AUDITING/ ETHICS/ INTERNAL CONTROL
GRADE 12 : E4
1. Which income and expense items should the internal auditor focus on?
2.1. Sales & Cost of Sales
* One of the most important figures for a business is the Sales figure. The current year’s sales figure sits at R3 230 000 which is R670 000 less than the previous year’s figure of R3 900 000 i.e. a decrease of 17.18%. The reason for this could be a lower percentage mark-up. The business could also be at a stage of lower economic activity. This can be seen as suspicious and the internal auditor would need to investigate a possibility of fraud or error as will be discussed below.
* The cost of sales account has decreased substantially by R790 000 to R1 810 000 in the current year from the previous year’s figure of R 2 600 000 i.e. A decrease of 30.38%. This indicates that the business had a worrying decrease in economic activity in the past year.
The remarkable decrease in the cost of sales figure, somewhat justifies the dramatic decrease in the sales figure. Although these trends do correlate, the internal auditor would still be required to identify where the cause of the downturn in economic activity.
* The profit percentage of sales for 2005 is 44%, a 10.7% increase from 33.3% in 2004. This trend would suggest that the business has grown because profitability has increased. However, judging by the Sales and Cost of Sales figures, the business has not grown in terms of economic activity.
Testing to see whether the business has maintained its the profit margin:
2005: Profit Mark-up = Gross Profit/ (Sales – Cost of Sales) x 100 Cost of Sales
= 3 230 000 – 1 810 000 x 100 1 810 000
2004: Profit Mark-up = Gross Profit/ (Sales – Cost of Sales) x 100 Cost of Sales
= 3 900 000 – 2 600 000 x 100 2 600 000
This increase in the mark-up on stock is worrying for the business, and if true, can be the cause of the sudden decrease in economic activity. In most businesses, the mark-up stays relatively constant or does shift marginally either way. There must be some errors/or fraud in the calculations of the sales and cost of sales accounts.
* The Net profit figure has shown an increase by R11 000 from R381 000 in 2004 to R392 000 in 2005, even though there was a decline in economic activity (sales and cost of sales figures decreased, but profit increased). The auditor must address the going-on concern principle to the directors of the company and find out if they wish to sell their business within the near future. It would be a good idea to raise profits if they intend to sell. However, if this is not the case, then inflating profits means additional taxes to SARS.
Though we may not be able to prove that the figures are inaccurate, we can conclude that an auditor needs to investigate these accounts to identify why the financial indicators are producing conflicting results.
It is highly plausible that internal control measures in place for proper recording of sales are not up to standard. What this means is that perhaps the staff that records & processes Sales are either incompetent or dishonest. In the scenario where a sale is made in an emergency situation (power failures, computer crashes), it gets recorded on a piece of paper known as a Delivery note. In a big company it often occurs that this note gets ‘misplaced’ either in error or fraudulently. These sales may never be processed. If fraudulently, then a staff member may benefit from the ‘undeclared’ sale. The internal auditor must check whether the Delivery note...