Date: November 10, 2010
To: Alchemy Corp. (Aren’t we addressing this memo to our parent co., Alchem Corp.?) From: External Audit Team
Subject: Internal Control Weakness and related fraud risk
After much research and time spent on understanding the inner working of Alchemy Inc., we have found some internal control weaknesses that could lead to potential fraud. Our audit procedures are designed to address internal control weaknesses and subsequent fraud risks in the most efficient and cost effective manner. We hope with our recommendation that Alchemy inc. will be able to minimize the risk of financial misstatement. We believe these concepts will have many positive impacts on the firm’s long-term profitability and efficiency.
The audit committee is not directly checking the financial statements for irregularities. The eighth tenant of the Audit Committee Policy reads that the audit committee must review financial statements for unusual transactions. Currently, the CEO, Chris Reddy, is performing financial statement evaluations without the oversight of the audit committee. The aforementioned control weakness lends itself to possible fraud risk. The CEO is under pressure to perform on behalf of the shareholders, and Mr. Reddy’s oversight of the financial statements creates an opportunity to misrepresent the performance of Alchemy Inc. Our recommendation is that the Internal Audit department sends the financial statements directly to the Audit Committee for review. The recommendation can be implemented at no additional cost to Alchemy Inc.
The Internal Audit department lacks the needed oversight and monitoring of Alchemy Inc. due to their limited scope and experience. The Audit Committee Policy indicates that the Internal Audit department should report to the Audit Committee. Furthermore, the Audit Committee is required to determine compensation and monitor the internal audit plan. Currently, the Internal Audit team reports and are managed by the CEO. Another major weakness in the Internal Audit department is their experience level. Most of the Internal Auditors are recent college graduates with no prior experience. The head Internal Auditor received his CPA certificate from online within two days. Therefore, they do not possess the necessary experience or freedom to monitor the company.
The internal audit department reports directly to the CEO, which in turn creates a major conflict of interest. The lack of experience by the Internal Audit team doesn’t help the cause. If they had more experience they would know that they are not supposed to report to the CEO. The Internal Audit team cannot perform their duties without the approval of the CEO. This would create an opportunity for the CEO to conceal any fraud or misstatement. For instance, if the CEO was committing any fraud, he could easily direct the Internal Audit team to another task so that the fraud will not be uncovered.
The Internal Audit department should report and be managed by the Audit Committee as stated in the Audit Committee Policy. This would give the Internal Auditors the freedom to investigate and monitor over the company as needed. They should also consider hiring more experienced Auditors or making sure that they give the current Auditors proper training. Improper safeguarding of assets increases the risk of misappropriation of spheres and theft by employees. Upon review of Appendix A, the audit team observed that the Pleasantville factory’s entrance gates do not have locks, this not only raises the risk of misappropriation internally, but theft by external parties as well. After reviewing the interview with the shipping clerk and the machine operator, we realized that the final sphere products are shipped out in Ziploc bags, raising the possibility of damaging the products and creating losses for the company. The stored spheres are contained in open bins while still in the factory, thus...