Referring to Delmoss Watergrant's policy for evaluating control deficiencies, determine if the following three deficiencies represent a control deficiency, significant deficiency, or a material weakness. Please consider each case separately and justify your answers.
(a) Sarbox's revenue recognition policy requires that all non routine sales (i.e. sales to clients other than dealerships) receive authorization from management in order to verify proper pricing and terms of sale. However, after examining a sample of non routine sales records you find that this control is not closely adhered to and that sales representatives offered discounts or altered sales terms that were not properly recorded in Sarbox's records. As a result, in instances when the control is not followed the recorded sales prices tend to be too high and/or terms are not correctly reflected in the sales invoice and the customers complain. In some situations, customers have cancelled orders due to the over-billing or changed sales terms. Non routine sales represent about 10% of Sarbox's sales revenue. From your sample testing of the authorization control, you find that the control doesn't operate 4% of the time, with an upper bound of 9% (i.e., based on your sample, you can be 95% confident that the exception rate does not exceed 9%).
(b) While examining Sarbox's period-end financial reporting process, you discover that revenue has been recognized on orders that were received and completed, but not yet shipped to the customer. No specific goods were set aside for these orders; however, there is sufficient inventory on hand to fill them. Also, you observe that some orders were shipped before being recorded as sales, so that your best estimate of total revenue cutoff error at year-end was approximately $2.3 million.
(c) Sarbox Scooter requires that all credit sales to new customers or to customers with a current balance over their pre-approved credit limit be approved by the credit manager prior to shipment. However, during peak seasons this policy is not strictly followed in order to accommodate the need of both the company and its customers to have orders processed rapidly. Because of these findings, you estimate that the allowance for doubtful accounts is materially understated. While the client does not dispute that the authorization control was not operating effectively during peak seasons, the client has pointed out compensating controls that it feels should reduce the magnitude of the deficiency below a material weakness. The first compensating control is that an accounts receivable aging schedule is reviewed each quarter by management and accounts that are older than 180 days are written-off. Also, management distributes a list of companies that default or fail to pay on time to all sales staff on a monthly basis to prohibit such companies from making additional purchases on credit.