Identify and explain two (2) weaknesses in the internal controls

In addition to providing the initial risk analysis for My Essential Care Limited. You have been asked to provide a preliminary assessment on the controls for  MyPet Limited (MyPet), a subsidiary of Essential Care Limited. MyPet is a distributor of specialised pet care products including shampoos, lotions and a small range of toys, throughout Australia and New Zealand.

MyPet uses an on-line computer system. No goods are manufactured in-house; rather, MyPet maintains an inventory of raw materials and sub-contracts the manufacture of its products to third parties. Approximately 30 suppliers and 20 sub-contractors are used, and all have proven to be reliable. You have made the following notes about three aspects of the inventory system:

  1. Procedures for raw materials

Purchase orders are automatically generated by the computer when the inventory of any raw materials fall below 70% of the prior month’s usage. The purchase orders contain the following details:

  • date;
  • supplier name and address; and
  • raw material needed.

Three copies of the purchase order (PO) are produced and distributed as follows:

  • Copy 1 – to warehouse to enable follow up of late orders.
  • Copy 2 – filed by accounts clerk in date order.
  • Copy 3 – sent to the supplier.

When raw material inventories are received, the barcodes attached to the delivery boxes by the supplier are scanned into the system. A two-part Inventory Received Note (IRN), sometimes referred to as a Receiving Report, is then produced and distributed as follows:

  • Copy 1 – matched to warehouse copy of purchase order by stores staff.
  • Copy 2 – filed by accounts clerk.

The scanning process is aborted if the codes do not match those on the master file.

  1. Procedures for finished goods inventory

Production orders are automatically generated when finished goods inventory falls below 60% of the prior month’s sales. The production orders contain the following details:

  • date;
  • sub-contractor name;
  • raw materials required;
  • finished goods inventory needed.

Two copies of the production order are produced:

  • Copy 1 – to the raw materials store for use as a ‘picking slip’, then it is packed with the raw material and sent to the supplier.
  • Copy 2 – filed by the production controller in date order.

When the finished goods inventories are received, the barcodes attached to the delivery boxes by the supplier are scanned into the system. A two-part IRN is then produced:

  • Copy 1 – is matched to the production controller copy of production order.
  • Copy 2 – is filed by accounts clerk.

The scanning process is aborted if the codes do not match those on the master file.

  1. Master file amendments

The inventory master file contains details of:

  • existing inventory items including codes and warehouse location;
  • approved suppliers and sub-contractors.

Orders will only be generated to suppliers and sub-contractors recorded on the master file.

Master file changes are made by the production controller for both raw materials and finished goods inventory. A master file amendment form is completed by the production controller and filed as a record of the changes made.


 

 

General notes

Separate systems, staff and warehouses are maintained for both raw materials and finished goods inventories.

The computer automatically selects the supplier of both raw materials and finished goods based on the:

  • latest price (as per their most recent invoice).
  • delivery times (based on the number of days between the date the purchase/ production order is raised and the date the goods are scanned by the warehouse).

Password access is as follows:

·         Stores staff (raw materials) Purchase order printing for raw materials only. IRN printing for raw materials.
·         Stores staff (finished goods) IRN printing for finished goods.
Production controller Production order printing, master file amendments.
·         Accounts clerk Master file amendments.

 

 

Required:

Please complete the following requirements and include your findings in the report prepared for question 1.

  1. Identify and explain two (2) weaknesses in the internal controls for each of the three aspects of the inventory system identified above, six (6) weaknesses in total. (12 marks)
  2. Discuss the implications of each of the weaknesses you have identified in part (a).    (6 marks)
  3. Assume your IT audit division is to perform testing of controls for the inventory systems described. Identify and explain three tests that you would recommend they perform.  (4.5 marks)
  4. Identify three (3) Computer Assisted Audit Techniques (CAATs) that you would request the IT auditors run to assist you in testing the valuation of inventory. (4.5 marks)
  5. Assume your IT auditors ran a CAAT on inventory data contained in MyPet’s management accounts. You intend to use this data to assist in your analytical procedures work. Identify two (2) tests that you would perform on the data produced by the CAAT, prior to placing reliance on the data. (3 marks)

 

Rationale

This assessment task will assess the following learning outcome/s:

  • be able to appraise the client’s business environment and apply the risk model.
  • be able to explain, select and apply procedures involved in the audit process.
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