Weakness And Real Earnings Management Essay

Question:

Discuss about the Weakness and Real Earnings Management.

Answer:

Introduction:

The current report aims to discuss the weakness in the internal control procedures of revenue cycle in Strings Private Limited. Strings Private Limited is a private Australian enterprise, which is involved in manufacturing musical instruments and parts needed for their repair. Along with this, the effects of such weaknesses on the organisation have been evaluated and accordingly, particular internal controls would be formulated in order to eliminate such weaknesses. The latter segment of the report concentrates on using systems development lifecycle for identifying five deficiencies in Queensland Health Payroll System. Hence, recommendations have been made for overcoming such deficiencies in future projects.

Based on the provided case study, it could be identified that the main internal control weaknesses in Strings Revenue Cycle comprise of the following:

As observed in the case study, 17% of the sales made on credit in the past year have to be written off as uncollectible, since the customers denied ordering or receiving merchandise. The problem in sales department of the organisation is that there is absence of any credit check to gain insights about the customer credibility. This is significant in generating profit for the organisation (Sun, 2016).

Another problem associated with the revenue cycle of Strings Private Limited is that the warehouse staff utilises the logbook for updating the inventory records. This implies that the warehouse clerk has access to inventory and the person could update the inventory ledger as well, which might be inaccurate (Jacoby et al., 2017).

The case study states that the organisation has experienced increase in the overall volume of sales this year, which have lead to large number of errors. This is because wrong items are delivered to the customers (Newton et al., 2015). Shipping delays are observed as well, since the items assumed to be in stock could not be found in the warehouse. Along with this, there is absence of physical count of inventory over the past two years, even though there is maintenance of perpetual inventory system. Thus at the time of placing the sales order, there is uncertainty related to transaction details, which could be subject to change (Feng et al., 2014).

Potential effects of the identified weaknesses on the organisation:

The potential effects of the identified weaknesses on Strings Private Limited constitute of the following:

With the help of credit check, it is possible to obtain a quick insight of the financial position of the customers. However, this needs to be used occasionally for monitoring the credit situation of the customers without negative effect on their credit scores (Yu, Zhang & Zheng, 2016). As Strings Private Limited could not recover 17.5% of the credit sales from the customers, it would result in minimisation of the overall profit generated. Hence, this might reduce the dividend payout to the shareholders and availability of working capital.

As the warehouse clerk is involved in updating the inventory ledger, it could lead to the chance of stealing inventory items along with covering up the threat. For instance, the warehouse staff could steal inventory from Strings Private Limited and it would not be detected until any other person modifies the inventory records for covering the deficit.

With the increasing number of orders, it has become difficult for Strings Private Limited to manage all the orders in a timely manner. Since wrong items are delivered to the customers, the organisation needs to incur additional amount in shipping. As a result, this has direct impact on the profitability of the organisation due to the rise in overall expenses. In addition, the delayed delivery would create negative impression on the minds of the customers and they might shift to the competitors to seek timely delivery of the items ordered.

Specific internal controls to be implemented for mitigating the risks identified:

The internal controls that could be implemented in order to mitigate the identified risks constitute of the following:

  • The credit policy of the organisation needs to be reviewed monthly to identify those customers not paying within the stipulated time (Amoah et al., 2017). In addition, it could put some customers to make payments on cash only, if they make delay in payments consistently. Although it might result in loss of sales to a certain extent, it is better than remaining unpaid for the items delivered.
  • The custody of warehouse inventory needs to be segregated from recordkeeping for inventory on the part of the inventory control department for minimising the incompatible functions.
  • The inventory records need to be updated regularly for the replacement of the delivered products (Cheng, Goh & Kim, 2017). In addition, the warehouse needs to be prepared in a manner for dispatching products to the respective destinations. This could be initiated by arranging the most popular products, which would be followed by the products having less popularity.

Five deficiencies in Queensland Health Payroll System Project and recommendations to overcome these deficiencies in future projects:

The five deficiencies identified in Queensland Health Payroll System Project are described as follows:

  • Payroll and certain tests have been carried out in parallel in various time schedules and the organisation has accepted inherent risk without testing the functionalities.
  • The largest factor is the industrial complexity, as the Australian healthcare sector needs various processes and security to the patients along with the large industrial size.
  • Deficiency has been observed in the implementation project of enterprise resource planning in formulating effective amount of nexus among clients, vendor and consultant (Philip, 2015).
  • The lack of communication had been one of the major drawbacks keeping the organisation behind from successful implementation of payroll project.
  • The IBM team involved in systems development life cycle (SDLC) was not found to be effective to carry out its job roles and responsibilities.

