Report of internal control deficiency

This a report provided by the auditor highlighting the IC deficiencies

the potential consequences and the recommendations of how the
deficiencies may be overcome.
Why is the auditor providing management report?
1. This can be viewed as a value-added service.
2. If the ICS is improved the auditor would be able to place
greater reliance on the ICS and reduce the substantive
procedures.
3. It provides evidence to the client of work done and justifies the
fees.
-
The financial statement amounts exposed to the deficiencies.
Is the amount material

Decide extent of substantive testing

Internal control over financial reporting strong--- decrease
substantive testing, select a smaller sample
Internal control over financial reporting weak--- increase substantive
testing, select a larger sample.
In the exams there will be a sure question on ICS. The question could
be on:
1. Sales and receivables System
2. Purchases and payables system
3. Payroll system
4. Inventory system
5. Cash System
6. Non-current asset system

Sales systems
Control objectives for sales and despatch system
- To ensure that orders are only accepted if goods are available to be
processed for customers.
If goods are not available, then goodwill with the customers may be
damaged.
- To ensure that all orders are recorded completely and accurately.
- To ensure that goods are not supplied to poor credit risks.
This would ensure that receivables are recoverable.
- To ensure that goods are despatched for all orders on a timely
basis.
- To ensure that goods are despatched correctly to customers and
that they are of an adequate quality.
- To ensure that all goods despatched are correctly invoiced.
- To ensure completeness of income for goods despatched.
- To ensure that sales discounts are only provided to valid customers
Sales order placed.
The sales order is normally the 1st documentation raised to
document a sales.
- All sales orders documented on a:
a. sequentially numbered. (It is best that all documents generated
are sequentially numbered so that they can be tracked.
Missing documents too can be detected by performing sequential
test)
b. multi-part SALES ORDER FORM.
Multi part so that copies can be provided to the relevant
departments.
a. Warehouse to generate the goods despatch note.
b. Retain one copy with the sales department.
c. Send one to the customer.
d. Forward a copy to the invoicing section.
- Confirm from the customer (preferably in writing except on
telephone sales, a verbal reconfirmation/ call recording should be
acceptable)
- Inventory check
To determine if the type and quantity ordered are available.
- Pre numbered, multipart goods despatch note(GDN) is generated
- One copy of the GDN is sent with the goods, one copy stays in the
warehouse, stapled to the relevant sales order, and one copy is sent
to the invoicing department ( it is also good practice for a copy to be
sent to the sales department. This is evidence that the order has ben
satisfied. This would also enable the sales department to monitor the
sales)
- New customer: credit checks, the obtaining of trade/bank
references and the setting of appropriate credit limits for customers
Credit limits must be set by responsible official, i.e. senior member of
the sales department.
- Existing customer: credit limit check, Customer credit limits should
be regularly reviewed and updated based on the level of sales
transactions and credit risk (Credit risk would also be indicated by
customers payment track record.
- Any discounts committed to be authorized by the responsible
official.
- Follow up on unfulfilled orders- On a regular basis, a sequence
check of orders should be undertaken to identify any missing orders.
When orders are fulfilled sales order forms must be cross referenced
to GDN and cancelled as fulfilled.
- Automated environment: access to master file limited to authorized
individuals only.

