1) ABCs capital-asset procurement policy requires the Board of CAEs (BOD) approve any single acquisition over $150,000. If the board approves a project, then the treasurer will transfer the funds to the respective plant. Within one year, the internal auditing function is charged with reviewing each acquisition to check the propriety of the purchase and disbursal of funds.

ABCs Plant Controller prepared the first proposal for a DEK cutting machine. Other plants were told to wait until internal auditing could inspect the documentation associated with the acquisition, and evaluate the projects operating effectiveness and efficiency. The plants proposal was the second largest proposal ever submitted in the companys history and it totaled $1.3 million dollars. The cost of the new machine by itself was listed in the proposal at $1.1 million. Labor and other costs necessary to remove the old machine and install the new machine totaled $200,000.

The internal auditor assigned to the investigation was Phil Ramone. Phil had been with ABC four years performing mostly production operational audits (on existing processes) and internal control payroll audits. Phils considerable experience in these areas led him to believe that the procedures associated with this capital-asset audit would be as simple and routine. This was not Phils first visit to the plant. In fact Phil had performed an audit on the plants payroll system only a year ago. Phils recollection of the experience was not a pleasant one. He had several confrontations with the plant controller, mostly as a result of personality clashes. While all the payroll issues were easily resolved, Phil felt there was still an adversarial relationship between him and the controller and was on guard for any preemptive strikes this time around by the controller.

It was a long drive to the plant so when Phil arrived a little late the day of his audit he was greeted by the controller with a perceived air of indifference and promptly led to a secluded office. The controller calmly explained that he was extremely busy and would answer any questions at the end of the day. Phil merely nodded his head and sat down in front of several tall piles of invoices, which the controller stated was the documentation supporting the purchase, set up, and testing of the new machine. Phil was somewhat surprised, fully expecting to see only a handful of invoices, but did not ask for any explanations. As Phil began looking through the myriad of statements and canceled checks he soon found one particular invoice near the top of the first pile that indicated the actual price paid for the machine itself was only $850,000.

Phils first reaction was to call the CAE of auditing. When he found that the CAE was out for the day and could not be reached he then decided to call the VP of Operations at corporate headquarters. Phil was critical of the plant controller when describing the seriousness of his suspicions based on this preliminary information. Phil didnt know that there was a BOD meeting that day and that the news would be passed on to them. The members of the Board were outraged, screaming over the alleged misuse of the funds and possible fraud.

Phil was unaware that in a private conference call the Chair of the Board of CAEs would soon lambast the plant controller. Seconds after the call, the controller walked up to Phil and had only two words to say get out. Phil was flabbergasted; he called back to headquarters, only to receive a rather icy response from the Chair of the BODs secretary suggesting that he return immediately.

Three days later Phil was called in to the CAEs office. The CAE described how he personally went to the plant the next day after Phils visit and performed the capital-asset audit himself. The CAE found that there were a number of reasonable explanations for the differences between the original proposal and the actual expenditure. To begin with, the company that sold the machine would not discount the price until the BOD approved the contract. Competing bids drove the cost of the machine from $1.1 million to $850,000. However, there were several factors that offset these savings.

Originally, the setup of the new machine was projected to take a week and a half but ended up taking a month. No one really knew how difficult it was going to be to remove the old machine that was embedded in the concrete floor (to minimize vibration). This removal took additional time and outside labor. Also, the new machine was to be put in the same area where the old machine was located. Since the plant could not afford to shut down for any extended length of time, the old machine was moved over the Thanksgiving Day holiday when labor rates were doubled. In addition, while the new machine was being tested, the old machine had to be kept running in its temporary location. During the time that both machines were running, machine operators and supporting personnel (e.g., those loading and unloading the conveyors) worked double shifts in order to test the new machine. This parallel process took longer than expected because the plant engineers were not familiar enough with the new machine to deal with minor problems. Also, special outside consultants were hired for the first two weeks to set up the machine.

Another unexpected cost arose because the new machine put out a greater number of larger pieces of wood requiring required an additional conveyor belt to accept and carry the larger pieces. The savings from the discount was used to purchase this necessary piece of equipment. In sum, all of these additional and unexpected outlays were very expensive and brought the total to just under the original proposed cost of $1.1 million.

The CAE went on to explain to Phil that the reason for the abnormally large number of invoices was an endless stream of trips to the local electrical and hardware stores to buy the necessary parts and supplies to keep the transition from the old to the new machine moving smoothly. As it turned out, the Controller of the plant actually did a commendable job in overseeing the project and keeping accurate records of the disbursements. In fact, the controller created a specialized installation guide that will probably save ABC hundreds of thousands of dollars when the remaining plants order more of these machines.

Required

a)Comment on Phils preparation for and conduct of the audit. What should Phil have done differently?

Discuss and cite the possible violations of the IIA Code of Ethics and/or International Standards for the Professional Practice of Internal Auditing that Phil committed. Be specific.