Question

Pioneer is caught up in the country's biggest accounting scandal since 2015. In July 2019, Pioneer Corp president and his two predecessors quit after investigators found that the company inflated earnings by at least $1.2 billion during the period 2012-2017. Pioneer is one of the early adopters of the corporate governance reforms initiated in Canada. The corporate governance structure met corporate governance standards. Time and again cases of corporate governance failures have provided evidence that good corporate governance structure does not necessarily lead to good corporate governance. Organizational culture is a critical determinant of the quality of corporate governance.

Some of the observations of the independent investigation committee of the company on internal audit demand discussion and debate.

The investigation committee observes, "According to the division of duties rules of Pioneer, the corporate audit division is in charge of auditing the corporate divisions, the companies, branch companies, and affiliated companies. However, in reality, the corporate audit division mainly provided consultation services for the 'management' being carried out at each of the companies, etc. (as part of the business operations audit), and it rarely conducted any services from the perspective of an accounting audit into whether or not an accounting treatment was appropriate."

The observations of the committee give the impression that the fault of the internal audit in Pioneer was that it focused on consultation service rather than assurance service. Should internal audits avoid providing consultation services? I do not think so. It was not the fault of the internal audit that it provided consultation service. The fault was that it did not pay attention to the accounting audit.

In Pioneer, the top management used to set targets that are unachievable. There was excessive pressure from the top management to achieve those targets.

The variable pay is a significant portion of the total pay. The compensation of executive officers comprises a base compensation based on title and a role compensation based on work content. 40 percent to 45 percent of the role compensation is based on the performance of the overall company or business department. 'Challenge' to achieve unachievable targets and performance-based pay provides enough motivation to manage earnings. Therefore, an accounting audit should have been a focus area for internal audits.

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Internal audit can function independently only if the audit committee is capable, independent, and effective, and the internal auditor reports to the audit committee.

Earnings management had the tacit approval of the top management. Therefore, it is not surprising that an accounting audit was excluded from the scope of the internal audit. It is incorrect to infer that the accounting audit did not receive the attention of the internal audit because its focus was on providing consultation service.

Pioneer has a written code of conduct that requires all employees to understand and follow. Based on this mandate it has never had any ethical conflicts reported and therefore does not have a formal mechanism for top management or the BOD to receive confidential information from employees lower in the organizational hierarchy. Also, all Pioneer’s staff are required to complete a certain amount of continuing education credits every year. From what you can see, they seem to be well trained at their tasks, or at least they stay very busy. Furthermore, the Board of Directors and Audit Committee consist of several ​individuals who take their jobs very seriously. Members of its audit Committee consist of a doctor, an engineer, and a pharmacist. Moreover, management stresses an ethical environment. In their weekly meetings, each team reports its operating results and the different teams quiz each other and respond with solutions and challenges. In the weekly meetings, management encourages the teams to act ethically while achieving their mandatory year-over-year, 40% revenue growth numbers. Due to high industry growth, Pioneer has enhanced its market share largely by significant mergers and acquisitions. To keep up with its growth, Pioneer is constantly upgrading its internal control system. Fortunately, the well-trained staff has been able to continue testing the new programs after they are put in place and change programming problems as they crop up. The human resource department does not have formal procedures for recruitment, training, and termination.

In assessing the internal controls for the company, the auditor finds that the company bills customers and receives payments at three offices in three separate states using three different and incompatible software systems for tracking payments. Pioneer’s terms of sale vary with the customer and vary from thirty days to ninety days. Open invoices are aged based on when they were booked to the receivables, but cash, chargebacks, or rebates are aged based on when they were applied to the account. Thus, a credit could be posted to the customer’s account when it was received, but the related invoice(s) remains open as a receivable and continues to age. Chargebacks are significant and linked to a batch of the product rather than an invoice. Most similar companies have credit limits or credit checks but Pioneer does not because all wholesalers are board-certified M.D.’s, like the company’s founder.

● Pioneer’s total accounts receivable was $35,276,025.

● Pioneer’s total accounts receivable part due over sixty-one days $19,434,500.

● Pioneer’s top-five wholesalers had accounts receivable of $16,457,516.

● Pioneer’s top-five wholesale customers had $8,428,850 past due over sixty-one days.

