ACCT 461
Writing Assignment 2
Spring 2020
ABC Retailers — Internal Controls
Introduction
This case gives students an opportunity to (1) understand the process of evaluating identified
control deficiencies; (2) understand the annual disclosure requirements for management’s report
on internal control over financial reporting (ICFR); and (3) determine the effect of identified
control deficiencies on other controls. Students are required to read the case and address the five
questions listed on the last page.
Background
ABC Retailers Inc. (ABC or the “Company”) is a U.S. public company that files quarterly and
annual reports with the Securities and Exchange Commission (SEC). ABC is a leading retail
chain operating more than 100 department stores across the continental United States. ABC
department stores offer customers a variety of nationally advertised products, including clothing,
shoes, jewelry, and other accessories. The Company’s supply chain of products is managed
through a single warehouse and distribution facility located in Kansas City, Missouri.
ABC has a centralized accounting and finance structure at its corporate headquarters, where all
processes and controls related to all substantive account balances occur, including controls
related to accounts payable and the Vendor Master File. ABC recognizes revenues from retail
sales at the point of sale to its customers. Discounts provided to customers by the Company at
the point of sale, including discounts provided in connection with loyalty cards, are recognized
as a reduction in sales as the products are sold. Cost of goods sold for the Company primarily
consist of inbound freight and costs relating to purchasing and receiving, inspection,
depreciation, warehousing, internal transfer, and other costs of distribution.
Facts
Audit Issue
On June 1, 2018, the Accounts Payable (AP) Manager received an e-mail inquiry about the
process required for a vendor to change its bank account information. The e-mail was sent from
John Smith at a domain address listed as “Watch-Makers.” Watch Makers is a manufacturer that
supplies ABC-branded watches to ABC’s west region department stores. In addition, John Smith
is the primary contact at Watch Makers with whom the Company typically interacts.
The AP Manager responded to the e-mail request on June 15, 2018, with the procedures required
of the vendor, which include completing a vendor bank account request form. On June 20, 2018,
the AP Manager received a reply e-mail from John Smith at “Watch-Makers” with a completed
vendor bank account request form, which included John Smith’s signature, new bank account
information, and other related information.
Upon receiving the vendor bank account request form, the AP Manager completed a separately
required Vendor Change Form for internal processing. The Vendor Change Form is completed
for new vendors or changes to existing vendors’ information, including bank account
information. The AP Manager sent the completed Vendor Change Form to ABC’s Assistant
Controller, who reviewed and approved the request on June 24, 2018. The bank account
information was updated within the Vendor Master File on June 26, 2018.
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ACCT 461
Writing Assignment 2
Spring 2020
Throughout the month of July, valid Watch Makers invoices were processed through the
Company’s accounts payable process, and the valid invoices were paid in accordance with the
Company’s processes for cash disbursements and wire transfers. However, because the bank
account information for Watch Makers was changed (as a result of the June 1, 2018, e-mail
request) approximately $2 million in payments was wired to an incorrect bank account. On
August 2, 2018, the Company received an inquiry from Watch Makers about the expected timing
of the $2 million in outstanding invoices. As a result of the direct interaction with Watch
Makers’ employee John Smith, the Company determined that the previous vendor bank account
change form was received from a fraudulent domain name with the intent to defraud the
Company. The e-mail domain for Watch Makers is “Watch Makers,” with no hyphen, rather than
“Watch-Makers,” with a hyphen. Both e-mails received from “Watch-Makers” were determined
to be from a fraudulent source (that also fraudulently used John Smith’s name in the e-mail).
As noted above, there are two employees within the Company that were involved in processing
and approving the Vendor Change Form.
The Company’s policy on bank account change requests was communicated by ABC’s Assistant
Controller in an August 2017 e-mail that indicated that for each Vendor Change Form requesting
a vendor bank account change, the accounts payable department was required to (1) obtain a
previously processed and paid invoice from the vendor requesting the bank account change, (2)
call the vendor using the contact information obtained from the prior invoice, (3) verify the
authenticity of the requested bank account change request by directly contacting the vendor, and
(4) include all relevant information obtained in steps (1) through (3) as an attachment to the
Vendor Change Form. The Company’s control description relating to the review of a Vendor
Change Form by the Assistant Controller is not explicit regarding the specific attributes of the
review. However, because the policy was distributed by the Assistant Controller and the
Assistant Controller is also the control owner (e.g., performs the review), there is a presumption
that the Assistant Controller would understand that as part of her review, she should evaluate
whether the AP Manager obtained sufficient information to confirm the authenticity of the bank
account change request.
Other Relevant Facts
• Materiality — $8 million.
