ISSUES IN ACCOUNTING EDUCATION

Vol. 26, No. 2

2011
pp. 361376

American Accounting Association

DOI: 10.2308/iace-10021

Relating Operational and Financial Factors

to Assess Risk and Identify Fraud in an
Operational Setting
Richard H. Gifford and Harry Howe
ABSTRACT: The current literature and Statement on Auditing Standards (SAS) 99
emphasize the importance of relating operational factors to financial factors when
evaluating the risk of fraud. The following case is based on an actual company and
demonstrates how an understanding of the relationship between operational factors and
financial reporting can aid an auditor in assessing risk and identifying fraud. The case
also gives students an opportunity to directly evaluate internal control in an operational
setting. The case is intended to strengthen students critical thinking and analytical skills
and to give them exposure to the importance of internal controls in an operational setting.

INTRODUCTION

ou are a member of Wilcox Internationals internal audit department. You are performing
an operational audit of one of the companys assembly plants located in Knoxville,
Tennessee. The objective of the audit is to determine the plants ability to satisfy its
production schedule efficiently and effectively. Your audit approach includes an overview of plant
performance and analysis of trends in production and related costs, a walk-through and
documentation of internal controls, interviews with plant personnel, and tests of compliance with
corporate policies. The company is particularly interested in controls over scrap and scrap recovery,
which represents a significant source of cash flow.
The companys internal audit department is based at the companys corporate headquarters in
Charlotte, North Carolina. The department consists of nine CPAs hired predominately from national
and international CPA firms, two engineers, and two computer specialists. The department reports
to the Vice President of Internal Audit, who reports directly to the companys audit committee.
The internal audit department performs a variety of financial, internal control, compliance, and
operational audits on a global basis, based on an annual audit plan. The department is respected within
the company for its objective and disciplined audit approach and for its ability to understand the role
of controls in the successful execution of the companys strategic plan. The department regularly
presents findings that aid management in strengthening controls and reducing costs. Accordingly, the
department is viewed as a source of talent when management positions open within the company.
Richard H. Gifford is an Associate Professor and Harry Howe is a Professor, both at SUNY at Geneseo.
The authors acknowledge the valuable comments provided by colleagues and the feedback provided by SUNY at
Geneseo accounting students who completed this case.
Editors note: Accepted by E. Kent St. Pierre.

Published Online: May 2011

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COMPANY AND INDUSTRY INFORMATION

Wilcox is one of the premiere suppliers of electronic and electrical connectors to original
equipment manufacturers (OEMs). Wilcox maintains a 7.5 percent overall global market share of
the estimated $33 billion interconnect market. The company was founded in 1964 in Charlotte,
North Carolina, by a team of electrical engineers with a mission of providing high-quality
interconnect products to the consumer products industry. The company quickly established a
reputation as a custom producer of high-quality specialty interconnections. Wilcox competes in the
Automotive, Communications, Electronics, and Consumer Products market segments.
The company is organized into four divisions by market segment. Profitability is reported by
division, by global region, and by product lines. The company employs approximately 20,800
people and maintains 34 manufacturing facilities in 12 countries, and sales and distribution facilities
in 38 countries. Over the past two years the workforce has declined by 5 percent as the company
reengineered and streamlined its value chain. The company markets its approximately 85,000
products to customers in 47 countries, primarily through a strategy of a direct sales force and
authorized distributors. Exhibit 1 presents summary financial data for Wilcox International for
20XX, the most recent fiscal year.
The interconnection industry is highly fragmented, subject to rapid change, and is very
competitive. The industry has a long-term growth rate of approximately 6 percent. Interconnection
products are both mature and rapidly changing, depending upon the product application and need
for more cost-effective solutions to customer problems. Companies within the industry succeed by
their ability to work closely with customers to innovate, reduce product size as end user products
become miniaturized (computers, cell phones, etc.), maintain high quality levels, meet customer
delivery schedules, and reduce product prices.
In recent years, the industry has started to consolidate as customers move increasingly to
supplier certification programs and just-in-time inventory systems in an attempt to reduce costs and
identify a smaller, core supplier base that can supply their global operations. This consolidation has
eliminated the less efficient firms and has placed increasing pressure on the remaining
interconnection suppliers to provide high-quality product at lower prices.

