IDEAS PLEASE DO NOT WANT IT WRITTEN JUST IDEAS I STINK AT AUDITING

Objective

The purpose of this assignment is to write a formal audit report identifying material internal control weaknesses and providing recommendations based on the facts in the case study. The assignment will challenge you to try to understand the business objectives, processes and overall internal controls presented in the case. Give it a lot of thought. Ask yourself some questions. What are the objectives of the loom reclamation program? What is preventing Tarheel Textiles from realizing the full benefits of the program? Where are the opportunities for fraud?

Required

Please read the case and all requirements carefully. Make sure your submission includes the two items detailed below. Please edit and proofread your paper. It represents 20% of your course grade. This assignment is to be completed using only the materials authorized for use in this class. If you have any questions as to what is expected, please contact the instructor.

1. While you are given a lot of information in this case, there is still additional information you would like to know. If you were part of the audit team, what additional questions would you ask to gather more audit evidence? You must come up with 15 relevant questions. You must indicate what you hope to learn from each question (i.e., what is the intent of the question) and to whom the question would be addressed.

I recommend documenting your questions in a table with three columns: question, person(s) to whom the question will be addressed and intent of the question. The questions are separate from your audit report. You should assume that no one at Johnstone & Company or Mr. Shaw will cooperate so do not direct any of your questions to them.

2) You will write a formal report for senior management and the audit committee of the board of directors. Your audit report must have an executive summary with your overall conclusions, and findings and recommendations. There are different ways to write an audit report. You are free to choose a format which works for you. Please reference the readings and discussion in week 7.

The focus of the audit report must be on the internal control weaknesses and recommendations for improvement. There are a lot of significant internal control weaknesses in this case. You need to identify the three most significant internal controls weaknesses in each of the following four areas: administration of the program, receiving, loom teardowns, and disposal of residues and scrap metal. You should use what you learn in week 7 to formulate your audit comments. When you describe an internal control weakness, make sure your intended audience will be able to understand it (i.e., senior management). For example, if you believe there is a segregation of duties issue, you need to indicate where and why it is a problem.

Case Study: Tarheel Textiles

Used with permission of The IIA Research Foundation

Background

Many of Tarheel Textiles' old Draper looms have recently been replaced with more modern and efficient weaving machines. Instead of being junked or scrapped, these surplus looms are sent by the plants to the Supply Support Division where they are stripped of all useable parts. These parts are reconditioned, stored, and placed on perpetual inventory records as used supply items.

Manufacturing facilities within Tarheel route all of their purchase orders for Draper loom parts through the Supply Support Division. This includes orders made out to Draper Company and all other vendors from whom Draper parts can be purchased. Supply Support reviews its inventory records (and will hold the order for no more than one day) to determine the availability of used parts generated from the loom stripping program. If parts are available within Tarheel, the purchase order to the vendor is altered and the Supply Support Division ships the available parts automatically to the ordering plant. The altered purchase order is then sent to the vendor.

This program has resulted in substantial savings to Tarheel. Also, many of these older parts are in short supply and are, therefore, difficult to obtain within a reasonable delivery time.

Operation

The Loom Reclamation Program operates as follows:

Receiving

Plant sends to the Supply Support Division all surplus Draper looms. These looms may or may not be operative, but would have been scrapped at the plant, or otherwise disposed of, had they not been shipped to Supply Support.

Plant prepares a shipping document, which accompanies each shipment of looms. This shipping document lists each asset shipped, identified with the Tarheel fixed asset tag number.

The shipping plant prepares the necessary reports to transfer these surplus items to the Supply Support Division fixed assets ledger.

The looms are transferred, unloaded, and placed in a 3-1/2 acre fenced-in field.

Shipping documents are sent to the administrative office, where looms listed on the shipping document are compared to the quarterly printout received from Corporate Accounting which lists all assets transferred to Supply Support during the quarter.

The administrative area keeps a manual listing of looms. This list is reconciled quarterly with the computer-generated fixed asset ledger received from Corporate Accounting.

Loom Teardowns

Looms are torn down daily (as many as time permits). The teardown process includes:

- Removing the Tarheel Textile asset tag number.

- Stripping the asset of all useable parts.

- Reconditioning these parts.

- Storing any salvageable metal and the residue (or carcass) in a central area. The residue is usually the loom frame and some useable pieces of metal.

