TechWear Case Study Parts III and IV This Module's assignment is a continuation of the extensive data analysis of TechWear's order-to-cash function which you started in Module 4. Part III: TechWear Ca

Part III Background:

One year has passed and it is now time to begin the 2016 audit. TechWear’s business has continued to expand. Our initial analysis of 2016 data indicates a much greater risk in accounts receivable (compared with 2015). When the audit team discussed this with company management, we were reminded that last year’s accounts receivable proved to be fully collectible and we were assured that this year accounts receivable would also prove to be fully collectible as well. Management indicated that, similar to 2015, there have been no product returns or accounts written off in 2016.

The senior has asked you to assist with planning the 2016 audit, beginning with the order-to-cash cycle, by focusing on accounts receivable and sales. In particular, she has provided you with the following key audit assertions that need to be addressed:

She has asked that, for each of these assertions, you describe the following at a high level:

• Audit objectives

• Things that could go wrong in TechWear’s sales and accounts receivable system

• Mitigating controls designed to prevent or detect such occurrences

• Audit tests that use data analysis (including graphical views) to obtain evidence

• Data requirements needed to run the tests

Your senior has already interviewed a number of key personnel (Director of Marketing and Sales, Shipping Supervisor, Business Office Director (responsible for billing and collections), Accounting Supervisor and the IT Director) and taken notes during these interviews, as follows:

General notes

TechWear has some very aggressive growth goals (targeting $38 million in global sales for calendar year 2016).

The excitement on social media has been very encouraging, resulting in very positive trends in the number and size of orders from existing customers, as well as some prominent new customers.

Sales personnel are under a significant amount of pressure to meet their monthly targets.

The production department is barely able to keep up with the orders. Some have expressed concern that product quality may be impacted in the future unless changes are made to improve the manufacturing infrastructure.

Management is planning a major renovation in early 2017 that will greatly expand its production capacity.

One individual involved with R&D expressed concern that the product may not function as designed in some less technologically developed environments with sporadic connectivity and slower transmission speeds.

Like many start-up companies, TechWear has operated with a very limited staff, resulting in an inadequate segregation of duties. At least two key employees are related, including the Director of IT and a top sales representative.

Director of Marketing and Sales

The Director oversees a small team of salespeople that market TechWear’s products to distribution outlets.

An order cannot be entered into the system unless the customer has been set up in the customer master file, which reflects data such as the customer’s name, identification number (assigned by TechWear), billing information and credit limits. Historically, the process to set up a new customer involved running an extensive background and credit check, which could take up to 30 days. However, due to complaints from sales personnel, management decided to create a “provisional status” that would enable immediate order fulfillment while the credit check is in process.

TechWear uses an order-entry system that enables sales personnel to generate an order. Once an order is entered, the system automatically generates a shipping order that appears on the shipping department’s order fulfillment log.

Shipping Supervisor

TechWear’s goal is to fulfill an order within 24 hours of its receipt. Orders entered near the end of the day (after the FedEx pickup time) are marked as “pending” and cleared out the following business day.

At the time of shipment, TechWear’s shipping clerk enters the shipping number into the system and the FedEx identification number (all shipments for the same day have the same FedEx identification number), which then releases the order, resulting in the sales transaction being posted (with a transaction number that matches the shipping number) and an invoice being generated. The invoice is sent either electronically or via mail to the customer. At the same time, the cost of inventory relieved for items sold is automatically generated and recorded based on the shipping number. Typically, the cost of sales ranges between 35% and 45%.

The ERP system automatically logs the date of shipment.

A listing of unfilled (pending) orders can be generated from the system based on orders entered that do not list a shipping number, FedEx identification number and shipping weight. One is rarely produced because the company historically has not had a problem with orders being unfulfilled beyond 24 hours.

The system allows an order entered late one day (noted as pending) to be overridden and released by the Director of IT as if the order had been fulfilled. The ERP system leaves no trail when this occurs, and simply removes the pending flag.

TechWear strongly believes in its products and has an unlimited 90-day return policy that allows a customer to return any product for any reason within 90 days of purchase. Additionally, it warrants its products against manufacturing defects for two years.

If a product is returned (which has not happened yet) the Shipping Department issues a credit memo to the customer, which results in a reversal of the sale.

Business Office Director (responsible for billing and collections)

Cash is collected either via checks received through the mail or a bank lockbox (which is the preferred method, given the size of its customers), whereby payments are posted by the bank directly into TechWear’s depository account.

