Smieliauskas/Bewley

OLC End-of-Chapter Questions

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CHAPTER 17 GENERAL INSTRUCTIONS FOR CASES 17.52–17.57:

These cases are designed like the ones in the chapter. They give the problem, the method, the paper trail, and the amount. Your assignment is to write the Audit Approach portion of the case organized around these sections: Objective: Express the objective in terms of the facts supposedly asserted in financial records, accounts and statements. Control: Write a brief explanation of desirable controls, missing controls and especially the kinds of “deviations” that might arise from the situation described in the case. Test of controls: Write some procedures for getting evidence about existing controls, especially procedures that could discover deviations from controls. If there are no controls to test, then there are no procedures to perform; go then to the next section. A “procedure” should instruct someone about the source(s) of evidence to tap and the work to do. Audit of balance: Write some procedures for getting evidence about the existence, completeness, valuation, ownership or disclosure assertions identified in your objective section above. Discovery summary: Write a short statement about the discovery you expect to accomplish with your procedures. 17.52 Employee Embezzlement via Cash Disbursements and Inventory. Follow the instructions at the beginning of this Discussion Cases section. STEALING WAS EASY

Problem: Cash embezzlement, inventory and expense overstatement. Method: Lew Marcus was the only bookkeeper at the Ace Plumbing Supply Company. He ordered the supplies and inventory, paid the bills, collected the cash receipts and cheques sent by customers and reconciled the bank statements. The company had about $11 million in sales, inventory of $3 million, and expenses that generally ran about $6–7 million each year. Nobody checked Lew’s work, so sometimes when he received a bill for goods from a supplier (say, for $8,000) he would make an accounting entry for $12,000 debit to inventory, write an $8,000 cheque to pay the bill, then write a $4,000 cheque to himself. The cheque to Lew was not recorded, and he removed it from the bank statement when he prepared the bank reconciliation. The owner of the business considered the monthly bank reconciliation a proper control activity. Paper trail: No perpetual inventory records were kept, and no periodic inventory count was taken. The general ledger contained an inventory control account balance that was reduced by 60 percent of the amount of each sale of plumbing fixtures (estimated cost of sales). The bank statements and reconciliations were in a file. The statements showed the cheque number and amount of Lew’s cheques to himself, but the cheques themselves were missing. The cheques to vendors were in the amounts of their bills, but the entries in the cash disbursements journal showed higher amounts.

Amount: Over an eight-year period, Lew embezzled $420,000. 17.53 Employee Embezzlement via Cash Receipts and Payment of Personal Expenses. Follow the instructions at the beginning of this Discussion Cases section. In this case you can assume that you have received the informant’s message. THE EXTRA BANK ACCOUNT

Problem: Cash receipts pocketed and personal expenses paid from business account. Method: The Ourtown Independent School District, like all others, had red tape about school board approval of cash disbursements. To get around the rules, and to make timely payment of some bills possible, the superintendent of schools had a school bank account that was used in the manner of a petty cash fund. The board knew about it and had given blanket approval in advance for its use to make timely payment of minor school expenses. The board, however, never reviewed the activity in this account. The business manager had sole responsibility for the account, subject to the annual audit. The account got money from transfers from other school accounts and from deposit of cafeteria cash receipts. The superintendent did not like to be bothered with details, and he often signed blank cheques so that the business manager would not need to run in for a signature all the time. The business manager sometimes paid her personal American Express credit card bills, charged personal items to the school’s VISA account, and pocketed some cafeteria cash receipts before deposit. Paper trail: An informant called the state education audit agency and told the story that this business manager had used school funds to buy hosiery. When told of this story, the superintendent told the auditor to place no credibility in the informant, who is “out to get us.” The business manager had in fact used the account to write unauthorized cheques to “cash,” put her own American Express bills in the school files (the school district had a VISA card, not American Express) and signed on the school card for gasoline and auto repairs during periods of vacation and summer when school was not in session. (As for the hosiery, she purchased $700 worth with school funds one year.) The superintendent was genuinely unaware of the misuse of funds. Amount: The business manager had been employed for six years, was trusted, and stole an estimated $25,000. 17.54 Employee Embezzlement via Padded Payroll. Follow the instructions at the beginning of this Discussion Cases section. In this case your assignment is to analyse the payroll register and see if you can identify any of the ghosts. GHOST RIDERS ON THE PAYROLL

Problem: Embezzlement with fictitious people on the payroll.

