CASE STUDY 2 – QUESTION 1

Wiggins International Co (Wiggins) is a manufacturer of electrical equipment. It has

factories across the country and its customer base includes retailers as well as individuals, to
whom direct sales are made through their website.

The company’s financial year end is 31 March. You are an audit supervisor of Cavendish &
Co and are currently reviewing documentation of Wiggins’ internal control in preparation for
the interim audit.

Wiggins’ website allows individuals to order goods directly, and full payment is taken at the
point that the order is placed. Currently the website is not integrated into the inventory
system and inventory levels are not checked at the time when orders are placed.

Goods are despatched via local couriers; however, they do not always record customer
signatures as proof that the customer has received the goods. Over the past 12 months
there have been customer complaints about the delay between sales orders and receipt of
goods. Wiggins has investigated these and found that, in each case, the sales order had
been entered into the sales system correctly but was not forwarded to the despatch
department for fulfilling.

Wiggins’ retail customers undergo credit checks prior to being accepted and credit limits are
set accordingly by sales ledger clerks. These customers place their orders through one of
the sales team, who decides on sales discount levels.

Raw materials used in the manufacturing process are purchased from a wide range of
suppliers. As a result of staff changes in the purchase ledger department, supplier statement
reconciliations are no longer performed. Additionally, changes to supplier details in the
purchase ledger master file can be undertaken by purchase ledger clerks as well as
supervisors.

In the past six months Wiggins has changed part of its manufacturing process and as a
result some new equipment has been purchased. However, there are considerable levels of
plant and equipment which are now surplus to requirement. Purchase requisitions for all
new equipment have been authorised by production supervisors and little has been done to
reduce the surplus of old equipment.

Required:

In respect of the internal control of Wiggins International Co:

(a) Identify and explain SIX weaknesses in the systems;

(12 marks)
(b) Recommend a control to address each of these weaknesses;
(6 marks)
(c) Assuming that your recommendations are accepted, describe a test of control
Cavendish & Co would perform to assess if each of these controls is operating
effectively at the next audit.
(6 marks)
Note: 1 presentation mark is available
TOTAL 25 MARKS
NO. Weaknesses Explaination
1. Lack of integration The website does not have real-
between website timeintegration with the inventory
andinventory system system, leading to the possibility of
accepting orders for items that are
out of stock or not available. This
can result in customer
dissatisfaction and delays in order
fulfillment.
2. Inadequate The local couriers do not
recording of goods consistently record customer
receipt signatures as proof of receipt of
goods. This creates a risk of
disputes regarding delivery and
potential loss of revenue if
customers claim non-receipt of
goods.
3. Sales orders not There is a breakdown in the
forwarded to the process of forwarding sales orders
dispatch department to the dispatch department,
resulting in delays and customer
complaints. This suggests a lack of
communication and coordination
between departments, which can
lead to inefficiencies and customer
dissatisfaction.
4. Lack of controls Due to staff changes, supplier
over supplier statement reconciliations are no
statement longer performed. This increases
reconciliations the risk of errors and irregularities
in the purchase ledger, such as
unauthorized payments or missed
invoices, which can lead to
financial misstatements and
potential fraud.
5. Insufficient controls Both purchase ledger clerks and
over changes to supervisors have the ability to make
supplier details changes to supplier details in the
purchase ledger master file. This
lack of segregation of duties
increases the risk of unauthorized
changes to supplier information,
which can result in fraudulent
activities such as payments being
directed to unauthorized accounts.
6. Ineffective Despite the purchase of new
management of equipment and changes in the
surplus plant and manufacturing process, little has
equipment been done to reduce the surplus of
old equipment. This indicates a lack
of proper inventory management
and disposal procedures, which can
lead to inefficient use of resources
and potential loss of value.
Recommendation
Implement real-time
integration between the website
and inventory system to ensure
accurate stock availability and
prevent customers from
ordering out-of-stock items.
Improve recording of goods
receipt by implement a system
where local couriers are required
to obtain customer signatures
upon delivery to ensure proof of
goods receipt. This will reduce
disputes and provide evidence of
delivery.
Strengthen sales order processing
by establish a clear process for
forwarding sales orders to the
dispatch department promptly
upon receipt, ensuring effective
communication and coordination
between departments.
Reinstate regular supplier
statement reconciliations to
ensure accuracy and
completeness of purchase ledger
balances. This will help detect
and prevent errors or
irregularities in supplier
transactions.
Implement controls that restrict
the ability to make changes to
supplier details in the purchase
ledger master file to authorized
personnel only. This segregation
of duties will reduce the risk of
unauthorized changes and
potential fraud.
Improve management of surplus
plant and equipment by develop a
comprehensive plan to dispose
of surplus plant and equipment
efficiently, including strategies
such as selling, leasing. This will
optimize the use of resources and
potentially generate revenue.
(c)
1. Test of control for integration between website and inventory system: Select a sample of
orders placed through the website and verify that the system accurately checks inventory
levels in real-time to prevent orders for out-of-stock items.