EXHIBIT 1
Financial Data for Wilcox International20XX
Panel A: Segment Data
Market Segment

Market Share

% of Company Revenues

Company Revenue ($000)

Automotive
Communications
Electronics
Consumer Products

7.8%
6.2%
9.0%
8.0%

32.50%
29.40%
24.10%
14.00%

$812,500
$735,000
$602,500
$350,000

Total Sales

7.5%

100.00%

$2,500,000

Panel B: Industry Data

20XX Annual Sales Growth
Average Annual Sales Growth5 years
20XX Profit Margin
Average Profit Margin5 years

Wilcox

Industry

6.1%
6.7%
9.6%
10.1%

6.2%
6.0%
9.8%
9.5%

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Wilcox is well positioned to effectively compete in the industry. It has continually offered
innovative, high-quality products and has expanded globally as it saw opportunities. With its global
presence and reputation, the company effectively services its customers. The companys philosophy
is to maintain its status as an industry leader through high levels of customer satisfaction, product
innovation, continuous improvement, and employee involvement. To address the pressure to reduce
product prices (and costs), the company implemented productivity and cost improvement programs.
Traditionally, the company operated relatively small specialized plants rather than large
integrated production facilities (large plants that can perform numerous manufacturing processes).
Wilcox believed smaller plants with a decentralized management structure enabled them to operate
with greater flexibility to meet customer expectations and gave the employees more ownership over
the production processes. Over the years, this philosophy enabled the company to maintain high
quality levels and higher employee productively than the industry average. It also helped forge a
satisfied workforce that was committed to the company. Employee turnover was half the industry
average.
As competitive pressures to reduce costs intensify, Wilcoxs manufacturing operations focus
on reengineering and automating its primary processes, migrating to integrated manufacturing
operations, and transferring production to its operations located in countries with lower labor costs.
As new plants come online, Wilcox consolidates and reduces production at its older, less efficient
operations.
The consolidation of Wilcoxs operations has necessitated a culture change within the company
toward a greater emphasis on efficiency. This change has strained relations with its long-term
employees. When it downsizes its older, less efficient plants, the company offers employee transfers
to its new facilities, where appropriate, and early retirement packages. The company also lays off
employees it cannot place at other facilities. Plant managers and front-line supervisors have been
advised by senior management to keep their workers apprised of what the company is doing and to
be aware of the morale issues the changes are generating. However, management efforts have not
alleviated employee perceptions of dislocation and abandonment. As a result, absenteeism has
increased and employee productivity at the older plants has declined marginally.
OVERVIEW OF THE COMPANYS MANUFACTURING PROCESS
Wilcox is an integrated designer and manufacturer of electrical and electronic components. Its
operations include molding, stamping, plating, and assembly plants. At the companys stamping
plants, raw metal stock is stamped into various configurations of contact pins (hereafter referred to
as contacts) and other related products. The stamped contacts remain attached to a carrier strip to
facilitate handling, plating, and assembly. The carrier strips are reeled (approximately 5,000
contacts per reel) and then transported to a plating facility, where they are plated with precious
metals (gold and palladium) to enhance electrical conductivity and to prevent corrosion. The reeled,
plated contacts are shipped to assembly plants for insertion into the molded plastic housings that are
produced at the companys molding plants.
The assembly operations produce the finished connector assemblies using insertion machines that
detach the contacts from the reels and insert them into plastic housings. After assembly, the connectors
are packaged and shipped to the companys distribution centers or sent to other plants for inclusion in
other product applications. Figure 1 provides an overview of Wilcoxs manufacturing process.
PRODUCTION SCRAP AT THE ASSEMBLY PLANTS
After the contacts are detached from the metal carrier strip, the strip remains as design scrap.
The carrier strips are chopped, automatically cut into small pieces at the assembly machines, to
maximize space utilization in the scrap containers. Although the company is continually refining its
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FIGURE 1
Wilcox International
Production Process for Connectors

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EXHIBIT 2
Knoxville Production Record Summary

20XX
January
February
March
April
May
June
July
August
September
October
November
December

Headcount

Contacts Issued to
Production Part #
CNTCT-AU-29XX

Good Production
(# Contacts in Connectors
Part # CNNCTR-2964)