Smieliauskas/Bewley

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OLC End-of-Chapter Questions

Method: Billy Joe had responsibility for preparing personnel files for new hires, approval of wages, verification of time cards and distribution of payroll cheques. He “hired” fictitious employees, faked their records and ordered cheques through the payroll system. Paper trail: The payroll department produces a payroll register listing various items of information about employees. A selection from the register is in Exhibit 17.54–1. Reading the columns from left to right, it shows the employee identification number, employee EXHIBIT

17.54–1

name, employees’ section number (retail store location), social insurance number and bank addresses (account numbers for electronic funds transfer). Amount: Billy Joe stole $160,000 over a three-year period. Required:

Analyze the payroll register in Exhibit 17.54–1 and identify the questionable employees who might be ghosts on the payroll.

PAYROLL REGISTER

I.D. No.

Name

Sect.

Social Ins. Number

Address

5592 8961 186 3553 6521 6999 8920 4534 6204 5481 5363 7891 9491 527 4042 6041 590 3054 8063 2964 9293 6729 3154 852 7219 9346 5261 4987 1667 6145 9265 1231 6919 6840 7489 9111 4873 9362 378 4613 5361 3276 3493 8857 7103 7559 8494 43 1948

Annalee, Michele Avondale, Richard Bryce, Sharon Gorman, Thalia Gordon, Marshall Harvey, Kevin Mazzini, Virgil Paperton, Karen Peterman, Jennifer Brione, Kimberly Brione, Douglas Jones, Jonothan Jones, Michael Jones, Thomas Bull, Lisa Bushman, Jolle Camp, Liana Cantraz, Luan Churchman, Matt Allford, Eric Altzheimer, Jeff Ameston, Jackie Arrgon, Mary Bulling, John Chidid, Adam Chu, Song Cooker, Scott Coolman, Maury Daughterford, Debby Butterby, Laura Butterby, Leigh Butterby, L.A. Cevil, John Chung, Hihnno Cordon, Andy Coward, Clay Cranehook, Mary Diercheski, Ward Fineman, Bryan Deitrick, James Larson, Kermit Newman, Paul Robertson, Jack Rosingale, Patricia Ruhle, Mabry Ruffinio, Jill Rummsfell, Judith Smith, Michael Shultze, Robert

1990 1990 1990 1990 1990 1990 1990 1990 1990 2000 2000 2000 2000 2000 2000 2000 2000 2000 2000 2010 2010 2010 2010 2010 2010 2010 2010 2010 2010 2020 2020 2020 2020 2020 2020 2020 2020 2020 2020 2025 2025 2025 2025 2025 2025 2025 2025 2025 2025

455411471 435315873 449435042 459497264 463355479 396546363 461785493 453491250 473600914 461635205 137567089 464373412 464373413 464373413 466471495 451355503 455690418 460594645 466232740 444782904 453493495 483889548 452535653 325462648 124491704 465350881 459983822 458531820 461478070 462237424 462236725 462236726 453454988 483113789 497605588 452639707 275643410 460496149 459679356 135635583 221156649 601669984 680623358 460654900 397804404 461394849 466539183 442641436 457020330

