Auditing and Audit Committee Policy free essay sample

External Audit Team Subject: Internal Control Weakness and related fraud risk After much research and time spent on understanding the inner working of Alchemy Inc. , we have found some internal control weaknesses that could lead to potential fraud. Our audit procedures are designed to address internal control weaknesses and subsequent fraud risks in the most efficient and cost effective manner. We hope with our recommendation that Alchemy inc. ill be able to minimize the risk of financial misstatement. We believe these concepts will have many positive impacts on the firm’s long-term profitability and efficiency. The audit committee is not directly checking the financial statements for irregularities. The eighth tenant of the Audit Committee Policy reads that the audit committee must review financial statements for unusual transactions. Currently, the CEO, Chris Reddy, is performing financial statement evaluations without the oversight of the audit committee. The aforementioned control weakness lends itself to possible fraud risk. We will write a custom essay sample on Auditing and Audit Committee Policy or any similar topic specifically for you Do Not WasteYour Time HIRE WRITER Only 13.90 / page The CEO is under pressure to perform on behalf of the shareholders, and Mr. Reddy’s oversight of the financial statements creates an opportunity to misrepresent the performance of Alchemy Inc. Our recommendation is that the Internal Audit department sends the financial statements directly to the Audit Committee for review. The recommendation can be implemented at no additional cost to Alchemy Inc. The Internal Audit department lacks the needed oversight and monitoring of Alchemy Inc. due to their limited scope and experience. The Audit Committee Policy indicates that the Internal Audit department should report to the Audit Committee. Furthermore, the Audit Committee is required to determine compensation and monitor the internal audit plan. Currently, the Internal Audit team reports and are managed by the CEO. Another major weakness in the Internal Audit department is their experience level. Most of the Internal Auditors are recent college graduates with no prior experience. The head Internal Auditor received his CPA certificate from online within two days. Therefore, they do not possess the necessary experience or freedom to monitor the company. The internal audit department reports directly to the CEO, which in turn creates a major conflict of interest. The lack of experience by the Internal Audit team doesn’t help the cause. If they had more experience they would know that they are not supposed to report to the CEO. The Internal Audit team cannot perform their duties without the approval of the CEO. This would create an opportunity for the CEO to conceal any fraud or misstatement. For instance, if the CEO was committing any fraud, he could easily direct the Internal Audit team to another task so that the fraud will not be uncovered. The Internal Audit department should report and be managed by the Audit Committee as stated in the Audit Committee Policy. This would give the Internal Auditors the freedom to investigate and monitor over the company as needed. They should also consider hiring more experienced Auditors or making sure that they give the current Auditors proper training. Improper safeguarding of assets increases the risk of misappropriation of spheres and theft by employees. Upon review of Appendix A, the audit team observed that the Pleasantville factory’s entrance gates do not have locks, this not only raises the risk of misappropriation internally, but theft by external parties as well. After reviewing the interview with the shipping clerk and the machine operator, we realized that the final sphere products are shipped out in Ziploc bags, raising the possibility of damaging the products and creating losses for the company. The stored spheres are contained in open bins while still in the factory, thus magnifying the possibility of theft and loss. The audit team also identified that the machine operator leaves the spheres unattended at the conclusion of the work shift. Alchemy Inc. needs to have a more adequate system of safeguarding its main source of revenue, producing spheres. If this process is compromised, the firm will subsequently jeopardize its profitability and market position. Our recommendation consists of implementing a more integral system of assessing the value of the company’s products and restricting access to the finished spheres. The production of spheres is one the company’s largest sources of revenue and the production processes should be maintained and guarded at all costs. Though these methods might not be cost-efficient in the short-term, the firm needs to revamp their methods of safeguarding assets to increase the chances of long-term firm longevity and profitability. Alchemy Inc. should implement a system to lock the factory’s gates in Pleasantville and also having restricted access to the factory’s premises. These costs are minimal compared to potential fraud that might inquire due to this weakness. The final sphere products should be stored and shipped in more secure bins and bags. Compromising the quality of these costly spheres can damage the firm’s approach to quality and product control. If it is cost effective to Alchemy Inc. , the management should integrate some sort of lock when the bins are left unattended or when the personnel is finished with the day shift. The code of conduct is in place, but the code is widely unknown by Alchemy’s employees. Acknowledgement of the ethical policies and practices is one of the critical point that can control the awareness of employees conduct. According to the interview performing by the external auditor to Alchemy staffs, no one is aware of or understands the code of conduct when they were hired. Referring to the internal auditor report, thought the code of conduct policies are documented, it is neither properly communicate to the employees nor trained to the employees. Therefore, no compliance of acceptable ethical code is established as of the documentation of Sarbanes-Oxley