relating operational and financial factors

ISSUES IN ACCOUNTING EDUCATION American Accounting AssociationVol. 26, No. 2 DOI: 10.2308/iace-100212011pp. 361376

Relating Operational and Financial Factorsto Assess Risk and Identify Fraud in an

Operational Setting

Richard H. Gifford and Harry Howe

ABSTRACT: The current literature and Statement on Auditing Standards (SAS) 99emphasize the importance of relating operational factors to financial factors whenevaluating the risk of fraud. The following case is based on an actual company anddemonstrates how an understanding of the relationship between operational factors andfinancial reporting can aid an auditor in assessing risk and identifying fraud. The casealso gives students an opportunity to directly evaluate internal control in an operationalsetting. The case is intended to strengthen students critical thinking and analytical skillsand to give them exposure to the importance of internal controls in an operational setting.

INTRODUCTION

You are a member of Wilcox Internationals internal audit department. You are performing

an operational audit of one of the companys assembly plants located in Knoxville,

Tennessee. The objective of the audit is to determine the plants ability to satisfy its

production schedule efficiently and effectively. Your audit approach includes an overview of plant

performance and analysis of trends in production and related costs, a walk-through and

documentation of internal controls, interviews with plant personnel, and tests of compliance with

corporate policies. The company is particularly interested in controls over scrap and scrap recovery,

which represents a significant source of cash flow.

The companys internal audit department is based at the companys corporate headquarters in

Charlotte, North Carolina. The department consists of nine CPAs hired predominately from national

and international CPA firms, two engineers, and two computer specialists. The department reports

to the Vice President of Internal Audit, who reports directly to the companys audit committee.

The internal audit department performs a variety of financial, internal control, compliance, and

operational audits on a global basis, based on an annual audit plan. The department is respected within

the company for its objective and disciplined audit approach and for its ability to understand the role

of controls in the successful execution of the companys strategic plan. The department regularly

presents findings that aid management in strengthening controls and reducing costs. Accordingly, the

department is viewed as a source of talent when management positions open within the company.

Richard H. Gifford is an Associate Professor and Harry Howe is a Professor, both at SUNY at Geneseo.

The authors acknowledge the valuable comments provided by colleagues and the feedback provided by SUNY atGeneseo accounting students who completed this case.

Editors note: Accepted by E. Kent St. Pierre.

Published Online: May 2011

361

COMPANY AND INDUSTRY INFORMATION

Wilcox is one of the premiere suppliers of electronic and electrical connectors to original

equipment manufacturers (OEMs). Wilcox maintains a 7.5 percent overall global market share of

the estimated $33 billion interconnect market. The company was founded in 1964 in Charlotte,

North Carolina, by a team of electrical engineers with a mission of providing high-quality

interconnect products to the consumer products industry. The company quickly established a

reputation as a custom producer of high-quality specialty interconnections. Wilcox competes in the

Automotive, Communications, Electronics, and Consumer Products market segments.

The company is organized into four divisions by market segment. Profitability is reported by

division, by global region, and by product lines. The company employs approximately 20,800

people and maintains 34 manufacturing facilities in 12 countries, and sales and distribution facilities

in 38 countries. Over the past two years the workforce has declined by 5 percent as the company

reengineered and streamlined its value chain. The company markets its approximately 85,000

products to customers in 47 countries, primarily through a strategy of a direct sales force and

authorized distributors. Exhibit 1 presents summary financial data for Wilcox International for

20XX, the most recent fiscal year.

The interconnection industry is highly fragmented, subject to rapid change, and is very

competitive. The industry has a long-term growth rate of approximately 6 percent. Interconnection

products are both mature and rapidly changing, depending upon the product application and need

for more cost-effective solutions to customer problems. Companies within the industry succeed by

their ability to work closely with customers to innovate, reduce product size as end user products

become miniaturized (computers, cell phones, etc.), maintain high quality levels, meet customer

delivery schedules, and reduce product prices.

In recent years, the industry has started to consolidate as customers move increasingly to

supplier certification programs and just-in-time inventory systems in an attempt to reduce costs and

identify a smaller, core supplier base that can supply their global operations. This consolidation has

eliminated the less efficient firms and has placed increasing pressure on the remaining

interconnection suppliers to provide high-quality product at lower prices.

