Background Mason Inc.

(Mason or the Company) is a U.S. public company that files quarterly and annual reports with the Securities and Exchange Commission (SEC). Mason is a leading retail chain operating more than 100 department stores across the continental United States. Mason department stores offer customers a variety of nationally advertised products, including clothing, shoes, jewelry, and other accessories. The Companys supply chain of products is managed through a single warehouse and distribution facility located in Kansas City, Missouri. Mason has a centralized accounting and finance structure at its corporate headquarters, where all processes and controls related to all substantive account balances occur, including controls related to accounts payable and the Vendor Master File. Mason recognizes revenues from retail sales at the point of sale to its customers. Discounts provided to customers by the Company at the point of sale, including discounts provided in connection with loyalty cards, are recognized as a reduction in sales as the products are sold. Cost of goods sold for the Company primarily consist of inbound freight and costs relating to purchasing and receiving, inspection, depreciation, warehousing, internal transfer, and other costs of distribution.

Facts Audit Issue:

On June 1, 2022, the Accounts Payable (AP) Manager received an e-mail inquiry about the process required for a vendor to change its bank account information. The e-mail was sent from John Smith at a domain address listed as Watch-Makers. Watch Makers is a manufacturer that supplies Mason-branded watches to Masons west region department stores. In addition, John Smith is the primary contact at Watch Makers with whom the Company typically interacts. The AP Manager responded to the e-mail request on June 15, 2022, with the procedures required of the vendor, which include completing a vendor bank account request form. On June 20, 2022, the AP Manager received a reply e-mail from John Smith at Watch-Makers with a completed vendor bank account request form, which included John Smiths signature, new bank account information, and other related information. Upon receiving the vendor bank account request form, the AP Manager completed a separately required Vendor Change Form for internal processing. The Vendor Change Form is completed for new vendors or changes to existing vendors information, including bank account information. The AP Manager sent the completed Vendor Change Form to Masons Assistant Controller, who reviewed and approved the request on June 24, 2022. The bank account information was updated within the Vendor Master File on June 26, 2022.

Throughout the month of July, valid Watch Makers invoices were processed through the Companys accounts payable process, and the valid invoices were paid in accordance with the Companys processes for cash disbursements and wire transfers. However, because the bank account information for Watch Makers was changed (as a result of the June 1, 2022, e-mail request) approximately $4 million in payments was wired to an incorrect bank account. On August 2, 2022, the Company received an inquiry from Watch Makers about the expected timing of the $4 million in outstanding invoices. As a result of the direct interaction with Watch Makers employee John Smith, the Company determined that the previous vendor bank account change form was received from a fraudulent domain name with the intent to defraud the Company. The e-mail domain for Watch Makers is Watch Makers, with no hyphen, rather than Watch-Makers, with a hyphen. Both e-mails received from Watch-Makers were determined to be from a fraudulent source (that also fraudulently used John Smiths name in the e-mail). As noted above, there are two employees within the Company that were involved in processing and approving the Vendor Change Form. The Companys policy on bank account change requests was communicated by Masons Assistant Controller in a January 2021 e-mail that indicated that for each Vendor Change Form requesting a vendor bank account change, the accounts payable department was required to (1) obtain a previously processed and paid invoice from the vendor requesting the bank account change, (2) call the vendor using the contact information obtained from the prior invoice, (3) verify the authenticity of the requested bank account change request by directly contacting the vendor, and (4) include all relevant information obtained in steps (1) through (3) as an attachment to the Vendor Change Form. The Companys control description relating to the review of a Vendor Change Form by the Assistant Controller is not explicit regarding the specific attributes of the review. However, because the Assistant Controller is the control owner (e.g., performs the review), there is a presumption that the Assistant Controller would understand that as part of her review, she should evaluate whether the AP Manager obtained sufficient information to confirm the authenticity of the bank account change request.

Other Relevant Facts

Materiality $8 million.

