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Case
Study: Tarheel Textiles
Objective
This assignment help case study is
designed to expose students to a variety of conditions that may or may not
indicate a fraud has been committed. Consideration must be given to errors that
are present in a normal business environment, internal control weakness
accepted by management, as well as obtaining an understanding of procedures and
their long-range effect on business. Students need to understand the overall
control environment and not just deal with individual procedure
errors.
Required
Please
read all of the requirements carefully. Make sure your paper addresses each
item. Please edit and proofread your paper. It represents 25% of your course grade.This
assignment is to be completed using only the materials authorized for use in
this class. If you have any questions as to what is expected, please contact
the instructor.
1. If you were part of the
audit team, what additional questions would you ask to gather more audit
evidence? . You need to focus on what is
most important to this case which is how to improve the process and secondly to
render an opinion on whether a fraud has been committed. You must come up with
at least 15 relevant questions. You must
indicate what you hope to learn from each question (i.e., what is the intent of
the question) and to whom the question would be addressed.
Parts
2-3must be written as a formal audit report. Assume you are writing your report for
senior management and the audit committee of the board of directors. There are
many different ways to write an audit report.
You are free to choose a format which works for you. In addition to the readings and discussion in
week 7, you may want to view actual audit reports on www.gao.gov or a state web site and
sample audit reports on KnowledgeLeader or AuditNet.
2. What is your overall conclusion concerning
the internal controls over the Loom Reclamation Program?In your opinion, has a fraud been
perpetrated? If so, what evidence supports the allegation? Is it
firm enough to convict the person(s) in court? Please explain the
rationale for your conclusions.
3.What are the ten most significant internal controls
weaknesses in the Loom Reclamation Program?
Give it a lot of thought. You need to write an audit comment for each item
which includes your recommendation. When you describe an internal control
weakness, make sure your intended audience will be able to understand it (i.e.,
senior management).
Background
Many
of Tarheel Textiles' old Draper looms have recently been replaced with more
modern and efficient weaving machines.
Instead of being junked or scrapped, these surplus looms are sent by the
plants to the Supply Support Division where they are stripped of all useable
parts. These parts are reconditioned,
stored, and placed on perpetual inventory records as used supply items.
Manufacturing
facilities within Tarheel route all of their purchase orders for Draper loom
parts through the Supply Support Division.
This includes orders made out to Draper Company and all other vendors
from whom Draper parts can be purchased.
Supply Support reviews its inventory records (and will hold the order
for no more than one day) to determine the availability of used parts generated
from the loom stripping program. If
parts are available within Tarheel, the purchase order to the vendor is altered
and the Supply Support Division ships the available parts automatically to the
ordering plant. The altered purchase
order is then sent to the vendor.
This program has resulted in substantial savings to
Tarheel. Also, many of these older parts
are in short supply and are, therefore, difficult to obtain within a reasonable
delivery time.
Operation
The Loom Reclamation Program operates as follows:
Receiving
1.
Plant sends to the Supply Support Division all surplus
Draper looms. These looms may or may not
be operative, but would have been scrapped at the plant, or otherwise disposed
of, had they not been shipped to Supply Support.
2.
Plant prepares a shipping document, which accompanies
each shipment of looms. This shipping
document lists each asset shipped, identified with the Tarheel fixed asset tag
number.
3.
The shipping plant prepares the necessary reports to
transfer these surplus items to the Supply Support Division fixed assets
ledger.
4.
The looms are transferred, unloaded, and placed in a
3-1/2 acre fenced-in field.
5.
Shipping documents are sent to the administrative
office, where looms listed on the shipping document are compared to the
quarterly printout received from Corporate Accounting which lists all assets
transferred to Supply Support during the quarter.
6.
The administrative area keeps a manual listing of
looms. This list is reconciled quarterly
with the computer-generated fixed asset ledger received from Corporate
Accounting.
Loom Teardowns
1.
Looms are torn down daily (as many as time permits). The teardown process includes:
- Removing the Tarheel Textile asset tag
number.
- Stripping the asset of all useable parts.
- Reconditioning these parts.
- Storing any salvageable metal and the residue
(or carcass) in a central area. The residue is usually the loom frame and some
useable pieces of metal.
2.
A Loom Teardown Report is prepared weekly. The report lists by identification tag number
each loom torn down during the week.
Sometimes, however, tag numbers are missing
from the looms--many of the looms
are old and thus the tags have been jarred loose or have fallen off during
shipment.