EXHIBIT 1

Financial Data for Wilcox International20XXPanel A: Segment Data

Market Segment Market Share % of Company Revenues Company Revenue ($000)

Automotive 7.8% 32.50% $812,500

Communications 6.2% 29.40% $735,000

Electronics 9.0% 24.10% $602,500

Consumer Products 8.0% 14.00% $350,000

Total Sales 7.5% 100.00% $2,500,000

Panel B: Industry Data

Wilcox Industry

20XX Annual Sales Growth 6.1% 6.2%

Average Annual Sales Growth5 years 6.7% 6.0%

20XX Profit Margin 9.6% 9.8%

Average Profit Margin5 years 10.1% 9.5%

Issues in Accounting EducationVolume 26, No. 2, 2011

362 Gifford and Howe

Wilcox is well positioned to effectively compete in the industry. It has continually offered

innovative, high-quality products and has expanded globally as it saw opportunities. With its global

presence and reputation, the company effectively services its customers. The companys philosophy

is to maintain its status as an industry leader through high levels of customer satisfaction, product

innovation, continuous improvement, and employee involvement. To address the pressure to reduce

product prices (and costs), the company implemented productivity and cost improvement programs.

Traditionally, the company operated relatively small specialized plants rather than large

integrated production facilities (large plants that can perform numerous manufacturing processes).

Wilcox believed smaller plants with a decentralized management structure enabled them to operate

with greater flexibility to meet customer expectations and gave the employees more ownership over

the production processes. Over the years, this philosophy enabled the company to maintain high

quality levels and higher employee productively than the industry average. It also helped forge a

satisfied workforce that was committed to the company. Employee turnover was half the industry

average.

As competitive pressures to reduce costs intensify, Wilcoxs manufacturing operations focus

on reengineering and automating its primary processes, migrating to integrated manufacturing

operations, and transferring production to its operations located in countries with lower labor costs.

As new plants come online, Wilcox consolidates and reduces production at its older, less efficient

operations.

The consolidation of Wilcoxs operations has necessitated a culture change within the company

toward a greater emphasis on efficiency. This change has strained relations with its long-term

employees. When it downsizes its older, less efficient plants, the company offers employee transfers

to its new facilities, where appropriate, and early retirement packages. The company also lays off

employees it cannot place at other facilities. Plant managers and front-line supervisors have been

advised by senior management to keep their workers apprised of what the company is doing and to

be aware of the morale issues the changes are generating. However, management efforts have not

alleviated employee perceptions of dislocation and abandonment. As a result, absenteeism has

increased and employee productivity at the older plants has declined marginally.

OVERVIEW OF THE COMPANYS MANUFACTURING PROCESS

Wilcox is an integrated designer and manufacturer of electrical and electronic components. Its

operations include molding, stamping, plating, and assembly plants. At the companys stamping

plants, raw metal stock is stamped into various configurations of contact pins (hereafter referred to

as contacts) and other related products. The stamped contacts remain attached to a carrier strip to

facilitate handling, plating, and assembly. The carrier strips are reeled (approximately 5,000

contacts per reel) and then transported to a plating facility, where they are plated with precious

metals (gold and palladium) to enhance electrical conductivity and to prevent corrosion. The reeled,

plated contacts are shipped to assembly plants for insertion into the molded plastic housings that are

produced at the companys molding plants.

The assembly operations produce the finished connector assemblies using insertion machines that

detach the contacts from the reels and insert them into plastic housings. After assembly, the connectors

are packaged and shipped to the companys distribution centers or sent to other plants for inclusion in

other product applications. Figure 1 provides an overview of Wilcoxs manufacturing process.

PRODUCTION SCRAP AT THE ASSEMBLY PLANTS

After the contacts are detached from the metal carrier strip, the strip remains as design scrap.

The carrier strips are chopped, automatically cut into small pieces at the assembly machines, tomaximize space utilization in the scrap containers. Although the company is continually refining its

Operational and Financial Factors to Assess Risk and Identify Fraud 363


FIGURE 1Wilcox International

Production Process for Connectors



plating process to limit the amount of precious metals to the contacts, some precious metal is plated

on the metal carrier strip. As a result, design scrap has significant value. The plant sells its scrap to a

salvage company for reclamation on a weekly basis. The companys central purchasing department

maintains long-term contracts with salvage companies that stipulate processing and transportation

(pick-up) charges.

The amount of scrap recovery is based on a content factor which is determined by the salvage

company after testing each load of scrap. The gross weight of each scrap shipment is adjusted

downward based on contamination with other scrap in the containers (such as plastic) and moisture.

The funds forwarded to Wilcox are calculated based on the relevant market prices of reclaimed

scrap metals (as reported by the Markulis Metals Digest [MMD]), less processing and scrap pick-up

(transportation) charges. On a company-wide basis, scrap sales account for approximately 0.7

percent of total revenues.