Connector
Line

Other
Departments

6,500,000
5,785,000
6,240,000
7,605,000
8,450,000
8,775,000
9,100,000
7,735,000
6,890,000
6,435,000
5,785,000
4,355,000

6,435,000
5,698,225
6,115,200
7,536,555
8,340,150
8,599,500
8,927,100
7,468,143
6,827,990
6,383,520
5,738,720
4,272,255

48
46
45
43
44
45
46
46
46
45
45
43

189
189
187
186
182
181
178
177
173
172
169
164

plating process to limit the amount of precious metals to the contacts, some precious metal is plated
on the metal carrier strip. As a result, design scrap has significant value. The plant sells its scrap to a
salvage company for reclamation on a weekly basis. The companys central purchasing department
maintains long-term contracts with salvage companies that stipulate processing and transportation
(pick-up) charges.
The amount of scrap recovery is based on a content factor which is determined by the salvage
company after testing each load of scrap. The gross weight of each scrap shipment is adjusted
downward based on contamination with other scrap in the containers (such as plastic) and moisture.
The funds forwarded to Wilcox are calculated based on the relevant market prices of reclaimed
scrap metals (as reported by the Markulis Metals Digest [MMD]), less processing and scrap pick-up
(transportation) charges. On a company-wide basis, scrap sales account for approximately 0.7
percent of total revenues.
OVERVIEW OF THE KNOXVILLE ASSEMBLY PLANT OPERATIONS
The Knoxville plant has been in operation since 1965. It is one of the companys original
assembly plants that employed an average of 225 individuals during 20XX. The plant produces
variations of one of the companys most popular connectors, part # CNNCTR-2964. To produce the
contact, the company uses a gold-plated contact stock, part # CNTCT-AU-29XX. This connector
contains the highest gold content of the companys products. The plant has the capacity to produce
connectors containing 120 million contacts annually. However, during 20XX, the plant used only
82 million contacts due to a transfer of production to an integrated facility. During the past two
years, approximately 20 percent of the plants total workforce has been reduced through transfers to
new facilities, layoffs, and retirements as a result of the companys efforts to consolidate operations.
Exhibit 2 summarizes 20XX production and headcount at the plant by month.
Production at the plant is controlled by a factory order process. Materials are issued to the
assembly machine operators by material handlers based on the authorization of factory order
requisitions. Access to stores inventory is limited to material handlers and store attendants.
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During 20XX, the plant ran two or three shifts, depending on demand, five days a week.
During the weekend, material handlers worked a four-hour shift to ensure the work centers had
sufficient materials for the beginning of the week. They also weighed and prepared the scrap for
weekly pick-up by the external salvage company. To fairly spread the weekend work among the
material handlers, they alternated weekends. Generally, two material handlers were scheduled for
each weekend shift. There were four material handlers assigned to the plant during 20XX. There
were no other employees in the plant during the weekend.
PLANT SECURITY
Plant security for four Wilcox facilities was consolidated two years ago to reduce costs. The
plant is located within five miles of three other Wilcox facilities, situated immediately outside the
perimeter of an industrial park in the suburbs of Knoxville in an area considered safe and free of
serious crime. The property is not fenced and consists of a parking lot and the building. The plant
loading dock is located in the back of the plant, away from the road. All visitors must park in the
front of the building and enter through the main entrance where the plant managers secretary issues
a security pass through an access window. After the visitors credentials are authenticated, they are
permitted to enter the plant under escort and must exit through the main entrance where they are
logged out. Employees enter the plant through the employee entrance located by the loading dock.
Security for the plant during nonworking hours is provided by Jones Security, which maintains
a full-time presence at one of the Wilcox plants within a five-mile radius. At the conclusion of
working hours and prior to the weekend, Jones Security does a walk-through of each plant to
determine it is properly secured and that the alarm system is turned on. After the plant is secured,
Jones Security drives by the facility at unscheduled times and looks for anything unusual or
suspicious. Jones Security personnel generally do not enter the plant. A police station is located
within a mile. During the past five years, there were no reported incidents.
The material handlers who must access the plant for their special shifts on the weekend are
given a key by the materials manager. When the handlers start the weekend shift, they deactivate
the alarm and telephone Jones Security to notify them they are in the building. When the shift is
over, they reactivate the alarm and notify Jones Security that they are leaving the building.
THE ACCOUNTING SYSTEM
The company uses a standard cost system. Production facilities are considered cost centers and
are evaluated based on their ability to achieve production and quality targets within standards and
budget. Standards are based on good production only and include no provision for scrap recovery.
Standards are established jointly by accounting, engineering, and manufacturing, as they are used
for both financial and operational purposes. The standards are updated annually or when processes
are modified. Exhibit 3 presents standard material information for part # CNNCTR-2964.
Standard cost variances (materials, labor, and overhead) are reviewed by corporate and
divisional accounting, the plant accountant, and the plant management on a monthly basis and
corrective action is taken as necessary. Scrap recovery from bad contacts (production scrap) and the
scrap generated by the metal reeled strip (design scrap)1 are not considered a reduction of standard
cost because of the difficulty in predicting fluctuating precious metals costs. Rather, scrap recovery
is credited to an unbudgeted scrap recovery account which, due to the companys policy of
maintaining low inventories, is a reduction to the companys cost of goods sold. The impact on
1

