The following scenario describes PPC, a small plastics producer with $250 million in revenue and approximately 300 employees. PPC is a public company that first became listed three years ago. It has been hit hard by the recent recession, and its sales have dropped from $1,375 million to $1,250 million. It is barely profitable and is just meeting some of its most important debt covenants.
During the past year, John Slade, CEO and owner of 22% of the company's shares, has taken the following actions (listed as A. through I. below) to reduce costs. For each action, complete the following.
a. Would the action be considered an operational issue and not a control deficiency, or would it likely constitute a material weakness or significant deficiency in internal control? Provide brief rationale for your assessment. If additional information is needed in order to assess whether the item is a control deficiency, briefly indicate what information would be required.
b. Considering all of the indicated actions (A. through I. below), how has the risk related to the objective of reliable financial reporting changed during the year? A. Laid off approximately 75 factory workers and streamlined receiving and shipping to be more efficient.
B. Cut hourly wages by $3 per hour.
C. Reduced the size of the board by eliminating three of the four independent directors and changed the compensation of remaining board members to 100% stock options to save cash outflow. The company granted options to the remaining six directors with a market value of $100,000 per director, but no cash outlay.
D. Eliminated the internal audit department at a savings of $450,000. The process owners (e.g., those responsible for accounts payable) are now required to objectively evaluate the quality of controls over their own areas and thus to serve as a basis for management's report on the effectiveness of internal control.
E. Changed from a Big 4 audit firm to a regional audit firm, resulting in an additional audit savings of $300,000. This is the first public company audit for the new firm.
F. Because internal audit no longer exists, the CEO relies on monitoring as the major form of control assessment. Most of the monitoring consists of comparing budget with actual results. Management argues this is very effective because the CEO is very much involved in operations and would know if there is a reporting problem.
G. Set tight performance goals for managers and promised a bonus of 20% of their salary if they meet the performance objectives. The performance objectives relate to increased profitability and meeting existing volumes.
H. The purchasing department has been challenged to move away from single-supplier contracts to identify suppliers that can significantly reduce the cost of products purchased.
I. Put a freeze on all hiring, in spite of the fact that the accounting department has lost its assistant controller. This has required a great deal of extra overtime for most accounting personnel, who are quite stressed.

  • CreatedSeptember 22, 2014
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