Q. A staff internal auditor was assigned to audit one of the companys wholesale distribution locations. The staff auditor returned to the office after a week and said that everything was fine.

The senior auditor reviewed the staff auditors working papers and noted that there was 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 location 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 that location was significantly lower than the gross margin at the other locations. 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 company controller. I guess those price reductions 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. The controller said that the staff auditor must have misunderstood because no problems had ever been reported.

Accordingly, the auditors expanded their fieldwork, tracing customer payments back and forth between the subsidiary ledger and the general ledger. Their expanded work uncovered the fact that the location manager was stealing payments customers made on account. That is 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.

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 pursue them?