You are an auditor employed by Nicholas & Williams Chartered Accountants. One day when you were sitting in your office, a partner in the firm asked to see you to discuss a special assignment he wanted you to conduct for Smart Controls (Smart), a large, successful manufacturer of electronic components used for smart phones. While Smart is not a financial statement audit client, they have hired your firm over the years to perform various consulting engagements. his particular engagement consists of a review of the company’s internal controls over the purchasing, storage, and issuance of special raw materials inventory which consists primarily of high-cost electronic components.

The partner went on to tell you, “Smart Controls has been experiencing some problems in the factory lately and the board of directors has asked us to verify whether their current procedures are adequate. hey have had some pretty significant write-offs when some expensive electronic components have gone missing. he board members are concerned about this situation and have asked us to examine the supply procedures and identify possible causes of the problems, specifically for their special raw materials inventory. hey mentioned that their external auditor had never expressed any qualifications on the company’s financial statements or mentioned any deficiencies in their letter to management. However, in light of the missing materials, I don’t believe that there aren’t any. I would like you to identify the deficiencies and provide recommended improvements for each. I have told the Controller that you will be there later today to meet with him and get more information regarding the procedures in place.”

You have also obtained a copy of the inventory policies and procedures from him to assist in your assignment (Exhibit 1). Later that day, you meet with the Controller to discuss the controls over the special raw materials inventory (Exhibit 2)

  

EXHIBIT 1 Smart Controls POLICY AND PROCEDURES-SPECIAL RAW MATERIALS INVENTORY Purchase of Special Raw Materials Inventory The Accounts Payable department is responsible for ordering all special raw materials inventory. Only the Cage Supervisor can send a parts requisition to the Accounts Payable Department for ordering. An Accounts Payable clerk prepares a purchase order for the predeter- mined reorder quantity for each item and mails the purchase order to the vendor from whom the item was last purchased. Only the Cage Supervisor is allowed to select a new vendor. When a new vendor is selected, the Supervisor sends an e-mail to the Accounts Payable department to request the vendor be added to the system. Receipt of Special Raw Materials Inventory Upon receipt of the ordered materials, a Cage Clerk must count the goods received and agree to the count on the shipper's bills of lading. The Cage Clerk must initial and date all bills of lading for materials received. All bills of lading must be stored in the cage. Storage of Special Raw Materials Inventory All special raw materials must be stored in the cage at all times unless they have been moved into production. The cage must be locked at all times. All cage employees must be bonded. No other employees are allowed into the cage and only cage personnel may possess a key to access the cage. >> >> Cage Clerks must perform monthly inventory counts. These must be done under the direct supervision of the Cage Supervisor. Transfer of Special Raw Materials Inventory to Production Cage employees will only release special raw materials inventory upon written or oral requests from a Production Foreman.