St. James Clothiers:
Evaluation of Manual & IT-Based Sales Accounting System Risks
St. James Clothiers is a high-end clothing store located in a small Tennessee town. St. James only has one store, which is located in the shopping district by the town square. St. James enjoys the reputation of being the place to buy nice clothing in the local area. The store is in its twentieth year of operation.
The owner, Sally St. James, recently decided to convert from a relatively simple manual sales system to an IT-based sales application package. The sales application software will be purchased from a software vendor. As the audit senior on the St. James engagement, you recently asked one of your staff auditors, Joe McSweeney, to visit with the client more formally to learn more about the proposed accounting system change. You asked Joe to review the narrative in last year's working papers that he prepared, which describes the existing manual sales accounting system, and update it for any current-year changes. You also asked him to prepare a second narrative describing the proposed IT-based sales accounting system, using information he obtained in his discussions with St. James personnel. The narrative from last year's working papers as well as the narrative recently prepared by Joe are provided in the pages that follow.
The audit partner on the St. James engagement, Betty Watergate, has asked you to review the narratives prepared by Joe as part of your audit planning procedures for the current year's 12/31/06 financial statement audit. Betty wants you to prepare a memorandum for her that addresses these questions:
1. What aspects of the current manual sales accounting system create risks that increase the likelihood of material misstatements in the financial statements? Specifically, identify each risk and how it might lead to a misstatement. For example, don't just put "Risk: Sales tickets are manually prepared by the cashier." Rather, you should state why this increases risks of material misstatements by adding "This increases the risk of material misstatements because it increases the risk of random mathematical errors by the cashier."
Hint: The question is asking what areas of the financial statements are likely to contain misstatements (which might ultimately impact on the auditor’s opinion and report) as a result of a lack of internal controls. Your task is to identify internal control weaknesses, and more importantly, how and why it may present a possible risk of error in the financial reports?
2. What features, if any, of the proposed IT-based sales accounting system will help minimize the risks identified in question 1? If a weakness exists that will continue with the new system, indicate that "no computer controls reduce this risk."
3. How does the IT-based sales system create new risks for material misstatements?
Hint: Discuss the merits of introducing an IT-Based Accounting System. With this in mind, think about potential errors that can still occur in the sales accounting system, even though the IT-Based system has been introduced. This may require to research computerised systems. This question also requires you to have a strong understanding of the sales and collections cycle. The application of this assumed knowledge and your personal experience will go some way towards identifying the potential misstatements that may occur in the sales system.
4. Prepare (draw) a flowchart documenting the sales accounting system.
Hint: Identify the key steps in the sales cycle. It might be useful to identify the key documents used, how many copies of documents should be prepared in your flowchart. Understanding of flow chart can be gained from the following links: http://home.att.net/~dexter.a.hansen/flowchart/flowchart.htm http://office.microsoft.com/en-us/assistance/HP030834741033.aspx
5. Prepare (draw) a flowchart documenting the...
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