LYLS Company is a wholesaler of electrical lighting fixtures and ceiling fans. The company has two locationsone in Kansas City and another that just recently opened in Wichita. The internal audit senior stayed in Kansas City to conduct the audit at the main store; a staff internal auditor was assigned to the Wichita store.

The staff auditor returned to Kansas City after a week and said that everything was fine at the Wichita store, which was good, thought the senior, because the time budget had been cut from the previous year and the audit team was under time pressure to finish the engagement.

The senior reviewed the staff auditors working papers and noted that the Wichita store had booked a year-end adjustment in excess of US $100,000a debit to sales and a credit to accounts receivable. To adjust the general ledger accounts receivable account to the accounts receivable subsidiary ledger is how the description read. The senior asked the staff auditor how an error that big could have happened. He told her the Wichita store manager said there had been some problems installing the accounting system at the new store.

Initially, the senior auditor thought the adjustment was proper since the general ledger balance was now in agreement with the subsidiary ledger. However, a short time later she was reviewing the analytical procedures performed by the staff auditor and noted that the gross margin percentage at the Wichita store was significantly lower than the gross margin at the main store in Kansas City. The staff auditors working papers included the following explanation: Per the store manager, prices were reduced at the Wichita store to attract customers in a new location.

The next day, the senior auditor was talking to the controller at the main store and she mentioned how it looked like there had been a few problems at the Wichita store that appeared to be resolved. I guess those price reductions you had earlier in the year really worked to attract new customers, she said. Price reductions? said the controller. What price reductions? The company is a wholesale distributorit does not have sales like one might find in a retail store.

The senior auditor questioned the controller about the problems the company had encountered installing the accounts receivable system at the Wichita store. The controller said that the staff auditor must have misunderstood because no problems had ever been reported by the Wichita store manager.

The senior realized something wasnt right and discussed the matter with the audit manager and chief audit executive. The audit manager then discussed the auditors concerns with the controller and company owner. Agreement was reached that the situation should be investigated further. Accordingly, the auditors expanded their fieldwork, tracing customer payments to the Wichita store back and forth between the subsidiary ledger and the general ledger.

Their expanded work uncovered the fact that the Wichita store manager was stealing payments customers made on account. Thats why the subsidiary ledger was out of balance with the general ledger. To cover up his theft, the manager debited the sales account, which was why the gross margins of the two stores were not aligned.

A. What created an opportunity for the Wichita store manager to commit the fraud? Be specific.

B. What evidence trail caused the auditors to suspect that a fraud might have occurred?

C. The staff auditor originally failed to give due consideration to the apparent warning signs of fraud. What are some of the more likely reasons why he either missed the red flags or failed to adequately pursue them?