6205193611 4723265701 2763431893 1565644635 8999781365 7409894998 2012719362 6371802086 7818539686 5622472908 4286008036 3890567269 3890567269 4609659041 2797567256 9103080617 4237338557 7894813997 6977367072 2935968014 6349921488 2722529584 8213209536 5587231055 7443759037 2171962355 4634865235 1291047566 8223680929 3463748143 3463748143 3463748143 9781429093 4888874664 5129368143 49242627 1622537823 7641205905 8703966421 6947113473 6947113473 6947113473 6947113473 6609741958 6940593886 2874916590 4621454720 6504510060 9202701679

Smieliauskas/Bewley

OLC End-of-Chapter Questions

17.55 Employee Embezzlement: Medical Claims Fraud. Follow the instructions at the beginning of this Discussion Cases section. DOCTOR! DOCTOR!

Problem: Fictitious medical benefit claims were paid by the company, which self-insured up to $50,000 per employee. The expense account that included legitimate and false charges was “employee medical benefits.” Method: As manager of the claims payment department, Martha Lee was considered one of Beta Magnetic’s best employees. She never missed a day of work in 10 years, and her department had one of the company’s best efficiency ratings. Controls were considered good, including the verification by a claims processor that (1) the patient was a Beta employee, (2) medical treatments were covered in the plan, (3) the charges were within approved guidelines, (4) the cumulative claims for the employee did not exceed $50,000 (if over $50,000 a claim was submitted to an insurance company), and (5) the calculation for payment was correct. After verification processing, claims were sent to the claims payment department to pay the doctor directly. No payments ever went directly to employees. Martha Lee prepared false claims on real employees, forging the signature of various claims processors, adding her own review approval, naming bogus doctors who would be paid by the payment department. The payments were mailed to various post office box addresses and to her husband’s business address. Nobody ever verified claims information with the employee. The employees received no reports of medical benefits paid on their behalf. While the department had performance reports by claims processors, these reports did not show claim-by-claim details. No one verified the credentials of the doctors. Paper trail: The falsified claim forms were in Beta’s files, containing all the fictitious data on employee names, processor signatures, doctors’ bills and phony doctors and addresses. The cancelled cheques were returned by the bank and were kept in Beta’s files, containing “endorsements” by the doctors. Martha Lee and her husband were somewhat clever: They deposited the cheques in various banks in accounts opened in the names and identification of the “doctors.” Martha Lee did not stumble on the paper trail. She drew the attention of an auditor who saw her take her 24 claims processing employees out to an annual staff appreciation luncheon in a fleet of stretch limousines. Amount: Over seven years, Martha Lee and her husband stole $3.5 million, and, until the last, no one noticed anything unusual about the total amount of claims paid. 17.56 Financial Reporting: Overstated Sales and Profits. Follow the instructions at the beginning of this Discussion Cases section. For this case, give the recommended adjusting journal entry as well as the audit approach. THANK GOODNESS IT’S FRIDAY

Problem: Overstated sales caused overstated net income, retained earnings, current assets, working capital and total assets. Overstated cash collections did not

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change the total current assets or total assets, but they increased the amount of cash and decreased the amount of accounts receivable. Method: Alpha Brewery Corporation has generally good control policies and procedures related to authorization of transactions for accounting entry, and the accounting manual has instructions for recording sales transactions in the proper accounting period. The company regularly closes the accounting process each Friday at 5 p.m. to prepare weekly management reports. The year-end date (cutoff date) is December 31, and in 20X1 December 31 was a Monday. However, the accounting was performed through Friday as usual, and the accounts were closed for the year on January 4. Paper trail: All the entries were properly dated after December 31, including the sales invoices, cash receipts, and shipping documents. However, the trial balance from which the financial statements were prepared was dated December 31, 20X1. Nobody noticed the slip of a few days because the Friday closing was normal. Amount: Alpha recorded sales of $672,000 and gross profit of $268,800 over the January 1–4 period. Cash collections on customers’ accounts came in the amount of $800,000. 17.57 Financial Reporting: Overstated Inventory and Profits. Follow the instructions at the beginning of this Discussion Cases section. For this case recalculate the income (loss) before taxes using the correct inventory figures. (Assume the correct beginning inventory two years ago was $5.5 million.) THE PHANTOM OF THE INVENTORY

