You may choose to do either the NE Textiles or State University Housing. The former is more operationally oriented, and the 2nd case is more of a financial audit. You may see a reference to Tarheel or Tarheel Textiles in the NE Textiles case. Same company.
UNIVERSITY HOUSING
Background
University Housing (Housing) is an auxiliary service enterprise of the State University consisting
of two dormitory complexes, housing 1,284 students, operated by the University under capital
leases with private companies. The leases are for periods of 30 and 40 years and require annual
lease payments of $1,750,000.
The University accounts for University Housing operations as part of the Auxiliary Trust Fund,
which includes other auxiliary operations in addition to Housing. Each auxiliary function is
accounted for separately. As an auxiliary enterprise, University Housing is a self-supported
operation and does not receive state funding.
The University has exercised an option, pursuant to the lease agreements, to acquire one of the
two housing complexes and is studying several courses of action. It is also considering
refinancing the lease obligation at a lower rate for the other complex in order to reduce lease
payments. The Vice President for Business and Finance requested Internal Audit to conduct an
audit of the housing operation. This audit would allow for review of the internal control
structure in place and development of recommendations to enhance existing controls.
You will assist the auditor assigned to the revenues and collections cycle in determining the
findings and issuing recommendations.
Internal Control Review
The auditor obtained the following information after a review of relevant documents and
discussions with the Director of Housing, the housing Fiscal Assistant, the University Controller
and the Head Cashier. To confirm understanding of the process, the auditor performed a
transaction walk-through.
Housing has a central office that handles all resident contracts, room assignments, billings,
and monitoring of payments and outstanding balances. Each housing complex has a
coordinator in charge of daily matters related to the operation of the complex.
The University Controller’s Office (Controller) maintains the official accounting records of the
university. Although the Fiscal Assistant in housing initiates transactions such as billings and
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receivable adjustments, these are then recorded by the Controller’s Office. A monthly
general ledger is produced by the University Controller’s Office.
In addition to the official account receivable system maintained by Controller, Housing has a
manual ledger card system to keep track of student payments. A card is kept for each
resident to reflect all charges and payments. The cards are maintained by the housing Fiscal
Assistant.
All collections are handled by the University Cashier’s Office (Cashier). Cashier sends a copy
of the receipt to Housing together with a daily list of all transactions affecting Housing.
Housing’s Fiscal Assistant records payments in the student’s ledger card and agrees
information on the transaction list to supporting documentation
Cashier records the collection in the computer, which produces a numbered receipt. At the
end of the day, the cash registers are balanced and the deposit is prepared. An armored car
service takes the deposit to the bank. Controller reconciles the deposit per Cashier to the
deposit per the bank and investigates any differences.
Housing fees are due at the beginning of each term. Before handing the room key to the
student during check-in, the complex coordinator verifies that the student is included on the
list of students with signed contracts and also on the list of students that have paid at least
50% of the semester’s rent fees (see automatic deferral explained below).
Residents have the option of automatically deferring up to 50% of the housing fees until the
midpoint of the semester. At that time, the housing Fiscal Assistant prepares billings for
those students who had partially deferred payment of the rent fee. The billings prepared by
the Fiscal Assistant are sent to Controller where they are entered into the computer and
recorded in the accounts receivable system.
After the billing for the second half of the payment is due, a list is printed of all past due
receivables. The Director sends the students a notice indicating that they have seven days to
pay or will be evicted. Students with past due accounts are not allowed to register for a new
term, obtain transcripts, or graduate.
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Adjustments to the accounts receivable system originate with the housing Fiscal Assistant.
After careful investigation, the Fiscal Assistant prepares an adjustment input form, which is
entered by Controller’s into the computer and adjusts the accounts receivable system. The
Fiscal Assistant also posts the adjustment to the resident’s ledger card.
TESTS OF INTERNAL CONTROLS
Several tests were conducted to determine whether key controls identified during the internal
control evaluation were in effect. The following is a list summarizing the results of the tests
performed:
1. A sample of residents was selected. For each resident the auditor: (a) examined the contract
noting if the correct room rate was charged; (b) traced payments per the contract to housing’s
ledger card, cashier records, bank statement and general ledger, noting that payment was
properly recorded and deposited; (c) for those contracts not yet paid in full, the auditor
traced outstanding balances to accounts receivable. No exceptions were noted.
2. A sample of credit adjustments was reviewed for authenticity, support and proper approval.
Adjustments were properly supported and occurred as a result of valid reasons. All were
prepared by the Fiscal Assistant without any evidence of review by the Housing Director.
3. Accounts receivable confirmations were sent to all accounts with past due balances over
$850. This sample represents 58% of Housing’s receivable balance. Second and third
requests were sent to those who did not respond to the first letter. The auditor tried to obtain
new addresses for those letters returned by the post office. Final results included 8%
confirmed correct, 12% confirmed with a difference, 52% no reply, and 28% returned by the
post office.
The auditor noted that several home addresses in the Housing files were either incomplete or
showed the housing address as the home address. This makes collection of accounts
receivable very difficult after the student leaves the university and the situation increases
credit risk.
The auditor investigated the responses with a difference and found that in most cases, the
receivable balance per Controller was different from the balance per Housing’s ledger card.
