Question

It is very important for all businesses to take proper precautions to safeguard their assets; this includes both cash and inventory. In order to do this, the business must establish internal controls that will effectively reduce or eliminate theft and loss.

Prepare a professional business memorandum directed to the Chief Financial Officer (CFO) of either an actual company that sells inventory to the public, or choose a hypothetical company. Assume that you are writing to the CFO as the external auditor who has just conducted an audit.

In the first paragraph, identify the company by name and explain what type of inventory is sold in this business. (5 points)

In the following paragraphs, identify three (3) internal controls that can be established to protect inventory. These paragraphs must include identification of the internal control method to be used as well as the rationale for why this method is suggested. Be sure to address how the internal control methods should be implemented and how these three methods will safeguard inventory. (15 points)

The memorandum should be formatted properly and written in a professional manner. It must be at least one page in length but no more than two pages. References must be cited if you use any external sources to support your suggestions in the memorandum. Points will be awarded for proper business memorandum format, spelling, grammar, punctuation and sentence structure. (5 points)

Answer 1

TO: John Brooks, CFO, Radon Wiring Solutions Inc.

FROM: Janice Shields, Partner (Shields-Smith LLP)

DATE: 06/19/2018           

SUBJECT: Internal controls relating to inventory

The audit of Radon Wiring Solutions Inc. has recently been conducted by us and one of the primary areas of concern identified was the inventory management system and the related controls. The company is engaged in the manufacturing of wire harnesses for automobiles and hence, the inventory consists of multiple components that are required for the manufacturing of the products which primarily include small plastic and metal parts and wires. Several of the said small components are high-value items. The wire spools also form a major part of the inventory.

One of the observations made by our team was that there is no demarcated area for the storage of the inventory. Several inventory items were found at various places on the shop floor for which no issue had been booked and which were a part of the inventory as per the books of accounts. This may result in theft and pilferage of inventory as the control over that same is difficult to maintain. We suggest the company to designate specific areas in the factory building for the storage of inventory. And the movement in or out of the same has to be recorded by that store manager which will result in improved control over the inventory.

Multiple discrepancies were observed by us in the physical stock take conducted by us. Several of these were observed in the high-value items which were considerably smaller in size. It was also observed that some of the stock lying with the company is non-moving and is related to some of the discontinued product lines. We have been told by the employees that the company had a process of conducting a stock take at the end of every quarter; however the same has not been complied with during the past year. The difference is the physical stock and the actual stock noted has been documented and inventories write off had been booked in the books of accounts. In our opinion, the same can be avoided by actually undertaking the period stock take. It will also help in identifying and potential pilferage or theft threats. The inventories write off also results in lower profitability which can also be avoided. We suggest assignment of the duty to a manager who in turn can ensure that the physical stock take had been conducted at the pre-decided intervals. The company should also identify the non-moving stock and either use it in some of the existing products if that is possible or sell it off in the market. This will help in reducing the costs incurred to maintain this stock and also free up some cash flow for the company.

Another prominent issue that came up during the course of our audit was the lack of quality check for goods when the same is brought into the factory. Currently, there seems to be no process for the quality check of the inventory delivered. This results in increased number of rejections in the production process, causing unnecessary delays in the delivery of the finished products to the customers. These will also result in unnecessary costs, as the faulty items identified at the time of the production process cannot be returned to the supplier and have to be scrapped most of the times. The hiring of quality managers and setting a process to assess the quality of goods supplied immediately after the delivery and then returning or replacing the faulty/ rejected items will help in saving costs as well as improving the overall quality of output.

Attachment: List of the non-moving items and the details of the write off of inventory