Question

Question 4 Strata Imports Limited (Strata) imports specialty metals from around the world. Strata is 100% owned by Phillip Mak, who is also the Chief Executive Officer and Chairman of the Board of Directors. Colin Danforth is the Chief Financial Officer and also a Director and Chair of the Audit Committee of the Board of Directors. He has worked for Strata for thirty years and is soon to retire. The Controller, Karen Singh, is expected to succeed him as CFO. There are nine other members of the Board of Directors. All are business associates of Phillip Mak or are retired politicians. Two of the politicians are also lawyers. Over the years, as the company grew, Colin wrote extensive policy and procedures manuals. Due to the risk of loss on foreign exchange, Colin approves all orders over $CAD 100,000. His approval is based on an economic analysis and a forecast of currency trading. Lately, Karen has been working with Colin to learn how to perform the analysis. Sales average $50,000,00 per year but are highly variable due to commodity prices and specialized demand. In addition to Karen, there is an Accounting Manager, three accounts payable clerks, two accounts receivable clerks, two inventory clerks, a payroll clerk, a general accountant, and a financial analyst, None are professional accountants, but all have been with Strata for at least ten years. Among the procedures are vacation procedures. It states that when a member of the team goes on vacation, then their duties are fulfilled by someone at the same level or above. Any conflicting duties are also bumped for the period of time to the next person above. For example, the Accounting Manager normally does the bank reconciliation, and his work is reviewed by Karen. If he goes on vacation during the first week after the month-end, then the bank reconciliation will be done by Karen and reviewed by the CFO. In thirty years, the auditors have had few or no recommendations to improve internal controls. Required It is the beginning of a new audit season. As the external auditor for Strata, evaluate the general and environmental controls.

Answer 1

Solution

THE CONTROL ENVIRONMENT

The control environment sets the tone of an organization, influencing the control consciousness of its people. It is the foundation for all other components of internal control, providing discipline and structure.

ESSENTIAL ELEMENTS OF THE CONTROL ENVIRONMENT ARE:

1. BOARD OF DIRECTORS

· Main power center of the corporation

· Primary function to represent shareholders

· Legal power to govern the corporation

2. ORGANIZATIONAL STRUCTURE

· Defines areas of responsibility, limits of managerial authority, and lines of reporting. Defines who is expected to do what. Defines what decisions the managers can make, what responsibility people have, who they report to, who reports to them.

· Provides the framework within which all the organization’s activities are planned, executed, monitored and controlled.

· Organizational chart and job descriptions

· Span of control

· Ways to organize a company: by geographic location, by functional activity, by industry or product line, by project, by distribution or marketing network

3. MANAGEMENT ATTITUDES, PHILOSOPHY, AND OPERATING STYLE

· Determine to large extent the internal control system

· Focus on business and personal ethics

· Approach to business risk (risk averse, risk loving, risk neutral)

· Behavior toward other managers or subordinates

· Expectations of work quality or performance

· Attitude toward accounting functions—accounting principle choices

· Concern for internal control

4. MANAGEMENT CONTROL MECHANISMS

· Use of budgets and standards

· Formal written statement of management’s goals and objectives expressed in dollars and cents.

· Provides set of targets for the entire organization, prepared for 12 month periods.

· Responsibility accounting: balance between management authority and responsibility.

· Controllable revenues, expenses, assets

· Weakness of short term financial control targets vs long term

5. PERSONNEL POLICIES AND PRACTICES

· Building a reliable work force

· Policies should address and document: hiring practices, training, evaluation (fair, periodic, copies of written evaluations to employees), promotion policy (hire from outside or from within)

· Compensation and recognition practices

· Necessary resources provided to employees

· Corporate code of conduct: behavior toward customers, vendors, other employees, nepotism (marriage to another employee), political contributions, outside activities of employees, confidentiality, personal appearance, conduct in the workplace, controlled substance abuse, safety regulations

6. AUDIT COMMITTEE

· The audit function is made up of three components: the audit committee, the internal auditor, the external auditor.

· The audit committee is responsible for:

· Making recommendations to the board regarding selection of external auditor.

· Reviewing significant financial information

· Seeing that effective internal control structure is maintained (Foreign Corrupt Practices Act 1977, SOX 2002)

· Conducting investigations concerning potential fraud or irregularities of management.

· Communications link between internal, external auditors, and the board.

7. INTERNAL AUDIT