Ex. 11.4 Assessing Control Risks

Quality Furniture Ltd revealed the following through the enquiries and observations associated with understanding internal controls. The managing director Michael Jones has always placed a premium on the values of integrity and ethics.

For years, business has been conducted on a handshake, and commitments made by the company were always honoured. Integrity and ethics are also valued in employees, and this quality has been evidenced in any employee who has been with the company for more than a year or two. In recent years, as the company has directed resources to a new product line, and company revenues have grown, the company has actively sought out competent employees to fill out the management team by bringing in a new chief operating officer and a new chief financial officer (CFO).

Many accounting and information systems issues have been delegated to the CFO, Roma White, who has the responsibility for the companys financing needs, accounting, and information systems.Roma almost immediately initiated a project to upgrade the companys computerized accounting system. A new director of Information Systems (IT), Henry Smith, directly to Roma and oversees data control and systems security.

Key positions within IT include a director of computer operations and a programming director. Roma was hired because of her familiarity with benefits and risks of enterprise resource planning systems, and she reviews progress on the new system installation with the IT manager monthly. The IT manager is also responsible for managing the current system until the new system has been tested and is ready to use. Furthermore Roma recently hired Bill Roberts to act as an internal auditor. Bill reports directly to the CFO.

Currently the internal auditor is reconciling all bank accounts. The board of directors approved the hiring of an internal auditor, and, in the absence of an audit committee, Roma plans to discuss internal audit findings with the board of directors on an annual basis.

Roma is currently under pressure to produce financial statements within ten days after the end of the month. Michael Jones believes that this is essential to good business management. Once the financial are produced they are closely reviewed with managers of day-to-day operations to ensure that managers are held accountable for the resources which they are entrusted.

Other procedures performed to obtain an understanding of internal control revealed the following information:

A. Quality Furniture has identified a small group of office furniture dealers whose operations have deteriorated to the point that their ability to repay the company is doubtful. The company has decided to make additional shipments to these dealers on a COD basis. It is expected that a large allowance for doubtful debts may be necessary to reduce these accounts to estimated realizable value.

B. The tool inventory consists of accumulation of miscellaneous items, most of which are small quantities with very minor unit prices. This inventory totals $ 50,200.This is considered to be insignificant portion of the total inventories.

C. The purchased parts stockroom is separated from the production areas by a wire fence. While visiting the plant, you noted that the gate was open all day, and access to the stock room (which contains many valuable and easily concealed items) was available to any employee. The stockrooms perpetual inventory records were formally checked by an employee who made periodic test counts. This employee has retired and has not been replaced. As a result, such counting has ceased. You expended your test in view of these situations and are satisfied that the perpetual records reasonably reflect the quantities on hand.

D. The board of directors just adopted a policy that will allow the company to invest excess funds in short term securities. The CFO will have sole authority for purchase and sale of the investments. Securities purchased will be credited to a company account at a local brokerage house. The securities are held in the companys name. All correspondence relating to the investments is sent directly to the CFO. She in turn, forwards brokerages advices to her assistant for recording in the accounts.

E. A complete physical inventory of the companys office furniture has recently been taken

Required:

(i)Identify and explain any four control environment factors that affect the companys internal control.

(ii)Describe two strengths and their implications for audit strategy in Quality Furniture Ltds internal control.

(iii)Describe four weaknesses and their implications for audit strategy in Quality Furniture Ltds internal control.