ACCT 436 SECTION 7380 Week 8 INTERNAL AUDITING SUMMER 2015 100% Satisfaction Guaranteed!

ACCT 436 SECTION 7380
INTERNAL AUDITING

INSTRUCTIONS
You are allowed to use any of the course materials. Make sure you take your time and provide complete
answers. Two or three sentence answers to any of these questions will not be adequate! Your logic, thought
processes and quality of your responses are what will determine your grade. Questions 1-2 are worth 15
points. Questions 3-4 are worth 10 points each. Please submit your responses in a Word document. Be sure
to put your name on each page. Good luck!
1) ABCs capital-asset procurement policy requires the Board of CAEs (BOD) approve any single acquisition
over $150,000. If the board approves a project, then the treasurer will transfer the funds to the respective plant.
Within one year, the internal auditing function is charged with reviewing each acquisition to check the propriety
of the purchase and disbursal of funds.
ABCs Plant Controller prepared the first proposal for a DEK cutting machine. Other plants were told to wait
until internal auditing could inspect the documentation associated with the acquisition, and evaluate the
projects operating effectiveness and efficiency. The plants proposal was the second largest proposal ever
submitted in the companys history and it totaled $1.3 million dollars. The cost of the new machine by itself was
listed in the proposal at $1.1 million. Labor and other costs necessary to remove the old machine and install
the new machine totaled $200,000.
The internal auditor assigned to the investigation was Phil Ramone. Phil had been with ABC four years
performing mostly production operational audits (on existing processes) and internal control payroll audits.
Phils considerable experience in these areas led him to believe that the procedures associated with this
capital-asset audit would be as simple and routine. This was not Phils first visit to the plant. In fact Phil had
performed an audit on the plants payroll system only a year ago. Phils recollection of the experience was not
a pleasant one. He had several confrontations with the plant controller, mostly as a result of personality
clashes. While all the payroll issues were easily resolved, Phil felt there was still an adversarial relationship
between him and the controller and was on guard for any preemptive strikes this time around by the controller.
It was a long drive to the plant so when Phil arrived a little late the day of his audit he was greeted by the
controller with a perceived air of indifference and promptly led to a secluded office. The controller calmly
explained that he was extremely busy and would answer any questions at the end of the day. Phil merely
nodded his head and sat down in front of several tall piles of invoices, which the controller stated was the
documentation supporting the purchase, set up, and testing of the new machine. Phil was somewhat surprised,
fully expecting to see only a handful of invoices, but did not ask for any explanations. As Phil began looking
through the myriad of statements and canceled checks he soon found one particular invoice near the top of the
first pile that indicated the actual price paid for the machine itself was only $850,000.
Phils first reaction was to call the CAE of auditing. When he found that the CAE was out for the day and could
not be reached he then decided to call the VP of Operations at corporate headquarters. Phil was critical of the
plant controller when describing the seriousness of his suspicions based on this preliminary information. Phil
didnt know that there was a BOD meeting that day and that the news would be passed on to them. The
members of the Board were outraged, screaming over the alleged misuse of the funds and possible fraud.

ACCT 436 SECTION 7380
INTERNAL AUDITING

SUMMER 2015
Phil was unaware that in a private conference call the Chair of the Board of CAEs would soon lambast the
plant controller. Seconds after the call, the controller walked up to Phil and had only two words to say get
out. Phil was flabbergasted; he called back to headquarters, only to receive a rather icy response from the
Chair of the BODs secretary suggesting that he return immediately.
Three days later Phil was called in to the CAEs office. The CAE described how he personally went to the plant
the next day after Phils visit and performed the capital-asset audit himself. The CAE found that there were a
number of reasonable explanations for the differences between the original proposal and the actual
expenditure. To begin with, the company that sold the machine would not discount the price until the BOD
approved the contract. Competing bids drove the cost of the machine from $1.1 million to $850,000. However,
there were several factors that offset these savings.
Originally, the setup of the new machine was projected to take a week and a half but ended up taking a month.
No one really knew how difficult it was going to be to remove the old machine that was embedded in the
concrete floor (to minimize vibration). This removal took additional time and outside labor. Also, the new
machine was to be put in the same area where the old machine was located. Since the plant could not afford to
shut down for any extended length of time, the old machine was moved over the Thanksgiving Day holiday
when labor rates were doubled. In addition, while the new machine was being tested, the old machine had to
be kept running in its temporary location. During the time that both machines were running, machine operators
and supporting personnel (e.g., those loading and unloading the conveyors) worked double shifts in order to
test the new machine. This parallel process took longer than expected because the plant engineers were not
familiar enough with the new machine to deal with minor problems. Also, special outside consultants were
hired for the first two weeks to set up the machine.
Another unexpected cost arose because the new machine put out a greater number of larger pieces of wood
requiring required an additional conveyor belt to accept and carry the larger pieces. The savings from the
discount was used to purchase this necessary piece of equipment. In sum, all of these additional and
unexpected outlays were very expensive and brought the total to just under the original proposed cost of $1.1
million.
The CAE went on to explain to Phil that the reason for the abnormally large number of invoices was an endless
stream of trips to the local electrical and hardware stores to buy the necessary parts and supplies to keep the
transition from the old to the new machine moving smoothly. As it turned out, the Controller of the plant
actually did a commendable job in overseeing the project and keeping accurate records of the disbursements.
In fact, the controller created a specialized installation guide that will probably save ABC hundreds of
thousands of dollars when the remaining plants order more of these machines.
Required
1. Comment on Phils preparation for and conduct of the audit. What should Phil have done differently?
2. Discuss the possible violations of the IIA Code of Ethics and/or International Standards for the
Professional Practice of Internal Auditing that Phil committed.