Problem: Overstated physical inventory caused understated cost of goods sold and overstated net income, current assets, total assets and retained earnings. Method: All Bright Company manufactured lamps. Paul M, manager of the State Street plant, was under pressure to produce profits so that the company could maintain its loans at the bank. The loans were secured by the inventory of 1,500 types of finished goods, work in process and parts used for making lamps (bases, shades, wire, nuts, bolts and so on). Paul arranged the physical inventory counting procedures and accompanied the external audit team while the external auditors observed the count and made test counts after the company personnel had recorded their counts on tags attached to the inventory locations. At the auditors’ request, Paul directed them to the “most valuable” inventory for their test counts, although he did not show them all of the most valuable types. When the auditors were looking the other way, Paul raised the physical count on inventory tags the auditors would not include in their test counts. When everyone had finished each floor of the multistory warehouse, all the tags were gathered and sent to data processing for computer compilation and pricing at FIFO cost. Paper trail: All Bright had no perpetual inventory records. All the records of the inventory quantity and pricing were in the count tags and the priced compilation, which was produced by the data processing

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Smieliauskas/Bewley

OLC End-of-Chapter Questions

department six weeks later. The auditors traced their test counts to the compilation and did not notice the raised physical quantities on the inventory types they did not test-count. They also did not notice some extra (fictitious) tags Paul had handed over to data processing. Amount: Paul falsified the inventory for three years before the company declared bankruptcy. Over that period the inventory was overstated by $1 million (17 percent, two years ago), $2.5 million (31 percent, one year ago), and $3 million (29 percent, current year). The financial statements showed the information in the schedule provided below (dollars in 000). 17.58 Role of Control, Analytical Procedures and Extended Procedures in Fraud Detection CORRUPT CAPERS IN THE CHICKEN BUSINESS

After fathering six children and completing 14 years of employment with a variety of federal law enforcement and regulatory agencies with whom I had served in audit, compliance, investigative and supervisory capacities, I fell prey to the need to earn more money. So I accepted an executive position with a new fast-food chain in Nashville, Tennessee, then called Minnie Pearl Chicken Systems, Inc. The company bore the name of that great lady of Grand Old Opry fame, but she herself was only a small shareholder and inactive in day-to-day management. The year was 1969, and any celebrity with national name recognition was in the fast-food business. But that’s another story. I was given the job of managing a company division called Nashco Equipment and Supply. Nashco was organized as a profit centre. It supplied both companyowned and franchised restaurants with restaurant decor, furniture, cooking equipment and utensils, uniforms, signage and ad specialties. Nashco’s operations were located about a mile from corporate headquarters in a leased warehouse and office facility of some 60,000 square feet. Nashco’s major functional components at that site included purchasing, inventory control, sales and physical distribution.

Nashco’s physical distribution function included warehousing, receiving and shipping activities. The latter included a fleet of leased trucks used to deliver restaurant equipment, supplies and certain construction materials to new restaurant sites throughout the United States and Canada. On the day I arrived to take over the division, the president of the company briefed me on his expectations. In simple terms his demand was, “Make money.” He didn’t say “or else.” But I instinctively knew the implications. I inferred that because he made it clear that the division had lost money the year before—about $500,000. The profit-centre manager who had incurred the loss was still employed by the company. In fact he had been demoted and made an assistant—to me! However, the president suggested I could terminate him at any time if I so desired. It seemed to me that terminating the poor man should have been handled by someone either above me or by the corporate personnel director. At any rate I was stuck with him for the time being, mainly because I didn’t know what else to do. When I did meet my assistant, he seemed like a pleasant-enough chap. His previous experience and his education were in aeronautical engineering—a little odd perhaps, since we were in the fast-food business. I didn’t give it much further thought. Why should I? What did I know about the restaurant business? I was as green as he was—greener! He had been with the company for nine months. My first day on the job, after my “executive briefing” with the president, was spent meeting all the members of my staff. Most of these folks were also relatively new at their jobs and showed evidence of insecurity in their roles. The only people who seemed secure in job roles were the warehousing people—stevedores, truck drivers and the traffic manager. They at least knew their jobs and their place. They even showed great deference to me when I met them. But I didn’t know why. (Was it