OVERVIEW OF THE KNOXVILLE ASSEMBLY PLANT OPERATIONS

The Knoxville plant has been in operation since 1965. It is one of the companys original

assembly plants that employed an average of 225 individuals during 20XX. The plant produces

variations of one of the companys most popular connectors, part # CNNCTR-2964. To produce the

contact, the company uses a gold-plated contact stock, part # CNTCT-AU-29XX. This connector

contains the highest gold content of the companys products. The plant has the capacity to produce

connectors containing 120 million contacts annually. However, during 20XX, the plant used only

82 million contacts due to a transfer of production to an integrated facility. During the past two

years, approximately 20 percent of the plants total workforce has been reduced through transfers to

new facilities, layoffs, and retirements as a result of the companys efforts to consolidate operations.

Exhibit 2 summarizes 20XX production and headcount at the plant by month.

Production at the plant is controlled by a factory order process. Materials are issued to the

assembly machine operators by material handlers based on the authorization of factory order

requisitions. Access to stores inventory is limited to material handlers and store attendants.

EXHIBIT 2

Knoxville Production Record Summary

20XX

Contacts Issued toProduction Part #CNTCT-AU-29XX

Good Production(# Contacts in Connectors

Part # CNNCTR-2964)

Headcount

ConnectorLine

OtherDepartments

January 6,500,000 6,435,000 48 189

February 5,785,000 5,698,225 46 189

March 6,240,000 6,115,200 45 187

April 7,605,000 7,536,555 43 186

May 8,450,000 8,340,150 44 182

June 8,775,000 8,599,500 45 181

July 9,100,000 8,927,100 46 178

August 7,735,000 7,468,143 46 177

September 6,890,000 6,827,990 46 173

October 6,435,000 6,383,520 45 172

November 5,785,000 5,738,720 45 169

December 4,355,000 4,272,255 43 164



During 20XX, the plant ran two or three shifts, depending on demand, five days a week.

During the weekend, material handlers worked a four-hour shift to ensure the work centers had

sufficient materials for the beginning of the week. They also weighed and prepared the scrap for

weekly pick-up by the external salvage company. To fairly spread the weekend work among the

material handlers, they alternated weekends. Generally, two material handlers were scheduled for

each weekend shift. There were four material handlers assigned to the plant during 20XX. There

were no other employees in the plant during the weekend.

PLANT SECURITY

Plant security for four Wilcox facilities was consolidated two years ago to reduce costs. The

plant is located within five miles of three other Wilcox facilities, situated immediately outside the

perimeter of an industrial park in the suburbs of Knoxville in an area considered safe and free of

serious crime. The property is not fenced and consists of a parking lot and the building. The plant

loading dock is located in the back of the plant, away from the road. All visitors must park in the

front of the building and enter through the main entrance where the plant managers secretary issues

a security pass through an access window. After the visitors credentials are authenticated, they are

permitted to enter the plant under escort and must exit through the main entrance where they are

logged out. Employees enter the plant through the employee entrance located by the loading dock.

Security for the plant during nonworking hours is provided by Jones Security, which maintains

a full-time presence at one of the Wilcox plants within a five-mile radius. At the conclusion of

working hours and prior to the weekend, Jones Security does a walk-through of each plant to

determine it is properly secured and that the alarm system is turned on. After the plant is secured,

Jones Security drives by the facility at unscheduled times and looks for anything unusual or

suspicious. Jones Security personnel generally do not enter the plant. A police station is located

within a mile. During the past five years, there were no reported incidents.

The material handlers who must access the plant for their special shifts on the weekend are

given a key by the materials manager. When the handlers start the weekend shift, they deactivate

the alarm and telephone Jones Security to notify them they are in the building. When the shift is

over, they reactivate the alarm and notify Jones Security that they are leaving the building.

THE ACCOUNTING SYSTEM

The company uses a standard cost system. Production facilities are considered cost centers and

are evaluated based on their ability to achieve production and quality targets within standards and

budget. Standards are based on good production only and include no provision for scrap recovery.

Standards are established jointly by accounting, engineering, and manufacturing, as they are used

for both financial and operational purposes. The standards are updated annually or when processes

are modified. Exhibit 3 presents standard material information for part # CNNCTR-2964.

