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TechWear is a privately-owned business that began operations in March 2015.

Analytics mindset

TechWear

Part I:

Background: 

TechWear is a privately-owned business that began operations in March 2015. Its sole business is the manufacture and sale of upper-end, high-tech sportswear. It only sells to large distribution outlets. Its primary product is a line of lightweight exercise clothes that contain a new, long-range RFID chip that captures the following information about the user based on personal data (age, weight, etc.) entered by the user: 

  • Heart rate
  • Perspiration rate
  • Calories burned
  • Exercise efficiency (percent of capacity)

The chip is able to continuously send this information to a host device as far away as 15 miles. The clothes are also GPS enabled and able to track routes, distances and elevations. Management prides itself on being on the cutting edge. The company expects to conduct an IPO within a year or two. 

TechWear recently retained your firm as its auditors, largely because of your commitment to conduct a highly efficient, technology-enabled audit.

Data

You are first responsible for performing a risk assessment of TechWear related to its order-to-cash function. Therefore, you know that your focus needs to be on sales and cash transactions. Your first task is to acquire the data for these transactions. You work with TechWear’s IT group to gain access to its sales and cash receipts data for its start-up period of operations, March through December 2015. You have been provided with an Excel file with this data (Analytics_mindset_case_studies_Techwear_P1.xls) so you can begin your analysis. The data file includes the following fields:

  • Type: this is the type of transaction, which is either a sale (Sales) or a cash receipt (CashReceipt).
  • Transaction Number: this is the transaction number (beginning with 1001). 
  • Applied To Transaction Number: this is the sales transaction number to which a cash receipt is applied.
  • CustNum: this is a unique customer number used to identify each customer.
  • CustName: this is the customer’s name.
  • TransactionDate: this is the date of the sale or cash receipt.
  • Amount: this is the amount of the sale or cash receipt. Cash receipts will show a negative amount.
  • InvoiceDate: this is the date the sale was invoiced (billed).
  • ShipDate: this is the date the goods were shipped.

Analytics mindset

TechWear

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:

Accounts receivable – account balanceSales – class of transactions
ExistenceOccurrence
CompletenessCompleteness
Valuation and allocationAccuracy
Classification and understandabilityCutoff
 Classification

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.

Required:

Complete the audit data analysis planning template on the following page. 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.
AssertionAuditing objectivesWhat could go wrong?Mitigating controlsData analysis auditing proceduresData requirements
Accounts receivable – account balance
ExistenceAmounts reported in the financial statements represent valid receivables.An order is placed and a receivable is recorded without any product being shipped.Debits to accounts receivable are only generated from the order entry system.Compare debits to accounts receivable against recorded sales.Review and test subsequent receipts.Evaluate proper segregation of duties by examining postings by source and preparer (e.g., sales only entered by authorized salesclerk).Sales amountsCash receipt amountsCustomer namesTransaction datesTransaction numbersGeneral ledger postings by preparer and source (e.g., order entry)
   A shipping number and FedEx identification number are entered into the system as evidence of order fulfillment and discrepancies are investigated.Verify that every sales transaction has a shipping number and FedEx identification number.Analyze gross margin percentage trends by month and by customer.Customer namesTransaction numbersShipping numbersFedEx ID numbersSales amountsCost of goods sold amountsTransaction dates
Completeness       
Valuation and allocation     
Classification and understandability     
Sales – class of transactions
OccurrenceAmounts reported in the financial statements represent valid sales.An order is placed and a sale is recorded without any product being shipped.A shipping number and FedEx identification number are entered into the system as evidence of order fulfillment and discrepancies are investigated.Verify that every sales transaction has a shipping number and FedEx identification number.Customer namesTransaction numbersShipping numbersFedEx ID numbersSales amounts
Completeness     
Accuracy     
Cutoff     
Classification     

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