The control environment reflects the company\'s attitude, awareness, and actions

Question

The control environment reflects the company's attitude, awareness, and actions of management and the board concerning the importance of control and how it is used. This is very relevant to an auditor%u2019s consideration of inventories and should include: a) commitment to competence and HR policies and procedure; b) integrity and ethical values; c) organizational structure and assignment of authority and responsibly.

Central Park Associates CPA is conducting an audit of a U.S. manufacturing company. When reviewing the company's inventory policy and physical inventory policy, they noted the following facts: 1) Physical inventory will be conducted this year by temporary workers, at a wage cheaper for management than the "regular" workers; 2) Approvals for purchase orders with discounts are not required any longer; 3) The shop manager is no longer responsible for the physical inventory, it is now responsibility of the CFO; 4) The physical inventory will be held four days after year end.

1. What aspects of the control environment is affected by the companies decision to hire temporary workers?

2. What aspect of the control environment is affected by the company%u2019s decision to no longer require approvals for purchase order discounts?

3. What aspects of the control environment are affected by the company%u2019s decision to no longer have the shop manager in charge of inventory?

4. What aspects of the control environment is affected by the companies decision to hold the physical inventory four days after year end?

Explanation / Answer

The company's decision to hire temporary workers to conduct the physical inventory would affect the internal control of the company. As the temporary workers would only be bound by contract, their actions would solely reflect the clauses put in the contract. They may not be dedicated enough to measure the inventory level with absolute accuracy, or may not be interested in rechecking whether their measurements are correct or not. Also inventory shrinkage may occur due to theft if the entire process is not administered extensively. Some parts of the inventory maybe damaged during the process due to mishandling as the temporary workers may not have the idea about the goods and how they should be handled and stored. The company's decision to no longer require approvals for purchase order discounts would affect the quality control and price control of the company. There would be no way to check whether the goods to be procured conform to the quality standards maintained by the company. It cannot be ensured whether the purchase order discounts are really beneficial for the company and if there are other better deals available in the marrket. Also it cannot be verified whether the people involved in the deal have conflict of interests. The company's decision to no longer have the shop manager in charge of the physical inventory and put that responsibility on the CFO would affect the internal control of the company. As the CFO has many other crucial responsibilities about the company it would be an extra burden on him. The CFO's primary role is to look after the financial aspects of the company, burdening him with the role of inventory management would be inappropriate and beyond his scope of duty, and he may not even possess the skills to do it either. The CFO may have to move to differrent locations to fulfil his job responsibilities and he may not always be physically present at the location where the inventory is stored to monitor it. The role of physical inventory management can be best performed by the shop manager as he would be locally available annd can be physically present when the inventory is moved or when the content of the inventory is modified. The company's decision to hold the physical inventory four days after year end would increase the inventory management cost for the company and may also result in loss of sales if the inventory cannot be moved according to the consumer demand.

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