Customer billing disputes, which management says have been rare, are resolved by the Business Office. Thus far, there have been no bad debt write-offs, which management credits to the quality of its products and its extensive background checks. On a quarterly basis, the Business Office reviews an “Aged AR” listing of old accounts warranting further attention. If necessary, an allowance for “bad debts” would be recorded in the general ledger. Actual bad debts would be charged against the allowance.

Accounting Supervisor

The Accounting Office is responsible for making the bank deposit. It also reconciles the depository bank account at month-end, ensuring that all cash receipts have been accounted for.

The main responsibility of the Accounting Office is to monitor daily sales and produce action reports for management. These are system-generated reports that are reviewed by an accounting analyst who flags adverse sales trends. The focus is on meeting company targets.

Director of IT

The IT Department (consisting of two individuals) is responsible for ensuring that TechWear’s website is running efficiently and is protected from internal and external threats. The Director has “super user” rights and can access any system. His assistant has full read-only rights and can only make changes to test files. The assistant has been charged with monitoring sales activity and ensuring continuity and security.

Requirements:

Complete the audit data analysis planning template on the following page and submit this template to your Instructor for grading and feedback.

Note the following:

• This template has been partially completed for you to provide examples about how to complete the template.

• The scope of this case study is limited to internal data (i.e., only internal data is provided and no external data). External data provides a higher form of evidence. Examples of external data include data from a bank, a vendor (like FedEx) or others. Additionally, some internal data supplied externally (such as sales tax filings) often is better than data only used internally.

• Note that testing of journal entries involving the general ledger, IT general and application controls, and controls over the financial statement close process are beyond the scope of this case study.

Important Additional Guidance:

This part of the case study seeks to build a bridge between audit assertions and audit procedures (especially ones involving data analysis) for the order-to-cash cycle by considering — at the assertion level — audit objectives, what-can-go-wrong (i.e., risks), controls and audit procedures. The data requirements to perform the audit procedures are also identified. You are provided with the results of interviews of TechWear employees performed by the audit senior. You are asked to complete an audit data-planning analysis template.

The template has been partially completed to better assist you in completing the required tasks.

Note that the scope of this case study is limited to internal data (i.e., only internal data is provided) so testing of external data should not be considered in completing the template. Also, note that testing of journal entries involving the general ledger, information technology (IT) general and application controls, and controls over the financial statement close process are beyond the scope of this case study.

Below explains some more details regarding the audit process surrounding data analytics before beginning this part.

• Auditors need a deep understanding of the business processes involved and the purpose for employing technology (which involves asking the right questions). It is necessary first to identify what data is needed and available. Only then, are auditors in a position to design tools and capture and transform data.

• Audit assertions are the specific implicit or explicit claims and representations made by management regarding the appropriateness of the various elements of financial statements and disclosures. Auditors test the accuracy of assertions. The tests they develop consider the risk of misstatement (i.e., what can go wrong and what controls are functioning that would prevent or detect such errors). The audit procedures that can be performed depend on the data that is available.

• Walk through the examples provided in the template and ask your Instructor any questions you have on those examples.

• Modern data analysis has enabled the auditor to move from sampling to testing 100% of a population. It also enables more timely application of procedures. As a result, some previously infeasible approaches to auditing may now be employed. For example, in the area of accounts receivable, the auditor previously relied heavily on circularization of receivables (i.e., sending confirmations), whereby for a sample of accounts, the auditor would ask the customer if they agreed with the amount the company showed as due from them. With data analysis, auditors would now see if (and how) an account was settled. So rather than asking if the customer owed a certain amount, the auditor can see if they paid the amount the company showed as previously outstanding, gaining evidence not only of existence but also of collectability — and not just for a sample but for the entire population.

• The pros and cons of internal and external data are important to understand. External data provides a higher form of evidence. Examples include data from a bank, a vendor (like FedEx) or others. But the downside is that external data is often more challenging to acquire. Some internal data supplied externally (such as sales tax filings) may be better than data only used internally because of the extra level of scrutiny it may be subject to by external parties.

• Note the process of data acquisition and the related challenges. This might bridge the gap in understanding being introduced to IT may have (e.g., ledgers [subledgers vs. files], fields and self-balancing debits [credits vs. unassociated alphanumeric characters]).

• Take note of the American Institute of Certified Public Accountants Audit Data Standards related to the order-to-cash cycle. A process map for this cycle is included as well and this might be helpful for students to review (Figure 2: Data Relationships among Tables in the O2C Audit Data Standard). https://www.aicpa.org/interestareas/frc/assuranceadvisoryservices/pages/assuranceandadvisory.aspx