Best Tiles Limited (BTL) sells clay tiles to the construction industry and has been in existence for the last four years. During this period, the financial controller has been refining the system of internal control and informs you that he has put together an internal control manual for the company. He has stated that this manual will create greater awareness of controls in the company, particularly with management which, in the past, has not been overly conscious of the need to implement and enforce effective internal controls.

QUESTION

Best Tiles Limited (BTL) sells clay tiles to the construction industry and has been in existence for the last four years. During this period, the financial controller has been refining the system of internal control and informs you that he has put together an internal control manual for the company. He has stated that this manual will create greater awareness of controls in the company, particularly with management which, in the past, has not been overly conscious of the need to implement and enforce effective internal controls.

Management staff receive bonuses based on certain agreed-upon target ratios which include measures such as targeted monthly sales volumes, variance of actual to budget departmental overheads and profit before interest and tax. The major shareholder takes an active interest in the performance of the company and is quick to request explanations on variances from the agreed-upon monthly budgets.

Two years ago, the company devoted significant time and resources to the development and implementation of a new IT system. All teething problems associated with the implementation phase have now been resolved and the financial controller is satisfied that the automated controls in place are assisting in producing accurate and complete accounting records. The sales director also looks after the IT function as the position is not regarded by management to be a full-time job. Once application programs have been tested, strict password control exists over access to the programs. Passwords are not required for access to databases.

The following information has been extracted from a review of the systems notes in the permanent file and perusal of the new internal control manual:

1. A) Manual delivery notes for despatch of tiles to customers are raised by the despatch department from the sales order form. Where a delivery is only partially filled, the delivery note is marked ‘hold for invoice’ and placed on the incomplete deliveries file. At month end, the supervisor of the despatch department is responsible for follow-up of the reasons for incomplete deliveries outstanding for greater than 30 days.
2. B) Returns of tiles by customers due to breakages, inferior quality, incorrect specifications or oversupply are received by the despatch department where staff are required to check quantity and condition of the returned tiles. Details noted by the despatch personnel, including the reason for the return, are recorded on a goods returned note. Once completed, this document is passed on to the trade receivables clerk who raises a credit note and sends it to the customer.
3. C) Once a delivery has occurred, the office copy manual delivery note is forwarded to the trade receivables clerk who is responsible for generating an invoice on the computer system. An invoice is raised by inputting the total quantity delivered (note: this could be a number of partial deliveries) and the stock code which are both recorded on the delivery note. The computer then automatically retrieves the stock code price from the selling price master file. Posting to the debtors account occurs automatically once the trade receivables clerk has performed a screen check on the accuracy of the input of delivery details.
4. D) For valued customers, discounts are applied in accordance with the company’s volume rating system. The trade receivables clerk is responsible for updating the individual customer volume ratings every six months after preparing the ‘sales volume analysis by customer’ report. This report is authorised by the sales director prior to updating the customer discounts.
5. E) A sales journal summarising all sales invoices is prepared monthly by the computer system. This journal is then used by the trade receivables clerk for posting to the general ledger.
6. F) Receipts from debtors are passed on to the trade receivables clerk after having been opened by the mail room. The trade receivables clerk lists all receipts from the debtors and then prepares a bank deposit slip. The list prepared by the trade receivables clerk is used to enter the debtors’ payments on the computer system. The batch total of postings to the individual debtors’ accounts is balanced to the bank deposit slip before processing occurs on the system.
7. G) At each month end, the trade receivables clerk prepares a reconciliation of the trade receivables ledger to the debtors control account in the general ledger.
8. H) The computer generates an aged analysis at month end based upon all invoices that have been processed onto the system for the period up until the last day of the month.
9. I) The financial controller obtains the latest trade receivables aged analysis at the end of each month and reviews all amounts outstanding for longer than 90 days. The trade receivables clerk is required to detail reasons for delays in payment by long outstanding debtors and the financial controller discusses items of concern with the clerk.
10. J) Usually an action plan is agreed for follow-up; this may include involvement of debt collectors or the issuing of writs. Where necessary, the financial controller records details of amounts that should be provided for as doubtful debtors. While performing this review, the financial controller notes the level of individual debtors’ balances and, in instances where he is uncomfortable with the level of this balance, he instructs the despatch area to withhold any shipments until a minimum prescribed payment is received.

REQUIRED  

1. Identify and briefly discuss five (5) factors at BTL you would need to consider in your assessment of the effectiveness of BTL’s control environment? (10 Marks)
2. Identify five (5) effective internal controls in the system and determine for each internal control, the risk that the control would/could mitigate. (10 Marks)
3. Identify and briefly discuss ten (10) weaknesses in internal control for sales and trade receivables that you would bring to BTL management’s notice in your management letter. (10 Marks)

4. ANSWER

5. Assessment of the Effectiveness of BTL’s Control Environment

   Management’s commitment to internal controls: It is crucial to assess the level of commitment demonstrated by BTL’s management towards implementing and enforcing effective internal controls. The financial controller’s efforts in developing an internal control manual indicate a positive step towards creating awareness and accountability within the company. However, management’s past lack of consciousness regarding internal controls raises concerns and requires evaluation.

