(CASE STUDY )Company Information: ABC Company is a large automotive dealer company operating in the field of automobile retailing that is owned by a big Holding Group Company XYZ. ABC Company buys cars from distributors of well known brands and sells them to customers as the authorised dealer. ABC Company also provides after-sales service, spare parts and second-hand services for many automobile brands. The company has 7 branches throughout the Country. The company prioritizes customer satisfaction, and relies on its years of expertise. ABC Company employs around 380 people and has an annual turnover of about NZ$100million. The Company doesn’t have an Internal Audit department. But the Group Holding Company XYZ (total employee of 2000 people with consolidated annual turnover of NZ$ 4 billion) has an internal audit department (4 qualified internal auditors working for the department) that audits 17 group companies based on their risk-based audit planning for their audit assignments. ABC Company has an Audit Committee. Incident / Case: Auto Parts Department’s Stock Planner (will be referred to as Stock Planner throughout this document) whose main duty is to plan the procurement of auto parts and to place purchase orders based on approved plan) was accused of stealing expensive parts and selling them personally in the street market. This came to management’s attention through informal internal whistleblowing (one employee said that a friend of his saw the Stock Planner doing something not right). The Management informed the Audit Committee. The Audit Committee asked the Group Internal Audit (will be referred to as Internal Audit throughout this document) to evaluate the whistleblowing information. At the start of their investigation, Internal Audit deactivated all system access rights of the Stock Planner and asked Company management to send him on annual leave. Internal Audit interrogated the Stock Planner several times outside the company premises and investigated all his previous years’ dealings looking for all possible ways for him to cheat. Internal Audit findings noted that this person was involved in several different fraudulent activities at the same time. It also became quite apparent that there were serious weaknesses in the Company’s Internal Control System, grouped under the following three headings:(1) unapplied operational process controls;(2) ineffective financial controls; and(3) deactivated system controls. As soon as the internal audit work was finalized the results were reported to the ABC Management, ABC Audit Committee and Group Holding Company XYZ (who is a shareholder of the ABC Company appointing some board directors). The main findings related to the Stock Planner’s fraudulent activities are as follows: - He made several product code modifications over 4 years (changing the product codes of expensive auto parts stolen from the warehouse to car paint product codes, an uncountable –liquid- product category so that inventory differences are not detected at stock counts). - He invoiced auto parts without approved customer’s order (customer is not aware – fictitous action); waiting as open account (showing as receivable in financial accounts) to be collected for some time. - He invoiced customers with unauthorized signature and fake stamps to collect cash money from the customer and not reflecting any of these in the accounting system. - He took expensive auto parts out of the warehouse assigning them to open job orders that were created for cars waiting to be serviced at scheduled times (so that warehouse responsible would allow the stock to be taken out of the warehouse). - He took expensive auto parts out of the warehouse assigning them to ‘reserved for customer’ status in the system (as if customer had ordered) so that warehouse responsible would allow the stock to be taken out of the warehouse. - He took some auto parts out of the warehouse assigning them to unauthorized/unapproved job orders bypassing any procedural controls. - He took an employee loan and has not paid back, claiming that he has financial difficulty. In response to the Internal Audit findings, the ABC management terminated the employment contract of the Stock Planner (and some other employee who did not do their jobs properly in relation with what happened) and started legal action to recover their losses and to get him prosecuted for his fraudulent activities. The Management also immediately undertook the following actions recommended by the Internal Audit and closely monitored by the Audit committee: – Made the necessary adjustments in the company accounts (financial entries) – Made organizational changes including job rotations. – Established a voice of ethics hotline and implemented a formal whistleblowing system in the company. – Revised company procedures governing the review, authorisation and approvals of job orders and the policy & procedures for monitoring open accounts (receivables from service customers). – Reviewed the reconciliations of customer accounts which were performed by Internal Audit during their investigations for any additional potential problems and instructed Finance to perform such reconciliations on a monthly basis going forward (which was not being made on a regular basis). – Reviewed stock count performed by Internal Audit and asked Finance to carry out monthly stock counts going forward. – Reviewed and updated system access rights. – Asked Information Systems Department to generate built-in locks and warnings for critical system transactions. – Produced exception reports and log reports (which need to be reviewed by appropriate management on a periodic basis) – Asked related line management to do a timely and effective implementation of operational controls and financial controls. A copy of the internal audit report circulated is attached (see attachment 1) for further details. Financials of the ABC Company is also attached at the end of this document (see attachment 2).   ATTACHMENT 1: INTERNAL AUDIT REPORT Summary Report on Auto Parts Fraud Company ABC Internal Audit Distribution: MA AN TA GS --Printed Copies: 4 PART I: FINANCIAL IMPACT OF THE FRAUD (I) AMOUNT THAT COULD BE CALCULATED UNTIL NOW: 1. Parts taken out of the inventory and the related amount were invoiced without the knowledge of the customers, receivable sitting as open item in the system: $50,801 2. Amount that was invoiced, signed with a fake stamp and collected from the customer in cash that was not posted in company accounts: $14,146 3. Parts taken out of the inventory on the basis of open job orders but not physically present anywhere in the warehouse: $36,396 (at cost) 4. Parts that were reserved in the system in the name of a customer but physically not present anywhere in the warehouse: $30,814 (at cost) 5. Amount that was borrowed from the company but not paid back: $6,500 6. Product code modifications made over 4 years (changing product codes of expensive auto parts stolen from the warehouse to paint product codes, an uncountable (liquid) product