Standard cost variances (materials, labor, and overhead) are reviewed by corporate and

divisional accounting, the plant accountant, and the plant management on a monthly basis and

corrective action is taken as necessary. Scrap recovery from bad contacts (production scrap) and the

scrap generated by the metal reeled strip (design scrap)1 are not considered a reduction of standard

cost because of the difficulty in predicting fluctuating precious metals costs. Rather, scrap recovery

is credited to an unbudgeted scrap recovery account which, due to the companys policy of

maintaining low inventories, is a reduction to the companys cost of goods sold. The impact on

1 Design scrap is anticipated as a normal byproduct of manufacturing operations. Production scrap occurs whendefective units are produced.



inventory valuation by not allocating scrap recovery among work-in-progress and finished goods

inventories is considered immaterial to Wilcox Internationals financial results.

THE SCRAP COLLECTION PROCESS AT THE KNOXVILLE PLANT

In the Knoxville plant, material handlers are responsible for collecting, weighing, and

preparing the scrap shipments. Scrap from the assembly machines is accumulated in specially

designed, jumbo corrugated containers that cost approximately $22.00 each. Because of their cost

and special design, the containers are designated for only metal scrap (both design and production).

Each container holds approximately 2,500 pounds of scrap. Although rejected product (production

scrap) includes the plastic housing, efforts are taken to avoid placing other waste items in the

containers as it will contaminate the metal content of the containers, thereby reducing the metal

content factor and amount of scrap recovery as discussed above. Figure 2 illustrates the standard

corrugated scrap container used by the plant, the Gaylord HPT 41.

Since the cost of the Gaylord containers is immaterial to Wilcoxs operations, the company

treats it as an expense and does not inventory or physically control access to the containers. At the

end of 20XX, the material handlers told you there were approximately 20 empty containers on site.

The handlers did not think there were any containers on hand at the beginning of the year.

The material handlers collect the scrap from each assembly machine scrap bin during the shift.

The handlers place the scrap in the Gaylord containers in a locked scrap cage located in the material

stores. Only the four material handlers have keys to the cage. The containers remain in the cage

except when the material handlers weigh and prepare the containers for shipment during the

weekend shift.

The scrap cage can only accommodate 1012 containers at any given time. During the summer

months, this constraint creates a problem because the plant fills more containers than can be

accommodated in the cages. When this occurs, the containers are stored in a small locked cage

located on the loading dock. The cage on the dock is used to store other recyclable waste and has

exposure to the weather. The placement of the scrap containers on the dock increases their chance

for contamination.

The materials handlers are also responsible for requisitioning and maintaining the scrap

containers. When additional containers are needed, the material handlers complete a purchase

requisition, which is approved by the materials manager and procured by the plant purchasing

agent.

During the weekend shift, the material handlers prepare the scrap for shipment. They remove

the containers from the scrap cage and weigh, seal, and number the containers. The company name,

weight, container contents, and container number are recorded on a label and attached to each

container. The containers cannot be opened without breaking the seals. The handlers record the

number of containers, the weight, the contents, and the bill of lading number on a scrap log. The

handlers return the containers to the scrap cage, where they remain until McClean Metal

EXHIBIT 3

Wilcox Bill of MaterialPart # CNNCTR-2964Finished Connector

Operation

Raw MaterialPlated ReeledContact Part #

RawMaterial

Unit

FinishedLot 100

ConnectorsGross Raw

Material Issue

NetWeight

FinishedUnit

Assembly CNTCT-AU-29XX contact 1,000 contacts 46.875 lbs 31.250 lbs



Reclamation arrives for the weekly shipment. One copy of the log is given to the shipping clerk on

Monday morning. The clerk prepares the bill of lading and related shipping documents that contain

a description of the shipment, the number of containers, and the weight.

When McClean arrives for pick-up, the handlers remove the scrap containers from the cage and

load the containers onto the truck under the direction of the driver. The driver verifies the number of

containers, signs the bill of lading and the shipping manifest, and gives one copy to the shipping

clerk. Another copy, along with the scrap log, is sent to the plant accountant.

The plant accountant compares the number of containers and weight on the log with that

recorded on the bill of lading copies. The documents are placed in an open scrap file and listed by

bill of lading number in an electronic spreadsheet. The file and spreadsheet serve as the only record

of what is owed to the plant. The plant accountant investigates any scrap remittances not received

by the company within ten days of shipment.

As part of the companys monthly closing process, the plant accountant reviews the open file

for any shipments for which no remittance has been received and prepares a standard journal entry

that debits miscellaneous receivables and credits the plant scrap recovery account. The journal entry

is automatically reversed the following month. Summary information relating to Wilcoxs scrap

shipments and bills of lading are presented in Exhibits 4 and 5.

