Required Audit Manager Sharon Gallagher and Audit Senior Josh Thomas previously met with the Cloud 9 Ltd. Finance Director, David Collier, to gain an understanding of the internal controls at the entity level. Based on their interview, they have assessed those controls as being effective. Therefore, at a high level, the company demonstrates an environment where potential misstatements are prevented or detected. You have been assigned the task of documenting the understanding of the process for recording sales, accounts receivable, and cash receipts for wholesale customers. In your absence, Josh met with the Cloud 9 Ltd. Financial Controller, Carla Johnson, and received permission to tape the interview, which is provided as a transcript (see Appendix 3).

Using this interview transcript, you are now asked to: Prepare a flowchart or narrative documenting your understanding of the sales to cash receipts process for wholesale sales. Document your understanding in working paper A41 and A42 (if needed) on pages 14 and 15. Identify any follow-up questions you would like to ask the client if aspects of the process are not adequately explained. Also identify any weaknesses in the internal controls over the sales and cash receipts. Document these in working paper A43 on page 16. For the follow-up points and control weaknesses, describe any potential misstatements that could occur in the financial statements in A43.

Appendix:

JT: Thanks for seeing me, Carla. CJ: Youre welcome, Josh. What can I do for you? JT: I need to ask you some questions around Cloud 9s process for recording wholesale revenue transactions, including the trade receivables and cash receipts aspects. After I understand the process, Ill need to select a sample transaction to confirm my understanding of the process as you have explained. CJ: Well, I can tell you what should be happening, but you may want to go and speak to the sales manager or warehouse managers to confirm they do what the company policy and procedures say. JT: Good point, Ill make appointments to see them. Thanks. So lets start at the beginninghow does a sale transaction get initiated? CJ: Weve got a pretty complex inventory management software system called Swift. It was designed by some of our tech guys. It tracks and does everything! JT: Sounds impressive! CJ: Anyway, the customerslets say the Myer store in Torontocomplete a purchase order on-line through a site that is linked to Swift. JT: How do the customers decide the quantity and know the price? CJ: Swift is linked (dont ask me how) to their store inventory records and sends them an alert when their inventory balance of our products gets below the predetermined limit they set with us. They can select the quantity based on their needs, but the prices are set in the system. They get sent price lists from the sales manager so they know the current prices. JT: How often are prices changed? CJ: Depends on the market, really. I dont think they change too frequently. JT: What if you dont have the products? CJ: The system doesnt allow them to place an order greater than our current inventory levels. If they need more, they need to fill out a separate request form that gets e-mailed to our warehouse manager so he can place the order with China. JT: OK, so they complete a purchase order, then what? CJ: The submitted purchase order goes through a credit check and then becomes a sales order. The sales order documents the quantity required, the selling price, and the shipping terms. Thats all done behind the scenes in the system. We really dont see anything on our side until the sales order stage. JT: Guess that saves a lot of time and trees! CJ: Yeah, theres so much that we rely on the system to do for us, its scary. If we were hit by an electrical storm, wed be in trouble. JT: What happens to the sales ordershow do they get filled? CJ: Every day, the warehouse manager downloads the outstanding sales orders to these little hand-held computer/scanner thingies. Its very Star Trek. Warehouse personnel use these to select the items off the shelves onto pallets. The pallets are taken to a staging area where each product is then scanned. This establishes the shipping in Swift, which then gets printed for the delivery. JT: Are the shipping documents approved before the goods go out the door? How do you know that what got sent is what was ordered? CJ: Swift matches the quantities and products on the shipping document to the sales order. Once they match, the approval box is activated and the shipping supervisor can enter his pass code. This officially approves the shipping document and it gets printed. JT: How many orders do you fill in a day? It sounds like a lot for one person to do. CJ: We probably complete about 50 orders a day. Shoes arent perishable items, you know, so its not like we are sending products to every store, every day. Were trying out the pit crew concept where there are two shipping supervisors with about four to five warehouse employees in their crew team. So they are in the staging area with them and do it right there with the hand-held devices. They like to have little contests on who can do it the fastest. You should go down there; its quite a lively group. David encourages it and its been great for productivity and morale. JT: Sounds like a great working environment. Better than being stuck in a broom closet sifting through invoices! CJ: Ah, the life of an auditor. I remember the good old days . . . JT: And the goods are sent out on your own trucks? CJ: Thats right. Weve bought our own trucks and vans rather than rely on couriers. The drivers pick up their loads in the morning and bring back anything undelivered. Because shoes are an easy product to off-load, we have to be careful about theft. So nothing can be left in the back of a truck at the end of the day. It comes back here and gets locked up in the shipping cage till it can be delivered again. JT: Why would goods be undelivered? CJ: Sometimes the drivers get behind or the store is closed unexpectedly. So there are occasions when all the goods wont get delivered in the day. JT: OK, so now the goods are delivered to the customer, how do you bill them? CJ: The drivers have the customers sign for the goods upon receipt and then give us the signed copy of the shipping document. We go in to the billing system and pull up the draft invoice that was generated when the shipping document was approved. We match the quantities in the invoice against the signed shipping document and confirm the customer sign-off. This way, we only bill for those goods that were actually received by the customer. At 4 p.m., we do a batch run of the days invoices, which are printed in duplicate, and mailed out. The copy is stapled to the signed shipping document and put on file. The running of the batch posts the invoices to the sales journal and accounts receivable subledger. JT: Does finance ever go back to the sales order? CJ: No, since the shipping document cant get generated unless it agrees to the sales order, we dont go back that far into the process. Why, do you think we have to? JT: I wouldnt say so at this stage. But youd have to be sure to have some tight controls around Swift given that it seems to do everything. CJ: Like I said, it does everything. JT: What is the cash receipts process? CJ: We get most payments via EFT, so my AR clerk downloads the previous days receipts from on-line banking. She then goes into the subledger to post the receipts against the customer accounts. When shes finished posting each entry, she runs a batch report of all postings and reconciles it back to the bank statement. I review that reconciliation and signoff. JT: Are bank reconciliations done in a timely manner? CJ: I do bank recs each month for the operating and savings accounts. David reviews and approves them. Keep in mind, what I just explained is for the wholesale transactions. We have separate procedures for the store regarding daily cash balance reconciliations to the deposits in the operating bank account. JT: Yes, our graduate will be handling the store side of the sales to cash receipts process. They will probably come talk to you in a day or two. Well, I think that should do it for now. I may have some follow-up questions for you as I start getting my head around all of this. CJ: Doors always open. JT: Thanks for your time.