its contract with its bank, ASBC, which requires Sooty to maintain a current ratio of 2:1.

Question 1

The business risk impactandthe accounts (as well as the related assertions) most likely affected by the strategic decisions made bySimo Ltd .

Question 2

Whether Tyrone's testing has obtained sufficient appropriate evidence for the relevant assertions (where appropriate) pertaining toPerkins Ltd.

Question 3

• Emms Ltd'sgoing concern, with reference to the ratios and the other information provided.
• Other audit techniques Tyrone can use to indicate whetherEmms Ltdhas a going concern problem.

Question 4

In relation to Hales Ltd:

• The weaknesses in the internal controls for each of the three aspects of the inventory system identified (raw materials, finished goods and changes to the master file).
• An assessment of the implications of each of the weaknesses you have identified.
• Three tests of control JDM's IT audit division could perform to assist Tyrone with verifying the effectiveness of the internal controls (assuming that JDM will be performing tests of control).
• Two Computer Assisted Audit Techniques (CAATs) that Tyrone could request the IT auditors run to assist him in testing the valuation of inventory.

Question 5

In regards to Sooty Ltd:

• Two key account balances at risk of material misstatement.
• For each account balance, the key assertion at risk.
• A justification as to why the account balances and assertions are at risk.
• An outline of one (1) substantive test of detail that Tyrone could undertake for each account to address the assertion and risk identified.