McClean wire transfers the scrap recovery, generally within ten days, to Wilcoxs bank.

McClean sends the remittance advice to corporate accounting and a copy to the plant accountant.

FIGURE 2Scrap Shipping Containers



Corporate accounting compares the deposit with the remittance, debits cash, and credits the plant

scrap recovery account. The plant accountant compares the bill of lading number, gross weight, and

number of containers on the remittance with the information listed on the log. The accountant also

compares the proceeds recorded by the company with those listed on the remittance advice.

Summary information relating to McCleans scrap recovery remittances is presented in Exhibit 6.

The plant accountant performs two additional procedures to verify the reasonableness of the

recovery. The net weight reclaimed represents an adjustment of the gross weight based on the

content factor. The accountant notifies the plant manager for all factors less than Wilcoxs average

of 0.96 (net weight/gross weight), as this suggests that the shipment may have been contaminated

with nonmetal waste.

The accountant also tests the amount of the recovery for reasonableness by comparing the

market price of the scrap as published in the Markulis Metals Digest (MMD) and adjusted for

EXHIBIT 5

Summary of Carrier Bills of Lading

20XX Containers Shipped

January 42

February 37

March 37

April 44

May 50

June 50

July 52

August 46

September 40

October 38

November 34

December 29

EXHIBIT 4

Knoxville Plant Summary of Scrap Accounting Records

20XX Containers Shipped Pounds Shippeda Cash Received

January 42 103,593.75 $528,991.13

February 37 93,102.34 $479,988.02

March 37 91,400.00 $477,838.91

April 44 108,467.03 $573,199.67

May 50 122,964.06 $601,943.52

June 50 125,093.75 $622,799.50

July 52 130,090.63 $608,588.71

August 46 114,198.67 $581,701.68

September 40 99,594.06 $500,405.19

October 38 94,655.63 $487,188.72

November 34 84,336.88 $433,129.50

December 29 70,632.66 $363,543.46

a Net of shipping container weight.



McCleans cost of scrap pick-up and processing per the contract with the proceeds. For differences

that exceed 2 percent, the accountant contacts McClean. During the past three years, there have

been no significant discrepancies. After verifying the remittance, the accountant updates the

spreadsheet with the actual remittance information and files the scrap log and related documents in a

closed file. As a further level of control, the corporate accounting staff of Wilcox reviews scrap

recovery against shipments for reasonableness.

DISCUSSION WITH PLANT PERSONNEL

During your audit, you interviewed the Plant Manager, Materials Manager, Production

Manager, and Human Resource representative at the plant. Excerpts from the interviews are

presented below:

Interview with the Plant Manager, R. E. Bob Howler

The Knoxville Plant has been the mainstay of Wilcox for years. We have the most dedicated

and productive labor in the United States. Some of our employees have been with us since we

opened in 1965. Our problem is not the productivity of labor, but the overall cost of the

operation. It is increasingly difficult for us to be cost competitive with plants located in

countries with lower wages or with fully automated facilities. As a result, the company has not

invested in upgrading this facility and has transferred a sizable portion of our production

volume to other locations. This reduction has created stress and some resentment among our

remaining employees. Although we are understaffed, we remain highly productive and

continue to produce a high-quality product.

Interview with the Materials Manager, Sarah Thompson

I recently took over the materials responsibility at this plant. The company consolidated the

Materials Managers positions at this and two other plants. As if I didnt have enough to do at

one plant, I am now responsible for managing the materials at all three of the plants. At this

EXHIBIT 6

Summary of McClean Reclaimers Scrap Summary Remittances

20XXContainersReceived

Gross WeightReceived (lbs)

ReclaimWeight (lbs)a

CashRemitted

January 42 103,186.64 101,729.06 $528,991.13

February 37 93,204.90 90,495.48 $479,988.02

March 37 91,600.10 89,389.20 $477,838.91

April 44 108,400.40 106,297.69 $573,199.67

May 50 123,014.17 110,667.66 $601,943.52

June 50 124,983.66 112,459.28 $622,799.50

July 52 130,100.26 113,959.39 $608,588.71

August 46 113,996.42 110,430.12 $581,701.68

September 40 100,076.01 97,203.81 $500,405.19

October 38 94,600.44 92,762.51 $487,188.72

November 34 84,047.99 82,144.12 $433,129.50

December 29 70,429.54 69,220.00 $363,543.46

a Weight adjusted for contamination (content factor) by McClean.



plant, my team is responsible for ensuring we have sufficient materials available for assembly

operations and shipment to our finished goods warehouse. Our raw materials consist primarily

of reeled plated metal contacts and plastic housings. We are constantly aware of security,

although it would be difficult for an employee to remove sufficient product from the plant to

make it worth his/her efforts. We are also responsible for scrap collection. Since we generally

do not have much production scrap due to our quality, most of our scrap is design scrapmetal

remaining after the contacts are stamped. My material handlers also ensure we have containers

available to store and transport the scrap. The containers are relatively inexpensive; I think they

run about $22.00 each and we go through $12,000$13,000 annually. As my staff needs

containers, they complete purchase requisitions and our plant purchasing agent places an order

with our supplier.

