Sharon Gallagher and Josh Thomas have assessed the internal controls at Cloud 9 as being effective at an entity level. This means that, at a high level, the company demonstrates an environment where potential material misstatements are prevented or detected. Answer the following questions based on the information presented for Cloud 9 in the appendix to this text and the current and earlier chapters. You should also consider your answers to the case-study questions in earlier chapters. Required You have been assigned the task of documenting the process for recording sales, trade receivables, and cash receipt transactions for wholesale customers. In your absence, Josh met with the Cloud 9 controller, Carla Johnson, and received permission to tape the interview, which is provided as a transcript (see the appendix to this text). Using this interview transcript and other information presented in the case, you are asked to

C: For each assertion associated with recording wholesale revenue transactions, identify a control related to that assertion. If no controls are identified, recommend a control for the assertion.

Transcript of Meeting with David Collier Present: David Collier, chief financial officer, Cloud 9 Inc. Josh Thomas, audit senior, W&S Partners JT: Thanks for seeing me, David. DC: You're welcome, Josh. What can I do for you? JT: I need to ask you some questions about Cloud 9's process for recording wholesale revenue transactions, including the trade receivables and cash receipts aspects. After I understand the process, I will be doing a system walkthrough and confirming my understanding by talking to the individuals who are involved in each step of the process. DC: We've got a pretty complex inventory management software system called Swift. It was designed by some of our tech guys. It tracks inventory and it integrates with our sales system. JT: How do customers decide the quantity and know the price? DC: The customers complete a purchase order online through a site that is linked to Swift. The site will tell customers the price for each item in inventory, as well as the quantity we have in stock. JT: How often are prices changed? DC: Price changes really depend on the market. While they don't change that often, our marketing management meets weekly to discuss price changes. Price changes are initiated after that meeting. Only the marketing manager and a few of her staff members have access to update the master price list. JT: What if a customer logs on and you don't have the products? DC: The system doesn't allow a customer to place an order greater than our current inventory levels. If a customer needs more inventory, the customer should fill out a separate request for inventory not on hand. The request gets e-mailed to our production manager and our marketing manager, who determine if we need to manufacture more goods. The decision about manufacturing more goods is complex as it integrates with our production decisions, or whether we can purchase additional inventory from a subcontractor that manufactures for us. JT: OK. This is helpful. Let's stay focused on the sales process. Once a customer's purchase order is complete, then what? DC: The submitted purchase order goes through a credit check and then becomes a sales order. If a customer exceeds his or her credit limit, there are a few people in my office that can approve a credit override, on a case-by-case basis. We tend to allow this only for good customers with good payment history. Then, the purchase order becomes our sales order. JT: I guess this electronic process saves a lot of time and trees! DC: Yes, there's so much that we rely on the system to do for us, it's scary. I worry about things like what happens if we are hit by a storm or lose power. We do have the whole system backed up off-site. JT: That is nice to know, and probably gives you some comfort. What happens to the sales order how does it get filled? DC: Every day, the system assigns shipments to the warehouse location nearest to the customer's location that can fulfill the entire order. The warehouse manager then downloads the outstanding sales orders to these little handheld computer/scanners. It's very Star Trek. Warehouse personnel use these to identify inventory in the warehouse, then the warehouse personnel put boxes of ordered shoes onto pallets. The pallets are taken to a staging area where each product is then scanned. 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? DC: Swift matches the quantities and products on the packing slip to the sales order. If they don't match, the order is set aside for follow-up to ensure that the order is accurately filled. Once they match, the approval box is activated, and the shipping supervisor can enter his or her passcode. This officially approves the packing slip and bill of lading, and each gets printed. JT: OK, so once the goods are shipped to the customer, how do you bill for this shipment? DC: We go into the billing system and pull up a draft invoice that was generated when the shipping document was approved. At this point, Swift performs a number of checks. The system matches the quantities in the invoice against the packing slip and sales order. Prices are also matched to the sales order. The customer number should also match on the sales order, shipping documents, and draft invoice. A report is run daily of any shipments that have not resulted in invoices. The reverse is also true. A report is run of any invoices that are not supported by shipping documents. At month-end, we run a report to compare dates on shipping documents with the month that transactions are recorded in the sales journal. If there are any discrepancies, the transaction is reported for manual follow-up. I believe discrepancies are rare as the system is very tight, and we ship only what was ordered. Then, the sales invoice is processed. Processing the sales invoice enters the transaction in a database from which we build the sales journal and accounts receivable subsidiary ledger. Also, at the end of each day, we compare the totals for accounts receivable with the total of each customer's balance in the accounts receivable subsidiary ledger. JT: When you do have discrepancies, who follows up on them and how are they cleared? DC: We have a data control group that follows up on discrepancies in a variety of systems. Discrepancies have to be cleared daily. Once the reason for the discrepancy is identified, changes to the underlying data must be approved by a manager in the data control group. The data is then corrected, and the invoice is processed. As I noted, discrepancies are very rare. We don't ship goods unless the order is completely filled. JT: Does finance ever go back to the sales order? DC: No. Since the shipping document can't be generated unless it agrees to the sales order, Swift only looks at the sales order for prices. Do you think we should do otherwise? JT: I wouldn't say so at this stage. But you'd have to be sure to have some tight controls around Swift, given that it seems to do everything. DC: Yes, good IT general controls over the Swift program, and other programs, are extremely important. I meet with the IT manager monthly, to talk about the few discrepancies found, reasons for discrepancies, and the importance of controls. I think you will find that our IT manager understands the importance of strong IT general controls, and strong controls over clearing any discrepancies identified in transaction streams. JT: Let's talk about accounts receivable. Who follows up on past-due receivables? DC: That is the sales manager's responsibility. In my opinion, we do a good job of screening credit upfront so we don't have a significant problem with past-due receivables. We send statements to customers with their receivable balances monthly. The sales manager and I discuss past-due accounts on a regular basis. The sales manager, controller, and I review the allowance for doubtful accounts monthly. A monthly adjusting journal entry is made by the controller, which I review and approve. You will find that our allowance for doubtful accounts is only about 1% of outstanding receivables as we do a good job of screening customer's credit upfront. JT: What is the cash receipts process? DC: We get most payments via EFT. If a customer pays by check, it goes to a lockbox where it also is directly received by our bank. Our AR clerk is able to download the previous day's cash receipts from online banking. She then merges this information with our accounting system, which first screens the data, matching customer numbers with the master customer file. On occasion, the bank has made errors in entering customer numbers, and we have to follow up on these transactions before they are processed in our accounting system. This is done the same day. Once the transaction is processed, it is posted to the database from which we build our cash receipts journal and accounts receivable subsidiary ledger. Finally, every morning someone reconciles what was posted to cash receipts with what has been deposited in various bank accounts. I believe it is critical that all cash receipts are posted timely and accurately. JT: Are bank reconciliations done in a timely manner? DC: Yes, someone in my office does bank recs every month for the main operating account and other bank accounts. Our standard is to complete this by the fifth business day of each month. My assistant reviews and approves the bank reconciliations. Keep in mind that what I explained is for the wholesale transactions. We have separate procedures for the retail store regarding daily cash balance reconciliations to the deposits in the operating bank account. JT: Yes, we have another auditor who will be handling the retail store side of the sales-to-cash-receipts process. She or he will probably come and 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 the revenue process. DC: The door is always open. JT: Thanks for your time.