LYLS Company is a wholesaler of electric lighting fixtures and ceiling fans. The company has two branches,
Question:
LYLS Company is a wholesaler of electric lighting fixtures and ceiling fans. The company has two branches, one in Kansas City and the other recently opened in Wichita. The internal audit senior remained in Kansas City to conduct the audit at the main store; A personnel internal auditor has been appointed to the Wichita store.
The staff supervisor returned to Kansas City a week later and said everything was fine at the Wichita store. April.
The senior reviewed the personnel auditor's working papers and noticed that the Wichita store had set aside an end-of-year adjustment of over $100,000 - one debit for sales and one credit for receivables. The description is "To set general ledger accounts receivable to accounts receivable subledger". The senior asked the personnel supervisor how such a big mistake could happen. He said that the Wichita store manager told him there were some problems setting up the accounting system in the new store.
Initially, the senior auditor felt that the adjustment was appropriate as the G/L balance is now in line with the subledger. Soon, however, he was reviewing the analytical procedures performed by the personnel supervisor and noticed that the percentage of gross profit at the Wichita store was significantly lower than the gross profit at the main store in Kansas City. The personnel auditor's working papers included the following statement: "According to the store manager, prices at the Wichita store were lowered to attract customers to the new location."
The next day, the senior supervisor was talking to the controller at the main store and mentioned that there seemed to be a few issues at the Wichita store that seemed to have been resolved. “I think the price cuts you made earlier in the year really worked to attract new customers,” he said. "Price cuts?" said the controller. “What price cuts?” The company is a wholesale distributor—it does not have sales that can be found in retail stores.
The senior auditor questioned the auditor about the problems the company encountered while setting up the accounts receivable system at its Wichita store. The supervisor said the staff supervisor must have misunderstood as no issues have been reported by the Wichita store manager so far.
The senior realized that something was wrong and discussed the matter with the audit manager and the chief audit executive. The audit manager then discussed the auditors' concerns with the controller and company owner. It was agreed that the situation should be investigated further. Accordingly, the auditors expanded their fieldwork by tracking customer payments to the Wichita store back and forth between the sub-ledger and the general ledger.
Their extended work uncovered the fact that the Wichita store manager stole payments made to customers' accounts. Therefore, the sub-ledger was not in balance with the general ledger. The manager debited the sales account to cover up the theft, so the gross margins of the two stores were not the same.
Required:
A. What created the Wichita store manager's opportunity to commit fraud?
B. What "traces" of evidence caused auditors to suspect that a fraud might have occurred?
C. The staff auditor initially did not give due consideration to the obvious warning signs of fraud. What are some of the more likely reasons he missed red flags or didn't follow up enough?
Intermediate Accounting
ISBN: 978-0077400163
6th edition
Authors: J. David Spiceland, James Sepe, Mark Nelson