Information Systems Auditing Case Study: Mathra Tool, Inc.

Case Note
Mathra Tool, Inc. (MTI) is a small business manufacturing case. It can be used by
undergraduate or graduate students studying management controls and auditing in a
computerized setting. Students integrate accounting, auditing, and information systems
concepts. They identify and assess controls to set detection risk and suggest the nature, extent
and timing of detailed tests for generalized audit software. They then prioritize weaknesses in
internal control, separating reportable conditions from other improvements.

MTI is particularly topical, in the light of SAS No. 80, Amendment to Statement on Auditing
Standards No. 31, Evidential Matter, effective for financial statements beginning on or after
January 1, 1997. This SAS recognizes that both electronic and paper evidence needs to be
considered when conducting risk assessments and during the evidence gathering process.
Instructors can discuss concepts of activity based costing (due to inappropriate overhead
application) and additional types of electronic data interchange (EDI) beyond the stand-alone
EDI method used by MTI. Used with permission of the American Accounting Association and
the author.

Introduction
Mark Green, a senior accountant with Dalen & Jay, CPAs, has recently been assigned as in
charge auditor of Mathra Tool, Inc. (MTI), a long time audit client of his firm. MTI is owned by
George Mathra, an experienced machinist. George established the business over 20 years ago,
and it has grown into a $10 million-a-year business, with an excellent reputation for high
quality machined parts. MTI has clients in the automobile sector and the health care sector
and has recently begun producing parts for environmentally friendly products, such as
recycling containers, due to the business's versatility in dealing with a variety of metals as well
as plastics.

Information Systems and Business Processes

The following description is based upon Mark's review of prior working paper files and
planning discussions with personnel of MTI.

MTI has a broad range of equipment, ranging from grinders, stampers, cutters and small
presses to numerically controlled machining and turning centers, some that individually cost
over $250,000. This latter group of equipment is tied into the company's computer aided
design and manufacturing (CAD/CAM) system, used by the four senior tool and die personnel.
Machining and turning center suppliers have helped MTI develop efficient operations, by
furnishing sample numerical control programs for standard machine operations and by
providing training to employees. One of the suppliers unfortunately sent sample programs that
had been infected with a virus. George's daughter, Tiffany, had to cleanse the servers and each
of the machines, using her copy of an anti-virus software. When contacted, the supplier did
not know that his software was infected and apologized profusely.
The four CAD/CAM terminals and printers are connected to the company's local area network
(LAN), which is maintained by Tony Lee, the owner of a computer shop conveniently located
three blocks away. All computer equipment, software and supplies are purchased from Mr.
Lee, who is responsible for attaching and maintaining equipment, upgrading software and
maintaining user security profiles on the network. There is one user identification and
password for accounting (shared by Tiffany, George and the accounting clerk). Each of the
plant supervisors has his own password, and a common password is used to initiate the
timekeeping system. The two word processing staff members have their own password and
use the common accounting password when they need to do data entry.

A standard routine has been set up to back up the accounting systems. One of the accounting
staff inserts one of seven tape cartridges into the system at the end of the day (they are
labeled with the day of the week), so that the company has a full set of backups for the week.
Tiffany keeps these in her office. These are particularly important, since during the last office
move, two years ago, the original disks for the accounting system were misplaced.

Tiffany Mathra, George's youngest daughter, has been working in the business for 15 years.
She started as a machine operator and has finished several college diplomas in numeric control
and in accounting over the years. She is being groomed to take over the business in two years
and is proving herself competent both on the shop floor and in administration. She works
along with the tool and die machinists and the shop supervisors, discussing design problems,
quality control methods and costing of quotes for potential orders. Wednesday morning 7:00
AM meetings are held by Tiffany and George to maintain a good working relationship with the
supervisors (one purchasing, three production, one design, one quality control) and to review
any problems that need to be addressed in the coming week. This includes any potential
scheduling changes required due to "rush" jobs that have been accepted or are being quoted.
This good working relationship is extremely important for satisfying some of the company's
larger customers. MTI has paid for computer equipment for each of the supervisors, so that
they have fully functioning microcomputers at home. If a rush job requires weekend work,
then these senior personnel can work at home to get the necessary quoting or design work
completed. Since the "at home" systems are identical with the office systems (Mr. Lee simply
copied the image from the MTI systems to the home computer hard drives), diskettes can
easily be taken home and then brought back to the office. It is understood that when work
slows down, a day off can be taken to compensate for this weekend work.