3.
This report is sent to the Administrative Office where
it is used to authorize removal of these looms from the fixed assets accounting
records. The tag number identifies
assets on the ledger.
4.
The loom parts salvaged as a result of the loom teardown
are collected. A quality control person
reviews each part to determine whether it is reusable as is, needs to be
reconditioned, or should be sold as scrap metal. The reusable parts are eventually sent to the
Supply Room and placed on perpetual inventory records for accountability.
Sale of
Reconditioned Loom Parts
Written Customer
Orders:
1.
The computer generates a shipping document based on a
written customer order. The customer may be a Tarheel Textiles plant or another
company.
2.
The shipping document is reviewed in the Supply
Room. If inventory records indicate
reconditioned Draper loom parts are available in bins, these parts will be used
to fill the order. If inventory records
show no parts available, the Supply Room Clerk copies these part numbers/descriptions
on a sheet of paper.
3.
This sheet of paper goes to the Loom Teardown
Supervisor. Crewmembers will go out to
looms in the field and strip the needed parts from the looms.
4.
These parts are sent to the Supply Room, along with the
piece of paper, for review and to make ready for shipment.
5.
The Shipping Supervisor loads goods onto the truck. He checks against Notice of Shipment to
assure accuracy of loading.
6.
The loaded truck leaves premises.
Telephone
Orders:
1.
Verbal orders received from customers, either by the
Supply Room or the Loom Teardown Supervisor, are handled similarly except that
no written customer order exists. All
information is written on an order form.
2.
The two supervisors coordinate selection of parts,
either from Supply Room bins or stripped from looms in the field.
3.
After the parts have been pulled and the order is ready
for shipment, the Supply Room Supervisor contacts the Administrative area so
that a shipping document may be prepared, based on the items listed on the
order form.
4.
The shipping document is sent to the Shipping
Supervisor.
5. The Shipping Supervisor loads goods onto the truck. He checks against the Notice of Shipment to
assure accuracy of loading.
6.
The Shipment leaves the
premises by Tarheel Textile truck, customer truck, or common carrier.
Disposal of Residues and Scrap Metal
1.
The Loom Teardown Supervisor usually receives customer
orders verbally. Johnstone & Company
is the primary customer to whom Tarheel sells loom residues and scrap
metal. A company representative will
often come to Tarheel, select loom residues and scrap parts he wants to
purchase from those available, and supervise the loading of his truck.
2.
The Loom Teardown Supervisor calls the Administrative
Area and requests a shipping document be prepared since Company policy
prohibits any vehicle from leaving the premises without a Notice of
Shipment. The Supervisor gives the
office all the information necessary to prepare the document.
3.
The truck leaves the premises from the loom field
through the main gate.
Situation
1. The Telephone
Call
Mr.
Arthur Thomas, the buyer in Corporate Purchasing responsible for the disposal
of Tarheel Textiles' surplus assets (including the sale of all parts from the
Supply Support Division), received a telephone call from a person who stated he
had previously worked for Tarheel Textiles.
The caller alleged that the Supervisor of the Loom Teardown Program at
Tarheel's Supply Support Division was instructing employees to locate 64"
X-3 Draper looms and load them onto trucks without a valid customer order. The caller, who refused to identify himself,
stated he had been fired from his job at the Supply Support Division because he
"knew too much about what was going on."
Mr. Thomas
contacted the Director of Corporate Purchasing (his superior), the Supply
Support Division Manager and Director of Corporate Security. An investigation ensued, and the information
on the following pages was obtained from various sources.
A
Corporate Security investigator visited the Supply Support complex. The
security survey disclosed that:
a.
The entire area was fenced, and the fences were in good
repair.
b.
The main entrance gate and the gate to the field of
looms could be locked.
c.
The field of looms was located approximately 400 feet
from the main gate. Surplus electric
motors had also been placed in this field.
d.
Administrative/Accounting Offices were located directly
across from the loom field.
e.
No safety or fire hazards existed.
f.
No security persons, guards, or watchmen were used at
the site.
g.
The main gate opens onto a relatively busy intersection.
A review of the Supply Support Division personnel records revealed that
only one person had been involuntarily terminated since the inception of the
Loom Reclamation Program. The security
investigator contacted this individual and reported he firmly believed that
this person did not place the telephone call to Mr. Thomas.In addition, in
order to facilitate his understanding of the situation, the investigator
obtained the Organization Chart.