2. Test of control for recording goods receipt: Select a sample of delivered orders and verify
that customer signatures are consistently obtained and recorded as proof of goods receipt.

3. Test of control for sales order processing: Select a sample of sales orders and trace them
to the dispatch department's records to ensure that all orders are promptly forwarded for
fulfillment.

4. Test of control for supplier statement reconciliations: Select a sample of supplier accounts
and verify that reconciliations have been performed by comparing supplier statements with
the purchase ledger records.

5. Test of control for changes to supplier details: Select a sample of supplier changes made
in the purchase ledger master file and verify that they have been authorized by appropriate
personnel and supported by valid documentation.

6. Test of control for management of surplus plant and equipment: Select a sample of
surplus equipment and verify that there is a documented plan for disposal or repurposing
and assess whether actions have been taken in accordance with the plan.
CASE STUDY 2 – QUESTION 2

Earlier this year, LMU Ltd appointed Jo Kerr as their Internal Auditor. Having just completed
a preliminary review of the system of internal control within the organisation, a report was
prepared for the internal audit manager. This report is summarised below.

To: Pat Man (the Chief Accountant and Internal Audit Manager)
From: Jo Kerr, Internal Auditor
Date: 3 November 20X5

Subject: Preliminary Review of Internal Control

My initial inquiries seem to indicate the existence of certain weaknesses in internal control
within the organisation. The most serious deficiencies are set out below.

(1) Urgent orders were frequently received late in the week. In these circumstances, it
was found to be common practice for sales personnel to make out orders and finalise
the sale over the weekend, when the company was officially closed. Sales
documentation was completed and, in the absence of accounting staff, computer
based accounting records were updated for the sale and any cash received.

(2) An invoice for an entry in a trade journal had been received and paid by accounts
department, even though the advertising feature had not been requested by the
company.

(3) The main office building, containing several micro computers, a video recorder and
other electrical equipment, was left unlocked and unattended at night.

(4) Bank reconciliations, to agree the accounting records with the bank, had not been
prepared since January.

(5) A newly appointed trainee buying clerk had accepted a £65,000 order from a
customer who had already exceeded his credit limit. Several similar instances
involving large orders being accepted by junior members of staff were also identified.

(6) No monthly sales analysis, aged debt analysis, stock control, or cash flow information
(budgeted or actual), have been prepared at any time during the year.

REQUIRED:

Prepare a management letter to LMU Ltd addressing the following:

a) Identify weaknesses in the systems and controls

(8 marks)
b) Suggest potential implications of these weaknesses
(8 marks)
c) Recommend improvements
(8 marks)

TOTAL 25 MARKS
Management Letter

To: Pat Man (the Chief Accountant and Internal Audit Manager)
From: Jo Kerr, Internal Auditor
Date: 3 November 20X5

Subject: Preliminary Review of Internal Control

We have completed a preliminary review of the system of internal control within LMU Ltd
and identified several significant weaknesses that require urgent attention. These
weaknesses pose potential risks and could have adverse implications for the company's
operations and financial stability. We have outlined the weaknesses below, along with their
potential implications, and provided recommendations for improvement.

