Auditing Online Tutoring

Answer to Q1

The detection of fraud committed by an employee at Pellegrino Shores hints at its weak internal controls as the senior staff member was able to reduce fees of several residents of the retirement village without any authorization or approval process. Moreover, the fraud was only discovered accidently when another staff member overheard the conversation between the resident and the fraudster. This shows that there are no preventative or detective controls employed to discourage and limit the occurrence of fraud within the organization. The effects of the fraud on the business and the accounts and related assertions mostly to be affected are discussed below.

Lack of segregation of duties is clearly an issue as the fees and rates should be approved by credit control or sales department rather than someone who is responsible for managing the resident’s room location and changes therein. The unnecessary access to the resident’s database has further aggravated the problem which has enabled the fraudster to coordinate and collude with the residents. Hence there seems to be an absence of user authorization matrix which limits the ability to access information by users/staff organization-wide. This would result in understatement of revenue and the assertion affected would be completeness of sales revenue as most of the sales would go unrecorded in the organization’s accounting system despite the rooms being occupied.

Further, the amount of other services offered to the residents have also been altered by the senior staff member to make room for his own fraudulent receipts from the customers. Depending on the types of services provided to the residents, this would mean that the inventory of items being provided as services would be overstated as most of it would go unrecorded in the accounting system as the fraudster has reduced their value. The assertion directly affected would be valuation of inventories. Likewise, there is a possibility that expenses incurred by the organization in providing services to the residents would be undervalued as the services provided have been deflated by a senior staff member.

In view of above, there is a very high risk of material misstatement in the accounts due to fraud such that it is unlikely that any controls over the recording and accounting of revenue and related services provided are operating effectively. In such cases the auditor would have to design an audit strategy to perform extensive substantive procedures on all areas of the financial statements. In such a situation, the auditor shall estimate the amount of error in financial statements due to fraud (including its materiality) and its likely impact on the other areas of the financial statements, including the possibility of fraud conducted by other employees and its severity. If the auditor believes that the risk of misstatement due to inadequate controls and the fraud of employee is such that it cannot be reduced to an appropriately low level through above strategy and a material amount of revenue would remain unrecorded due to insufficient records or alteration in underlying accounts by the fraudster, then he may consider its impact on the overall financial statements and implication on audit opinion including whether it’s possible to continue the audit (ISA 240, paragraph 38).

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The changeover from the in-house developed IT system of recording revenue from patients to DHL’s ‘off the shelf’ revenue system is a major development during the period under audit and this means that controls relating to the recognition of patient revenue have significantly changed during the year. Accordingly, there is a risk that the new system of recording revenue might not be operating correctly and timely recording the revenue transactions. Auditors will need to design and perform tests of controls to obtain more persuasive audit evidence with regard to the operating effectiveness of controls relating to revenue recognition in the information system of the company. Since detailed testing of a large sample of revenue transactions would be impossible considering St. Neville’s is a highly regarded private and a popular hospital located in Tamworth, additional tests of controls will need to be performed based on the inquiries of management done by Jek Porkins. These are discussed hereunder:

It appears that there is a problem with process alignment in the new changeover IT system. This refers to the way that various IT systems (such as billing system, patient database and rates database in this case) are integrated with one another and thus operate, in effect, as one system, combining to achieve the reporting objective of the entity. Hence there is a high risk over the effectiveness of controls over revenue as there are various instances wherein:

Existing patients were wrongly billed, showing misaligned Billing system and Rates database;
Past patients have been invoiced showing ineffective working and alignment of the Patients’ database with the Billing system;
Some patients were billed at lower than the standard rates thereby evidencing disintegration between the Billing system and the Rates database.