    Incentives and performance measurement: The bonus structure tied to specific target ratios suggests that management staff at BTL are motivated by financial rewards. While this can be an effective driver for performance, it is essential to assess whether these targets align with the company’s overall objectives and long-term sustainability. There is a risk that employees may prioritize meeting these targets at the expense of other important control measures.

    IT system implementation and automation: The successful implementation of the IT system and the financial controller’s satisfaction with its automated controls indicate a positive step towards accuracy and completeness of accounting records. However, the fact that the sales director also handles the IT function part-time raises concerns about the adequacy of IT oversight and the potential for segregation of duties issues.

   Documentation and follow-up procedures: The existence of manual delivery notes, goods returned notes, and reconciliation processes demonstrates a commitment to proper documentation and follow-up (Patel & Chotai, 2011). However, it is essential to evaluate whether these procedures are consistently followed, reviewed, and monitored. In particular, the follow-up on incomplete deliveries outstanding for over 30 days should be closely scrutinized to ensure timely resolution.

   Risk management and doubtful debts: The financial controller’s involvement in assessing long outstanding debts and instructing the despatch area to withhold shipments until a minimum prescribed payment is received demonstrates a focus on risk management and mitigation of doubtful debts. However, it is important to evaluate whether this practice is consistently applied and if there is a systematic approach to identifying and managing potential bad debts.

   Effective Internal Controls in the System and Their Risk Mitigation

   Strict password control over access to IT programs: This control mitigates the risk of unauthorized access to sensitive information and helps ensure data integrity and confidentiality.

   Reconciliation of trade receivables ledger to the debtors control account: This control reduces the risk of misstatements or discrepancies between the subledger and the general ledger, enhancing the accuracy of financial reporting.

   Aged analysis of trade receivables at month end: This control provides visibility into outstanding invoices and helps identify potential collection issues or late payments, facilitating timely follow-up and risk management.

   Manual delivery notes and incomplete deliveries follow-up: By marking incomplete deliveries and investigating reasons for delays, this control helps identify potential issues with fulfillment or customer service, enabling timely resolution and customer satisfaction.

    Review of individual debtors’ balances and withholding shipments: This control allows the financial controller to assess the creditworthiness of customers and mitigate the risk of bad debts by ensuring a minimum payment is received before shipment (Chang, n.d.).

   Weaknesses in Internal Control for Sales and Trade Receivables

   Lack of segregation of duties: The sales director’s dual role as the IT function handler raises concerns about the segregation of duties, potentially compromising the integrity and reliability of financial information.

    Inconsistent follow-up on incomplete deliveries: While there is a procedure in place for follow-up, the effectiveness of monitoring and resolving incomplete deliveries outstanding for over 30 days needs improvement.

    Lack of formal approval process for updating customer discounts: The absence of a documented approval process for updating customer volume ratings and discounts increases the risk of unauthorized changes or potential favoritism.

   Limited control over password access to databases: The absence of password control for database access poses a risk of unauthorized changes to critical information or potential data breaches.

   Insufficient controls over credit note issuance: The trade receivables clerk’s responsibility for raising credit notes based on despatch personnel’s notes may lack adequate review and authorization, increasing the risk of errors or fraudulent activities.

   Lack of independent reconciliation of bank deposits: The trade receivables clerk’s preparation of the bank deposit slip without independent reconciliation increases the risk of errors or misappropriation of funds.

    Inadequate review and follow-up on long outstanding debts: While the financial controller reviews long outstanding debts, there should be a more systematic approach to documenting reasons for delays and establishing clear action plans for follow-up (RoosterCreativeMarketing, 2023).

   Absence of formal credit control policy: The lack of a documented policy for credit control, including criteria for assessing creditworthiness and credit limits, increases the risk of inconsistent practices and potential bad debts.

   Limited oversight and monitoring of IT controls: The part-time involvement of the sales director in the IT function raises concerns about the adequacy of oversight and monitoring of IT controls, potentially exposing the company to IT-related risks.

   Lack of regular internal control assessments: The internal control manual, while a positive step, should be supported by periodic assessments to ensure the effectiveness and adequacy of controls, addressing any evolving risks or deficiencies.

   In conclusion, while BTL has made efforts to establish internal controls and refine its control environment, there are several areas that require attention and improvement. Management should address the weaknesses identified in the sales and trade receivables processes to strengthen internal controls, enhance risk management, and ensure the integrity of financial information. Regular assessments, monitoring, and documentation of control procedures are essential for maintaining an effective control environment and mitigating potential risks.

   References

   Chang, R. (n.d.). How to proactively manage the late deliveries of supplier. www.linkedin.com. https://www.linkedin.com/pulse/how-proactively-manage-late-deliveries-supplier-rob-chang 

   Patel, K. B., & Chotai, N. P. (2011). Documentation and Records: Harmonized GMP Requirements. Journal of Young Pharmacists, 3(2), 138–150. https://doi.org/10.4103/0975-1483.80303

   RoosterCreativeMarketing. (2023, March 6). Credit Control Tips. Hilton-Baird Collection Services. https://www.hiltonbairdcollections.co.uk/credit-control-tips/