SCHEDULE FOR 17.57

Sales Cost of goods sold Expenses Income (loss) before taxes Ending inventory Other current assets Total assets Current liabilities Long-term debt* Shareholder equity *Secured by inventory pledged to the bank.

Two Years Ago

One Year Ago

Current Year

$25,000 (20,000) (5,000)

$29,000 (22,000) (8,000)

$40,500 (29,000) (9,000)

—

$(1,000)

$2,500

$6,000 9,000 21,000 5,000 5,500 10,500

$8,000 8,500 21,600 5,500 6,600 9,500

$10,200 17,500 34,300 13,000 9,300 12,000

Smieliauskas/Bewley

OLC End-of-Chapter Questions

typical of Southern culture to show deference for the boss? Perhaps. But here it seemed more than just deference. They almost feigned servility when I met them.) As it turned out these were no gentlemen of the South. They were crooks. The evidence of their scams began to surface after I had had enough time to become better educated in my job. I spent my first two months learning as much as I could about the fast-food industry, franchising restaurant layouts and designs, and restaurant equipment purchasing and sales. I finally moved through the area I knew least and began to concentrate on what I knew best—accounting, finance, audits, controls, investigations, management and security. My first effort to reverse the previous year’s loss was to review the previous year’s operating statements and search for causes. Two items glared at me. Cost of sales was out of line the year before because of a large inventory shrink. Inventory per books was $200,000 higher than the physical count had indicated. The variance was about 10 percent—far more than anyone had expected. But nothing had been done to investigate the loss. The outside auditors made the appropriate adjustments, and the matter was left at that. Another item was the high cost of transportation expense. I divided the total cost of transportation by the number of miles Ryder Truck Systems had billed us during the previous year. The resultant cost per mile was about double the national average for that time period. So I had two things to work on now that I was freed from learning how to run a fried-chicken restaurant. The inventory control group that reported to me consisted of three young ladies, two recent high school graduates and a supervisor, a woman of about 25 who appeared bright and hard-working. One day when things seemed quiet (which wasn’t very often in the halcyon days of fast food in Nashville in 1969), I visited with the inventory control supervisor and asked that she give me a briefing on what she and her crew did. She explained she manually kept perpetual inventory control system to me as best she could, after apologizing that she really was neither an accountant nor an auditor. She said she took a year of high school bookkeeping and had worked in the office of a moving company for several years before we hired her. At Minnie Pearl her training consisted of a four-hour briefing given by a member of the controller’s staff. She apologized for the condition of the inventory records, saying there was more work than she and her staff could handle on a timely basis. So she often had to work overtime to catch up (for which she said she was not paid). A cursory review of her in-process work and a few inventory ledger cards made my knees feel weak. She had not yet entered shipments of goods made three weeks earlier. And her recording of inbound merchandise was about equally tardy. For all intents and purposes we had no real inventory control system. Some goods were received and shipped out two weeks before any entry was made on the appropriate inventory ledger card.