section 404, and it is not reliable. Also, the Ethics Hotline, Whistleblower, is not checked regularly by the internal auditor. Actually, according to Mr. Pat, internal auditor, he knows nothing about how the hotline is used, and he has no concern regarding why any issues are raised. As an internal auditor, he is responsible for investigating any risk or fraud associate with the company. Conversely, the hotline is sent directly to the audit committees who should have no obligation to this matter. For instance, the company background document indicates that one call has occurred, but no further detail is known or investigated. All of these absence and improper implementing of the code of conduct and responsibility of the employees can potentially conceal the fraud that could exist. Employees witnessing fraud cannot report it due to unknown of one responsibility is. Additionally, the internal auditor does not get the calls, therefore he cannot investigate them. As of result, a rationalize risk could incur where a conflict of interest could exist from either top management or employees. To reduce the likelihood of misstatement, hiring management should take the initiative to confirm the acknowledgement to the code of conduct and establish a continual update of the policy to employees. They should post copies of the code of conduct all around the property. They should set up meeting to let employees know about the ethics hotline, and encourage every single employee to use it. Also, the hotline notification should be sent to both management as well as internal auditor for additional concern regarding any frauds. Though it seems like a lot of additional procedures or exertions that are needed, it is cost-effective to prevent intentional risk by someone. The pay structure at Alchemy Inc. also poses further Internal Control weaknesses and subsequent Fraud Risks. The Shipping Clerk is compensated on an hourly basis, with no potential for over time. The Machine Operator is compensated based on the sphere output that the individual produces. There is no incentive or motivation for the shipping clerk to maximize her efforts to increase production of final product of spheres; this is also due to a poor system of checking on the output by the management. As the machine operator, C. J. Ready is responsible for the product quality and final output of spheres. Since she manually counts the spheres individually, with no proper system of checks by management, she can inflate the final output figures, further increasing her compensation. With this current system of compensation, the Fraud Risks that are associated with these positions are eminent. The company’s financial position will be potentially falsified due to the inflation of wage expenses. Our recommendation is to have a cost-benefit analysis of differing pay structures for the two lines of services with the employees. Human Resources screening policies are ineffective. According to the Internal Audit Report, Alchemy has HR Policy #404 in place. It is the opinion of the audit team that the policy is adequate, but the implementation of the policy is not effective. Alchemy appointed accountant without enough skills or qualification. He did not hold CPA certification and worked with inexperienced people prior to this job. Machine operator, who is colorblind, is also not qualified for this position. The hiring manager did not go through proper medical evaluation before she got hired. Additional, Joe Bozo who has no original document of background check and without the proper performance evaluation was promoted within 3 months. All of these three conditions have violated the HR Policy #404. These unqualified employees can bring to error that could potentially lead to financial misstatement such as a machine operator, who is responsible for color sorting, is color blind. To Alchemy’s business, it can be a big loss by just not sorting color incorrectly. Furthermore, simply the relationship between CEO and machine operator could undermined the organizational structure of the company. In order to eliminate or reduce these from existence, proper screening system for qualified candidate must be strictly reinforced before hiring. Though as the internal auditor report has indicated the freeze on the external hiring, a performance evaluation is still needed in order to promote someone for higher position. This firm implementation is to ensure that the job is fulfilled with the right candidate who not only can perform their duty, but also they can perform it at their full capacities with the skill and knowledge for the benefit of the company. No one is verifying the transfer of inventory from one department to another within the manufacturing process. Inventory should be carefully checked by others to ensure the completeness and accuracy of packing. Also, before loading the inventory, the shipping clerk must be checked by management personnel. According to the interview conducted by external auditor to machine operator, receiver and shipping clerk, there is no proper verification from upper management of the inventory coming in or going out. Everything count or check of inventory is performed on them self. Without proper verification or authorization of inventory, this could result in an opportunity of fraud risk such as theft. Therefore, it is important for a company to have a management in place to make sure that all the transactions are verified including reconciling all the purchase order, bill of lading, how many orders Alchemy received and how many of them they are producing. At the end of the day it is management’s responsibility to make sure all the numbers are right. Inventory is material account, therefore appropriate and maybe strictly supervision must be needed for any material misstatement anticipation. In summary, Alchemys internal control is not as effective as the management indicate. In order to mitigate the potential fraud risk incurred due several weakness found, a cost effective in implementing the recommendation that are offered above will reduce the risk of material weakness to the financial statement and improve the management and operation performance in the long run.