Controller balance tended to be overstated mainly due to errors originated by Housing. The
auditor decided to expand the sample and conducted the test described below.
Page 3 of 4
4. Accounts receivable balance per Housing’s ledger card was compared to Controller’s
accounts receivable balance for a sample of 26 residents. Seven instances were noted where
the receivable balance per Controller system was higher than the balance per Housing’s
ledger card. The auditor investigated the differences and found that in all cases the balance
per Housing was correct.
Reasons for differences included:
Student payment was credited to revenues instead of receivables because Cashier
received payment before the receivable was recorded in the system. The billing was
recorded later, creating a receivable for a bill that was already paid.
Housing sent incorrect adjustments to the receivable system. These adjustments,
however, were properly reflected in Housing’s ledger card.
The Fiscal Assistant did not send some adjustments made by Housing to the ledger cards
to the accounts receivable system due to an oversight.
5. A review of the accounts receivable aging at the end of the fiscal year (6/30/X1) disclosed the
following past due receivable balances:
Total A/R
6/30/X1
$202,840
Summer
19X1
$30,835
Spring
19X1
$24,430
Fall
19X0
$11,697
Summer
19X0
$4,319
Spring
19X0
$23,551
Prior to
1/1/X0
$108,008
The auditor noted that the billing for the Spring term 19X0 was recorded in the controller’s
receivable system two weeks before the end of the semester. According to explanations given
to the auditor, the Fiscal Assistant was too busy and was not able to prepare the billings on
time. As a result, many residents were able to complete the term without paying the second
half of the fee.
6. Account receivable written off during the fiscal year totaled $38,724. The auditor examined
supporting documentation ascertaining that all write-offs were properly approved in
accordance with university policy. No exceptions were noted.
Page 4 of 4
Required
You are to write a portion of an audit report based on the facts in this case. Your report will
include the executive summary, findings, and recommendations.
1. Write an executive summary of your findings and recommendations. What are the key
issues you want to get across to senior management? What is your overall conclusion?
2.
Based on the results of the internal control review and tests conducted, develop a list of
audit findings. For each finding indicate the probable underlying cause and possible
financial impact to the housing operation.
3. Develop a list of recommendations to correct the conditions noted during the audit.
Page 5 of 4
AUDIT REPORT ASSIGNMENT
Required
The purpose of this assignment is to write a formal audit report identifying material internal
control weaknesses and providing recommendations based on the facts in the case study. I
am not asking you to express an opinion on whether a fraud has been committed. Please read
the case and all requirements carefully. Make sure your paper addresses each item. Please
edit and proofread your paper. 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.
You are writing a formal report for senior management and the audit committee of the board
of directors. Your audit report must have an executive summary with your overall
conclusions, and a findings and recommendations section. There are different ways to write
an audit report. You are free to choose a format which works for you. Please reference the
readings and discussion in week 7.
I want the focus of the audit report to be on the internal control weaknesses and
recommendations for improvement. There are a lot of significant internal control weaknesses
in this case. You need to identify the ten most significant internal controls weaknesses in
the Loom Reclamation Program. Give it a lot of thought. Ask yourself some questions. Here
are a couple of suggestions to get you started. What are the objectives of the loom reclamation
program? What is preventing NE Textiles from realizing the full benefits of the program?
Where are there opportunities for fraud? You may want to flow chart the process as a way of
identifying where controls are lacking.
I want you to write a specific audit comment for each item which includes your
recommendation. You should use what you learn in week 7 to formulate your audit
comments. When you describe an internal control weakness, make sure your intended
audience will be able to understand it (i.e., senior management). For example, if you believe
there is a segregation of duties issue, you need to indicate where and why it is a problem.
Case Study: NE Textiles
(Based on the IIA Research Foundation, Case Studies in Internal Auditing, Volume 4,
2004. The case study has been modified for UMGC Acct 436)
Page 1 of 7
Background
Many of NE 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 NE 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 NE 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.
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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 NE 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
Customer Orders:
1. The computer generates a shipping document based on a written customer order. The
customer may be a NE 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
Page 3 of 7
3.
4.
5.
6.
the order. If inventory records show no parts available, the Supply Room Clerk copies
these part numbers/descriptions on a sheet of paper.
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.
These parts are sent to the Supply Room, along with the piece of paper, for review and
to make ready for shipment.
The Shipping Supervisor loads goods onto the truck. He checks against Notice of
Shipment to assure accuracy of loading.
The loaded truck leaves premises.
Disposal of Residues and Scrap Metal
1. The Loom Teardown Supervisor usually receives customer orders verbally.
Johnstone & Company is the primary customer to whom NE 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
NE 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 NE 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.”
Page 4 of 7
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.
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 NE plant and has
been employed by NE 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.” “We’re really glad
Page 5 of 7
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.”
A second crewmember, Harvey Jolly, appeared somewhat ill at ease. “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.”
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 NE 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.”
Alan Shaw asked to be suspended of all job responsibilities, pending the result of the
investigation.
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
Page 6 of 7
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.
Mr. Johnstone vehemently denied knowledge of any wrongdoing. He stated he had not
given any financial inducement to NE 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 NE 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 NE Textiles for over 10 years, and our methods and
approaches have never been questioned. Our ethics, I assure you, are above reproach.”
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
Page 7 of 7
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 NE 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 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 NE 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.
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