Lumos Computing Limited (PCL), a private company, buys computers, parts and related equipment and resells them at
Question:
Lumos Computing Limited (PCL), a private company, buys computers, parts and related equipment and resells them at a markup using the Internet and at its four warehouse store locations. Corporate and retail customers stay loyal to PCL due to its low annual maintenance fees and excellent customer service. This is important, as the technology sales and services area is highly competitive.
The owner is involved in all business decisions, particularly in the purchasing decisions (models and quantities) and in the approval of credit for all new corporate customers. He also approves all transfers from the bank loan to the general bank account for operating finance needs. The bank loan is secured by accounts receivable and inventory. The company currently has substantial room on the bank loan, and does not see the need to renegotiate the loan in the near future.
PCL keeps minimal inventory - current model machines and peripherals for demonstrations to prospective customers as well as a maximum of five units of each model. Any remaining stock after new models are released is sold at a 30% discount. The implementation of the discount is announced via an email by the accounting supervisor, at the verbal request of the owner.
Corporate customers send their orders to PCL using various methods: some use EDI (electronic data interchange), others use e-mail, fax or regular mail. Once the order is received at the administrative offices, it is entered into the sales order system. The computer systems automatically check the order plus the accounts receivable amount to determine whether the resulting total is less than the customer credit limit. If it is, then the order is routed to the closest warehouse for processing. If the order amount causes the customer accounts receivable balance to exceed the credit limit, then the order is routed to the corporate customer sales manager for review and approval (if warranted). If the order plus accounts receivable is more than $5,000 over the credit limit, then the order is reviewed and approved (if warranted) by the owner. Although PCL has many customers, most do stay within their credit limits, and there are only a handful of orders that need to be reviewed on a weekly basis.
As part of your audit, you used Audit Software to print a list of all customers who had accounts receivable balances that exceeded their credit limit. To your surprise, there were about 150 such customers. Most were over their credit limit by $3,000 or $4,000, while there were about ten who had greater excesses, one with a credit limit about $50,000 less than the accounts receivable balance. Upon talking this over with the corporate customer sales manager, she explained that she routinely approves customer purchases that are within the $5,000 range. The owner stated that the other amounts were due to customers that had been provided with goods on consignment. If they were not sold within about 45 days, they could be returned. The owner explained that he permits consignment sales only if there are no new models expected, so that PCL can sell the products if they are returned by the customer.
The receptionist is responsible for recording payments received by customers in the mail. She also retrieves EDI and automatic banking records to record amounts received by e-payments. Once every three months or so she produces an aged accounts receivable trial balance and points out to the owner if corporate accounts have gone into arrears by more than six months.
Required:
A. Assess audit risk.
- (2 Factors that Increase Audit Risk (4 marks), 3 Factors that Decrease Audit Risk (6 marks) and Conclusion
B. Assess internal controls at PCL with respect to sales and accounts receivable.
- Provide two strengths in internal controls. Describe the strength and explain why it is important.
- Provide five draft management letter points discussing internal control weaknesses for inclusion in the management letter to the client.
- Organize your management letter points clearly, labeling:
- W - weakness in internal controls
- I - impact to the clienfs operations or financial statements of the weakness
- R - recommendation to the client for improvement
- Conclude on Control Risk
C. Assess risk of material misstatement (IR x CR) for the valuation assertion of accounts receivable.
- (3 Factors that Increase RMM (3 marks) , 2 Factors that Decrease RMM (2 marks) and Conclusion