(This is from IIA Research Foundation "Case Studies in
Internal Auditing" Volume 4)
Please note there is
no one right answer for these assignments. You should consider different
points of view on the ethical issues before drawing your conclusions.
 |
| Examining the papers... |
Objective
This case study is
designed to expose students to a variety of conditions that may or may not
indicate a fraud has been committed. Consideration must be given to errors that
are present in a normal business environment, internal control weakness
accepted by management, as well as obtaining an understanding of procedures and
their long-range effect on business. Control weaknesses by themselves are not
major problems. The combination of the control weaknesses, coupled with the
inexperience of the internal auditor and a limited audit budget present real
life situations. Students need to understand the overall control environment
and not just deal with individual procedure errors.
Control weaknesses by
themselves are not major problems. The combination of the control weaknesses, coupled with the inexperience of
the internal auditor and a limited audit budget present real life
situations. For example, does the auditor know when to expand an audit test,
discontinue tests, and ask for additional data? What information is needed, who
should respond, and what reliability should be placed on the information? Does
the auditor know what is necessary to support an audit recommendation or, more
importantly, to provide evidence in a criminal case?
Required
Please read all of
the requirements carefully and make sure your paper addresses each item. It
would be helpful for your own use to develop a high-level process map. This
assignment is to be completed using only the materials authorized for use in
this class. A rough guideline to adequately complete the assignment is 5-6
single-spaced pages. If you have any questions as to what is expected, please
contact the instructor.
1. If you were part of the audit team,
what additional questions would you ask to gather more audit evidence? You
need to focus on what is most important to this case. You must come up with at
least 15 relevant questions. You must have some questions for each of the five
areas: receiving, loom teardowns, customer orders, disposal of
residues and scrap metal, and administration
of the loom reclamation program. You must indicate what you hope to
learn from each question (i.e., what is the intent of the question?) and to
whom the question would be addressed.
2. Identify your top four internal
control weaknesses in order of materiality in each the following five
areas: receiving, loom teardowns, customer orders, disposal of residues and
scrap metal, and administration of the loom reclamation program. Please make
sure you address the most important control weaknesses.
3. For
each observation identified in #2, write your recommendation(s) to strengthen
internal controls over the loom reclamation program. Make sure each
recommendation is clearly associated with an observation(s) from #1. One
recommendation can cover several internal control weaknesses.
4. In
your opinion, has a fraud been perpetrated? If so, what evidence supports the
allegation? Is it firm enough to convict the person(s) in court? Please explain
the rationale for your conclusions.
Background
Many of Tarheel
Textiles' old Draper looms have recently been replaced with more modern and
efficient weaving machines. Instead of being junked or scrapped, these surplus
looms are sent by the plants to the supply support division where they are
stripped of all useable parts. These parts are reconditioned, stored, and
placed on perpetual inventory records as used supply items.
Manufacturing
facilities within Tarheel route all of their purchase orders for Draper loom
parts through the supply support division. This includes orders made out to
Draper Company and all other vendors from whom Draper parts can be purchased.
Supply support reviews its inventory records (and will hold the order for no
more than one day) to determine the availability of used parts generated from
the loom stripping program. If parts are available within Tarheel, the purchase
order to the vendor is altered and the supply support division ships the
available parts automatically to the ordering plant. The altered purchase order
is then sent to the vendor.
This
program has resulted in substantial savings to Tarheel. Also, many of these
older parts are in short supply and are, therefore, difficult to obtain within
a reasonable delivery time.
Operation
Receiving:
1. Plant sends to the supply support division all surplus Draper looms.
These looms may or may not be operative, but would have been scrapped at the
plant, or otherwise disposed of, had they not been shipped to supply support.
2. Plant prepares a shipping document, which accompanies each shipment of looms. This shipping document lists each asset shipped, identified with the Tarheel fixed asset tag number.
3. The shipping plant prepares the necessary reports to transfer these surplus items to the supply support division fixed assets ledger.
4. The looms are transferred, unloaded, and placed in a 3-1/2 acre fenced-in field.
5. Shipping documents are sent to the administrative office, where looms listed on the shipping document are compared to the quarterly printout received from corporate accounting which lists all assets transferred to supply support during the quarter.
6. The administrative area keeps a manual listing of looms. This list is reconciled quarterly with the computer-generated fixed asset ledger received from corporate accounting.
Loom
Teardowns:
1. Looms are torn down daily (as many
as time permits). The teardown process includes:
- Removing the Tarheel Textile asset tag
number.
