Question 1 (50 Marks: 15 minutes)

You are a 3rd year trainee accountant at the internationally acclaimed audit firm, DPY Incorporated (DPY Inc.). You are based at the Durban office of DPY Inc. DPY Inc. are the auditors of Silky Hair (Pty) Ltd (Silky Hair) and you have been assigned to the audit for the year ended 31 December 2021.

Silky Hair is a subsidiary of Sunsilk Hair Corporation a company based in The United States of America. Silky Hair was originally started by Mr Brown 15 years ago and was owned 100% by Mr Brown. After experiencing tremendous growth in the market Mr Brown sold 65% of his shares to Sunsilk Hair Corporation 5 years ago.

Your audit firm was appointed 2 years ago as the auditors locally due to a decision made at the global headquarters to change the auditors of all material subsidiaries to DPY Inc. The previous auditor of Silky Hair was a small owner managed practice.

Silky Hair is a company involved in the manufacturing of hair care products and includes a wide variety of products such as; shampoos, conditioners, treatment for damaged hair, hair gel, and hair relaxers aimed at ethnic hair. All products are manufactured at the plant located on the company premises in Durban.

Silky Hair has a complex computer environment as they operate on the global headquarters accounting software, SAP. The company has been using SAP since becoming part of the Sunsilk group. Mr Brown is still involved in the day to day running of the business and has remained as the Managing Director.

Silky Hair sells to both local and foreign customers and all sales are recorded in Rands. Local sales are made to both large retail and distribution outlets as well as smaller independent retailers. All sales are made on credit and the company has 1500 active debtors on the debtors masterfile. At 31 December 2021 the Debtors balance on the Trial balance was R 25 million. The bulk of the balance relates to sales made in December 2021. The debtors balance represents a significant portion of the current assets. The terms of sale vary for each customer. Terms of sale include the following:

Credit limits

Settlement discount rates and terms

Discount rates

Credit terms

Shipping terms (only for foreign customers)

The terms for each customer are determined by the sales director Mr Pillay and is approved by Mr Brown (MD). All terms are coded into the debtors masterfile. As Silky Hair operates on the global SAP system their invoice sequence follows a global sequencing, i.e., the invoices printed locally do not run in their own sequence. The debtors masterfile consists of the following fields:

Debtors account number

Name

Address and contact details

Total Amount owed

Settlement discount rate and terms

Credit limits & terms

Discount rates

Status query code

- code 1 = unresolved dispute with debtor

- code 2 = internal letter of demand sent

- code 3 = handed over to lawyers for collection

Shipping terms (Free on board {FOB}, Customs in freight {CIF})

The following staff members work in the debtors department:

- Monica Potter (Sales Clerk)

- Chandler Bing (Sales Manager)

INTERNAL CONTROLS At the end of January 2022, the audit team visited the company to carry out the completion of an internal control questionnaire relating to the revenue and receipts cycle (completed by another member of the audit team) and the results were as follows:

Process No	Function	YES/NO	Comments
1	Are all orders received from customers, recorded on sequenced internal sales orders (ISOs)?	NO	ISOs are only made out for orders received over the telephone. When an order is faxed or sent through the post, an ISO is not necessary as we have a document to work with. ISOs are pre-printed but are not sequenced as there is no need for this
2	Does the order clerk confirm that all orders received are from authorised customers (account holders)?	YES	The order clerk has a list of all debtors names against which she confirms this. If an order is accepted from a non account holder, the accounting department will pick it up later on, when the customer signed delivery note is sent to the department.
3	Does the order clerk confirm that the order will not result in the customer exceeding its credit limits prior to accepting the order?	NO	This is not applicable. Before opening an account for a customer, we merely request two trade references from the customer which we follow up. Only if these are satisfactory, will we open an account for the customer. There is no need to set credit terms or limits when accepting the customer
	Warehouse/Dispatch
4	Are goods picked from the stores using sequenced picking slips (ISO)?	NO	As indicated above, ISOs are not made out for all orders received. Where an ISO is made out (phone orders) it is sent to the warehouse and used for picking the goods. Where the order is received through the post or by fax, the customers order/fax is sent by the order department to the warehouse for picking the goods.
5	Does a senior staff member check that all goods picked are supported by a picking slip (either an ISO or a customer order/fax)?	NO	This is not necessary. Goods picked are laid out in the picking area for dispatch. Pickers are instructed to pick carefully according to the document they are using to pick goods.

As part of the audit, you have sent out debtors circularisation letters to a sample of debtors. Whilst most debtors have responded and no variances were identified, the following debtor responded that the balance was incorrect. You have summarised the response of the debtor in the document below:

Debtor Lovely Hair (Pty) Ltd

Balance per Silky Hair as at 31 Dec 2021 R3 580 000.00

Balance per Lovely Hair (Pty) Ltd R3 190 000.00

Difference R 390 000.00

The R 390 000 relates to an incorrect billing reflected on the Silky Hair statement. INV 200 dated 28 Dec 2021 as noted on the statement for R 390 000 was not ordered or received by Lovely Hair (Pty) Ltd. Accordingly, we (Lovely Hair) do not accept that this amount is owed to Silky Hair. Our sales department has been in correspondence with Silky Hair and the matter has not been resolved as yet.

Required:

1. Describe the programmed controls which should be in place relating to the entry of the sales orders onto the system to ensure that the order captured is valid(7 Marks)
2. Based on the extracts from the internal control questionnaire provided, identify weaknesses in the revenue and receipts cycle of Silky Hair (Pty) Ltd. For each weakness you identify, explain why you believe it is a weakness. Prepare the answer in a tabular format(25 Marks)
3. Identify and explain what reports can be extracted from SAP system to assist the auditor with assessing the completeness of the Silky Hair provision for doubtful debts. In your explanation you are to include how the reports will be used.(4Marks)
4. Identify the substantive test of detail that will have to be performed on the debtor reconciliations Do not include generic recon procedures such as testing the logic, casting the reconciliation in your solution(10 Marks)