Alabama Industries manufactures and wholesales small tools. It sells the tools to a large group of regular customers and makes most sales by telephone to this group. Additionally, it receives orders online by its sales team who signs up new customers within the sales area. In the past, Alabama Industries has had trouble with customers who do not pay their accounts on time. Despite instructing the sales team not to make sales to customers before their creditworthiness has been assessed, sales are still being made to new customers before their limits have been set and to existing customers beyond their credit limit. Also, an economic downturn has started to impact its customers, and Alabama’s management is concerned about the possibility of increasing bad debts.

1a. What sort of preventive control could be used to deal with the problems faced by Alabama Industries? Explain how the control would work.

1b. Assume the preventive control is implemented, and during this year there have been no sales to customers that have taken any customer beyond its credit limit. What are two possible explanations for this that the auditor must consider?

1c. If an auditor finds two sales transactions during the year that exceed a customer’s credit limit at the time of the sale, what conclusion would the auditor draw from this evidence? What other evidence could the auditor consider before concluding that the preventive control has failed?