Q4. Success Company, a diversified manufacturer, has five divisions. Success has historically allowed its divisions to operate autonomously. The corporate intervention occurred only when planned results were not obtained. Corporate management has high integrity, but the board of directors is not very active. Success has a policy of hiring competent people. The company has a code of conduct, but there is little monitoring of compliance by employees. Management is fairly conservative in terms of accounting policies and practices, but employee compensation packages depend highly on performance. Success Company does not have an internal audit department, and it relies on your firm to review the controls in each division.

Bader Fahad is the general manager of the Fiberglass Division. The Fiberglass Division produces a variety of standardized parts for small appliances. Bader has been the general manager for the last seven years, and each year he has been able to improve the profitability of the division. He is compensated based largely on the division's profitability. Much of the improvement in profitability has come through aggressive cost-cutting, including a substantial reduction in control activities over inventory.

During the last year, a new competitor has entered Fiberglass's markets and has offered substantial price reductions to grab market share. Bader has responded to the competitor's actions by matching the price cuts in the hope of maintaining market share. Bader is very concerned because he cannot see any other areas where costs can be reduced so that the division's growth and profitability can be maintained. If profitability is not maintained, his salary and bonus will be reduced.

Bader has decided that one way to make the division more profitable is to manipulate inventory because it represents a large amount of the division's balance sheet. He also knows that controls over inventory are weak. He views this inventory manipulation as a short-term solution to the profit decline due to the competitor's price cutting. Bader is certain that once the competitor stops cutting prices or goes bankrupt, the misstatements in inventory can be corrected with little impact on the bottom line.

Required:

1. Evaluate the strengths and weaknesses of Success Company's control environment.

1. What factors in Success Company's control environment have led to and facilitated Bader's manipulation of inventory?