Almost ten years ago Tiffany arranged for the implementation of the network and the
purchase of a standard integrated accounting package (general ledger, order entry/accounts
receivable, purchases/payable, payroll), and for the purchase of the job costing and
timekeeping system. The job costing package is used to prepare and print quotes. For
automotive customers, the quote is entered into the stand alone electronic data interchange
(EDI) system for transmission. Customer purchase orders received via EDI are simply printed
and filed. Once a quote has been accepted, the job is given a unique job number. The job
control sheets include a list of the machining center, labor and quality control tasks, each with
a unique optical scanning label used by the employees to "sign in" and "sign out" of particular
tasks by machine type and by operation. Standard control sheets are also used for overhead
tasks, such as cleaning or machine setup. Employees have plastic cards with their employee
number coded. They use a laser pen to scan their employee number, the job number and the
operation label for each activity, as it is commenced or completed. To sign out, they simply
scan their employee card again.

Accounting Systems
A variety of reports are printed daily, weekly, or monthly from the costing system; these are
used for monitoring employee hours, the status of jobs, the costs accumulated for particular
jobs and the work-in-progress inventory. The weekly report of hours from the costing system is
approved by the production supervisors and is used as a data entry input source into the
payroll system for hours worked. The accounting clerk enters the hours into the accounting
system, so that weekly payroll checks and reports can be produced. When volume is high, one
or both of the administrative staff assist. The administrative staff also does filing or document
matching, as necessary.

Tiffany is really pleased with her accounting clerk, Isabel, who has been with the company for
three years. She insists that fate had a hand in getting Isabel for MTI. Isabel was "pounding the
pavement," having recently immigrated, and had no local business experience. Her accounting
skills were rudimentary, but she quickly learned the accounting software and has reorganized
the filing system. Tiffany considers her indispensable. When Isabel goes on vacation, many
things simply don't get done. Tiffany can do the payroll in a pinch, but Isabel always does
accounts payable and cash disbursements. If she's away, suppliers are simply told to wait, or
Tiffany issues a manual check, which is recorded later. Isabel is very good at responding to
queries from suppliers and ensuring that new suppliers are set up properly. The purchasing
supervisor and his staff rely on Isabel, for she checks the account allocation of purchases and
makes any necessary corrections. Isabel also ensures that necessary EDI acknowledgments are
sent and reports printed.

Tiffany and George are signing officers, although Tiffany realizes that she checks supporting
materials more thoroughly than George, who usually just queries Isabel verbally about larger
purchases. George normally handles the bank deposits, while Tiffany does the monthly bank
reconciliation. Every three months, an accountant from Dalen & Jay reviews the regulatory
returns for reasonableness, as well as journal entries made in the last three months. He
updates the recurring journal entries and advises Tiffany of any changes in procedures or
modifications to monthly journal entries that are required to help ensure accuracy and
completeness of transaction processing. Tiffany runs the standard financial statements every
month from the accounting package, but normally some additional adjustments are required
when the accountant comes in. These are adjustments to depreciation expenses, changes to
prepaid expenses and some account reallocation (e.g., repairs and maintenance to capital
accounts) based on discussions with Tiffany. The regular technician assigned to MTI is Louis
Jaborwock, who has just completed the most recent month end entries.

Louis informed Mark that MTI had a problem one of their systems on Friday. Apparently, one
of the servers might have "crashed." Luckily, this was the server with the accounting systems
and was fully backed up on tape. A new server was to be installed the next day, and Mr. Lee
was reconfiguring the network so that the remaining systems could function from the single
server.
Work-in-Process Inventory
The engagement partner from Dalen & Jay believes that MTI's growth may have expanded the
company sufficiently to warrant increased levels of controls reliance during the audit. She is
particularly interested in work-in-progress (WIP) inventory, the largest item on the balance
sheet, typically close to three months' sales. She has requested an updated controls analysis
and that computer assisted audit techniques using the firm's generalized audit software be
considered. To this end, Mark has updated the narrative description associated with WIP
inventory.

To calculate the WIP inventory for any particular month, one of the purchasing staff transfers
data from a report in the job costing system into a spreadsheet (exhibit 1). 2 Since the job
costing system does not have sales information, progress billings are added manually, and the
spreadsheet total is used for the monthly financial statement's work-in-progress figure.