• The Company processed approximately 105 vendor requested bank account changes during
2016 before the realization that the request from “Watch-Makers” was fraudulent (from
September 25, 2017, to August 2, 2018). After the identification of the misappropriation of
assets, the Company’s internal audit department obtained and reviewed all 105 Vendor Change
Forms reviewed by the Assistant Controller, noting that only five Vendor Change Forms
contained the information required by the policy. In addition, internal audit determined that the
primary review procedure performed by the Assistant Controller related to the verification that
the bank account number was appropriately included on the Vendor Change Form. This
procedure was performed in all cases before the bank account information was input into the
accounts payable system.
• The total wire transfer payments made to the 105 vendors that requested bank account changes
in FY16 totaled approximately $56.2 million (based on an analysis prepared by Internal Audit of
the invoices processed and paid by the Company after the processing of a Vendor Change Form
for the 105 vendors).
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ACCT 461
Writing Assignment 2
Spring 2020
There are more than 30 vendors with annual purchase activity of over $20 million (12 of which
have purchase activity of over $40 million); thus, the amount of payments made to any single
vendor in a payables cycle could approximate $2 million, assuming a cycle of 30 days.
• The Company’s Chief Security Officer completed an internal investigation and concluded that
there was no indication that the AP Manager and Assistant Controller were involved in the
scheme that resulted in the $2 million misappropriation.
• After the determination on August 2, 2018, that the Vendor Change Form was from a
fraudulent source, the Company ceased processing additional Vendor Change Forms until it
could understand the root cause of the deficiency. On September 10, 2018, the Assistant
Controller sent a reminder regarding the importance of following the vendor bank account
request change policy. The e-mail also highlighted an enhancement to the process, which
primarily included an enhancement to the Vendor Change Form. The form was revised to
include the following three new, explicit sections that are required to be completed: (1) contact
phone number pulled from previously processed and paid vendor invoice, (2) name of individual
at the vendor (from a previous invoice) that was contacted, and (3) date discussed/contacted. The
policy e-mail reiterated the requirement to include a copy of the previously processed vendor
invoice with the Vendor Change Form.
• Internal Audit performed a thorough evaluation of the competency of the Assistant Controller
and concluded that notwithstanding the Assistant Controller’s lack of historical performance, the
Assistant Controller was suitably competent to perform the control.
Engagement Team Note
In planning the 2018 audit, the engagement team obtained an understanding of the internal
controls related to cash disbursements. This understanding was developed through the
engagement team’s walkthrough of the cash disbursements process. As part of its walkthrough
procedures, the engagement team made inquiries of appropriate personnel, inspected relevant
documentation, and in certain cases, observed the control performers carrying out required
control procedures. As a result, the engagement team concluded that there were no significant
changes to the cash disbursements process in the current year.
The engagement team identified four risks of material misstatement relating to the cash
disbursements process. For each risk identified, the team documented the control activity that
addresses the risk of material misstatement in the excerpted worksheet (see Appendix 1). As a
result of the ‘Audit Issue’ described above, the engagement team identified a control
deficiency in the following control:
CD5C — The accounts payable department is required to complete the following for each
Vendor Change Form requesting a bank account change:
1. Obtain a previously processed and paid invoice from the vendor requesting the bank account
change.
2. Call the vendor using the contact information from the obtained invoice.
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ACCT 461
Writing Assignment 2
Spring 2020
3. Verify the authenticity of the requested bank account change request.
4. Attach all relevant information obtained in steps (1) through (3) to the Vendor Change Form
for review and approval.
The Company’s control description regarding the Assistant Controller’s review of the Vendor
Change Form is not prescriptive regarding the specific attributes of the review. However, there is
a presumption that the Assistant Controller would understand the primary objective of the
control, which is to evaluate whether sufficient information was obtained by the AP Manager to
confirm that the bank account change request was authentic.
Required:
1. According to PCAOB Auditing Standard (AS 2201)
(https://pcaobus.org/Standards/Auditing/Pages/AS2201.aspx), what factors should auditors
consider when evaluating the severity of a deficiency in a control that directly addresses a risk of
material misstatement?
2. PCAOB AS 2201 distinguishes the difference between a deficiency in design and a deficiency
in operation. Does the Assistant Controller’s failure to adequately review the Vendor Change
Form represent a deficiency in the design or operating effectiveness of the control?
3. Based on guidance in AS 2201, determine if the failure in the vendor request change form
control indicative of a material weakness in internal control over financial reporting.
4. SEC Regulation S-K requires that management provide a report on a registrant’s ICFR in the
company’s Form 10-K. Assuming the company and the auditor concluded that this internal
control failure indicates a material weakness in internal control, what information would the
company be expected to disclose?
5. In light of the identified deficiency, auditors should consider a possibility that the deficiency
may have an impact on other controls, and/or the similar problem may exist in other controls.
What implications does the failure to adequately review the Vendor Change Form have on other
controls?
The list above does not present a complete list of issues related to the topic. You may
additionally discuss other issues relevant to the audit process of internal control in your paper.
