Ritter Tire Warehouse Company had a high volume truck and passenger car tire business in Hamilton, Ontario (area population 500,000). Jay Lock, the chief accountant, was a long-time trusted employee who had supervisory responsibility over the purchasing agent as well as general accounting duties. Jay had worked several years as a purchasing agent before moving into the accounting job. Jay carried out a fraudulent scheme for three years, diverting tires that costs Ritter $2.5 million, which Jay then sold for $2.9 million. Inventory and income were overstated by Jay's substitution of the new-tire inventory with lower-quality retread tires, which he valued at new-tire prices. Jay's cost for retread tires was approximately $500,000.

Jay often prepared the purchase orders, and the manufacturers were directed to deliver the tires to a warehouse in Milton (a town of 60,000, about 30 kilometres north of Hamilton). Ritter Tire received the manufacturers' invoices, which Jay approved for payment. Jay and an accomplice (his sister-in-law) sold the tires from the Milton Warehouse and pocketed the money. At night, Jay moved cheaper retread tires into the Ritter warehouse so that the space would not be empty. As chief accountant, Jay could override controls e.g., approving invoices for payment without a receiving report, and T. Ritter (President) never knew the difference because the cheques presented for her signature were not accompanied by the supporting documents.

Audit Trail

Ritter Tire's files were well organized. Each cheque copy had supporting documents attached (invoice, receiving report, purchase order), except for the misdirected tire purchases, which had no receiving reports. These purchase orders were all signed by Jay, and the shipping destination on them was the Milton address. There were no purchase requisition documents because "requisitions" were in the form of verbal requests from salespersons. There was no paper evidence of the retread tires because Jay simply bought them and moved them in at night when nobody was around. Ritter engaged external auditors for the first time in the third year of Jay's scheme, after experiencing a severe cash squeeze.

 Required:

1. State the audit objectives of the case.

2. Discuss the controls relevant to the process. Describe the tests of controls you will use as auditor. Were the controls effective?

3. Discuss the tests of details of balances you would use.