A Loom Teardown Report is prepared weekly. The report lists by identification tag number each loom torn down during the week. Sometimes, however, tag numbers are missing from the looms--many of the looms are old and thus the tags have been jarred loose or have fallen off during shipment.

This report is sent to the Administrative Office where it is used to authorize removal of these looms from the fixed assets accounting records. The tag number identifies assets on the ledger.

The loom parts salvaged as a result of the loom teardown are collected. A quality control person reviews each part to determine whether it is reusable as is, needs to be reconditioned, or should be sold as scrap metal. The reusable parts are eventually sent to the Supply Room and placed on perpetual inventory records for accountability.

Sale of Reconditioned Loom Parts

Written Customer Orders:

The computer generates a shipping document based on a written customer order. The customer may be a Tarheel Textiles plant or another company.

The shipping document is reviewed in the Supply Room. If inventory records indicate reconditioned Draper loom parts are available in bins, these parts will be used to fill the order. If inventory records show no parts available, the Supply Room Clerk copies these part numbers/descriptions on a sheet of paper.

This sheet of paper goes to the Loom Teardown Supervisor. Crewmembers will go out to looms in the field and strip the needed parts from the looms.

These parts are sent to the Supply Room, along with the piece of paper, for review and to make ready for shipment.

The Shipping Supervisor loads goods onto the truck. He checks against Notice of Shipment to assure accuracy of loading.

The loaded truck leaves premises.

Telephone Orders:

Verbal orders received from customers, either by the Supply Room or the Loom Teardown Supervisor, are handled similarly except that no written customer order exists. All information is written on an order form.

The two supervisors coordinate selection of parts, either from Supply Room bins or stripped from looms in the field.

After the parts have been pulled and the order is ready for shipment, the Supply Room Supervisor contacts the Administrative area so that a shipping document may be prepared, based on the items listed on the order form.

The shipping document is sent to the Shipping Supervisor.

The Shipping Supervisor loads goods onto the truck. He checks against the Notice of Shipment to assure accuracy of loading.

The Shipment leaves the premises by Tarheel Textile truck, customer truck, or common carrier.

Disposal of Residues and Scrap Metal

The Loom Teardown Supervisor usually receives customer orders verbally. Johnstone & Company is the primary customer to whom Tarheel sells loom residues and scrap metal. A company representative will often come to Tarheel, select loom residues and scrap parts he wants to purchase from those available, and supervise the loading of his truck.

The Loom Teardown Supervisor calls the Administrative Area and requests a shipping document be prepared since Company policy prohibits any vehicle from leaving the premises without a Notice of Shipment. The Supervisor gives the office all the information necessary to prepare the document.

The truck leaves the premises from the loom field through the main gate.

Situation

1. The Telephone Call

Mr. Arthur Thomas, the buyer in Corporate Purchasing responsible for the disposal of Tarheel Textiles' surplus assets (including the sale of all parts from the Supply Support Division), received a telephone call from a person who stated he had previously worked for Tarheel Textiles. The caller alleged that the Supervisor of the Loom Teardown Program at Tarheel's Supply Support Division was instructing employees to locate 64" X-3 Draper looms and load them onto trucks without a valid customer order. The caller, who refused to identify himself, stated he had been fired from his job at the Supply Support Division because he "knew too much about what was going on."

Mr. Thomas contacted the Director of Corporate Purchasing (his superior), the Supply Support Division Manager and Director of Corporate Security. An investigation ensued, and the information on the following pages was obtained from various sources.

A Corporate Security investigator visited the Supply Support complex. The security survey disclosed that:

The entire area was fenced, and the fences were in good repair.

The main entrance gate and the gate to the field of looms could be locked.

The field of looms was located approximately 400 feet from the main gate. Surplus electric motors had also been placed in this field.

Administrative/Accounting Offices were located directly across from the loom field.

No safety or fire hazards existed.

No security persons, guards, or watchmen were used at the site.

The main gate opens onto a relatively busy intersection.

2. The Loom Teardown Crew

While at the location, the Corporate Security investigator interviewed some of the members of the Loom Teardown Crew. Leon Curtis, a crewmember, spoke first. Leon, now a part-time employee, is a retired loom mechanic from a nearby Tarheel plant and has been employed by Tarheel for 35 years. "Every day Shaw (Loom Teardown Supervisor) had us looking all over the field for 64" X-3 Draper looms. And that's no easy job either, especially when the looms are stacked on top of each other, so close together and 8 or 9 in every row. He wouldn't tell us why and wouldn't ever take `no' for an answer. None of us knew of

any customer order for those looms. We would load the looms onto a truck with other items Johnstone wanted--loom residues, scrap parts, and sometimes even reconditioned parts. Johnstone kept a truck in the Loom Teardown Area between pick-ups. We loaded scrap metal onto his truck each day. A fellow from Johnstone & Company would come by, usually every Friday. He would look over the parts on the lot for anything else he wanted to buy and would exchange trucks."