(1) One significant weakness identified is the unauthorized weekend sales processing. This
practice allows sales personnel to complete sales transactions and update accounting
records over the weekend, when the company is officially closed and accounting staff are
absent. The implication of this weakness is that it opens the door to potential problems such
as incomplete or inaccurate sales documentation and the misappropriation of cash received.
As a result, there is a heightened risk of financial misstatements and the occurrence of
fraudulent activities within the sales process. To address this weakness, it is recommended
that LMU Ltd implements controls to prevent unauthorized weekend sales processing. This
may include limiting access to accounting records during non-business hours and
establishing clear procedures that require all sales transactions to be properly authorized
and recorded within the designated working hours. By doing so, LMU Ltd can enhance the
accuracy and integrity of its sales processes, reducing the risk of financial misstatements
and potential fraud.

(2) Another weakness identified is the payment for an unrequested advertising feature. This
weakness implies a lack of proper authorization and review procedures for invoices within
the accounts department. As a result, there is an increased risk of making payments for
goods or services that were neither requested nor received by the company. This exposes
LMU Ltd to financial losses and potential damage to its reputation. Therefore, it is
recommended that LMU Ltd strengthens its invoice approval processes. This can be
achieved by implementing a formal authorization procedure, which involves designated
individuals reviewing and approving invoices before payment. The review should ensure that
invoices are accurate, legitimate, and supported by appropriate documentation. By
implementing this control, LMU Ltd can minimize the risk of making payments for
unauthorized or unnecessary expenses, thereby safeguarding its financial resources and
preserving its reputation.

(3) Another weakness identified is the unsecured main office building. The implication of this
weakness is that it poses a significant security risk to the valuable equipment housed within
the office, including microcomputers and a video recorder. The absence of proper security
measures increases the likelihood of theft or damage to the equipment, which can result in
the loss of sensitive information and disrupt business operations. To address this weakness,
it is recommended that LMU Ltd implements physical security measures to protect the main
office building and its contents. Access controls should be put in place to limit entry to
authorized personnel only. This can be achieved through the use of secure entry systems
such as key cards or biometric authentication. Additionally, installing alarms and surveillance
cameras can act as deterrents and provide a means of monitoring and recording any
unauthorized access or suspicious activities.

(4) Weakness identified in the internal control system of LMU Ltd is the lack of bank
reconciliations. This weakness arises from the failure to prepare bank reconciliations since
January. The implication of this weakness is that it increases the risk of undetected errors
and irregularities within the company's financial records. Without regular bank
reconciliations, unauthorized transactions or misappropriation of funds may go unnoticed.
Furthermore, the absence of timely reconciliations prevents the identification and resolution
of discrepancies between the company's accounting records and the bank statements,
leading to inaccurate financial reporting. To address this weakness, it is recommended that
LMU Ltd establishes a regular schedule for bank reconciliations. These reconciliations should
be performed on a monthly basis by independent personnel who are separate from the day-
to-day financial operations. By assigning this responsibility to independent personnel, it
helps ensure the integrity and objectivity of the bank reconciliation process.

(5) Another weakness identified in the internal control system of LMU Ltd is the acceptance
of orders exceeding credit limits by junior staff. This weakness indicates a lack of proper
credit control procedures and oversight. The implication of this weakness is that it exposes
the company to significant credit risk. Allowing junior staff to accept orders from customers
who have already exceeded their credit limits increases the likelihood of bad debts, strained
customer relationships, and potential financial losses. It is recommended that LMU Ltd
strengthens its credit control procedures by implementing a formal approval process for
accepting orders. This process should include a review by a designated credit control
authority, such as a credit manager or supervisor, before exceeding credit limits. The credit
control authority should assess the creditworthiness of customers and evaluate the potential
risks associated with accepting orders that exceed their credit limits. This review process
should consider factors such as the customer's payment history, creditworthiness, and
overall financial position.

(6) Last weakness identified in the internal control system of LMU Ltd is the lack of
management information and analysis. This weakness stems from the absence of monthly
sales analysis, aged debt analysis, stock control, and cash flow information throughout the
year. The implication of this weakness is that it deprives the management of crucial insights
necessary for effective decision-making, planning, and monitoring of the company's financial
performance. To address this weakness, it is recommended that LMU Ltd develops and
implements regular reporting procedures for essential management information and
analysis. This includes establishing processes to generate and review monthly sales analysis,
aged debt analysis, stock control reports, and cash flow information. These reports should
provide management with timely and accurate data, enabling them to make informed
decisions and proactively manage financial resources.

Yours faithfully,

Jo Kerr
Internal Auditor
Cavendish & Co