2. The
Loom Teardown Crew
While at the
location, the Corporate Security investigator interviewed some of the members
of the Loom Teardown Crew. Leon Curtis, a crewmember, spoke first. Leon, now a part-time employee, is a retired
loom mechanic from a nearby Tarheel plant and has been employed by Tarheel for
35 years. "Every day Shaw (Loom
Teardown Supervisor) had us looking all over the field for 64" X-3 Draper
looms. And that's no easy job either,
especially when the looms are stacked on top of each other, so close together
and 8 or 9 in every row. He wouldn't
tell us why and wouldn't ever take `no' for an answer. None of us knew of
any customer order
for those looms. We would load the looms
onto a truck with other items Johnstone wanted--loom residues, scrap parts, and
sometimes even reconditioned parts.
Johnstone kept a truck in the Loom Teardown Area between pick-ups. We
loaded scrap metal onto his truck each day.
A fellow from Johnstone & Company would come by, usually every
Friday. He would look over the parts on
the lot for anything else he wanted to buy and would exchange trucks."
A
second crewmember, Harvey Jolly, appeared somewhat ill at ease. He was a lanky fellow with thinning hair,
about 45 years of age. He was constantly
smoking a cigarette. Harvey said,
"I've thought something crooked was up for quite a while, ever since Bob
Johnstone started coming over here occasionally instead of the usual guy. A couple of times Shaw and Johnstone would
leave for lunch in Shaw's Corvette, and they wouldn't come back until 3:00
p.m. No, you can't tell me something wasn't happening."
Danny Burton, a young crewmember about 19
years old, interjected, "We aren't the only ones who knew something wasn't
right. Ask Clark Danley (a Supply
Support Division Engineer). He can tell
you a lot more than we can. Anyway, I've
always wondered why Tarheel Textiles would even think about hiring somebody
with a criminal record."
Harvey Jolly spoke again. "It's difficult keeping up with all
these parts, especially when you tear down as many as 12 or 14 looms a
week. Take the brass, for instance. We put all the brass pieces in separate
baskets, and entire baskets will sometimes disappear during weekends. We try to
keep track of all the parts, especially after we steam clean, repair, and
repaint them. But with so many parts,
it's really hard."
Leon Curtis said, "We're really glad
to be able to talk to you about this.
We've been talking about it among ourselves but didn't know whom to turn
to. It just isn't right for us to work
hard and try to do the best we can at our jobs, when somebody else is doing
just the opposite."
The Security investigator thanked each
crewmember for his cooperation and urged them to contact him if they thought of
anything further.
3. Alan Shaw
The Security investigator and Supply
Support Manager interviewed Alan Shaw, the Supervisor of the Loom Teardown
Program. Mr. Shaw is 36 years old and
married. He and his wife are expecting
their second child shortly. Shaw is a
very outgoing and congenial person and makes friends easily. Many have said Shaw is a "natural"
manager and works well with people. Past
performance evaluations have indicated that his only shortcomings are his
impatience and quick temper.
When confronted with the charges, Mr. Shaw
denied any wrongdoing and demanded proof of the allegations. Shaw said, "I've always followed
established procedures and tried to do things properly. But you just can't watch everybody all of the
time, and I trust my employees to do
the right thing." Shaw stated,
"I've never had any trouble in the three years I've worked with Tarheel
Textiles or with anybody I've ever worked for.
I'm a hard worker. You know I've worked a lot of overtime hours in order
to get the job done. I even had to request
gate keys so I could work at night in order to keep up with my workload. I would be foolish to do anything to
jeopardize my career with Tarheel, especially since my family and I have just
moved into a new house."
Two days later Mr. Shaw requested a
meeting with the Supply Support Manager.
Shaw stated that this situation had cast suspicion upon him, that his
employees could never have confidence in him again, and that he wasn't sure he
wanted to work for a company that would accuse him of such things. Alan Shaw asked to be suspended of all job
responsibilities, pending the result of the investigation.
The Supply
Support Manager was disappointed; he thought Mr. Shaw had always performed
well, had a lot of potential, and was a "diamond in the rough." But he had no alternative but to suspend Mr.
Shaw.
4.
The Johnstone & Company Visit
Mr. Arthur Thomas, Corporate Buyer, and a
Corporate Security investigator visited Johnstone & Company for the purpose
of interviewing key employees who might provide pertinent information. Johnstone & Company was the customer to
whom the majority of loom residues and surplus loom parts were sold. The company deals primarily with the sale of
scrap and junk metal, but also markets converted looms and other textile machinery.