As a result, following procedures are necessitated to be performed as test of controls in order to obtain reliance over the operating effectiveness of the newly implemented revenue recognition system at the hospital:

Obtain an understanding of how sales are recorded for each patient. The select a single transaction and perform a walkthrough test to understand how the transaction flows in the system and what documentation and computations are involved in each step until the final billing;
For a sample of transaction, perform test of controls to evaluate whether the controls identified above are operating effectively during the year;
Review global reconciliation of Sales, account receivables and inventory items at St. Neville’s. Identify the major reconciling items and understand what they pertain to. Whether they are recurring in nature and have they been corrected by the management;
Identify all types of errors including the ones explained by administration staff about the impact of switching to the DHL patient revenue system. Review and study the reconciliation for their logic and likely impact over the rest of sales before making any corrections.
Recalculate sales revenue for a sample of patients with high risk based on the formula given by the accounting personnel.

Based on the results of the above procedure, the auditor would devise an appropriate strategy for detailed substantive tests (IAASB, 2016). These tests could include:

Inspection of significant post year-end payments or credit notes to determine if revenue is overstated;
Reviewing last minute adjustments and cut-off date transactions more carefully
Review overall sales reconciliation and perform tests for verification thereof

The auditor can also gain important information about the new IT system for revenue by inquiring the internal auditors about:

Key security issues identified in the system and how management intends to address them;
User access controls over the system of revenue and whether there is an authorization matrix limiting certain user’s access to databases
Whether autosave controls are incorporated in the system and how the transactions occurring over the two week’s period have been ensured to be correct
Whether any instances of human intervention found in the otherwise automated processes

Answer to Q3

The sales force of Acuity Vision is paid a very low base salary and their majority take-home pay is in the form of bonus that depends on the sales generated by them. This results in high risk of overstatement in two major account heads of sales revenue and employees’ salary and wages which are dependent on the revenue.

The subsequent receipt testing procedure performed by Jek Porkins is relevant in determining whether all sale transactions were recorded prior to year-end and is to some extent relevant for completeness assertion of sales revenue and mainly relevant for the existence assertion of customer balances, but since it is unlikely that management would want to understate the revenue, all sales revenue would have been recorded and the major risk relates to whether sales revenue has been overstated by the employees who would be over-optimistic about the sales made by them and could be reporting revenue in advance to inflate their bonus. This is the reason why the procedure performed by Jek Porkins is mostly performed in trade payables where there is a high risk of understatement (in the form of unrecorded liabilities) rather than receivables (Jackson & Stent, 2015).

The assertions that are mainly at risk in relation to sales transaction are as follows:

Occurrence – i.e. the transactions reported by the sales force have actually happened and is an outright sale rather than their expectation or advance payments form the customers. In this regard the management needs to ensure that the sale that qualifies for bonus is the one under which medical supplies have actually been delivered to the customer with a valid acknowledgement from the customer. A point of sale software available with the salesperson would need to be integrated with the organization’s information system that ultimately records the transaction in its accounting system.
Accuracy – i.e., the sales transactions reported by the sales force should be recorded at the appropriate amounts. Since employee’s bonuses are linked with the dollar value of sales, they might be inclined to report inflated values and this needs to be taken care of by designing controls that reconcile the physical quantities of the inventory of medical supplies with their sales value.
Cutoff – i.e., only transactions that have happened within the period should have been recorded. Controls over the cutoff date transactions and how management intends to deal with transactions occurring close to the year end date are relevant in this case.

The above procedures would also ensure that the sales force is being remunerated for the bonus they are actually entitled to based on the correct value of sales revenue generated by them.

Customer payments testing

To test the effectiveness of his customer payments testing auditor could perform a number of procedures including the following:

Total on the list of individual debtors should be matched to control accounts of debtors and sub-accounts for each sales agent of the company in the general ledger and trial balance;
Debtors’ list should be reviewed for any credit balances or entries, reasons for them should be inquired and noted. Any reversals should be backed with necessary evidences and reasoning or this could indicate that employees are booking fictitious sales to artificially enhance their bonus payments;
An aging analysis of the customer balance should be periodically performed by management to identify long outstanding customer balances, doubtful or substandard customer balances;
First few and last few invoices of the period should be traced back to the delivery challans/notes to ensure that they were created and goods delivered to customers within the relevant period.
A period comparison of sales ratios to prior periods e.g. sales commission to sales, if commission to agents has increased, sales should have risen and vice versa.