The Company processed approximately 105 vendor requested bank account changes during 2022 before the realization that the request from Watch-Makers was fraudulent (from September 25, 2021, to August 2, 2022). After the identification of the misappropriation of assets, the Companys internal audit department obtained and reviewed all 105 Vendor Change Forms reviewed by the Assistant Controller, noting that 65 Vendor Change Forms did not contain all the information required by the policy. In addition, internal audit determined that the primary review procedure performed by the Assistant Controller related to the verification that the bank account number was appropriately included on the Vendor Change Form. This procedure was performed in all cases before the bank account information was input into the accounts payable system.

The total wire transfer payments made to the 105 vendors that requested bank account changes in FY2022 totaled approximately $63.2 million (based on an analysis prepared by Internal Audit of the invoices processed and paid by the Company after the processing of a Vendor Change Form for the 105 vendors). There are more than 30 vendors with annual purchase activity of over $20 million (12 of which have purchase activity of over $40 million); thus, the amount of payments made to any single vendor in a payables cycle could approximate $2 million, assuming a cycle of 30 days.

The Companys Chief Security Officer completed an internal investigation and concluded that there was no indication that the AP Manager and Assistant Controller were involved in the scheme that resulted in the $4 million misappropriation. Internal Audit performed a thorough evaluation of the competency of the Assistant Controller and concluded that notwithstanding the Assistant Controllers lack of historical performance, the Assistant Controller was suitably competent to perform the control.

Engagement Team Note:

In planning the 2022 audit, the engagement team obtained an understanding of the internal controls related to cash disbursements. This understanding was developed through the engagement teams walkthrough of the cash disbursements process. As part of its walkthrough procedures, the engagement team made inquiries of appropriate personnel, inspected relevant documentation, and in certain cases, observed the control performers carrying out required control procedures. As a result, the engagement team concluded that there were no significant changes to the cash disbursements process in the current year. The engagement team identified three risks of material misstatement relating to the cash disbursements process. For each risk identified, the team documented Masons control activity that addresses the risk of material misstatement in the excerpted worksheet (see Appendix 1). As a result of the Audit Issue described above, the engagement team identified a control deficiency in the following control:

CD5C The accounts payable department is required to complete the following for each Vendor Change Form requesting a bank account change:

1. Obtain a previously processed and paid invoice from the vendor requesting the bank account change.

2. Call the vendor using the contact information from the obtained invoice.

3. Verify the authenticity of the requested bank account change request.

4. Attach all relevant information obtained in steps (1) through (3) to the Vendor Change Form for review and approval.

The Companys control description regarding the Assistant Controllers review of the Vendor Change Form is not prescriptive regarding the specific attributes of the review. However, there is a presumption that the Assistant Controller would understand the primary objective of the control, which is to evaluate whether sufficient information was obtained by the AP Manager to confirm that the bank account change request was authentic.

Required:

Assume the auditor believes the deficiency is a material weakness, but the company pleads that a material weakness in internal controls will greatly damage the companys reputation. The company notifies the auditor that the company will consider changing the auditor in the subsequent year if the auditor concludes the deficiency is a material weakness. Mason Inc. is an important client for the auditor, and losing the client will have a nontrivial impact on the auditors revenue. What should the auditor do? Based on what we have discussed in class on professional ethics and legal liabilities of auditors, list all possible consequences you can think of for the auditor who agrees to issue a more favorable report in order to retain the client.

AS 2201 was issued after passage of Section 404(b) of the Sarbanes-Oxley Act (SOX) of 2002, a provision of SOX that is most costly to the companies and (therefore) hotly debated. Some opponents to this provision argue that the compliance costs for the requirement far outweigh the benefits when all public companies are already having their financial statements audited. Discuss the potential benefits to investors of having an external auditor audit and obtain reasonable assurance on effectiveness of internal control over financial reporting. You can use this case as an example.

I need some sources for my citation: encourage to use popular and business press articles (New York Times, Wall Street Journal, Financial Times, Business Week, The Economist, etc.) practitioner journals (Journal of Accountancy, CPA Journal, Accounting Today, etc.) and academic journals (The Accounting Review, Journal of Accounting Economics, Auditing, etc.) to inform the research.