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ACCT 436-ALCO PRODUCTS, INC-The auditing department of Alco Products

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ACCT 436-ALCO PRODUCTS, INC-The auditing department of Alco Products

Alco Products, Inc. 01.08.01CASE STUDY NO. 01.08ALCO PRODUCTS, INC.BackgroundThe auditing department of Alco Products was contacted by the manager of accounting for themetal-stamping division who informed it that one of their plants had been experiencing inventoryshortages. The manager stated that he believed the finished goods book inventory had beenoverstated and that this condition had been discovered as a result of an analysis of materialconsumption that indicated that the finished-goods inventory level should be higher than it was.The manager informed the auditors that, at month’s end, production employees from eachproduction stage performed the inventory counts for the raw materials and work-in-processinventories and reported them to the accounting department. The finished-goods inventory wascontrolled through perpetual inventory records that were reconciled to the general ledger at the endof each quarter. Material consumption was then calculated based on beginning inventory pluspurchases or transfers-in less ending inventory and standard scrap loss currently at 10 percent(based on scrap sales remittances from the scrap dealer) of the material transferred to thefinished-goods inventory. Based on the material input and consumption, it was determined thatthere should have been more finished goods in the inventory. The auditors were asked to visit thelocation to review the inventory and proof-of-billing procedures and validate the reportedshortages and determine the causes. (See exhibit for activity recap.)Audit PlanThe auditors arrived at the location and discussed their preliminary audit plan with plantmanagement. It was agreed that, since the raw material and work-in-process inventories weretaken at different times, the auditors would observe the physical inventory count procedures forboth and would perform these counts of the finished goods later in the day. Also, the auditorswould review the prior months’ inventories. The auditors were advised that they would meet withthe production people taking the inventory. It was agreed that a review would be made of theproduction and the scrap-reporting systems subsequent to completion of the inventory work. Rawmaterial receiving procedures would be examined as well as procedures for control offinished-goods shipments.Plant ProceduresRaw MaterialsThe auditors learned that the aluminum was received in two-pound sheets, 100 sheets to a bundle,and four bundles to a pallet and was stored in the manufacturing area to facilitate access duringproduction. When received, a material-received record was prepared, pre-numbered and used forreceipt of items entering the plant. The record was sent to the accounting department where it wascompared to a copy of the purchase order and held, pending receipt of the invoice. As the materialwas introduced into the manufacturing process, a requisition was prepared and forwarded to theaccounting department.Copyright © 1996, The Institute of Internal AuditorsAlco Products, Inc. 01.08.02Work in ProcessAfter the material was requisitioned from the raw-material inventory, it was fed into machineswhere 24 finished-goods pieces were stamped out of each sheet. The skeleton (raw-material-sheetremainder) was then placed in a scrap bin; and the finished-goods pieces were packed 200 piecesto a package, a maximum of 50 packages to a pallet. A two-part load ticket was then prepared, anda copy was sent to the accounting department for updating the perpetual inventory records. Theother accompanied the load to the finished-goods warehouse.Scrap ProceduresThe skeletons were collected in a scrap bin, and the full bins were emptied into a trailer located atthe scrap dock. At his convenience, the scrap dealer came to the plant, dropped off an emptytrailer, and picked up the full one. When the scrap dealer left the plant, the gate guard recorded thescrap dealer’s bill-of-lading number. If the guard was making his hourly security inspection, thescrap dealer was responsible for recording this number. If a filled trailer was not picked up, thescrap dealer was contacted and requested to pick it up.The scrap dealer took the load to a local business that had a truck scale, weighed the truck, andrecorded the weights. The scrap dealer sent a copy of the weight ticket to the plant along with thecheck and the remittance advice for the value of the scrap. These data were used to develop thescrap loss. The accounting department received the check, compared the weight tickets to theremittance advice, and verified the value per pound to the contract.Finished GoodsWhen the material was received from the working-process area, warehouse employees verified theload-ticket count; and the pallets were stored. At the time of shipment, a pre-numbered bill oflading was prepared with copies for the accounting department, customer, shipping departmentfiles, and a gate guard who verified the load. The accounting department verified the shippinginformation on the bill of lading to the original shipping authorization and invoice to the customer,accounted for the bills of lading through a sequential numerical check-off list, and posted theperpetual inventory records from the copy of the bill of lading forwarded from the gate guard.Audit ProceduresThe auditors observed the current month’s physical inventory of raw material and work in processand verified that the counts and summarizations were accurate. They made test counts of thefinished goods and agreed on the counts in the perpetual records. They reviewed the prior month’sphysical inventories of raw materials and work in process and agreed on the tabulations in thegeneral ledger. They tested the preceding month’s receipts and issuances of raw material, verifiedthe accuracy of material reported as used in work in process, and verified the reported workin-process production by reference to load-ticket recaps and finished-goods-storage reports.Reported scrap shipments were reviewed by comparison of the gate log to remittances receivedfrom the scrap dealer, and finished goods shipments were verified by examination of thebill-of-lading check-off list for completeness and tracing to the related invoices.Copyright © 1996, The Institute of Internal AuditorsAlco Products, Inc. 01.08.03Required1. Evaluate the plant systems and procedures and identify the weaknesses.2. What is the probable source of the shortage? Please provide support for your conclusion.3. Recommend changes to the plant procedures to facilitate control.Copyright © 1996, The Institute of Internal AuditorsAlco Products, Inc. 01.08.04ExhibitInventory and Activity RecapSubjectRaw MaterialsWork in ProcessFinished GoodsBeginning70,000 Sheets30,000 Sheets2,400,000 PiecesEnding80,000 Sheets30,000 Sheets2,256,000 PiecesSubjectRaw MaterialsWork in ProcessFinished GoodsMaterial Requisitioned/Received45,000 Sheets35,000 Sheets672,000 PiecesSubjectRaw MaterialsWork in ProcessFinished GoodsProduction and Shipping35,000 Sheets672,000 Pieces816,000 PiecesCopyright © 1996, The Institute of Internal Auditors

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