The purchasing clerk has explained the contents of her spreadsheet and described the origin of
the information. Following is an explanation of the spreadsheet on a column by column basis:

Job number: A unique job number is assigned by one of the production supervisors. There
is a manual log in the production area, and the supervisors write down the customer,
purchase order number and the job numbers used. Where a purchase order lists multiple
parts, a different job number must be used for each part produced.

Customer code: Each customer has a unique customer code. Tiffany assigns these codes, so
that the same code can be used in the accounting and in the job-costing system.

Customer Purchase Order Number: These match the purchase orders received from
customers. Due Date and Scheduled Completion Date: The customer purchase order will
indicate the date that an order is due. The production supervisors will schedule the job so
that it is completed prior to the due date.

Customer Part Number and Part Description: MTI always uses the part numbers of its
customers and the customer description when describing parts being produced. These
must match customer purchase orders.

Quantity Ordered: The quantity ordered on the purchase order is entered into the job
costing system.

Quantity on Hand: The quantity on hand is based upon the figures in the costing system.
This is initiated with the first operation. For example, if component parts are purchased
and then additional work is done on a component part, then the quantity on hand is based
upon the parts purchased. If raw material is purchased and cut on the premises, then the
person who completes the first operation notes the quantity cut, for subsequent entry by
the production supervisor. Any damaged parts that cannot be passed on to the next
operation are reported to the quality control staff, who enter the part into the system as
damaged, thereby reducing the quantity on hand. All data entry is accomplished using the
common job costing password. Such entries will show on a damaged-parts report, which is
discussed every Wednesday at the supervisors' meeting.

Percentage Complete: Each operation on the job control sheet is assigned a percentage of
the job. The system tracks which operations have been completed and reports the
percentage complete based upon the last operation that has been fully completed for all
the parts.

Quoted Costs (labor center, materials, total): These costs are all listed at a rate-per-
individual-unit part. Labor center rates are based upon standard rates that have been
developed by George and Tiffany. They include the labor rate of the employee multiplied
by a factor, depending upon the machine used. The factor incorporates both plant
overhead charges plus machine charges. The lowest factor is 2.5, the highest 23. Thus, an
employee earning $10 per hour would result in a labor center cost at the lowest factor of
$25 per hour and $230 per hour at the highest factor. Material cost is based upon quotes
from suppliers, plus a markup. Some customers have a fixed arrangement with the markup
as low as 5 percent, while others are marked up as much as 150 percent. During the last
year, the company has changed its costing and overhead allocation methods to absorption
costing, based upon the accounting firm's advice. MTI reduced its labor center factors by
10 percent and added a flat materials handling charge ($50) and ordering charge ($25) to
each of its quotes.

Actual Cost-to-Date: As work is completed and supplier invoices are received, these costs
are entered into the job costing system. Actual hours worked on an operation may be
higher or lower than quoted. The hours worked are automatically posted using the
timekeeping system. The production supervisors review each daily printout of hours
worked, to ensure that employees have properly clocked out. Production supervisors must
approve any job cost system adjustments, which are entered by one of the purchasing
staff. As supplier invoices are received, they are recorded into the job-costing system by
the purchasing staff and then forwarded to Isabel for entry into the accounts payable
system.

Sales Price: This is the price that the customer has agreed to pay, according to the purchase
order.

Progress Billings: Normally, MTI does not request advance payments or progress billings.
However, if a customer is new or a part requires a substantial material purchase, an
advance payment is requested to cover the cost of the material. MTI then considers this
material as already owned by the customer and deducts this progress billing from the cost
of its WIP.

Work-in-Progress Inventory Value: Isabel updated the spreadsheet template this year,
applying a formula to calculate inventory as follows: ([quantity on hand] x [percentage
complete /100] x [actual cost to date]) - progress billings. She reviews the inventory list
prepared by purchasing for one of two necessary adjustments. First, if a job has not been
started it will show as zero percentage complete. Sometimes, parts have been ordered on
 a subcontract basis and been placed into production. Then, the WIP value must be
increased from zero to the value of these parts. Second, if a job has an overrun and the
actual costs exceed the sales price, then the value of the inventory must be reduced so that
it does not exceed the sales price. Isabel makes these changes by manually scanning the
inventory listing and changing the inventory value for these items.

Required
The engagement partner has requested a meeting tomorrow to discuss engagement planning
for MTI. She has requested several documents for that meeting.
1. A preliminary audit plan assessing internal control risk and providing preliminary
judgment for detection risk.
2. A draft management letter to be provided to management containing any additional
weaknesses and recommendations for improvement.