Computer Aspects of Accounting System

 Mt. Hood Furniture, Inc. owns its own computer and computer software for sales, inventory management, purchases, payroll, general ledger, and other accounting applications. None of the accounting processing is outsourced. Mt. Hood's computer operations are headed by Jay Harris, the IT manager, who is relatively new to Mt. Hood. Jay also has taken on the responsibility for security administration. Mr. Harris recently hired Julie Macbeth as head of Systems Development. Ms. Macbeth has focused most of her attention on the development of a new system which was implemented at the beginning of the year. John Rufner is head of computer operations and is responsible for the day to day operations of existing computer systems, as well as installing hardware and operating system software associated with the new system. Keith Brown serves as an assistant to the CFO and also is responsible for the data control function. Keith reconciles computer output every morning and is responsible for following-up on exception reports generated by the computer system.

Mt. Hood's accounting and inventory management are supported by a network of personal computers (PCs) at locations in the offices and the central warehouse and a central server to handle all accounting and inventory files. Printers are located in areas in which printed documents or records are routinely needed. The computer is used to control and process most transactions, to print documents, prepare accounting records, and prepare periodic financial statements. The company uses a network housed on a HP 9000 server. Access is controlled by passwords, and passwords are changed regularly and are the company is conscious about password security. Only employees with jobs requiring computer data entry or access to file information and reports are given passwords. Passwords are required to enter the system and specific applications within the system, and employees have access only to specific programs and data. Once on the application, employees have access to most programs and can enter relevant data. All entered data are processed by batch processing at the end of the day. Data is stored on data base. Normal data entry takes place via the software, which subjects any input to various logical and numerical tests. Most input is backed up by paper trails of source documents and other business papers. The client has strong electronic backup capabilities and no hardware malfunctions have resulted in the loss of data.

Initiating Sales and Delivering Goods

The company sells its office furniture products to independent dealers in major U.S. cities, several national chains, and warehouse-club chains. The company also has an office cabinetry line that offers custom orders for on-site installation. Customers include major hotels, professional, and corporate offices. The company also produces a catalogue and has an information web site with an order link. Most sales orders are taken by company sales staff that visits the dealers and buyers for national chains (with the exception of orders that are taken from the order link on the Company's web site).

Approved prices are modified monthly based on quantities in inventory, recent production costs, and competitive forces in the marketplace. Prices are determined at a meeting involving the CEO (Conrad Saws) the COO (James Doyle) and the CFO (Julia Anderson). Julia Anderson is responsible for updating the master price file, which is reviewed by the entire team once new prices have been entered into the computer.

Finished products are shipped FOB from the warehouse or picked up by the customer. Sales terms on all office furniture and custom cabinetry are F.O.B shipping point, net 30, and interest is charged on all receivables over 30 days at a rate of the prime rate plus two percent. The company does not ship any inventory on consignment, but office furniture inventory has been shipped to new dealers with terms on an initial shipment of net 120 days, before interest is charged.

When orders are received from the sales staff they are routed directly to the warehouse where customers orders are input. The order is then electronically are compared with an approved customer list. If the customer is not on the approved customer list the order is routed to Keith Brown, assistant to the CFO, who reviews the prospective customer's credit background and prepares a report for Julia Anderson. Julia puts her written approval or disapproval on the credit report. If credit is not approved, Mr. Brown contacts the company directly and asks if the company is prepared to accept goods shipped C.O.D. If they will accept goods shipped C.O.D. the customer is put on the approved customer list with notation to ship only on a C.O.D. basis. If credit is approved, the customer is added to the approved customer list and the warehouse is notified so that it can ship goods. Julia Anderson and Keith Brown are the only individuals with authority to update the approved customer master file, which includes information on whether goods can be shipped on credit or C.O.D. When the customer sales order is electronically approved, Mt. Hood Furniture prints its own prenumbered sales order.

