Question

You are a business consultant with an extensive knowledge of auditing and business controls. You have been asked by the directors of Festival Ltd. (Festival) to perform a review of their business specifically in relation to their internal controls system. Festival is an engineering company in Hong Kong which has been operating for many years. Festival makes unique products to order for specific projects needed by Festival’s clients who are located round the world. Recent examples of Festival’s orders have been a large metal door for an unusual old building in England, machinery for factories in Africa making a range of products including components for bicycles and towers for storing water in South America.

Festival’s clients usually want products made from a range of metals and Festival typically orders copper, aluminium, steel and bronze depending on the clients’ needs.

Mark has been head of the factory activities for many years and is responsible for purchasing the metal required for the business. He has an excellent knowledge of how to estimate the quantities of metal needed for each client order, and has long standing contacts in the metal supply business. Because of this, when materials are needed, Mark telephones his suppliers and places orders verbally stating which metal he wants delivered and how much by weight. He uses his regular suppliers, who he has been using for over 20 years, and accepts the price quoted without question. The suppliers and prices are not reviewed by the Directors because they know and trust Mark to make the right decisions and get best value for the company’s supplies. Recently there has been a complaint received from the owners of the old building in England. They say the metal door is rusting after only one year of use and now has a crack in the middle.

When the metal arrives the factory takes receipt of it at the main door. The metal is unloaded and the supplier delivery driver usually passes a printout of the order with the weight and detail of the type of metal ordered and the cost. The factory clerk usually takes the sheet and files it in a file in the factory manager’s office. The sheet is only referred to if someone wants to contact the supplier to ask for more of the same product.

A few weeks after the order is received an invoice is sent by suppliers. This is sent directly to the accounting department where an accounting clerk pays the invoices by bank transfer and files the invoice in a folder on the assistant accountant’s desk.

During the manufacturing work of the factory scrap metal is usually produced. Because of rising market prices for metal the scrap is often worth a substantial amount of money. Mark usually takes the scrap in a van on his day off to a scrap dealer who pays him in cash which he keeps for himself. The Directors are aware of this and feels it is a fair way of keeping Mark happy.

Prepare a report for Festival that provides details of:

1. The control weaknesses found during your review of internal controls; (for identification of relevant control weaknesses from the scenario)
2. The implications of each weakness found; (for valid and reasonable reasons as to why the weakness is a risk to the business)
3. Recommendations for improvements to the system of internal control. (for a valid recommendation to resolve the control weaknesses identified.)
4. Briefly discuss, giving examples, what is meant by the internal control category referred to as ‘Management Controls’ (for clear explanation and relevant examples of management controls.)