category) $408,537* 7. Some auto parts taken out of the warehouse with unauthorized/unapproved job orders $55,934 TOTAL CALCULATED AMOUNT: $603,128 * Examples for parts whose product codes were changed to paint are as follows: expensive accessories sold at the Boutique ($22,200), steel tire rim ($24,050), tyres ($11,100), injector ($6,660), Screen & Mirrors ($18,500), headlamps ($6,013), hydraulic suspension & compressor ($8,048), arm-rest tool ($4,625), indicator panel ($4,255), refrigerator ($2,775), cabrio-type car ceiling ($5,365) PART II: DEFICIENCIES NOTED (I) UNAPPLIED OPERATIONAL PROCESS CONTROLS: • Other Service managers confirmed that physical access to the Parts Warehouse is not restricted and that even the workshop employee could enter to the warehouse without any control. • Periodic stock counts are not performed on a regular basis. • Open job orders are not reviewed by appropriate manager on a periodic basis. • Discounts given on parts are not reviewed by appropriate manager on a periodic basis. • Material movement vouchers are not reviewed by appropriate manager on a periodic basis. • Exception reports such as overrides/changes to master data like product code changes are not reviewed by appropriate manager on a periodic basis. • Aftersales department has worked with unapproved customers on an open account basis instead of cash basis. • Aftersales insurance receivables are not followed up for collection on a timely basis by the respective operations manager. (II) INEFFECTIVE FINANCIAL CONTROLS: • Periodic customer reconciliations are not performed. • Nobody from Finance participates in the stock-counts • Open account follow-up is not performed effectively and on time. Problematic situations are not escalated to the management. (III) DEACTIVATION OF SOME SYSTEM CONTROLS: • Service employee who is authorized to issue invoices has access to make changes in customer master data (including creating a new customer). The system allows changes to master data even if there has been a transaction posted over this customer. • During invoicing, changes/overrides can be made to default customer group discounts field and customer information flowing from the master data and log reports are not created to review such overrides. PART III: RECOMMENDED URGENT ACTION PLAN Actions with effects at organizational level:  Termination of employee + legal actions 1) In order to communicate the appropriate message to the organization, fair penalty mechanism should be utilized. In this line, in order to give highest penalty the ones with the highest responsibility, After Sales Manager, Parts Chief, Parts Stock Planner, Warehouse Responsible, Operations Open Account Follower and the cashier should be penalized with one of the following: termination of job employment, giving notice, monetary penalty, job rotation.  2)Organizational changes including rotations Rotating employee working in the same position for too long should be part of a regular activity as a company principle. This is especially critical for those who are directly involved with money and valuable company assets.  3)Voice of ethics hotline (whistleblowing) implementation Actions that require procedural changes:  1) Job order review, authorizations and approvals Personnel who are authorized to issue material movement vouchers should be restricted to issue them only to their assigned cost centre (predefined in the system). Issuance, receipt and approval authorities should be segregated in terms of access rights in the system.  2)Policy & procedures for open accounts As the company policy is to work cash-basis for aftersales customers, all customers that will be worked with on an open account basis have to be approved by the Management.  3)Customer reconciliations on a monthly basis Aftersales (Service) should make effective follow up of open accounts (receivables from service customers) including insurance. Finance should make periodic customer reconciliations. Finance should check aftersales team on a monthly basis for progress.  4)Participation of Finance in periodic stock counts Finance should participate in periodic counts as well. Surprize spot counts in addition to cycle counting should be organized and the related procedure should be issued by Finance. Actions that require changes in the system:  1) System access rights Unneeded access to customer master data must be revoked immediately. Employee who has access to sales invoice generation should not have access to customer master data maintenance.  2) Built-in locks and warnings for critical system transactions System should be configured in a way that users are not allowed to make any over-rides.  3) Production of exception reports and log reports (which need to be reviewed by appropriate management on a periodic basis) Log reports and exception reports needed to control that the right transactions are made for the right purpose must be produced and these must be reviewed on a periodic basis to detect wrong-doings for further assessment. Management actions:  1) Timely and effective implementation of operational controls  2) Timely and effective implementation of financial controls PART IV: URGENT ACTIONS ALREADY TAKEN BY THE MANAGEMENT • Executive Committee issued a letter to all department managers about the issue stressing internal controls • The following employees’ job employments were terminated: - SM, XY, ZX • Written notices were given to the following employee: - CK, SE, HK, LS • Following job rotations were made: - Open aftersales customer accounts follow-up will be performed by the Car Guarantee Department (by controller DZ) - Cashier A and Cashier B • Action plans are being discussed for other issues noted in this report • Indemnification for company loss based on our current liability insurance policy is being discussed with our insurance account manager and lawyers   ATTACHMENT 2: FINANCIALS (All figures are in NZ'000) 1. ABC Company 31/12/XX Balance Sheet Assets liability banks 3500 loans 25000 trades receivable 12000 trade payables 30000 other receivable 2500 other payables 5000 investments 6000 accrued liability 9000 inventories 35000 provisions 10000 property plant equipment- net 37950 paid capital 10000 reserves 6350 current year P/L 1600 Total assets 96950 Total liabilities 96950 2. Profit & Loss Statement Revenues 100,000 Cost of Sales 85,000 Gross Profit 15,000 Operating Expenses 10,500 Operating Profit 4,500 Non-operating Expenses 2,500 Profit Before Tax 2,000 Tax 400 Profit After Tax 1,600 Please discuss and evaluate and discuss the case study in your groups and answer the following questions: 1. In relation to the detected incident, evaluate the ABC Company’s internal control system and determine its effect on the incident. (10 Marks) 2. For ABC Company, in relation to the detected fraud, critically assess the internal auditor’s role both before the incident and after the incident? (10 Marks) 3. In your opinion explain how well did the Internal Auditor carry out its fraud investigation role? (10 Marks)