07 - Acc653 Assignment One Wk2

Camilo Toro-Ramirez Feb 15, 2021
ACC653 N1A Auditing II
ASSIGNMENT ONE
BACKGROUND INFORMATION
Fabian Ming a CIA, is an internal auditor employed by Flow. 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 a 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.”
Required
Assume the role of Fabian. Prepare a report, identifying and analyzing
the following:
a. What are the ethical issues involved?
b. What are the identified control weaknesses?
c. What are the possible courses of action?
d. What is your recommendation?
REPORT
Date: Feb 15, 2021
To: Audit Committee, Flow, Division of Paper
RE: Internal Audit Of Manufacturing Inventory
I, Fabian Ming, have been tasked with the internal audit of the
manufacturing inventory of the Division of Paper in Flow.
Although the inventory was already reviewed by the external auditors,
and they have not had any issues with it, there are potential issues
with not writing down the obsolete inventory and aged receivables
that are uncollectible. The issues here have been raised to
management who have pointed out a lack in specificity in clear
company and accounting policy towards these two items.
Management has, however, refused to investigate and correct the
errors in the findings until after the next fiscal year after the books are
closed due to potential issues with he external auditors and until
bonuses are issued as the corrections can impair the bonuses for this
year.
A. The ethical issues involved include:

a. Management is potentially knowingly allowing misstated
financial statements with material factual errors that could
mislead shareholders and can steal from them the equity that
they think they have.
b. Investors could make incorrect decisions based on the
misinformation contained in the financial statements.
c. Management, by issuing bonuses that may not be appropriate
once the errors are fixed, could be potentially defrauding their
shareholders.
d. The decisions management has made here could be
potentially illegal and in contravention of accounting
standards.
e. Management is placing duress on the internal auditor to hide
key findings on this report, which adds a new layer of
improper conduct on top of the issues discussed above.
B. The identified control weaknesses include:
a. Accounting policies dealing with accounts receivable and

inventories that need to be more explicit and clear to avoid
willful misinterpretation.
b. If obsolete inventory of manufacturing equipment is
accumulated, there may need to be an adjustment to the
budgeting, costing and financial projections that the company
works with and the assumptions of sales and manufacturing
projections that the division is working with.
c. The fact that the external auditors did not find any issues with
the accounts receivable or the manufacturing inventory
suggests that the firm may need to be evaluated for their
processes and performance of audits or perhaps considering a
new firm that has a better quality of service may be
necessary.
d. The operations manager performing the aging of accounts
receivable instead of the accounting department suggests
that there is insufficient division of duties in the company that
may allow for biased and potentially fraudulent actions to
occur in the aging of accounts receivable and the
determination of collectible and uncollectible debt.
e. There seems to be an inexplicably high number of accounts
that are past due and uncollectible which has driven the
operations management to try to extend without much
reason the age that accounts receivable could be normally
considered uncollectible. This increase in doubtful accounts
may suggest that the division may need to tighten their credit
granting criteria to their customers in the future to avoid
these spikes in uncollectible accounts and losses as a result.
C. The possible courses of action include:
a. For the accounting department to fix the financial statements
in line with accounting reporting guidelines and notifying the
external auditors before releasing end of year financial
statements.
b. Present the findings to the board to provide direction.
D. My recommendation includes:
a. For the accounting department to investigate and correct the
financial statements and let the appropriate parties know.

b. For the board to be shown this report and launch an
investigation on company practices to see if there is a pattern
of misconduct around the areas discussed.
c. For management to clarify policies with respect to accounts
receivable and inventory.
d. For management to establish clear division of duties so that
bias and conflicts of interest are not represented in financial
statements.

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Camilo Toro-Ramirez Feb 15, 2021

ACC653 N1A Auditing II

Fabian Ming a CIA, is an internal auditor employed by Flow. He is just

The division manager’s administrative assistant, Belinda Gardner,

which arose during the audit.) The auditee’s comments Fabian

A. The ethical issues involved include:

a. Accounting policies dealing with accounts receivable and

financial statements and let the appropriate parties know.

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