The above-stated deficiencies could be illustrated with the help of SDLC framework. SDLC framework provides a sequence of activities for the system designers and developers (Thite & Sandhu, 2014). The relevant phases of this framework in the context of the project are described briefly as follows:

This is the initial step of the framework, which signifies the information and cost associated with the system (Kerzner & Kerzner, 2017). The health payroll project of the organisation had suffered from ineffective handling and increased complexity in the IS system.

Queensland Health is involved in large industrial sector, which is related to various health businesses. The organisation was using complicated conceptual design for obtaining information that needs to be corrected in timely manner.

As identified above, Queensland Health has low level of conceptual design due to communication issue and system process. Henceforth, for upgrading the SDL framework, it is necessary for the organisation to alter its physical design in an effective fashion (Church, Schmidt & Smedley, 2017).

Conversion and implementation:

For better development of the systems development lifecycle, Queensland Health needs to make installation of the following changes:

  • The use of decision support system in the organisation at the time the conflicts and problems coming into notice are not structured
  • The business executive, system users and process staffs need to work in combination for finding out new working processes along with eliminating issues in the provided areas
  • Creating bifurcating procedure for defining information and data to the respective individuals systematically (Rock-Evans, 2014)

Recommendations for overcoming the identified deficiencies:

In order to avoid the identified deficiencies in future projects, Queensland Health needs to conduct the following:

  • Development of new software and hardware in the SDLC program of the organisation
  • Rotating the staffs in the process system or recruiting competent staffs
  • Change of procedure related to testing
  • Completing the system documentation

For formulating the new effective SDLC framework of Queensland Health, effective planning is required to be made for correcting the existing deficiencies in the business processes. In addition, the cost of the new project needs to be projected along with ascertaining whether the proposed system would be cost-effective for the organisation. In order to measure cost-effectiveness, the techniques of investment appraisal like net present value, payback period and internal rate of return could be used for analysing the process cost.

Conclusion:

According to the evaluation of the first segment, it has been found out that the main internal control weaknesses of Strings Private Limited include absence of credit check, access to inventory along with delayed delivery and shipping errors. For dealing with these issues, updating the inventory records, segregation of record-keeping for inventory and tightened credit policy are essential. In the second segment, certain deficiencies have been identified in Queensland Health Payroll System Project. These include acceptance of inherent risk, industrial complexities, lack of communication, IS implementation issue and ineffectiveness of IBM team. For minimising these deficiencies, the cost of the new project needs to be projected along with ascertaining whether the proposed system would be cost-effective for the organisation.

References:

Amoah, N. Y., Anderson, A., Bonaparte, I., & Tang, A. P. (2017). Internal Control Material Weakness and Real Earnings Management. In Parables, Myths and Risks (pp. 1-21). Emerald Publishing Limited.

Cheng, Q., Goh, B. W., & Kim, J. B. (2017). Internal control and operational efficiency.

Church, K. S., Schmidt, P. J., & Smedley, G. (2017). Casey's Collections: A Strategic Decision-Making Case Using the Systems Development Lifecycle—Planning and Analysis Phases. Journal of Emerging Technologies in Accounting Teaching Notes, 13(2), 31-81.

Feng, M., Li, C., McVay, S. E., & Skaife, H. (2014). Does ineffective internal control over financial reporting affect a firm's operations? Evidence from firms' inventory management. The Accounting Review, 90(2), 529-557.

Jacoby, G., Li, Y., Li, T., & Zheng, S. X. (2017). Internal control weakness, investment and firm valuation. Finance Research Letters.

Kerzner, H., & Kerzner, H. R. (2017). Project management: a systems approach to planning, scheduling, and controlling. John Wiley & Sons.

Newton, N. J., Persellin, J. S., Wang, D., & Wilkins, M. S. (2015). Internal control opinion shopping and audit market competition. The Accounting Review, 91(2), 603-623.

Philip, K. (2015). Allied health: untapped potential in the Australian health system. Australian Health Review, 39(3), 244-247.

Rock-Evans, R. (2014). Analysis within the Systems Development Life-Cycle: Book 4 Activity Analysis—The Methods. Elsevier.

Sun, Y. (2016). Internal control weakness disclosure and firm investment. Journal of Accounting, Auditing & Finance, 31(2), 277-307.

Thite, M., & Sandhu, K. (2014). Where is My Pay? Critical Success Factors of a Payroll System–A System Life Cycle Approach. Australasian Journal of Information Systems, 18(2).

Yu, J., Zhang, Z., & Zheng, S. X. (2016). The effect of internal control weakness on firm valuation: Evidence from SOX Section 404 disclosuresAuthor-Name: Li, Yingqi. Finance Research Letters, 17(C), 17-24.

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