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● Pioneer’s allowance for doubtful accounts of $766,000 did not include any estimates for the top-five wholesale customers, because it was management’s belief at the time was that the top-five wholesalers did not present a collection risk.

During the audit, the auditor noticed that only 20% of the confirmations of receivables were returned. Also, the general ledger of many accounts lacked documentary evidence, and the fixed assets depreciation ledger was not reconciled with the general ledger. The internal control report showed a number of internal control compliance problems.

In his audit work papers, the auditor included the following:

● “I inspected the entity’s reports of prenumbered shipping documents that have not been recorded in the sales journal”

● “In the course of my testing, I have found 0 items that have been sold but have not recorded in the sales journal.”

● “Since testing was performed without exception, I have determined that the controls to address the completeness of sales transactions are operating effectively.”

Required:

Answer the following questions:

1. What “red flags” do you see in the above description of Pioneer’s control environment?

2. What are the most important assertions for Pioneer?

3. Which essential elements of documentation requirements did the auditor omit from his

documentation?

4. What recommendations can be given to Pioneer to improve its internal control?

Answer 1

The biggest red flag for the Pioneers Control environment is that there is no good control itself starting from Human Resource, Accounting , Collection and even Performance when there is no control for any of the process or department then it is very difficult for the company to operate effectively.

Departmentwise the redflag are given below:-

1. Human Resource : The basic thing to run any company is to hire right people for the rigt job hence the role of Human Resource Department plays a very important role in the growth of the company. Now in the Pioneers Control Environment there is no formal process of recruitment, training or even terminationir it means whoever the management feels is good enough can be hired and if they are not performing well they would be fired

2.Sales Targets : Targets should be based on the projection of the companies sales and that would depend on the demand of the companies product in the market and then accordingly the sales target for the employees should be given but here the target given are unachievable which is pressuring the employees as a result either the employees would be demoralised and resign from th company or then they would take up unethical ways to show their target achievement which might hamper the companies sales revenue as well as companies reputation and growth

3. Companies Accounting Policies : Companies Accounting policies are not standardised , all locations follow different mehodology of accounting due to which at any given point of time we cannot say the companies accounts are accurate

4.Receivables and Payables needs to be reviewed on regular basis so that accordingly the reserves can be created and written off

5. The company should appoint a internal audit department who are qualified to check the internal controls of the system like a CPA or ACA

6.Consultation Service and Assurance Service should be a different department and different people should be handling it , As assurance can be given only by the independent person

Answer 2. The assertions of the Pioneer Company are :-

a. The Board of Directors and Audit Comittee know their job and do the same seriously

b.Meetings are held to discuss the revenue members and the management encourage the employees by doing emplyee engagement activity

c. Though not having a formal recrutiment process the company has a well formal trained staff

d Management believes in ethical environment to work for themselves as well as employees

e. Company is expanding becasue ofs significant  mergers and acquisitons which shows growth in company

Ans3.

a.The auditor very importantly missed on reporting that a standardised accounting process is not being followed by all he branches of the company and the impact of the same to the financials of the company

b. Auditor also did not verify all the Receivable and their aging specially their top 5 wholesale customers

c. Depreciation amount matches with the general ledger amount was also omited by the auditor

d. Internal controls of sales right from the sale to the receivable of the amount was not verified by the auditor to understand whether it is working effectively or no

Ans5.

After going through all the reports we would recommend that

a. The Company needs to have a standardised process across for all the departments all the branches and subsidiaries

b. The internal controls systems need to be placed and documented for all the departments and process so that all the departments and process function properly and effectively

c. Human Resource team needs to ensure they have a proper system in place to hire , train and terminate people so that they can know the performance of the person as well the cost allocation , department allocation , recruitment cost, training cost all can be known and accordingly allocated to th departments so that it would be known if the departments are achieveing the target or no

d. The process of employee goals should be targeted but then the target should be something which is achievable so that the employee too will work towards it and for the same proper study of market demand, market growth , company sales , employee capabilities should be done

e. Last a proper qualified person should be appointed preferably CPA or ACA to check the financial controls of the company so that if there are any flaws then the same can be highligted by them and corrective action can be taken and he shoule be independent and not relating to the Trustees or management so that his opinions are fair and independent