You are a 3rd year trainee accountant at an internationally acclaimed audit firm, PYD Incorporated. You are based at the Durban office of PYD Inc. PYD has been recently appointed as the auditors of Silky Hair (Pty) Ltd (Silky Hair) 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 10 years ago and was 100% owned by Mr Brown. After experiencing tremendous growth in the market, Mr Brown sold 65% of his shares to Sunsilk Hair Corporation 2 years ago. Your audit firm was appointed 2 years ago as the auditors locally due to a decision being made at the global headquarters to change the auditors of all material subsidiaries to PYD 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. The company purchases raw materials from both local and overseas suppliers. 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. After the sale of the business to Sunsilk, Silky Hair underwent a major restructuring, whereby clear levels of authority were established and a formal organisational structure was determined. Silky Hair sells to both local and foreign customers. All sales are recorded in Rands. The foreign customers include other companies within the Sunsilk group. The shipping terms for foreign sales vary from customer to customer. Local sales are 1 made to both large retail and distribution outlets as well as smaller independent retailers. Transportation to local customers is handled by an external logistics company called Lakers Transport (Pty) Ltd. Deliveries to larger retail customers in South Africa can take between 3 to 7 days due to the widespread location across the country. 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 R25 million. The bulk of the balance relates to sales made in December 2021. The debtors balance represents a significant portion of current assets. The terms of sale vary for each customer. Terms of sale include the following: Credit Limits Settlement discounts rates and terms Discount rates Credit terms Shipping terms (only for foreign customers) The term for each customer is 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 a global SAP system, their invoice sequence follows a global sequencing, i.e. the invoices printed locally do not run their own sequence. The debtors Masterfile consists of the following fields: Debtors Account number Name Address and Contact Details Total amount owed Credit limits Settlement discount rate and terms. Discount rates Credit terms 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)) 2 A smaller proportion of the debtors do not have proper customer details but there are plans sort this out within the next six months. SAP also has an enquiry facility which enables a user to print out a detailed account reflecting all the transactions with the debtor for the preceding 12 months. The SAP System makes use of various application controls to ensure that the information captured is accurate and complete and that the data processed is accurate and complete. For the last 2 years, the company has been following the global headquarters policy for determining the doubtful debt allowance. The global policy is to provide for debtors based on their ageing category and the following % rates are used: Current: 0% 30 Days: 2% 60 Days: 5% 90 Days and over: 10% Once the allowance has been calculated, it is approved at the month directors meeting. The company has been experiencing a large number of defaulters in the last year due to the impact of the global recession on South Africa. In previous years your audit team has sent out debtors circularisations however not all debtors responded. As a result alternative procedures had to be performed. The group auditors have communicated that the deadline for the year-end audit is 31 March 2022. The following staff members work in the debtors department: o Monica Potter (Sales Clerk) o Chandler Bing (Sales Manager) 3 PETTY CASH You are unfamiliar with surprise cash counts and your Audit Manager kindly informs you about the following principles: The counts must be on a surprise basis as the intention is to determine whether the petty cash is being properly maintained and that no unauthorised expenditure or theft is taking place; If the person in charge knows you are coming, they will make sure everything is in order. If the person in charge is not present and there is a shortage of cash, person in charge can accuse me of stealing; If petty cash boxes are not present and counted one after the other (when there are two), the person in charge has a better chance of covering shortages by transferring cash from one box to the other. All audit procedures should be supported by audit documentation. The workpaper becomes part of the audit evidence. Petty Cash is being kept on Imprest System with an original float of R800 every month. Again this prevents the person in charge from claiming at a later stage that you were responsible for any shortages/other problems relating to the petty cash. The following expenditure was incurred for the month of December 2021: o Petty Cash Voucher 772 Licensing fees for ND 7597 R430.00 o Petty Cash Voucher 73 Refreshment # R134.00 # Refreshment purchased from SPAR for the Audit Committee meeting held on 15 December 2021. 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 of were as follows: 4 Process No. Function Yes/No Comments Order Department 1 Are all orders received from customers, recorded on sequenced internal sales orders (ISOs)? No ISOs are only made out for order received over the telephone. When an order is faxed, emailed 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-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 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. Warehouse/Despatch 5 4 Are goods picked up from the stores using sequenced picking slips? 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 is 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 despatch. Pickers are instructed to pick carefully according to the document they are using to pick goods. You are required to: a) Assess the risk of material misstatement relating to trade receivable as at 31 December 2021. (Comment on both an overall financial statement level and assertion level- consider each assertion). (8) b) 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. (5) c) Describe the substantive procedures you will conduct (both manual and computer assisted) on the existence and valuation assertions relating to trade debtors as at 31 December 2021. (36) 6 d) In the form of a working paper, prepare a petty cash reconciliation for Silky Hair and record the procedures that you conducted on petty cash for the month ending 31 December 2021. (12) e) 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. (25) f) Describe two tests of control you would carry out on each of the 3 controls listed under Function: Order Department ASSUMING that the answer to all the questions were YES. Ignore the comments for this part (part f) of the question. (Hint: Use verbs such as inquire, observe and inspect). (8) g) Describe 6 inherent limitations of internal controls and the reason for their existence. (6)