Case

Preview Company, a

diversified manufacturer, has

five divisions that operate

throughout the United

States and Mexico. Preview

has historically allowed its

divisions to operate

autonomously. Corporate

intervention occurred only

when planned results were

not obtained. Corporate

management has high

integrity, but the board of

directors and audit

committee are not very active. Preview has a policy of hiring competent people. The company has a

code of conduct, but there is little monitoring of compliance by employees. Management is fairly

conservative in terms of accounting principles and practices, but employee compensation packages

depend highly on performance. Preview Company does not have an internal audit department, and it

relies on your firm to review the controls in each division.

Chip Harris is the general manager of the Fabricator Division. The Fabricator Division produces a variety

of standardized parts for small appliances. Harris has been the general manager for the last seven years,

and each year he has been able to improve the profitability of the division. He is compensated based

largely on the divisions profitability. Much of the improvement in profitability has come through

aggressive cost cutting, including a substantial reduction in control activities over inventory.

During the last year, a new competitor has entered Fabricators markets and has offered substantial

price reductions in order to grab market share. Harris has responded to the competitors actions by

matching the price cuts in the hope of maintaining market share. Harris is very concerned because he

cannot see any other areas where costs can be reduced so that the divisions growth and profitability

can be maintained. If profitability is not maintained, his salary and bonus will be reduced.

Harris has decided that one way to make the division more profitable is to manipulate inventory

because it represents a large amount of the divisions balance sheet. He also knows that controls over

inventory are weak. He views this inventory manipulation as a short-run solution to the profit decline

due to the competitors price cutting. Harris is certain that once the competitor stops cutting prices or

goes bankrupt, the misstatements in inventory can be corrected with little impact on the bottom line

Questions

Discuss the requirements for an auditor to report fraud.

Discuss COSOs framework for implementing corporate internal controls.

Differentiate between the types of procedures used by auditors to test internal controls.

Describe the variables used by an auditor to determine evaluate when setting detection risk.

Evaluate Internal Controls for deficiencies.