Because of
their long-standing business relationship, Arthur Thomas asked to speak
privately with Mr. Gordon Johnstone, President of Johnstone & Company,
before the Security investigator questioned him. After a 45-minute discussion, the Security investigator
joined them.
Mr. Johnstone
vehemently denied knowledge of any wrongdoing.
He stated he had not given any financial inducement to Tarheel employees
for shipping any completed looms or other parts. He said, "Loom residues and scrap parts
are brought onto my lot in a Johnstone & Company truck from Tarheel
Textiles. The items are unloaded and
placed in the "junk field" with all other scrap metal. We don't check each item received to an
invoice from your company. We just don't
have the time and don't consider it necessary.
I have been conducting business with Tarheel Textiles for over 10 years,
and our methods and approaches have never been questioned. Our ethics, I assure you, are above
reproach."
The
investigator asked to speak with Mr. Johnstone's son, who was associated with
the business as a Vice President of Sales.
Mr. Johnstone replied, "Bob is not here at present; however, I see
no reason for your talking to him. No
member of my family has ever been associated with any disreputable business
transaction. My son and I are both
active members of local civic organizations.
Your innuendos are not appreciated, and I don't think we have anything
else to discuss."
Mr. Thomas and the security investigator
thanked Mr. Johnstone for his assistance.
As they were leaving, the investigator noticed that the Draper
identification plates had been removed from some of the Tarheel loom residues
on the lot.
5. The Inventory
Corporate Security reviewed its findings
to date with the Director of Corporate Purchasing and the Supply Support
Manager. All concurred that a physical
inventory of looms in the field needed to be taken. Written procedures were developed and included
the following:
a.
The inventory would be taken by total count only, not by
individual type/size loom. An exception
was that all 64" X-3 looms would be identified separately.
b.
Each loom would be tagged when counted.
c.
The total number of looms in each row was to be written
on a separate tag and attached to the loom at the end of each row.
d.
All tags must be accounted for.
e.
Instructions were to be discussed with all persons
participating in the inventory-taking process prior to starting.
Approximately
2,700 looms were counted, and 42 man-hours were needed to take the
inventory. Reconciliation of the overall
physical count to quantities on inventory records disclosed a net shortage of
59 looms. (There was a 72-unit shortage
of looms that had not yet been stripped.
A gain of 13 looms residues was disclosed.)
The variance relating to 64"
X-3 looms was isolated:
34 looms on inventory records
(5)
looms on hand in field
29 loom shortage
6. The
Inventory Record Review
The Administrative/Accounting Office also
did some investigative work:
a.
A reconciliation of loom residues invoiced since
inception of the program (approximately 24 months) to looms removed from the
fixed asset ledger, taking into consideration residues currently on hand,
revealed a shortage of 38 looms.
b.
Accounting personnel stated that the possibility of poor
record keeping, especially in the first months of the program, and inaccurate
preparation of Loom Teardown Reports could explain a portion of this variance.
c.
Sixteen Tarheel Textile fixed asset identification tags
were located in Mr. Shaw's desk drawer and toolbox. These appeared to have been accumulated over
a period of time. Accounting personnel
traced these tag numbers to the fixed asset ledger: all numbers were identified with 64" X-3
Draper looms.
d.
No customer invoices for brass had been issued during
the last 12 months.
e.
No 64" X-3 Draper looms were listed on shipping
documents which supported shipments made during the last six months.
7. Other
Pertinent Information
The
average market value for these Draper looms is $750. Converted looms can sell for as much as
$7,500. The value of parts varies, but
ranges from $2 to $70. Johnstone & Company has been paying
Tarheel Textiles $75 to $100 for each loom residue purchased.
a.
Approximately two pounds of brass can be salvaged from
each stripped loom. This brass can be
sold to a local dealer for 53 cents/pound.
b.
The 64" X-3 Draper loom parts may be used in
converting looms to air-jet looms, which are more efficient and utilize newer
technologies.
c.
In recent months, Johnstone & Company has also been
purchasing reconditioned loom parts in addition to scrap metal.
d.
Cathy Shaw, wife of the Draper Area Supervisor, works as
a billing clerk in the Supply Support Accounting Office.
e.
Leventhal Parts & Supply Company also purchases a
small percentage of loom residues and unusable parts, but only offers Tarheel
Textiles $50 per residue.
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