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What was worse, I discovered that a number of ledger cards contained red-ink entries. She explained that the procedure was recommended by a member of the controller’s staff who informed her that she should make such an entry whenever she went to the warehouse to make a spot check of certain inventory items. She hadn’t fully understood the rationale for cycle counting of selected items, so whenever she noted a discrepancy—the balance shown on the card disagreed with her count—she merely made a red-ink entry on whichever side of the card the discrepancy favoured. But she never advised anyone of the discrepancy or investigated any further, and she never reconciled her pluses and her minuses to determine whether she had a net of more or less. At the year-end, however, she did total the minuses and pluses out, she said. But not during the working year. On one such ledger card there was a succession of red-ink entries. The ledger card related to large electric chicken fryers that cost the company over $1,000 each. Each of our restaurants needed four fryers. I quickly tallied her pluses and minuses and found the minuses were ahead by some 40 units, or by over $40,000! A little investigating showed that an equipment serviceman for the company occasionally called from the field and ordered a replacement fryer for one that was in such a state of disrepair it needed to be sent back to the manufacturer on a warranty-claim basis. The warehousemen, lacking any prohibiting instructions, accommodated him. What the serviceman did in fact was repair the chicken fryer on site, and when the new one arrived he would tell the restaurant manager the warehouse erred, and he himself would return the fryer—no problem. However the fryer never got back to the warehouse. It ended up in his garage, which was filled with other company property as well—refrigerator cabinets, heated cabinets and even a knocked-down walk-in cooler. As soon as it became apparent that something was wrong by way of the ledger card for chicken fryers, I began calling franchises and asking them whether anyone had offered to sell them chicken fryers at reduced prices. On the fifth call a franchisee mentioned that the serviceman had offered to sell him several fryers for a new restaurant at very “reasonable” prices. The serviceman told him the fryers were brand new and still in the manufacturer’s carton. “Sure enough and so they were,” said the franchisee. “Where did he say he got them?” I asked. “He didn’t say and I didn’t ask him,” said the franchisee. “But I know where he kept them.” “Where’s that?” I asked. “In his garage,” he said. Armed with the franchisee’s statement and our garbled inventory card, we got a search warrant for the serviceman’s garage. There we found a treasure trove of restaurant equipment and supplies that belonged to the company.

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Smieliauskas/Bewley

OLC End-of-Chapter Questions

So first things first, we developed a real inventory control system and hired an experienced person to supervise the function. Transportation costs were next on the agenda. Our transport costs were horrendous. I tried the “rant and rave” approach to reduce costs early on but saw no real reduction. After the theft matter had settled down, I tried to find why transportation costs were so high. I found that our truck fleet, after making deliveries of restaurant equipment, deadheaded back to Nashville, bypassing equipment manufacturers along the route. I thought that was strange, so I talked to the traffic manager. He said it was illegal for us to pick up our own inbound freight, that we were not common carriers and restaurant equipment was not an exempt commodity like farm produce. Our ICC permits allowed us to handle our own goods only after title had passed to us, which he said occurred after we received them at our warehouse. So I called several manufacturers who sold us equipment and asked whether we could pick up our equipment purchases at their plant sites with our own fleet. They each said they would accommodate us, but we should change our purchase orders to show FOB their plant sites so as to not run afoul of ICC regulations. Changing the shipment for FOB destination point to FOB origination point caused title to pass to us at their plant so we could haul our own merchandise back and thus save the freight-in charges. Feeling buoyed by this cost-cutting discovery, I called in the traffic manager and told him to co-ordinate his driver’s return trips with the purchasing director and to pick up our equipment along the routes back to Nashville. A month went by. No real reduction in transportation costs. The traffic manager skirmished with the purchasing director whenever he was told to have a returning truck make a pickup. Then information came our way that indicated our truck drivers were unhappy about the notation of return loads. It kept them on the road a day or two longer, and away from their wives and children—or so they claimed. At least four of our drivers sought union representation from the Teamsters, as did a half-dozen warehouse employees. What I didn’t fully grasp was that I was ruining something a lot of people had a financial stake in. The drivers didn’t want to pick up chicken fryers in Dallas or stainless steel sinks in St. Louis on their way back from Los Angeles because they already had a load to carry. What they were carrying back to Nashville was head lettuce and other fresh fruits and vegetables from California. Several things tripped up the scheme. The first was collect phone calls made by our drivers to the traffic manager from strange places in California, places where we had neither existing restaurants nor new ones under construction; for example, Salinas has been known for its head lettuce ever since William Saroyan and John Steinbeck made it famous for that.

