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AUD 1206 Case Analysis Number 2

Answer each case briefly. Cite references, as necessary.

1. A company's accountant was able to approve payment of invoices and write company checks to a
family member, with whom the accountant would split the proceeds. The accountant covered up the
theft with journal entries in the accounting information system.

Which duties should be separated to prevent such problems in the future?

2. You are the Chief Executive Officer of a large USA multinational company operating in the energy sector.
Your company has operations in 23 different countries, some of which are developing economies, and it
has raised debt finance, as well as equity finance, in 17 of these countries. You are aware that there have
been protests from environmental lobby groups in several areas regarding oil pipelines. There have also
been demonstrations about the impact of operations on local communities.

Your company has an internal audit committee, an audit committee, and a reasonably well-developed
system of internal control loosely structured around the Turnbull Report's recommendations. However,
the board has decided that perhaps it should form a new committee, a 'risk committee', which will deal
with risk management and internal control specifically.

Accordingly, the board has asked you to prepare a memo which summarizes the main risks facing the
business at present, and the relative importance of these risks to the business, to highlight where the
primary exposures are likely to be. (You may refer to Chapter 5 of our reference material, specifically on
Risk Assessment topic.)

3. Raiza Motors Company, a diversified manufacturer, has five divisions that operate throughout
Singapore and Australia. Raiza Motors has historically allowed its divisions to operate autonomously.
Corporate intervention occurred only when planned results were not obtained. Corporate management
has high integrity, but the board of directors and audit committee are not very active. Raiza Motors 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 principles and
practices, but employee compensation packages depend highly on performance. Raiza Motors Company
does not have an internal audit department, and it relies on your firm to review the controls in each
division.

Don Erico is the general manager of the Fabricator Division. The Fabricator Division produces a variety of
standardized parts for small appliances. Erico 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 Fabricator’s markets and has offered substantial price
reductions in order to grab market share. Erico has responded to the competitor’s actions by matching
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the price cuts in the hope of maintaining market share. Erico 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.

Erico 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-run solution to the profit decline due to the
competitor’s price cutting. Erico is certain that once the competitor stops cutting prices or goes bankrupt,
the misstatements in inventory can be corrected with little impact on the bottomline.

a. Evaluate the strengths and weaknesses of Raiza Motors Company’s control environment.

b. What factors in Raiza Motors Company’s control environment have led to and facilitated Erico’s
manipulation of inventory?