Nick Ming a CIA, is an internal auditor employed by Hatch. He is just completing an audit of the inventory manufacturing Division of Paper line Inc during the first five weeks of the year. The division and manufactures inventories to supply about 50% of Paper line sales. In addition to the manufacturing divisions, Paper Line has two marketing divisions (domestic and international) and a technical service division that offers world-wide technical support. Each customer is assigned to the most suitable manufacturing division which functions as the supplier for that customer. The manufacturing division then approves the customer's credit, ships against orders obtained by the sales representatives, and collects the customer receivables when due. This allows order-to-order monitoring of customer credit limits against customer orders received.

Findings Two items that came to his attention during the audit concern Fabian: There is a material dollar amount of inventory of part number A2 that is still carried on the Paper Line books, despite the fact that the Fast-tac machining component in which part A2 was used is now considered first generation and is no longer manufactured. Company policy requires an immediate write-off of all obsolete inventory items. Some accounts receivable still carried as collectible were over 180 days old. All receivables are due in 30 days, which is standard for the industry. Fabian believes that many of these old accounts are uncollectible.

The division manager's administrative assistant, Belinda Gardner, performed the aging of accounts receivable, rather than the division accountant, as is standard practice. (The division accountant refused to discuss the circumstances of Belinda's actions or either of the issues which arose during the audit.) The auditee's comments Fabian scheduled a meeting with Belinda and discussed the above concerns. "Well, Fabian," Belinda responded, "I know that policy requires that obsolete inventories be written off, but that part A2 is just not being used at present. We might start to make those Fast-tac components again. Who knows? Wide ties are coming back again, aren't they? Fast-tac could too. There are plenty of customers, especially in developing nations, who are finding those newer generation machines pretty expensive to maintain. I mean, there is a policy that states obsolete inventories should be written off, but there is no policy defining an obsolete part. "And as for those receivables," Belinda continued, "that is certainly a judgment call, too. Who knows if those receivables will be collected? We're in a slight recession now. When things pick up, we'll probably collect a few. There isn't even a policy in this division on writing off receivables I checked: nothing says I have to write them off.So who are you to say I have to?" Fabian argued: "Belinda, you know those parts will never be used. And you know those receivables are bad." "Look, Fabian," Belinda finally bargained, "it's only a few weeks from the close of the year. Let's leave these items as they are after the close so that everyone gets their bonuses. Then, I promise I'll take a fresh look at both inventories and receivables. I'll write them down after year end, after the financial reports are issued. No one will know. And, after all, who's to be hurt?"

Fabian continued his audit, drafted his report containing findings related to the inventory and receivables, and reviewed the draft report with the division manager, Allyson Barrett. Allyson was visibly disturbed. "Gee, Fabian, this couldn't have come at a more awkward time. Our figures just got audited by the external auditors there was a guy out here for our inventory count in November and Brenda sent her aging of the year-end receivables to corporate headquarters. No one up there, in our group or on the external audit team, was the least bit critical. If you go raising problems particularly now, the external auditors will catch us writing off inventory and receivables. They'll adjust profit and there will be hell to pay, for all of us. And, Fabian, this is no clear-cut issue, either. I mean, I can see how you can write one report calling for clearer policy, but never one calling for specific write-downs. That's way out of your jurisdiction. But still, I promise, we'll look at all this after our statements are accepted. Right now, I feel the managers of this division have worked their hearts out and I intend to fight to protect what little bonuses they have coming. If we write down as you suggest, those bonuses will go and the stockholders will lose too. Earnings per share will drop like a rock. They might even close this division. Now you don't want that, do you?" "Well, Allyson, I could word my findings as they are in the draft but include your response...." Allyson was suddenly angry. "What? And let the audit committee decide the issue? They have nothing to do with this. They accepted the external auditors' report. If you want to make the audit committee happy, you'll accept it too and leave this adjustment stuff alone."

The internal audit director Concerned, Fabian delayed finalizing his report and discussed the draft with John Wong, director of internal audit. John was not trained as an auditor and was promoted to director of internal audit from the treasury division of corporate finance so that she might develop a better understanding of operating relationships. Still, John is very smart and Fabian has always respected him opinion. The discussion was by telephone, with Fabian still at the Paper Line Division headquarters and John at the corporate office. "Fabian, Allyson is right. If you blow the whistle on management bonuses this year, we can forget all the goodwill that I've been struggling to build for our department. It will all go out the window." Fabian responded, "I know you've been trying to put us on a better footing with management, John, but Allyson is intractable. As far as she is concerned, the only finding he will accept in the report is that of deficient policy, with nothing mentioned about the inventory or receivables needing adjusting." "Well, do what you have to do," John ended the discussion. "But I insist that you submit a report that Allyson agrees to and has signed. I don't want to upset anyone, then have to try to explain my report to the board when everyone is complaining about the effect on the results and the bonuses."

I need an internal auditing report to identify and analyze the following:

1) ethical issues involved

2) control weaknesses

3) possible course of action

4) recommendation