The warehouse prepares a shipment for customers with approved sales orders, and goods are shipped the same day or the next day for goods that are in stock. Goods not in stock are put on a back-order list that is shared with production. Using the computer, a warehouse clerk prepares printed copies of both packing slips and bills of lading. The computer does not allow the preparation of a packing slip or a bill of lading for companies not on the approved customer list. At the end of every day packages of packing slips and bills of lading, signed by the freight carrier or customer, are sent to accounting.

Recording Sales

Sales invoices are prepared in accounting by Paula Nicholson based on the information entered in shipping. The computer calculates an invoice based on the customer information, the information on goods shipped, and the pricing information from the master price file. The company also grants a 1% discount to dealers for orders over $50,000. The computer performs the following control procedures:

• The computer checks to see that the following fields have appropriate alpha or numeric information before the invoice is processed:
  • Customer information
  • Quantities ordered for each stock number
  • Quantities shipped for each stock number
  • Prices are checked against the master price list
  • Bill of lading number
  • The computer performs a reasonableness test on the amount of the sale invoice based on the customer number and customer sales history. A transaction is not processed without further approval if the calculated sales invoice is greater than 120% of the largest sale to the customer in the last two years.

Transactions that result in an error report are not processed and are printed on an error report. Keith Brown is responsible for clearing all exceptions the next day, including approving sales that exceed the reasonableness test. A report is also run comparing the number of items shipped with the number of items billed. This report also goes to Keith Brown for review and follow-up if necessary.

Keith Brown also queries the database each day to compare beginning receivables, plus daily sales, less daily cash receipts, with ending receivables, and he reconciles and corrects any discrepencies.

Cash Collections

All cash receipts are routed to the cashier, Megan Rogers, who prepares a prelisting of cash receipts and the bank deposit. Megan is also responsible for depositing cash and returning the validated deposit slip to Julia Anderson, the CFO. The prelisting of cash receipts is forwarded to Erin Riley in accounts receivable.

Erin is responsible for entering cash receipts in the computer. When the transaction is processed, the computer checks for appropriate alpha or numeric information in customer number and cash receipt fields before the cash receipt is processed. If these controls find errors, the routine is not processed. Keith Brown needs to follow-up and make a determination on the errors and needs to ensure that the run is correctly processed the next day. A report is also run preparing a listing of cash received which is forwarded to Julia Anderson for comparison with the bank deposit.

A separate report is printed of all customers whose balance results in a credit balance in accounts receivable. This report also goes to Keith Brown for review and follow-up if necessary. Monthly statements are mailed to customers the customers beginning balance, any monthly activity, and the customer's ending balance. If a customer complains, all calls are directed to Paula Nicholson as she is responsible for entering sales information.

Other Procedures

You may assume that you have concluded that the control environment is strong.

Keith Brown prepares a monthly bank reconciliation which is reviewed by Julia Anderson by the 10th of every month. Julia Anderson reviews an aging of accounts receivable weekly. She and Keith Brown follow-up on past due accounts. Julia Anderson prepares any journal entries to write-off accounts receivable. These reports are reviewed and approved by Conrad Saws. The company has had sufficient cash flow that it has not factored receivables.

REQUIRED

a. Evaluate the adequacy of segregation of duties in the revenue cycle. If you determine that segregation of duties need to be improved, write out a recommendation such that you (1) explain the issue, (2) summarize your findings, and (3) recommend improvements.

b. Evaluate the strengths and weaknesses in the sales cycle for Mt. Hood Furniture, Inc. using the table format on the following page. Organize your evaluation by audit assertion. Evaluate controls for the transactions class assertions for sale, the transaction class assertions for cash receipts, and the account balance assertions for accounts receivable. For each assertion

• Identify if internal controls related to the assertion are strong or weak.
• Describe the internal control strength or recommend a control if controls are weak.
• If internal controls are strong describe the nature of your test of controls. Leave this column blank for internal control weaknesses.
• Describe the substantive test that you would perform for the assertion.
• Discuss how you plan for the nature timing and extent of your planned substantive tests is affected the design of internal controls assuming that they operate effectively.