Unfortunately, the company has not invested in our operation and, consequently, we are

squeezed for space. This is particularly true during the summer months when our production is

high. We just dont have the space to store materials and scrap. During the summer we end up

putting scrap on the back dock. This is not good for the scrap or security, but we do the best we

can. In addition, my materials handlers point out that because of space limitations, we also have

to store the empty containers on the back dock. They tell me as much as 810 percent of our

container purchases end up being disposed of because they get wet and cannot be used. If the

company would just give us the resources, we could reduce container costs and increase our

scrap yield.

Because of my ever-growing responsibilities, I have to travel among plants and I rely heavily

on my staff. I am very fortunate to have material handlers who are long-term employees and

who take pride in their work even though the company has sought to downsize us. Since the

downsizing, my material handlers are stretched. They are still company people and volunteer to

come in on weekends so our production staff has product the following week and so our scrap

shipments are ready for pickup on Monday morning. I am lucky to have such a dedicated staff

under such difficult conditions.

Discussion with the Production Manager, Ben Stampman

I am responsible for the actual manufacturing operations at the plant. My team keeps the

assembly machines running. As I am certain Bob and Sarah have told you, our volume is down

significantly from prior years. But I am happy to report that my machine operators remain

productive and motivated. Our standard cost variances for last year remain low. We continue to

meet all of our manufacturing goals. Bad contacts generally account for only 0.5 percent to 1.0

percent of scheduled production. This is due to good teamwork among plant operations.

Maintenance keeps our antiquated machines running and Materials keeps our assembly areas

clean of scrap and properly supplied with materials. Although morale is suffering somewhat

due to the downsizing, my employees are professionals.

Discussion with the Plant Human Resources Representative, Joan Softskill

The workers at this plant are very good and dedicated to the company. Unfortunately, they are

in a high-cost operation, which the company has sought to transfer to more automated and

lower-cost operations. When we are able, we offer employees the opportunity to transfer to

other plants. However, as most of the transfers involve relocation and we have fewer positions

available, many of the employees in this area must either retire or be laid off. The company has



a fair severance package, but it is not viewed favorably by the employees. Consequently,

morale has suffered and absenteeism has increased, particularly among the newer employees.

Our hourly production workers are not the only staff to feel the pinch. The company has also

consolidated its management staff in the area. For example, the Materials Manager and Quality

Assurance Manager positions at this plant have been consolidated with two of the other plants

in the area. This has put an added burden on the managers, who now have to travel among

plants and supervise additional employees.

CONCLUSION

You have completed your production and cost overview, interviews, major system

walk-throughs, and documentation of controls. You are preparing your preliminary assessment

of the plants controls and are preparing to test its production and scrap operations. You are

satisfied, based on the results of your preliminary work, that the plant appears to be operating on a

reasonably efficient basis despite the uncertainty the plant employees are facing. However, your

professional training has taught you to be skeptical of all controls and processes until they have

been tested. You hope the results of your tests will be consistent with the results of your preliminary

work and interviews.

CASE QUESTIONS

1. How would you characterize the Knoxville plants controls over its operations using a

COSO framework? In your evaluation, consider company and operating factors in addition

to procedural controls. Evaluate and identify any control risks associated with the

companys scrap operations. Categorize your risks according to management assertions

relating to its scrap transactions (occurrence, completeness, accuracy, classification, and

cutoff ).

2. Using elements of the Fraud Triangle, as described in forensic accounting/auditing texts

and adopted by SAS 99, evaluate the potential for fraud in Wilcoxs operations. Make

certain you consider the company and operating issues that impact the plant in addition to

specific procedural controls. What key fraud factors (if any) do you see present, and what

might account for them?

3. Is there any evidence of fraud in the scrap operations? Support your evaluation through the

use of analytical procedures and corroborating evidence. Your manager has requested that

you quantify the amount of any fraud you think is present. Would your evidence be

convincing to management that a problem exists?