Design scrap is anticipated as a normal byproduct of manufacturing operations. Production scrap occurs when
defective units are produced.

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EXHIBIT 3
Wilcox Bill of MaterialPart # CNNCTR-2964Finished Connector

Operation

Raw Material
Plated Reeled
Contact Part #

Raw
Material
Unit

Finished
Lot 100
Connectors

Gross Raw
Material Issue

Net
Weight
Finished
Unit

Assembly

CNTCT-AU-29XX

contact

1,000 contacts

46.875 lbs

31.250 lbs

inventory valuation by not allocating scrap recovery among work-in-progress and finished goods
inventories is considered immaterial to Wilcox Internationals financial results.
THE SCRAP COLLECTION PROCESS AT THE KNOXVILLE PLANT
In the Knoxville plant, material handlers are responsible for collecting, weighing, and
preparing the scrap shipments. Scrap from the assembly machines is accumulated in specially
designed, jumbo corrugated containers that cost approximately $22.00 each. Because of their cost
and special design, the containers are designated for only metal scrap (both design and production).
Each container holds approximately 2,500 pounds of scrap. Although rejected product (production
scrap) includes the plastic housing, efforts are taken to avoid placing other waste items in the
containers as it will contaminate the metal content of the containers, thereby reducing the metal
content factor and amount of scrap recovery as discussed above. Figure 2 illustrates the standard
corrugated scrap container used by the plant, the Gaylord HPT 41.
Since the cost of the Gaylord containers is immaterial to Wilcoxs operations, the company
treats it as an expense and does not inventory or physically control access to the containers. At the
end of 20XX, the material handlers told you there were approximately 20 empty containers on site.
The handlers did not think there were any containers on hand at the beginning of the year.
The material handlers collect the scrap from each assembly machine scrap bin during the shift.
The handlers place the scrap in the Gaylord containers in a locked scrap cage located in the material
stores. Only the four material handlers have keys to the cage. The containers remain in the cage
except when the material handlers weigh and prepare the containers for shipment during the
weekend shift.
The scrap cage can only accommodate 1012 containers at any given time. During the summer
months, this constraint creates a problem because the plant fills more containers than can be
accommodated in the cages. When this occurs, the containers are stored in a small locked cage
located on the loading dock. The cage on the dock is used to store other recyclable waste and has
exposure to the weather. The placement of the scrap containers on the dock increases their chance
for contamination.
The materials handlers are also responsible for requisitioning and maintaining the scrap
containers. When additional containers are needed, the material handlers complete a purchase
requisition, which is approved by the materials manager and procured by the plant purchasing
agent.
During the weekend shift, the material handlers prepare the scrap for shipment. They remove
the containers from the scrap cage and weigh, seal, and number the containers. The company name,
weight, container contents, and container number are recorded on a label and attached to each
container. The containers cannot be opened without breaking the seals. The handlers record the
number of containers, the weight, the contents, and the bill of lading number on a scrap log. The
handlers return the containers to the scrap cage, where they remain until McClean Metal
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FIGURE 2
Scrap Shipping Containers