The Salinas calls caught my attention first. But then when Bakersfield showed up (potatoes) and Ventura/ Oxnard (oranges, lemons), I knew something strange was happening. We had no restaurants within miles of these places and they weren’t exactly along the route back to Nashville from San Francisco and Los Angeles, where we did have a large number of restaurants. The strange calls piqued my curiosity, but they weren’t evidence of anything yet. My next move was to review the expense claims submitted by the drivers after their returns. That had been the responsibility of my assistant. When I asked that he send the vouchers directly to me from then on, he seemed miffed, as though I had insulted his integrity. He said it was a Mickey Mouse chore, better left to him or the traffic manager, who really knew how to check the excesses of truck drivers who crib on their expense vouchers. When I insisted, he pouted but agreed to send me the vouchers. I then visited the controller’s office at corporate headquarters and asked to see all documentation that supported truck driver expense reports for the preceding six months. In reviewing the documents submitted by drivers, I noted a recurring oddity. Weight statements at entry points on the Arizona border coming in from California seemed to be smudged, erased, written over, or just plain undecipherable. I selected about a half-dozen examples, made copies of the statements, and returned to my office. I then sent copies to a friend who was an Arizona state trooper, and asked him to secure for me copies of the state’s own originals of the weight slips. Sure enough, when I got them back, the weights written on our copies were 20,000 or more pounds lower, indicating that the truck was loaded with something on its way back home. Next we made phone calls to the numbers in Salinas, Oxnard, and Bakersfield. They were offices of produce growers, merchants and shippers. One claimed he sold lettuce to Minnie Pearl restaurants in St. Louis. When told we had opened no restaurants in Saint Louis yet, he stammered and hung up. We thought we could piece together what had happened at that point, but we needed confirmation. Our theory of the case was that the traffic manager through contacts with produce merchants in Nashville and St. Louis and growers and shippers in California was doing a little moonlighting with our fleet. Shipping fresh produce by rail or by truck from California is not cheap. But because the federal government has attempted to support agricultural economics by making special rules for farm products, such products are generally exempt commodities from the standpoint of certain ICC regulations. Truckers who haul farm products are subject to far fewer requirements and regulations. But because California ships out so much more produce than it takes in, its growers are chronically short of transportation mediums. So growers and shippers are eager to find any poor and lonesome trucker heading east with excess capacity. A thriving bootleg trucking

Smieliauskas/Bewley

OLC End-of-Chapter Questions

business therefore existed that utilized the trucks of companies that could not find legitimate return loads. The Minnie Pearl trucks were “sleepers” and carried two drivers so as to expedite deliveries and returns. The typical bootleg arrangement consisted of a $400 fee paid in cash to the two drivers by the grower or shipper. The drivers in turn took $100 each and gave $200 to our traffic manager, who had brokered the deal to begin with. We cracked the case by asking one pair of driver-partners to explain the discrepancy between the weight slips they had submitted with their expense vouchers and the originals of those slips that we had secured from the state of Arizona. They laid out the scheme and implicated other drivers, and the traffic manager as the mastermind. Both confessed mainly because they were on parole—a report of the incident to parole authorities might have caused them to complete their prison sentences. The traffic manager then implicated several other managers in the company as deriving benefits from his scheme. (Source: G.J. Bologna and R.J. Lindquist, Fraud Auditing and Forensic Accounting (New York: John Wiley & Sons, 1987), pp. 227–33. Reprinted with permission of the publisher.)