- Stripping the asset of all useable parts.
- Reconditioning these parts.
- Storing any salvageable metal and the
residue (or carcass) in a central area. The residue is usually loom frame and
some useable pieces of metal.
2. A loom teardown report is prepared
weekly. The report lists by identification tag number each loom torn down
during the week. Sometimes, however, tag numbers are missing from the
looms--many of the looms are old and thus the tags have been jarred loose or
have fallen off during shipment.
3. This report is sent to the administrative
office where it is used to authorize removal of these looms from the fixed
assets accounting records. The tag number identifies assets on the ledger.
4. The loom parts salvaged as a result of
the loom teardown are collected. A quality control person reviews each part to
determine whether it is reusable as is, needs to be reconditioned, or should be
sold as scrap metal. The reusable parts are eventually sent to the supply room
and placed on perpetual inventory records for accountability.
Sale
of Reconditioned Loom Parts:
Written Customer Orders:
1. The computer generates a shipping
document based on a written customer order. The customer may be a Tarheel
Textiles plant or another company.
2. The shipping document is reviewed in
the supply room. If inventory records indicate reconditioned Draper loom parts
are available in bins, these parts will be used to fill the order. If inventory
records show no parts available, the supply room clerk copies these part
numbers/descriptions on a sheet of paper.
3. This sheet of paper goes to the loom
teardown supervisor. Crew members will go out to looms in the field and strip
the needed parts from the looms.
4. These parts are sent to the supply
room, along with the piece of paper, for review and to make ready for shipment.
5. The shipping supervisor loads goods
onto the truck. He checks against notice of shipment to assure accuracy of
loading.
6. The loaded truck leaves premises.
Telephone
Orders:
1. Verbal orders received from
customers, either by the supply room or the loom teardown supervisor, are
handled similarly except that no written customer order exists. All information
is written on an order form
2. The two supervisors coordinate
selection of parts, either from supply room bins or stripped from looms in the
field.
3. After the parts have been pulled and
the order is ready for shipment, the supply room supervisor contacts the
administrative area so that a shipping document may be prepared, based on the
items listed on the order form.
4. The shipping document is sent to the
shipping supervisor.
5. The shipping supervisor loads goods
onto the truck. He checks against the notice of shipment to assure accuracy of
loading.
6. The shipment leaves the premises by
Tarheel Textile truck, customer truck or common carrier.
Disposal
of Residues and Scrap Metal:
1. The loom teardown supervisor usually
receives customer orders verbally. Johnstone & Company is the primary
customer to whom Tarheel sells loom residues and scrap metal. A company
representative will often come to Tarheel, select loom residues and scrap parts
he wants to purchase from those available, and supervise the loading of his
truck.
2. The loom teardown supervisor calls
the administrative area and requests a shipping document be prepared since
company policy prohibits any vehicle from leaving the premises without a notice
of shipment. The supervisor gives the office all the information necessary to
prepare the document.
3. The truck leaves the premises from
the loom field through the main gate.
The
Telephone Call
Mr. Arthur Thomas,
the buyer in corporate purchasing responsible for the disposal of Tarheel
Textiles' surplus assets (including the sale of all parts from the supply
support division), received a telephone call from a person who stated he had
previously worked for Tarheel Textiles. The caller alleged that the supervisor
of the loom teardown program at Tarheel's supply support division was
instructing employees to locate 64" X-3 Draper looms and load them onto
trucks without a valid customer order. The caller, who refused to identify
himself, stated he had been fired from his job at the supply support division
because he "knew too much about what was going on."
Mr. Thomas contacted
the director of corporate purchasing (his superior), the supply support
division manager and director of corporate security. An investigation ensued,
and the information on the following pages was obtained from various sources.
A corporate security
investigator visited the supply support complex. The security survey disclosed
that:
a. The entire area was fenced, and the
fences were in good repair.
b. The main entrance gate and the gate to
the field of looms could be locked.
c. The field of looms was located
approximately 400 feet from the main gate. Surplus
electric motors had also
been placed in this field.
d. Administrative/accounting offices were
located directly across from the loom field.
e. No safety or fire hazards existed.
f. No security persons, guards, or watchmen
were used at the site.
g. The main gate opens onto a relatively
busy intersection.
A review of the
supply support division personnel records revealed that only one person had
been involuntarily terminated since the inception of the loom reclamation
program. The security investigator contacted this individual and reported he
firmly believed that this person did not place the telephone call to Mr.