Reclamation arrives for the weekly shipment. One copy of the log is given to the shipping clerk on
Monday morning. The clerk prepares the bill of lading and related shipping documents that contain
a description of the shipment, the number of containers, and the weight.
When McClean arrives for pick-up, the handlers remove the scrap containers from the cage and
load the containers onto the truck under the direction of the driver. The driver verifies the number of
containers, signs the bill of lading and the shipping manifest, and gives one copy to the shipping
clerk. Another copy, along with the scrap log, is sent to the plant accountant.
The plant accountant compares the number of containers and weight on the log with that
recorded on the bill of lading copies. The documents are placed in an open scrap file and listed by
bill of lading number in an electronic spreadsheet. The file and spreadsheet serve as the only record
of what is owed to the plant. The plant accountant investigates any scrap remittances not received
by the company within ten days of shipment.
As part of the companys monthly closing process, the plant accountant reviews the open file
for any shipments for which no remittance has been received and prepares a standard journal entry
that debits miscellaneous receivables and credits the plant scrap recovery account. The journal entry
is automatically reversed the following month. Summary information relating to Wilcoxs scrap
shipments and bills of lading are presented in Exhibits 4 and 5.
McClean wire transfers the scrap recovery, generally within ten days, to Wilcoxs bank.
McClean sends the remittance advice to corporate accounting and a copy to the plant accountant.
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EXHIBIT 4
Knoxville Plant Summary of Scrap Accounting Records
20XX

Containers Shipped

Pounds Shippeda

Cash Received

42
37
37
44
50
50
52
46
40
38
34
29

103,593.75
93,102.34
91,400.00
108,467.03
122,964.06
125,093.75
130,090.63
114,198.67
99,594.06
94,655.63
84,336.88
70,632.66

$528,991.13
$479,988.02
$477,838.91
$573,199.67
$601,943.52
$622,799.50
$608,588.71
$581,701.68
$500,405.19
$487,188.72
$433,129.50
$363,543.46

January
February
March
April
May
June
July
August
September
October
November
December
a

Net of shipping container weight.

Corporate accounting compares the deposit with the remittance, debits cash, and credits the plant
scrap recovery account. The plant accountant compares the bill of lading number, gross weight, and
number of containers on the remittance with the information listed on the log. The accountant also
compares the proceeds recorded by the company with those listed on the remittance advice.
Summary information relating to McCleans scrap recovery remittances is presented in Exhibit 6.
The plant accountant performs two additional procedures to verify the reasonableness of the
recovery. The net weight reclaimed represents an adjustment of the gross weight based on the
content factor. The accountant notifies the plant manager for all factors less than Wilcoxs average
of 0.96 (net weight/gross weight), as this suggests that the shipment may have been contaminated
with nonmetal waste.
The accountant also tests the amount of the recovery for reasonableness by comparing the
market price of the scrap as published in the Markulis Metals Digest (MMD) and adjusted for

EXHIBIT 5
Summary of Carrier Bills of Lading
20XX
January
February
March
April
May
June
July
August
September
October
November
December

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Containers Shipped
42
37
37
44
50
50
52
46
40
38
34
29

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EXHIBIT 6
Summary of McClean Reclaimers Scrap Summary Remittances
20XX
January
February
March
April
May
June
July
August
September
October
November
December
a

Containers
Received

Gross Weight
Received (lbs)

Reclaim
Weight (lbs)a

Cash
Remitted

42
37
37
44
50
50
52
46
40
38
34
29

103,186.64
93,204.90
91,600.10
108,400.40
123,014.17
124,983.66
130,100.26
113,996.42
100,076.01
94,600.44
84,047.99
70,429.54

101,729.06
90,495.48
89,389.20
106,297.69
110,667.66
112,459.28
113,959.39
110,430.12
97,203.81
92,762.51
82,144.12
69,220.00

$528,991.13
$479,988.02
$477,838.91
$573,199.67
$601,943.52
$622,799.50
$608,588.71
$581,701.68
$500,405.19
$487,188.72
$433,129.50
$363,543.46

Weight adjusted for contamination (content factor) by McClean.

