Badger Ltd, is a diversified manufacturer, has three divisions that operate throughout Australia. Badger has always allowed its divisions to operate autonomously, with head office intervention occurring only when planned results were not obtained.Head office management has high integrity, but the board of directors and audit committee are not very active. Badger has a policy of hiring very competent people and has an ethical code of conduct, but there is little monitoring of compliance by employees. Management is relatively conservative in terms of accounting principles and practices, but employee compensation packages depend largely on performance. Carlo Andre is the general manager of the electronics division, which produces a variety of standardised parts for small appliances. Carlo has been the general manager for the past four years, and each year he has been able to improve the profitability of the division. His compensation is based largely on the division's profitability. Much of the improvement in profitability has come through aggressive cost cutting, including a substantial reduction in control activities over inventory.

During the past year, a new competitor has entered the electronics division's markets and has offered substantial price reductions in an effort to obtain market share. Carlo has responded to the competitor 's actions by matching the price cuts to try and maintain Badger's market share. However, Carlo is very concerned, as he cannot see any other areas where costs can be reduced so that the division's growth and profitability can be maintained. If profitability is not maintained, his salary and bonus will be reduced.

Carlo has decided that one way to make the division more profitable is to manipulate inventory, because it represents a large amount of the division's statement of financial position.He also knows that controls over inventory are weak. He views this inventory manipulation asa short-run solution to the profit decline due to the competitor 's price cutting. Carlo is certain that once the competitor stops cutting prices, the misstatements in inventory can be easily corrected.

Required:

A)Evaluate the strengths and weaknesses of Badger's control environment.

B)What factors have led to and facilitated Carlo's manipulation of inventory?