Thomas. In addition, in order to facilitate his understanding of the situation,
the investigator obtained the organization chart.
The Loom Teardown Crew
While at the
location, the corporate security investigator interviewed some of the members
of the loom teardown crew. Leon Curtis, a crewmember, spoke first. Leon, now a
part-time employee, is a retired loom mechanic from a nearby Tarheel plant and
has been employed by Tarheel for 35 years.
"Every day Shaw
(loom teardown supervisor) had us looking all over the field for 64" X-3
Draper looms. And that's no easy job either, especially when the looms are
stacked on top of each other, so close together and 8 or 9 in every row. He
wouldn't tell us why and wouldn't ever take `no' for an answer. None of us knew
of any customer order for those looms. We would load the looms onto a truck
with other items Johnstone wanted - loom residues, scrap parts, and sometimes
even reconditioned parts. Johnstone kept a truck in the loom teardown area
between pick-ups. We loaded scrap metal onto his truck each day. A fellow from
Johnstone & Company would come by, usually every Friday. He would look over
the parts on the lot for anything else he wanted to buy and would exchange
trucks."
A second crewmember,
Harvey Jolly, appeared somewhat ill at ease. He was a lanky fellow with thinning
hair, about 45 years of age. He was constantly smoking a cigarette.
Harvey said,
"I've thought something crooked was up for quite a while, ever since Bob
Johnstone started coming over here occasionally instead of the usual guy. A
couple of times Shaw and Johnstone would leave for lunch in Shaw's Corvette,
and they wouldn't come back until 3:00 p.m. No, you can't tell me something
wasn't happening."
Danny Burton, a young
crewmember about 19 years old, interjected, "We aren't the only ones who
knew something wasn't right. Ask Clark Danley (a supply support division
engineer). He can tell you a lot more than we can. Anyway, I've always wondered
why Tarheel Textiles would even think about hiring somebody with a criminal
record."
Harvey Jolly spoke
again. "It's difficult keeping up with all these parts, especially when
you tear down as many as 12 or 14 looms a week. Take the brass, for instance.
We put all the brass pieces in separate baskets, and entire baskets will
sometimes disappear during weekends. We try to keep track of all the parts,
especially after we steam clean, repair, and repaint them. But with so many
parts, it's really hard."
Leon Curtis said,
"We're really glad to be able to talk to you about this. We've been talking
about it among ourselves but didn't know whom to turn to. It just isn't right
for us to work hard and try to do the best we can at our jobs, when somebody
else is doing just the opposite."
The security
investigator thanked each crewmember for his cooperation and urged them to
contact him if they thought of anything further.
Alan Shaw
The security
investigator and supply support manager interviewed Alan Shaw, the supervisor
of the loom teardown program. Mr. Shaw is 36 years old and married. He and his
wife are expecting their second child shortly. Shaw is a very outgoing and
congenial person and makes friends easily. Many have said Shaw is a
"natural" manager and works well with people. Past performance
evaluations have indicated that his only shortcomings are his impatience and
quick temper.
When confronted with
the charges, Mr. Shaw denied any wrongdoing and demanded proof of the
allegations.
Shaw said, "I've
always followed established procedures and tried to do things properly. But you
just can't watch everybody all of the time, and I trust my employees to do the
right thing. I've never had any trouble in the three years I've worked with
Tarheel Textiles or with anybody I've ever worked for. I'm a hard worker. You
know I've worked a lot of overtime hours in order to get the job done. I even
had to request gate keys so I could work at night in order to keep up with my
workload. I would be foolish to do anything to jeopardize my career with
Tarheel, especially since my family and I have just moved into a new
house."
Two days later, Mr.
Shaw requested a meeting with the supply support manager. Shaw stated that this
situation had cast suspicion upon him, that his employees could never have
confidence in him again, and that he wasn't sure he wanted to work for a
company that would accuse him of such things. Alan Shaw asked to be suspended
of all job responsibilities, pending the result of the
investigation.
The supply support
manager was disappointed; he thought Mr. Shaw had always performed well, had a
lot of potential, and was a "diamond in the rough." But he had no
alternative but to suspend Mr. Shaw.
The Johnstone & Company Visit
Mr. Arthur Thomas,
corporate buyer, and a corporate security investigator visited Johnstone & Company
for the purpose of interviewing key employees who might provide pertinent
information. Johnstone & Company was the customer to whom the majority of
loom residues and surplus loom parts were sold. The company deals primarily
with the sale of scrap and junk metal, but also markets converted looms and
other textile machinery.
