Question

Abid and Company manufactures a variety of pumps and valves that it distributes through several thousand plumbing supply houses as well as 100 manufacturer’s representatives. As a result of the less-than-favorable business conditions that have existed over the last several years, Abid’s cash flow situation has deteriorated. Accounts receivable have continually grown due to creeping extensions of time that Abid’s customers have been taking in remitting payments for supplies. In addition, as Abid has been easing credit to its customers, bad debts have grown to 3 percent of sales.
Abid’s president has hired Joe Jackler, an experienced cash manager, to improve
Abid’s liquidity position. Jackler met with Dora Mooney, Abid’s controller, and ascertained that Abid’s (1) product sales prices have a 20 percent margin over the sum of direct operating costs and all delivery and selling costs; (2) production is currently slightly less than full capacity; (3) current credit terms are 2/12, n/45, which is in line with industry practices; and (4) dunning notices are sent monthly on all past due accounts with telephone follow-ups for delinquent accounts in excess of $8,000. On average, customers currently pay 35 days after the sale. Delinquent accounts are sent to collection agencies when they reach a past due status of 12 months.
From a review of credit records, Jackler was able to group Abid’s customers into risk classes according to the probability of loss associated with sales to a customer, as follows:
After considering the available alternatives, Jackler has implemented the following changes to Abid’s credit policies in order to improve cash flow:
• The credit terms extended to customers will change to 2/10, n/30. Jackler believes the current customers will accept this change as a sound business decision and, consequently, there will be minimal effect on sales. The overall effects of this change will be to improve accounts receivable turnover, reduce the opportunity costs of carrying receivables, and identify potentially troubled accounts sooner to minimize write-offs.
• Customers in risk groups 1 through 5 will continue to have the customary credit extended to them; selling to groups 6 and 7 will be under more stringent credit terms, such as cash on delivery; and sales to group 8 will require advance payments. Jackler believes this change will cause a reduction in sales; however, this reduction will come from the high-risk customer profile.
• Collection efforts will be increased to ensure better compliance with the new credit terms.
Dunning notices will continue to be sent monthly; however, telephone follow-ups will be initiated for all delinquent accounts in excess of $2,000. Accounts outstanding nine months or more will be turned over to a collection agency. Jackler believes this action, coupled with the other changes in policy, will reduce bad debts to a level of 1 to 1.5 percent of sales.
Mooney is responsible for extending credit to customers who deal directly with the company and for establishing the guidelines under which manufacturer’s representatives operate. Mooney has tailored credit to various customers to meet their needs and over time has developed a close relationship with a number of the larger customers. In view of the indicated impact the new policies will have on company sales and production, as well as on some of the larger customers, Mooney performed her own risk study. She concluded that some of Jackler’s “risk classifications” were inappropriate and believes that some of the larger customers are better business risks than indicated in Jackler’s analysis.
Mooney did not share her findings with Abid’s president or with Jackler. She decided that to follow the policies in their entirety would reduce sales more than Jackler estimates and result in idle manufacturing capacity. Consequently, Mooney does not intend to totally comply with the new policies, particularly as they affect her larger customers.
What internal control strengths and weaknesses are indicated by the narrative?
What additional internal controls would you recommend in this situation? Evaluate
Mooney’s actions using the IMA code of ethics.


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  • CreatedAugust 06, 2015
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