ACCT 436 SECTION 7380
INTERNAL AUDITING

SUMMER 2015
2) Recently, several states have outsourced some of the services traditionally provided by government
employees. In one state, the Department of Health and Human Services (Department) has outsourced its
electronic benefit transfer services to eFunds Inc. Under the contract, eFunds Inc. handles the electronic
distribution of food stamp programs, including transaction processing, reporting, contract management,
contract settlement, operations support, help desk services, and project management. For cost reasons,
eFunds Inc. sent the work to five offshore service centers it owns in India.
a) Describe the three most significant risks that this offshore outsourcing arrangement introduces to the states
Department of Health and Human Services.
b) What are the key controls you would recommend to mitigate the risks cited in part a.
c) What role should the Departments internal audit function take to assist the Department in dealing with these
risk and control issues? Be specific.
3) On March 4, 2013 the NASDAQ Stock Market LLC filed a proposed rule change that would require listed
companies to establish and maintain an internal audit function. Specifically:
Each Company must establish and maintain an internal audit function to provide management and the
audit committee with ongoing assessments of the Companys risk management processes and system
of internal control. The Company may choose to outsource this function to a third party service provider
other than its independent auditor. The audit committee must meet periodically with the internal auditors
(or other personnel responsible for this function) and assist the Board in its oversight of the
performance of this function. The audit committee should also discuss with the outside auditor the
responsibilities, budget and staffing of the internal audit function.
Some of these comments supported the rule change but a significant number, particularly from smaller
companies, argued against the change. A common theme of those against the change is reflected in the
following from the CFO of Perceptron, Inc.:
There already exists a requirement for public companies to review, maintain and report on internal
controls under Federal securities law. Rules 13a-15 and 15d-15 specifically require a certification by the
Chief Executive Officer and the Chief Financial Officer. This proposed rule by NASDAQ adds a second
layer of regulation that is not necessary and would not provide value. Perceptron maintains internal
controls with management oversight and already engages outside, independent firms to perform SOX
404 testing of its internal controls. Management provides a report of the results of its independent firms
testing every quarter to the Audit Committee. Further, the Companys independent auditor meets with
the Audit Committee regularly, including in private sessions without managements presence.
Most companies listed on NASDAQ have an internal auditing function. However according to an article by
Richard Chambers, research by the consulting firm Navigant indicates that 40 percent of NASDAQ-listed
companies with market capitalization between US $75 million and US $250 million do not have internal audit
functions. Chambers, R. (2013, June 3). NASDAQ Hesitates in Its Quest to Mandate Internal Audit. Retrieved
July 30, 2015.
Ultimately NASDAQ withdrew the proposed rule. If you agree with the logic of the critics of the proposed rule,
explain how SOX 404 and CEO/CFO certification removes the need for an internal audit function. If you dont
agree with the critics as well as the decision of NASDAQ, explain what an internal audit function adds beyond
SOX 404 and CEO/CFO certification.
ACCT 436 SECTION 7380
INTERNAL AUDITING

SUMMER 2015
4) a) When and in what ways do audit engagement communications occur?
b) What actions regarding audit engagement observations must the internal audit function take after the
final engagement communication is disseminated?