Because of their
long-standing business relationship, Arthur Thomas asked to speak privately
with Mr. Gordon Johnstone, president of Johnstone & Company, before the
security investigator questioned him. After a 45-minute discussion, the
security investigator joined them.
Mr. Johnstone
vehemently denied knowledge of any wrongdoing. He stated he had not given any
financial inducement to Tarheel employees for shipping any completed looms or
other parts.
He said, "Loom
residues and scrap parts are brought onto my lot in a Johnstone & Company
truck from Tarheel Textiles. The items are unloaded and placed in the
"junk field" with all other scrap metal. We don't check each item
received to an invoice from your company. We just don't have the time and don't
consider it necessary. I have been conducting business with Tarheel Textiles
for over 10 years, and our methods and approaches have never been questioned.
Our ethics, I assure you, are above reproach."
The investigator
asked to speak with Mr. Johnstone's son, who was associated with the business
as a vice president of sales. Mr. Johnstone replied, "Bob is not here at
present; however, I see no reason for your talking to him. No member of my
family has ever been associated with any disreputable business transaction. My
son and I are both active members of local civic organizations. Your innuendos
are not appreciated, and I don't think we have anything else to discuss."
Mr. Thomas and the
security investigator thanked Mr. Johnstone for his assistance. As they were
leaving, the investigator noticed that the Draper identification plates had
been removed from some of the Tarheel loom residues on the lot.
The Inventory
Corporate security
reviewed its findings to date with the director of corporate purchasing and the
supply support manager. All concurred that a physical inventory of looms in the
field needed to be taken. Written procedures were developed and included the
following:
a. The inventory would be taken by total
count only, not by individual type/size loom. An
exception was that all
64" X-3 looms would be identified separately.
b. Each loom would be tagged when counted.
c. The total number of looms in each row was
to be written on a separate tag and attached to the loom at the end of each
row.
d. All tags must be accounted for.
e. Instructions were to be discussed with
all persons participating in the inventory-taking
process prior to starting.
Approximately 2,700
looms were counted, and 42 man-hours were needed to take the inventory.
Reconciliation of the overall physical count to quantities on inventory records
disclosed a net shortage of 59 looms. (There was a 72-unit shortage of looms
that had not yet been stripped. A gain of 13 looms residues was disclosed.)
The variance relating
to 64" X-3 looms was isolated: 34
looms on inventory records, five looms
on hand in field, 29 loom
shortage.
The
Inventory Record Review
The
administrative/accounting office also did some investigative work:
a. A reconciliation of loom residues
invoiced since inception of the program (approximately 24 months) to looms
removed from the fixed asset ledger, taking into consideration residues
currently on hand, revealed a shortage of 38 looms.
b. Accounting personnel stated that the
possibility of poor record keeping, especially in the first months of the
program, and inaccurate preparation of loom teardown reports could explain a
portion of this variance.
c. Sixteen Tarheel Textile fixed asset identification
tags were located in Mr. Shaw's desk drawer and toolbox. These appeared to have
been accumulated over a period of time. Accounting personnel traced these tag
numbers to the fixed asset ledger: all numbers were identified with 64"
X-3 Draper looms.
d. No customer invoices for brass had been
issued during the last 12 months.
e. No 64" X-3 Draper looms were listed
on shipping documents which supported shipments made during the last six
months.
Other
Pertinent Information
The average market value
for these Draper looms is $750. Converted looms can sell for as much as $7,500.
The value of parts varies, but ranges from $2 to $70. Johnstone & Company
has been paying Tarheel Textiles $75 to $100 for each loom residue purchased.
a. Approximately two pounds of brass can be
salvaged from each stripped loom. This brass can be sold to a local dealer for
53 cents/pound.
b. The 64" X-3 Draper loom parts may be
used in converting looms to air-jet looms, which are more efficient and utilize
newer technologies.
c. In recent months, Johnstone & Company
has also been purchasing reconditioned loom parts in addition to scrap metal.
d. Cathy Shaw, wife of the Draper area
supervisor, works as a billing clerk in the supply support accounting office.
e. Leventhal Parts & Supply Company also
purchases a small percentage of loom residues and unusable parts, but only
offers Tarheel Textiles $50 per residue.
Requirement: Make an assessment from this case study and the actions needed to do so. The latest case regarding will be posted in the Pitzviews Learning site.
No comments:
Post a Comment