Due Date
A hardcopy is due in class on Wednesday, March 25th. You also need to submit an electronic
version to SafeAssign by the due date.
NOTE: This assignment will undergo a draft/feedback/revision process. A writing grader and I
will provide feedback on the first submission of the writing project, and you will revise your
writing project in response to that feedback before submitting the final version toward the end of
the semester. YOU MUST SUBMIT A COMPLETE FIRST DRART. Points you lose for not
addressing a significant portion of the required questions and not meeting the world-count
requirement will not be recoverable even if the final version meet all those requirements.
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ACCT 461
Writing Assignment 2
Spring 2020
Format
Length of the paper: minimum 2000 words (no more than 2500) (on double-spaced
pages) PLUS a list of references (make sure you follow an appropriate introduction,
conclusion and reference format).
Follow APA formatting guidelines: The guidelines are described at
https://owl.english.purdue.edu/owl/resource/560/01/
Margins: 1” (Left justification ONLY).
Font: Times New Roman, 12 point.
Headings and Subheadings: Use them as appropriate.
Do not forget Page Numbers.
References
You must provide proper citations for all references used to avoid plagiarism. Any direct quotes
must be indicated as such. You must include at least FOUR unique references (Note: PCAOB
Auditing Standards are counted as one reference even if you cite different sections of the
standards). Wikipedia.com, random blogs, and class lecture notes do NOT count as
references! Include references in your paper using the author/year (e.g. Smith 2015)
parenthetical citation method with the full citation listed in the reference section (i.e., do not use
footnotes to list your references). In additional to AICPA/PCAOB Auditing Standards, a wealth
of excellent resources exists at your disposal. I encourage you to use popular and business press
articles (New York Times, Wall Street Journal, Financial Times, Business Week, The
Economist, etc.) practitioner journals (Journal of Accountancy, CPA Journal, Accounting Today,
etc.) and academic journals (The Accounting Review, Accounting Horizons, Auditing, etc.) to
inform your research. You have access to these and many more through George Mason
University’s Library website.
Grading
You will be graded on content, grammar, and compliance with instructions. Your paper should
be professional in tone and free from grammatical errors.
Writing:
Content:
Submission Total:
20 points
20 points
40 points
Other Instructions/Suggestions
Write a clear, concise Introduction: Your introduction should summarize your arguments
and conclusion.
Show your analytical skills. This assignment is not about how well you summarize what
you read.
Do not use lists, bullet points, contractions or the second person (e.g., “you”) in your
writing.
Be clear and direct! Professional writing must be as unambiguous as possible.
Paragraphs need at least three sentences.
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ACCT 461
Writing Assignment 2
Spring 2020
You may only use up to three (3) SHORT direct quotes, which should be properly
anchored in your paper (i.e., quotes should not disrupt the flow of your essay).
Use passive voice sparingly.
Remember, you must submit a paper that is unique to this class. If you have written about this
topic in a prior class, you must either write a completely new paper or ask me for a new topic.
Students who want additional help with their writing should visit one of the writing center
locations on campus. Visit http://writingcenter.gmu.edu for more information.
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ACCT 461
Writing Assignment 2
Spring 2020
Appendix 1
Control Deficiency Evaluation
Identified Risks of Material Misstatement
Cash Disbursement 1
Incorrect vendor set.
Cash Disbursement 2
Invoice is received for goods or services never received; therefore, a
liability and expense are recorded when ABC has no obligation.
Cash Disbursement 3
Payments are not appropriately authorized and accurate.
Controls in Cash Disbursement Process
CD1C
Bank statements are reconciled to the general ledger regularly and
differences are investigated and resolved on a timely basis.
CD2C
Cash disbursements are generated through the ERP system. The ERP
system automatically records the journal entry for cash disbursements
to the accounts payable and cash sub-ledgers.
CD3C
All manually generated checks, including supporting documentation
and the related journal entry, are reviewed and approved by
management before the journal entry is recorded.
CD4C
Finance personnel record bank account activity to the general ledger
on a daily basis; management reviews recorded entries and cash
position regularly for unusual activity and investigates and resolves
issues on a timely basis.
Each Vendor Change Form requesting a bank account change, the
accounts payable department is required to complete the following
for each Vendor Change Form requesting a bank account change:
1. Obtain a previously processed and paid invoice from the vendor
requesting the bank account change
2. Call the vendor using the contact information from the obtained
invoice
3. Verify the authenticity of the requested bank account change
request
Attach all relevant information obtained in steps (1) – (3) to the
Vendor Change Form for review and approval.
At month-end, corporate accounting performs variance analysis for
all financial statement line items as compared to prior month and
prior year to identify variances in excess of $5 million or 10 percent
period to period. All variances in excess of this threshold are to be
explained.
CD5C
FR1C
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