A second crewmember, Harvey Jolly, appeared somewhat ill at ease. He was a lanky fellow with thinning hair, about 45 years of age. He was constantly smoking a cigarette. Harvey said, "I've thought something crooked was up for quite a while, ever since Bob Johnstone started coming over here occasionally instead of the usual guy. A couple of times Shaw and Johnstone would leave for lunch in Shaw's Corvette, and they wouldn't come back until 3:00 p.m. No, you can't tell me something wasn't happening."

Danny Burton, a young crewmember about 19 years old, interjected, "We aren't the only ones who knew something wasn't right. Ask Clark Danley (a Supply Support Division Engineer). He can tell you a lot more than we can. Anyway, I've always wondered why Tarheel Textiles would even think about hiring somebody with a criminal record."

Harvey Jolly spoke again. "It's difficult keeping up with all these parts, especially when you tear down as many as 12 or 14 looms a week. Take the brass, for instance. We put all the brass pieces in separate baskets, and entire baskets will sometimes disappear during weekends. We try to keep track of all the parts, especially after we steam clean, repair, and repaint them. But with so many parts, it's really hard."

Leon Curtis said, "We're really glad to be able to talk to you about this. We've been talking about it among ourselves but didn't know whom to turn to. It just isn't right for us to work hard and try to do the best we can at our jobs, when somebody else is doing just the opposite."

The Security investigator thanked each crewmember for his cooperation and urged them to contact him if they thought of anything further.

3. The Inventory

Corporate Security reviewed its findings to date with the Director of Corporate Purchasing and the Supply Support Manager. All concurred that a physical inventory of looms in the field needed to be taken. Written procedures were developed and included the following:

The inventory would be taken by total count only, not by individual type/size loom. An exception was that all 64" X-3 looms would be identified separately.

Each loom would be tagged when counted.

The total number of looms in each row was to be written on a separate tag and attached to the loom at the end of each row.

All tags must be accounted for.

Instructions were to be discussed with all persons participating in the inventory-taking process prior to starting.

Approximately 2,700 looms were counted, and 42 man-hours were needed to take the inventory. Reconciliation of the overall physical count to quantities on inventory records disclosed a net shortage of 59 looms. (There was a 72-unit shortage of looms that had not yet been stripped. A gain of 13 looms residues was disclosed.)

The variance relating to 64" X-3 looms was isolated:

34 looms on inventory records

(5) looms on hand in field

29 loom shortage

4. The Inventory Record Review

The Administrative/Accounting Office also did some investigative work:

A reconciliation of loom residues invoiced since inception of the program (approximately 24 months) to looms removed from the fixed asset ledger, taking into consideration residues currently on hand, revealed a shortage of 38 looms.

Accounting personnel stated that the possibility of poor record keeping, especially in the first months of the program, and inaccurate preparation of Loom Teardown Reports could explain a portion of this variance.

Sixteen Tarheel Textile fixed asset identification tags were located in Mr. Shaw's desk drawer and toolbox. These appeared to have been accumulated over a period of time. Accounting personnel traced these tag numbers to the fixed asset ledger: all numbers were identified with 64" X-3 Draper looms.

No customer invoices for brass had been issued during the last 12 months.

No 64" X-3 Draper looms were listed on shipping documents which supported shipments made during the last six months.

5. Other Pertinent Information

The average market value for these Draper looms is $750. Converted looms can sell for as much as $7,500. The value of parts varies, but ranges from $2 to $70. Johnstone & Company has been paying Tarheel Textiles $75 to $100 for each loom residue purchased.

Approximately two pounds of brass can be salvaged from each stripped loom. This brass can be sold to a local dealer for 53 cents/pound.

The 64" X-3 Draper loom parts may be used in converting looms to air-jet looms, which are more efficient and utilize newer technologies.

In recent months, Johnstone & Company has also been purchasing reconditioned loom parts in addition to scrap metal.

Leventhal Parts & Supply Company also purchases a small percentage of loom residues and unusable parts, but only offers Tarheel Textiles $50 per residue.