Internal Control Weaknesses and Risks

This assignment delves into the internal control systems of a company, highlighting several weaknesses that pose significant risks. The analysis focuses on areas like order processing, bad debt write-offs, and the absence of an internal audit function. It demonstrates how these deficiencies can lead to inaccuracies in financial statements, potential fraud, and negative cash flows. The assignment concludes with recommendations for strengthening the control system to mitigate these risks.

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By student name
Professor
University
Date: 07 January 2018.
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Executive Summary
In the given assignment, a report needs to be prepared as an auditor of the Richardson’s who is
conducting an audit of the sales and the receivables area of the client named Clarkson Ltd. A series of
activities and the procedures being followed by the company has been identified starting from placing
an order by customers to delivery and collection from the debtors. The internal control beingmaintained
at the entity needs to be identified, both on the positive as well as on the negative side, which is
contributing to the effectiveness of the control and ones which is posiung a risk of material
misstatement in few of the accounts. Recommendations and conclusion have also been drawn based on
the above inputs.
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Contents
Executive Summary.....................................................................................................................................2
Internal control Activities in Clarkson..........................................................................................................4
Test of control for measuring effectiveness of control................................................................................5
Internal control weaknesses........................................................................................................................6
Account balance and assertion at risk.........................................................................................................7
Conclusion and Recommendation for implementation of control..............................................................8
References...................................................................................................................................................9
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Internal control Activities in Clarkson
Internal control is a group of activities which if properly implemented within the organization can lead to
strong control and lowers the risk of material misstatement within the organization. IN case the internal
control is strong within the organization, the auditor would have to apply less of substantive and
compliance audit procedures while doing auditing and vice versa in case it is weak. Furthermore, the
implementation of strong internal control practices are needed as per the SOX guidelines and
increasingly lowers the risk of frauds within the organization. The given company Clarkson has a lot of
internal control activities being implemented and practiced within the organization. Few of them are:
 The company is practicing segregation of duties is some of the areas like the sales cleark
prepares the sales order, the invoicing clerk prepares the invoice and the accounts clerk passes a
journal entry in the books of accounts. Two other staffs are there, one for receiving the cheques
by mails and recording the receipt and the other for taking custody of cheques. All this ensures
that no single person in the system can take control of the entire group of activities and override
the set procedures (Bizfluent, 2017). Since, it is being handled by many persons in chain, it can
easily help in identifying the material misstatement.
 The other critical control being placed by Clarksons is preparation and filing of the Sales order in
triplicate, one of which is sent to the shipping department, one to the invoicing and one being
held back at the sales department. This ensures no body in the loop misplaces the order copy
and there is proper documentation of all the orders received and no order can be intentionally
misplaced till final delivery is done.
 The 3rd control being placed is the bank reconciliations being prepared by the accounting clerk
on a monthly frequency which will help in identifying material misstatements, if any, and where
the gaps are. It further should be done by the independent person for the process to be risk
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free. Currently, he is also responsible for making the sales journal and updating the accounts
receivable subsidiary ledger. This can lead to fraud in some cases, therefore, different people
can be hired for the same.
Test of control for measuring effectiveness of control
The above stated control activities can be checked for its effectiveness by using the below test of
controls:
 The segregation of duties can be checked by checking the signature of the respective clerks and
officials on the sales order copies, the delivery challans, the warehouse receipts, the shipping
note, the delivery docket and the sales invoice. All of them should have the sign of the dedicated
personnel assigned with the job, it should be properly dated and most importantly since all of
them are pre numbered, it should be in a sequence and in case the same is not available, the
test of control fails.
 Since the sales order is prepared in triplicate, the same should be properly filed with all the
requisite supporings in 3 different departments namely the invoicing department, the sales
department and the shipping department. It should match in every single aspect and in case,
even one of the copies is missing or there is a same person at more than 1 place, the test of
control fails (Chron, 2017).
 The 3rd control being an accounting control w.r.t. bank reconciliation, it should be matching at
every month end with reasons being established for whatever differences are being established.
In case the same is not matching, then it is matter of concern and the risk of material
misstatement rises. The reconciliation in a more short interval like fortnightly will ensure further
effectiveness of the control.
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Internal control weaknesses
There are a lot of areas which still needs improvement for strong internal control to be implemented
some of which are:
 The orders from customers is received over emails and telephones without a proper
documentation. This may lead to misplacing of the orders and a situation where someone has
either fraudulently not recorded the order or has missed o (DeZoort & Harrison, 2016)ut on
recording the same as a sales order. This needs to be properly documented and have a better
tracking system.
 Other control weakness is the entire responsibility of taking decision on write off of the debtors
being given to the financial controller. Even though the credit manager is involved in the same,
but this can lead to forming groups and negotiation among the team and writing off huge
amounts as bad debts and hence the same should have involvement of the top management to
give the final decision and approval on bad debts as well as sales allowance as both impacts the
profits by great deal.
 In the entire list of activities, the internal audit function hasn’t been discussed, the same should
be implemented within the organization to check whether the proper documentation is there in
place or not, whether all the supportings are in place and window dressing is not being done.
Also, monitoring procedure in terms of credit days and outstanding debtors, collection and sales
analysis is missing which is very much required in order to retaliate a growing function within
organization.
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Account balance and assertion at risk
From the above identified weaknesses in the internal control system, below are the risks being posed:
 The order being received over mails and calls will directly impact the sales account and the cash
collection from the debtors. It will also lead to loss of inventory and improper bank
reconciliations if properly not recorded. This impacts management assertion that all the sales
have been completely accounted for.
 The authority for writing off debts and approving sales allowances directly impacts the net
margin by impacting the expenses GLs. If either of them is approved in case of inappropriate
sales, the same can lead to negative cash flows and losses. This impacts the assertion that bad
debts have been allowed after due course of action and efforts to collect the same, legal action
has been initiated and it is almost certain that the amount is not collectible.
 The absence of internal audit and financial management function directly impacts overall
financial statements, the revenue and collectability from debtors. It impacts the assertion that
the company is trying to bring debtors outstanding days in control and working to increase the
overall sales and revenue (Jones, 2017).
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Conclusion and Recommendation for implementation of control
In view of the above mentioned irregularities, there are many areas which can be improved to reduce
the risk of material misstatements:
 A proper online system of recording the purchase order by the customers can be put in place
such that nothing goes out of track and everything can be maintained electronically at customer
as well as order level. This will not only ensure proper recording of orders but 360 degree
analysis.
 Management can reserve some decisions and a proposal note should be there in place from the
financial controller for any major financial decision like bad debt writing off or changes in sales
allowance policy which should be approved and signed by the top management before
implementation.
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References
Bizfluent, 2017. Advantages & Disadvantages of Internal Control. [Online]
Available at: https://bizfluent.com/info-8064250-advantages-disadvantages-internal-control.html.
Chron, 2017. five-common-features-internal-control-system-business. [Online]
Available at: http://smallbusiness.chron.com/five-common-features-internal-control-system-business-
430.html.
DeZoort, F. & Harrison, P., 2016. Understanding Auditors sense of Responsibility for detecting fraud
within organization. Journal of Business Ethics, pp. 1-18.
Jones, P., 2017. Statistical Sampling and Risk Analysis in Auditing. NY: Routledge.
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