Required:

a. Identify any potential management or personnel problems that might contribute to or facilitate fraud. b. Identify the analytical procedures and findings that raised signals for further investigation and management work. c. Identify some detail (extended) procedures performed to give signals and definite information about operational and fraudulent problems in connection with the inventory write-downs (shrink). d. Identify some detail (extended) procedures performed to give signals and definite information about operational and fraudulent problems in connection with the high transportation costs. 17.59 Bank Reconciliation. Chapter 17 covers a wide range of fraud topics. The audit of bank reconciliations is in Chapter 11. Discussion Case 11.64 deals with a manipulated bank reconciliation and refers to Exhibit 17–3 in Chapter 17. You may wish to use Case 11.64 as an assignment for Chapter 17. 17.60 Payroll Fraud. You had established a national reputation as head of management audit at Henry Vanier Inc., a food manufacturing and processing corporation based in Calgary, with 40,000 employees in eight plants across the country and profits in 2003–04 of $92 million on revenue of $900 million. Your reputation had been based on innovations inspired by your financial control system audits and your performance audits in such areas as investment in new technology, costing and quality assurance. Vanier had also avoided the embarrassing public revelations of fraud suffered over the last two years by your major competitor—Top Brands, which is based in Montreal. You were due to present your updated threeyear audit plan to the board meeting next month, and the

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CEO dropped into your office as you were pondering your draft presentation. “I have been watching the debacle at Top Brands with dismay,” he said. “I realize that they are our competitors, but this fraud business affects the whole industry. Your approach to fraud is, I understand from our previous chats, really to keep an eye open for any signs while you conduct your financial control, compliance and performance audits, and, as far as we all know, that has kept us from serious problems. But I wonder if we should build on that good public record by actually taking a careful pre-emptive look at fraud, and possibly even adding to our mission statement what I would like to call our corporate ‘fraud policy.’ To this end, I would like you to take an additional hour at the forthcoming board meeting to do three things: first, I would like a short statement on the definition of fraud and the responsibilities of management and auditors; then you should give the board a brief overview, but with all the stages defined, on how you would conduct a fraud investigation at Vanier. Finally, for, say, the last third of your presentation, I would like you to present a draft of the components that could go into a fraud policy statement for consideration by the board. I would envisage that this statement would be given to all employees and board members, and indeed widely publicized.” While you were working on this presentation, you received a call from Susan, one of your staff. Apparently, in a routine review of the payroll system, she had encountered a possible case of fraud, and she wanted you to review her findings. As part of the routine review, Susan extracted payroll records for the last quarter from the mainframe computer into a dBASE file. She then used ACL to analyze the payroll records. The dBASE file contains the following fields that are of relevance for the audit: EMPNUM NAME ADDRESS DEPT SUPRVSOR PERIOD

Employee number Name of employee Address of employee Department Supervisor name Payroll period (1 for January, 2 for February, and so on) BANK Bank for payroll deposit BANKACCT Account number of payroll deposit PAY Amount of payment

The following is a partial printout from the dBASE file that Susan found disturbing: EMPNUM

BANK

BANKACCT

691023

BNS

71029-2

701932

HKB

8923-12

702595

BNS

78910-3

710941

RBC

81-234

711120

HKB

9012-15

720187

BNS

73015-2

720198

TDB

1-29305

729510

BOM

128-412

729102

BNS

71029-2

730194

RBC

81-234

Smieliauskas/Bewley

8

OLC End-of-Chapter Questions

732103

BNS

72076-3

Required:

732461

RBC

81-234

a. Prepare the presentation on fraud for the forthcoming meeting. b. Explain what conclusions can be drawn from the partial ACL printout. c. What additional computer-assisted audit techniques would you use to make the printout more useful? You do not need to provide the ACL commands. d. What audit procedures are required to follow up these payroll records?

732518

BOM

128-412

732892

TDB

1-29305

733019

HKB

8923-12

740125

BNS

72076-3

742957

TDB

1-29305

744910

BOM

128-412

751025

BNS

78910-3

760120

HKB

9012-15 (CGA-Canada adapted)