- Goods dispatched to the customer

- Sequentially pre-numbered multi part Goods Dispatched Note are
generated based on the customers orders.
- Matched to the sales order- Upon despatch, the GDN should be
matched to the sales order; a regular review of unmatched orders
should be undertaken to identify any unfulfilled orders.
- Signed by the warehouse manager after quantity and quality checks
- 4 copies (warehouse, customer, accounts/invoicing and sales).
- Customer should sign the copies to acknowledge receipt of goods
3. Sales invoice raised and entered in the accounting system
- Sequentially pre-numbered invoices
- Matched to GDN
- 3 copies (accounts/invoicing, customer, sales day book clerk if
applicable)
If the goods have not been delivered and an invoice is required what
type of invoice would you issue?
A proforma invoice is issued. (This is an estimated invoice)
- Ensure the authorized price list is used to prepare the invoice
- All discounts must be authorized by the relevant official.
- Arithmetic checks on invoices to ensure accuracy.
- Sequence check on GDNs to ensure all GDNs have been invoiced, to
ensure completeness of invoicing.
- Sequence check on Invoices to ensure all invoices have been
entered in the accounting system (In a computerised system the
system would detect missing invoice numbers).
- Customer statements should be sent monthly to ensure any errors
and disputed invoices are quickly identified and resolved
These are statements showing the amount invoiced in that month
and the total amount due.
- The sales ledger control account should be reconciled on a monthly
basis to the individual ledger to identify any errors. The
reconciliations should be reviewed by a responsible official and they
should evidence their review.
Payment received from the customer.
- Match payment to invoice to confirm that the correct amount has
been received.
- Check validity of any settlement discounts availed by the customer
- Segregation of duties: receiving payment and recording
Payments should not be received by any person who involved in
recording.
- Encourage bank transfers or any form of electronic payments.
- A Bank Reconciliation Statement should be prepared on a
monthly basis. If not misstatements may never by detected.

. Goods returned by the customer.

When customers return goods they would require that the amount
returned is reduced from the outstanding.
The warehouse should generate a goods returned note.
- Sequentially pre-numbered credit note
Credit notes are issued to reduce the amount outstanding.
- Signed by the manager
- Matched to invoice
- Prepare a report for reasons for returns and actions taken by the
management.
6. Other controls
Aged receivables report: prepare monthly and reviewed by a senior
official.
An aged receivable report would provide details of the amount due
by individual receivables and period that the debt has been due.
Exceptions reports created and reviewed (old receivables, credit limit
exceeded etc.)
Amendments to master file data should be restricted so that only
senior officials to make changes.
Master data in a sales system are:
1. Customers identification
2. Credit limit.

There are ways of understanding a internal control system.

1. Understand the documents used as above.
2. Understand the process.
Understand the process.
a. Customer makes an order.
b. A sales order is generated after checking the customers credit
availability as well availability of the goods.
c. A copy of the sales order is sent to the warehouse.
d. The goods are prepared, and a Goods Despatch note is
generated.
e. The goods are despatched to the customer who signs a copy of
the GDN as acknowledgement of receipt.
f. The GDN is used by the warehouse to update the inventory
records.
g. A Copy of the GDN is sent to the sales department to indicate
that sales has been completed.
h. Another copy of the GDN is sent to the invoicing department
for the invoice to be prepared and despatched to the customer.
i. A copy of the invoice is also sent to the accounts department to
record the sales.
j. Receipt of payment from the customer.
Receipts are issued for cash and credit card payments but not for
bank transfers and cheque payments.
As internationally cheques that are issued are returned to the
issuer when they have been cleared.
A returned cheque means a cleared cheque.
A dishonored cheque is what we call a bounced cheque in
Malaysia.
k. If the customer is entitled to a settlement discount or any other
discounts or rebates a credit note is issued.
Bulk or quantity discounts would have normally been included
in the sales invoice.
Unless the quantity discounts are for cumulative purchases.
 l. The receipt is updated to the cash book as well the sales ledger.
m.Goods are returned by the customer due to defects or other
issues.
n. Goods received are checked for quantity and quality and are
documented by a goods returned note.
o. The inventory records are updated for goods returned.
p. A credit note is issued to reduce for goods returned.
q. The Sales ledger is updated for goods returned.
It should be noted that all documents are:
a. Pre numbered,
b. Multi part, and
c. Authorised.
Some of the controls that must be present are:
a. Authorisation – All documents must be authorised.
b. All documents must be pre numbered.
c. The function of authorisation, recording and custody should
not be performed by the same person. – Segregation of duties.
d. All cash should be banked in as soon as possible – Safe custody
of cash.
THE PURCHASE SYSTEM
Objective
The main objectives in purchase system are:
– Procurement is made only when the requirements are genuine.
– Purchases are made at the most optimum prices and terms (Best
prices) .
– Purchases meet the required quality standards and if substandard
quality is accepted, must be at negotiated terms.
– Payments are made according to agreed terms.
– They are procured on time and the payments are made according
to agreed terms.
- Payments are made to maximise discounts.

. Purchase requisition- generated by the user department.

