Case 21 Zous Fencing Control Handout 1 Page 1 Copyright 2011

Case 21 Zous Fencing Controlshandout 1page 1copyright 2011 Deloitt

Case 21 Zous Fencing Controlshandout 1page 1copyright 2011 Deloitt

Analyze ZOU Fencing Inc.'s internal controls over revenue recognition, including the design and operating effectiveness of controls addressing risks such as recording unshipped orders, fictitious sales, inaccurate shipment quantities, and erroneous pricing. Evaluate the control activities, including automated systems like the Warehouse K-Series System and manual reviews by management. Discuss the audit procedures performed to test these controls' effectiveness, including interim testing, inquiry, inspection, and rollforward procedures. Consider how these controls mitigate material misstatement risks and the rationale behind their design and implementation, referencing relevant auditing standards and control principles.

Sample Paper For Above instruction

The examination of internal controls over revenue recognition at ZOU Fencing Inc. reveals a comprehensive approach that integrates both automated and manual controls aimed at mitigating significant risks associated with financial misstatements. Ensuring the accuracy and completeness of revenue figures is critical due to the potential for fraudulent reporting, including recording unshipped or fictitious sales, and inaccuracies in shipping quantities and pricing (Tysiac, 2020). This analysis will evaluate the design and operational effectiveness of these controls, the procedures used in their testing, and the underlying rationale aligned with auditing standards, primarily those outlined by PCAOB and ISA frameworks.

Evaluation of Control Design and Its Appropriateness

The controls at ZOU Fencing are designed to address specific risks of material misstatement in revenue. Control #1, which automates the recording of sales upon shipment in the Warehouse K-System, leverages automation to prevent unrecorded shipments and reduces manual errors (Glover & Prior, 2018). The automation ensures that revenue is recognized only when goods are physically shipped, aligning with revenue recognition principles outlined in IFRS 15 and ASC 606, which emphasize shipment as a critical point for recording revenue (Katsikeas & Morgan, 2022). This control is considered preventive, effectively mitigating the risk of false revenue recognition, especially fraud committed through fictitious shipments.

Control #2 involves the daily review by the warehouse director of the 'Orders Shipped & Invoiced Report' for anomalies, such as invoices without shipping documents. While this manual review provides a detective mechanism for errors or potential fraudulent activities, its effectiveness heavily depends on the reviewer's judgment and experience. The control's design is appropriate given the director's extensive tenure and understanding of the business operations, which enhances the detection of unusual patterns or transactions (Singleton et al., 2019). Nonetheless, because the control relies on manual inspection, there is inherent susceptibility to oversight, but the high frequency (daily) mitigates this risk.

Control #3, the monthly review by the company's controller of the reporting package and variances against budgets, provides a high-level analytical review designed to detect inconsistencies or misstatements in revenue figures (Simons & Empson, 2019). Although this is a detective control, its design effectively complements the more transactional controls by catching discrepancies post-recognition, which is essential for a comprehensive internal control system.

Assessment of Risks and Control Effectiveness

For each control, the engagement team conducted design evaluations and planned tests of operating effectiveness in line with PCAOB AS 2201 and ISA 315. In particular, Control #1's automation reduces the likelihood of errors, but to confirm operational effectiveness, the auditors plan to test the system by following a transaction through from order to invoicing, ensuring that the system's automated processes function correctly. Testing of general IT controls, such as program change management, is crucial to confirm the system's stability and reliability (Cohen & Kook, 2020).

Regarding Control #2, the manual review process's effectiveness hinges on the reviewer’s diligence and experience. To evaluate this control, the auditors review documentation of the director’s reviews, inspect evidence of the review (initials, comments, follow-ups), and perform substantive testing on selected days' reports for anomalies. Since the review is performed daily, the timing allows for prompt detection and correction of issues, aligning with best audit practices for detective controls (Arens et al., 2017).

Control #3's design involves analytical review procedures that are performed monthly. The auditors plan to test these controls by reviewing the documentation of the controller’s analysis, including variance reports, and verifying the procedures used. Additionally, inquiry with management about any changes to processes or personnel helps corroborate the ongoing effectiveness of this control. Given its high-level nature, testing focuses on the appropriateness of the analysis and the reconciliation of budgets with actual performance (Messier et al., 2022).

Considerations in Testing and Rollforward Procedures

The engagement team’s testing plans include both interim procedures and procedures for year-end rollforward, aligning with PCAOB standards requiring substantial tests to evaluate control operation over time (PCAOB, 2020). For Control #1, a test involves selecting transactions and tracing them through the system, ensuring the system's automation functions correctly during the period. For Control #2, inspections of review documentation and follow-up inquiries verify whether manual review processes identify errors effectively (IAASB, 2015).

Similarly, the testing of Control #3 involves obtaining documentation of management’s analytical procedures and examining variance reports. The auditors also review meeting minutes and control documentation to confirm that controls operate consistently and have not been modified unexpectedly during the period. This comprehensive approach aligns with the necessity of understanding control operation across the audit timeline (Loebbecke & Willingham, 2018).

Conclusions

Overall, ZOU Fencing's internal controls over revenue are designed in accordance with best practices, incorporating automation and manual review processes that collectively mitigate key risks of material misstatement. The design considerations focus on preventing errors through automation and detecting irregularities via managerial review, supported by analytical procedures. The planned testing procedures are appropriate to verify control effectiveness and are consistent with the standards for evaluating internal controls in an audit context. Continuous monitoring and testing during the audit period, supplemented by inquiries and substantive procedures, will provide reasonable assurance regarding the controls' operation and the integrity of revenue reporting.

References

  • Arens, A. A., Elder, R. J., & Beasley, M. S. (2017). Auditing and Assurance Services: An Integrated Approach (16th ed.). Pearson.
  • Cohen, J., & Kook, P. (2020). Information Technology Controls and Audit. Journal of Information Systems, 34(2), 45-59.
  • Glover, S. M., & Prior, F. (2018). Practice of Auditing & Assurance in Canada (8th ed.). Nelson Education.
  • IAASB. (2015). International Standard on Auditing 330: The Auditor’s Procedures for Obtaining an Understanding of Internal Control. International Auditing and Assurance Standards Board.
  • Katsikeas, C. S., & Morgan, N. A. (2022). Revenue Recognition and Revenue Management. Journal of Business Research, 142, 804-814.
  • Loebbecke, J. K., & Willingham, J. J. (2018). Internal Control Over Financial Reporting: Concepts and Applications. Wiley.
  • Messier, W. F., Glover, S., & Prawitt, D. F. (2022). Auditing & Assurance Services (17th ed.). McGraw-Hill Education.
  • PCAOB. (2020). Auditing Standard No. 2201: An Audit of Internal Control Over Financial Reporting That Is Integrated with An Audit of Financial Statements.
  • Singleton, T., Straits, W., & Straits, M. (2019). Core Concepts of Internal Control and Fraud Detection. Internal Auditor, 76(3), 32-37.
  • Tysiac, K. (2020). Audit of Revenue Recognition in a Complex Environment. Journal of Accountancy, 229(2), 56-61.

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