4. Identify any internal controls and/or operational changes you would make to improve the

plants controls over scrap and its plant operations. Quantify the potential benefits of any

suggestions you make.



CASE LEARNING OBJECTIVES AND IMPLEMENTATION GUIDANCE

Introduction and Learning Objectives

SAS 99 (AICPA 2002) requires auditors to explicitly consider the likelihood of fraud in

planning and conducting an audit. This consideration includes an evaluation of unexpectedrelationships that are identified by analytical procedures. The authors survey of widely usedauditing textbooks suggests that the relationship between financial and nonfinancial data receives

little attention and thus is likely not to be often considered in the classroom.

This case, which is based on an actual company, can be used to demonstrate the importance of

internal controls in a nonfinancial process, and the relationship of financial and nonfinancial data

when performing analytical reviews and in evaluating the likelihood of fraud in a manufacturing

environment.

At the conclusion of the case, students should be able to demonstrate proficiency with four key

learning objectives:

1. Identify and evaluate the likelihood of fraud in a manufacturing process using a SAS 99

framework.

2. Understand the relationship between financial and nonfinancial factors when performing

analytical procedures.

3. Evaluate internal controls for a manufacturing process.

4. Understand the importance of professional skepticism in evaluating evidence.

The teaching notes discuss relevant skill sets that support each of these learning objectives.

Implementation Guidance

The case has been used in one instructors undergraduate auditing classes for four years (six

sections) and in another instructors class for two years (two sections). The instructors using the

case assign it after the students are grounded in the audit process through internal control evaluation

and fraud. Students should have a foundation in risk assessment, analytical procedures, internal

control, evidence, and fraud (both financial reporting and misappropriation of assets). The

instructors find that having the class review recent SEC enforcement actions relating to fraud and

professional literature, in such journals as The Journal of Accountancy and Fraud, enables thestudents to better understand how frauds relating to financial reporting and misappropriation of

assets can and do occur. This background may enable students to better address the issues in the

case.

The case can be assigned individually or in teams of students. The authors find that team

assignments generally result in higher and more confident levels of class participation, as the

students have had the opportunity to talk through the solutions with someone before class. The case

is assigned as homework approximately one week (two class periods) before it is reviewed in class

so that the students have time to complete the calculations and adequately review the manufacturing

process. Students (working individually or in teams) each submit one summary outline. The

submission is intended to provide assurance that the students have given the case sufficient

consideration before the class discussion.

The case and discussion questions may be covered in one 75-minute class period. Exhibit 7

provides an example of how the instructors allocate class time to the case. The schedule gives the

instructor time to introduce and to recap the case. The questions are sequenced so that students

move from a general evaluation of control risk at the plant level and review of internal controls over

scrap collection to an assessment of the likelihood of fraud and an estimation of the fraud amount.

The sequence is intended to demonstrate how weakness in controls, when combined with incentives



and rationalization, can lead to fraud in a real-world setting. The final question provides an

opportunity for students to provide value-added recommendations to help an organization improve

its profitability through strengthening its controls.

Student Feedback

At the conclusion of the case, the instructors distribute an assessment form that students

complete anonymously and return the following class period. The students assess their learning

based on six statements that are related to the learning objectives discussed above. The assessment

form, which was revised for the fall 2009 classes, is presented in Exhibit 8.

EXHIBIT 7

Example of Time Allotted to Case Coverage

Question/TopicMinutesAllotted General Discussion Topics

Case Introduction and Overview 10 Overview and comment that case is based on an actualcompany.

Discussion of the importance of internal controls to allaspects of an organization.

# 1Risk Assessment 10 Discussion of qualitative issues impacting the controlsas gleaned from the interviews with management and

review of company shift in cultural philosophy. Discussion of the adequacy of the controls over

operations. Discussion of the adequacy of controls over scrap

based on assertions with emphasis given to the

completeness assertion.

# 2Fraud Assessment 15 Application of fraud triangle in assessing thelikelihood of fraud due to employee theft.

Relating the adequacy of controls noted in Question 1to the opportunity for fraud.

# 3Quantification of Fraud 20 Review of how analytical procedures relatingproduction to financial information (expected

production based on standards versus actual scrap

shipments and scrap recovery) could identify a fraud. Quantification of potential amount of fraud by

reviewing the calculations on an electronic spreadsheet. Discussion of the strength of the evidence. Brief discussion of how the fraud was uncovered in

the actual company and steps that were taken after

fraud was discovered.

# 4Recommendations 10 Discussion of recommendations relating to controlprocedures.

Discussion and quantification of potential operationalimprovements.