If the purchases system is automated and the purchases are based
on reorder level requisitions are also automated.
- Sequentially pre-numbered
- Authorized to ensure only those goods are ordered which are
required
- Monitor inventory level or Re-order level set
- Inventory/ re-order level checked before raising the requisition to
ensure only order when required.
2. Purchase order – This the document that is sent to the vendors /
suppliers.
- Sequentially pre-numbered and matched to requisition order
- Authorized supplier list used and updated annually (this should take
into account the price of goods, their quality, and the speed of
delivery.)
- All POs must be Authorized
- 4 copies (supplier, order department, warehouse, and accounts
department)
- Follow up on order placed but not yet received (exception reports
can be created in a computerized environment) and sequence check
can be performed for any unfulfilled orders.

3. Goods received Note is generated after the goods received is

checked for quality and quantity.
- Sequentially pre-numbered GRN
- Matched to purchase order
- Signed by the warehouse manager after quantity and quality checks
( Some organisations have a separate receiving bay)
- 3 copies ( ordering department, warehouse for their records, and
account)
4Invoice received from supplier.
- Match to GRN
- File in an order (CANNOT be Sequentially pre-numbered) but should
be numbered manually. This way, a sequence check can then be
carried out to ensure all invoices have been entered in the
daybook/ledger.
- Arithmetic checks, the amounts in the invoice must be casted.
- Entered in the Purchase ledger /day book on a daily basis-
application controls(such as control total) should be applied to
ensure completeness and accuracy over the input of purchase
invoices.
- Stamp ‘entered’ when recorded
- Segregation of duties (order placement, goods received and
recording are performed by separate staff)
- Monthly reconciliation: Purchase Ledger to Purchase Ledger Control
Account.

5. Payment made
- Segregation of duties (Purchase order, goods received, payment )
- Before approving invoices for payment, a senior official should
match them to the audit trail ( esp. the GRN)
Payment vouchers should be supported by
a. Purchase requisition
b. GRN
c. Purchase invoice.
- Bank transfer preferred
- If payment by cheque: senior individuals only plus two signatories
for high amounts
- Stamp invoice ‘paid.’ ( to avoid duplicate payments)
- Try and avail settlement discounts and pay according to supplier’s
terms to maintain supplier goodwill
- Payment against specific invoices only ( avoid ‘on account
payment’)
- Supplier statement reconciliation with Purchase Ledger
- PL reconciliation with PLCA
- Monthly BRS (Bank reconciliation statement)
Goods returned to the supplier.
- A prenumbered goods returned to supplier note to be generated
and sent with the goods.
- Credit notes from supplier to be manually numbered.
- Vendor-wise analysis to identify consistent quality problems

7. Examples of application controls to ensure the completeness and

accuracy of the input of purchase invoices.
a. Document counts – the number of invoices to be input are
counted, the invoices are then entered one by one, at the end the
number of invoices input is checked against the document count.
This helps to ensure completeness of number of invoices input.
b. Control totals – here the total of all the invoices, such as the gross
value, is manually calculated. The invoices are input, the system
aggregates the total of the input invoices’ gross value, and this is
compared to the control total. This helps to ensure completeness
and accuracy of input.
Exams has emphasised on control totals
d. One for one checking – the invoices entered into the system are
manually agreed back one by one to the original purchase invoices.
This helps to ensure completeness and accuracy of input.
e. Check digits – this control helps to reduce the risk of transposition
errors.
Mathematical calculations are performed by the system on a
particular data field, such as supplier number, a mathematical
formula is run by the system, this checks that the data entered into
the system is accurate. This helps to ensure accuracy of input.
f. Range checks – a pre-determined maximum is input into the
system for gross invoice value, for example, $10,000; when invoices
are input if the amount keyed in is incorrectly entered as being
above $10,000, the system will reject the invoice. This helps to
ensure accuracy of input.
g. Existence checks – the system is set up so that certain key data
must be entered, such as supplier name, otherwise the invoice is
rejected. This helps to ensure accuracy of input.

What happens if there is a vacancy in the position such as sales or

purchase manager?
Yes this a deficiency, but the deficiency can overcome if another
responsible official is required to perform the reviews and
authorisation that must be performed.

Can we have a class on Monday the 20th of March?