Answer 1

Control Weaknesses	Implications	Recommendations
First of all , the Procurement process is faulty. There is no Comparative with at least 3-4 suppliers and the fair comparison and conclusion	Present, faulty process of procurement leads to mismanagement and fraud by the Factory Management. It could lead to bad quality of metal purchases at high prices and resulting into bad market conditions.	Metal , being the main material , should be procured with proper method. There should be at least 3-4 suppliers of the same metal and there should be a proper and perfect Technical Comparative with respect to the Quality ,description and specification of Metal as well as Commercial Specifications, like basic price, discounts, taxes , freight and insurance etc. The comparison should be apple to apple and then it should be signed by Purchase Head, Accounts Head as well as Factory Head , to make it transparent . A Copy of this Comparison with a conclusion as to why x/y/z has been recommended , should be sent to the Directors on every purchase. The Directors should examine it critically and also negotiate with the Suppliers, if required.
Method of Communication is also faulty. Every Supplier who already knows , is called over phone . It is absolutely unwanted method.	Informing Suppliers over phone is never recommended and it may lead to mismanagement and bad practices. It may result into legal disputes , sometimes.	Communication to any Supplier who has been finalized, should always be made by email and the consent of the Supplier should be asked over email for the quantity and the price agreed.
It is evident that there is no negotiation on the price as Mark accepts the price quoted by the Supplier , without any negotiation and comparison.	Not negotiating and accepting the price quoted ,as it is , is indicative of the mal practices and should be investigated in detail.	No verbal acceptance of price should be implemented. Nobody is authorized to confirm pricing over phone and it should be strictly banned by Directors.
There is no review system as Metal itself is a costly affair and a purchase over a certain amount , there is no involvement of the Top Management.	Little involvement of Top Management is also indicative that it could be a “friendly affair” between Mark and some of the Top Management person.	When Metal is the only and the most costly purchases , Top Management has to be involved and their consent should be the only document , before proceeding for purchases.
The material unloading process is also faulty. There is no Invoice with the material, there is no weighment slip alongwith the material so as to ascertain the weight as per PO and Invoice.	Unloading the material without proper documents may lead to legal dispute and also into mismatch of records , where the Production might suffer for any shortages, while Stores might have confirmed the high quantity.	The unloading process should have the weighment slip from the Supplier end , which should be verified by Receiving Plant by independent verification. All three documents, viz. Supplier Invoice, Weighment slip by Supplier and Weighment slip by Receiving Plant should tally and the tolerance as per standard norms may be allowed. Once all the three documents are aligned , no unloading should be done. Any variation over and above the tolerance , which may be due to the different calibrations of different weighing scales, could be there; should be highlighted and after the consent of the concerned authorities, the vehicle can be unloaded.
The Suppliers Driver gives the printout of the PO with weight ,which is filed , directly , without verification by Security , Accountants and Store keeper	The implication of wrong document is again leading to legal issues where no verification is there of the material received and Accounts department is unable to verify , before processing of payment.	The documents viz Suppliers Invoice , alongwith the PO , Weighment slip by Supplier , Weighment slip by Receiving plant should be collectively filed and sent to Accounts department so as to enable them to process the payments.
Invoice is sent after few weeks. It is a critical negative point here, which itself states about the unfair trade practices prevailing in the Company.	Generally, the Invoice should accompany the material , alongwith the PO and delivery challan and delay of Invoice here could lead to delay in payments and mismanagement for money.	Invoice should accompany the material and material should not be unloaded unless Invoice is received. Moreover, the Accountants should not release any payments unless the proper documents with the material are received and checked , properly.
Invoice payment process is also faulty . Invoice is directly sent to Accounts who pays it , without verifying the quantity , rate etc as per PO .	Faulty processing of Invoices could lead to mismanagement and unfair practices , leading to destructing the future of the Organization.	Accounts should never any payment without verifying the Quantity and prices as per PO and with all checking of weight of the material and with proper authorizations.
Scrap handling process is also faulty and there is lack of Internal Controls. Scrap is not recorded any where and it is not reported . Nobody is checking the Yield and comparing it with the standard scrap allowed in metal industry.	A faulty scrap handling process, that too in a Metal industry is highly risky and it could lead of mismanagement and misuse of the Company money. Not recording scrap is like a crime .	Scrap should be recorded as if it is product with all whereabouts , where it is going , at what rate , what quantity and who has checked it before dispatch. Moreover, no scrap handling should be done after business hours. It is required as there is nobody after office hours to verify the transaction.
Scrap Disposal process is again faulty. Scrap is generally handled during business hours and not after business hours.	Scrap disposal after business hours is a faulty and an example of mismanagement. Not recording scrap of metal is truly unfair trade practice.	Scrap handling should have a Standard Operating Procedure , which should state the manner of handling scrap.
Scrap is also not recorded at the main gate as Mark himself takes the scrap in his personal car, which is absolutely wrong.	Not recording scrap at Factory gate is an example of bad management and can have illegal transaction. Using personal vehicle is again questionable .	Scrap movement should always be done by an outside vehicle and no personal vehicle should be used. Security should check the scrap physically as well as with the documents.
Scrap sold is done in cash , it is also an example of weak Internal Controls .	Cash handling is leading to mismanagement and could lead to fraud and bad practices.	Scrap handling in cash has to be restricted . The payment has to be made , in advance , by Cheque or bank transfer and any difference with actual should be dealt with in next transaction. Generally, the company selling scrap , keeps an advance money from the scrap dealer as a security so as to handle any future mishappenings.
Scrap sold is in cash and cash is kept by Mark , personally . It is neither reported into the Company Finance and Accounts department so that they could record it , properly. Moreover, the metal scrap is costly affair and involvement of cash quantum is quite high , which is again an abnormality.	Keeping Company’s money is illegal and it can lead to bad cash management and Auditors may take it very seriously. High cash in the given case is out of question and it is again leading to fraud by some key person.	As mentioned above, Scrap consideration should be received , in advance from the scrap supplier and in no case it should be done in cash. Cash is highly objectionable and cash handling should be punishable by the Top Management.
Directors also seems to have a consent to Mark for their own reasons for not questioning him on any of the above malpractices.	Less involvement of Directors indicates that something is wrong with the Top Management too . Either they are not interested or they are less concerned about the Company.	Directors should question about the deviation from the SOPs and should ask Mark. Had they asked him ,earlier; the things could have been better.
Directors are also not interested in any customer complaint and it is leading to negative business practices. They are not going into the details of the Customer Complaint , which is a must for any Industry	Customer Complaints are the alarms for a unit and if not taken seriously , could lead to loss of business and the reputation as well.	Customer Complaints should be immediately brought to the notice of the Top Management and Top Management should ask the reasons for the complaint with the Corrective and preventive actions for future.

Answer D

• Management Controls are part of Internal Controls and should be designed before start of the activities.
• In the given case, they are into Metal Industry and must have worked out the Production process, storage process , scrap handling process ,in advance.
• Festival must have designed and circulated the Standard Operating Procedures ( SOP)s for handling at the factory and nobody should be allowed to deviate from it.
• Festival is operational for five years and Mark is also working there for long time. We are unable to understand the limitations of the Directors for continuing Mark any more.
• Handling of Metal , without proper documentation , without Comparisons is not acceptable and Directors have never got involved into this and due to this Mark is seems to have taken advantage of being the Oldest guy who knows everything and Directors know nothing.
• When Directors are dependent upon Mark , Mark is clever enough to take advantage
• Accepting the price at will is surely having some wrong methods of collecting money from the suppliers.
• Festival is handling with Copper, Steel, Aluminium and bronze ,which is costly affair and without any verification the affairs are on.
• It also seems that there is no reporting system ,except for annual reports , who is not even audited by anybody.
• Since the Directors, lately , have realized that something is seriously wrong with the affairs of the Company, it is our duty to highlight each and every practice in detail to the Top Management .
• Mark should be asked for the questions as per the case to case basis , happened and noticed as Auditor. After his written explanations, it should be shared with the Top Management.
• As Auditor, we would recommend following
• A) Implementation of SOPs , which should be taught to each and everyone from HO to Factory for all levels, whether it is Factory Manager or a Security person.
• B) Circulation of monthly reports should be started , immediately
• C) Cash and Bank accounts should be checked on daily basis by Accounts team and no cash handling should be allowed.
• D) If required , one Internal Auditor should be appointed to be based at Plant and he should report the deviation from SOPs and Internal Controls Questionaire on weekly basis.
• E) On Investigation if anything wrong doing has been found, the concerned person should be sacked with immediate effect.
• F) In the given case, after detailed investigation, it would reflect that Mark is the responsible person for wrong doings and bad practices at the Plant and Top Management should take a call on him , immediately.