Brief overview of what the company actuallyimplemented.

Wrap-up 10 Reiteration of the importance of control to all aspectsof a business and discussion of professional skill sets

required to be an effective auditor.



The information is summarized and presented to the classes the following class meeting.

During the review, students are invited to comment as to what they have learned and to share any

recommendations as to how to improve the case. The discussion of the assessment and request for

comments is intentional to build student confidence in making recommendations, something they

will be expected to do as professionals. Student participation has been very good. The results for the

fall 2009 classes are presented in Exhibit 9. Only the 2009 results are presented, as the instructors

implemented a new assessment form. The results of prior class assessments are consistent. The

results are nonscientific.

Student responses were positive and generally support the learning objectives. Students

indicated that they gained a better knowledge of the relationship between internal controls and

fraud. Student responses related to the case are summarized below:

Students indicated that although they were reasonably confident in their understanding ofanalytical procedures relating to financial information, the case expanded their awareness of

the use of analytical procedures in a nonfinancial setting. They indicated the use of

production information was particularly useful because it used an actual company to

demonstrate how analytical procedures can be used to identify potential problems. Students indicated the case provided a real-world setting that helped them better understand

the importance of internal controls. Students indicated they had developed a better understanding of how control weaknesses

can contribute to fraud. They indicated the case enhanced their understanding because it

added realism to what appeared to be a somewhat theoretical discussion in the auditing text.

EXHIBIT 8

Wilcox Scrap Case Learning Assessment InstrumentAt the conclusion of the Wilcox Scrap Case, I ask students to assess the extent to which the Wilcox Case has

enabled them to better understand audit issues relating to internal control and fraud. Please circle the degree to

which you agree or disagree with the following statements. Your response is anonymous and will be used to

improve the case. Please submit your assessment at the beginning of the next class. I will summarize the results

and review them with the class. Thank you for your response.

1. The case enabled me to better understand the interrelationship between controls and fraud.

1. Disagree 2. Disagree Somewhat 3. Neutral 4. Agree Somewhat 5. Strongly Agree

2. The case enabled me to better understand the importance of relating nonfinancial factors to financial

factors when evaluating financial information.

1. Strongly Disagree 2. Disagree 3. Neutral 4. Agree 5. Strongly Agree

3. The case enabled me to better understand how to evaluate internal controls.


4. The case enabled me to better understand how to apply SAS 99 in determining the likelihood of fraud.


5. The case enabled me to better understand how to apply and interpret analytical procedures.


6. The case enabled me to better understand the role of professional skepticism in evaluating evidence.




Students indicated they gained an appreciation of professional skepticism. Virtually all thestudents indicated they had accepted the reconciliation of the containers and the statements

of the material handlers, as discussed by the materials manager, at face value. Responses

indicated that the learning came after we discussed the case in class. Students indicated they learned how to use information to quantify weaknesses and add

value to their recommendations. Students indicated they gained an appreciation of how to corroborate findings. The missing

scrap containers could reasonably corroborate the amount of the discrepancy between

expected and reported scrap shipments.

TEACHING NOTES

Teaching Notes are available only to full-member subscribers to Issues in AccountingEducation through the American Accounting Associations electronic publications system at http://aaapubs.org/. Full-member subscribers should use their usernames and passwords for entry into the

system where the Teaching Notes can be reviewed and printed. Please do not make the Teaching

Notes available to students or post them on websites.

If you are a full member of AAA with a subscription to Issues in Accounting Education andhave any trouble accessing this material, then please contact the AAA headquarters office at info@

aaahq.org or (941) 921-7747.

REFERENCES

American Institute of Certified Public Accountants (AICPA). 2002. Consideration of Fraud in a Financial

Statement Audit. Statement of Auditing Standards 99. New York, NY: AICPA.

EXHIBIT 9

Summary of Student Responses2009

StatementAverageRating

% StudentsAgreeing or

Strongly AgreeingStudents

Responding

1. The case enabled me to better understand the

interrelationship between controls and fraud.

4.23 87.9% 66

2. The case enabled me to better understand the

importance of relating nonfinancial factors to financial

factors when evaluating financial information.

4.26 86.4% 66

3. The case enabled me to better understand how to

evaluate internal controls.

4.06 80.0% 65


apply SAS 99 in determining the likelihood of fraud.

4.24 89.4% 66


apply and interpret analytical procedures.

4.08 79.4% 63

6. The case enabled me to better understand the role of

professional skepticism in evaluating evidence

4.48 90.9% 66

Students Attending = 72.Student Responses = 66.



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