McCleans cost of scrap pick-up and processing per the contract with the proceeds. For differences
that exceed 2 percent, the accountant contacts McClean. During the past three years, there have
been no significant discrepancies. After verifying the remittance, the accountant updates the
spreadsheet with the actual remittance information and files the scrap log and related documents in a
closed file. As a further level of control, the corporate accounting staff of Wilcox reviews scrap
recovery against shipments for reasonableness.
DISCUSSION WITH PLANT PERSONNEL
During your audit, you interviewed the Plant Manager, Materials Manager, Production
Manager, and Human Resource representative at the plant. Excerpts from the interviews are
presented below:
Interview with the Plant Manager, R. E. Bob Howler
The Knoxville Plant has been the mainstay of Wilcox for years. We have the most dedicated
and productive labor in the United States. Some of our employees have been with us since we
opened in 1965. Our problem is not the productivity of labor, but the overall cost of the
operation. It is increasingly difficult for us to be cost competitive with plants located in
countries with lower wages or with fully automated facilities. As a result, the company has not
invested in upgrading this facility and has transferred a sizable portion of our production
volume to other locations. This reduction has created stress and some resentment among our
remaining employees. Although we are understaffed, we remain highly productive and
continue to produce a high-quality product.
Interview with the Materials Manager, Sarah Thompson
I recently took over the materials responsibility at this plant. The company consolidated the
Materials Managers positions at this and two other plants. As if I didnt have enough to do at
one plant, I am now responsible for managing the materials at all three of the plants. At this
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plant, my team is responsible for ensuring we have sufficient materials available for assembly
operations and shipment to our finished goods warehouse. Our raw materials consist primarily
of reeled plated metal contacts and plastic housings. We are constantly aware of security,
although it would be difficult for an employee to remove sufficient product from the plant to
make it worth his/her efforts. We are also responsible for scrap collection. Since we generally
do not have much production scrap due to our quality, most of our scrap is design scrapmetal
remaining after the contacts are stamped. My material handlers also ensure we have containers
available to store and transport the scrap. The containers are relatively inexpensive; I think they
run about $22.00 each and we go through $12,000$13,000 annually. As my staff needs
containers, they complete purchase requisitions and our plant purchasing agent places an order
with our supplier.
Unfortunately, the company has not invested in our operation and, consequently, we are
squeezed for space. This is particularly true during the summer months when our production is
high. We just dont have the space to store materials and scrap. During the summer we end up
putting scrap on the back dock. This is not good for the scrap or security, but we do the best we
can. In addition, my materials handlers point out that because of space limitations, we also have
to store the empty containers on the back dock. They tell me as much as 810 percent of our
container purchases end up being disposed of because they get wet and cannot be used. If the
company would just give us the resources, we could reduce container costs and increase our
scrap yield.
Because of my ever-growing responsibilities, I have to travel among plants and I rely heavily
on my staff. I am very fortunate to have material handlers who are long-term employees and
who take pride in their work even though the company has sought to downsize us. Since the
downsizing, my material handlers are stretched. They are still company people and volunteer to
come in on weekends so our production staff has product the following week and so our scrap
shipments are ready for pickup on Monday morning. I am lucky to have such a dedicated staff
under such difficult conditions.
Discussion with the Production Manager, Ben Stampman
I am responsible for the actual manufacturing operations at the plant. My team keeps the
assembly machines running. As I am certain Bob and Sarah have told you, our volume is down
significantly from prior years. But I am happy to report that my machine operators remain
productive and motivated. Our standard cost variances for last year remain low. We continue to
meet all of our manufacturing goals. Bad contacts generally account for only 0.5 percent to 1.0
percent of scheduled production. This is due to good teamwork among plant operations.
Maintenance keeps our antiquated machines running and Materials keeps our assembly areas
clean of scrap and properly supplied with materials. Although morale is suffering somewhat
due to the downsizing, my employees are professionals.
Discussion with the Plant Human Resources Representative, Joan Softskill
The workers at this plant are very good and dedicated to the company. Unfortunately, they are
in a high-cost operation, which the company has sought to transfer to more automated and
lower-cost operations. When we are able, we offer employees the opportunity to transfer to
other plants. However, as most of the transfers involve relocation and we have fewer positions
available, many of the employees in this area must either retire or be laid off. The company has
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a fair severance package, but it is not viewed favorably by the employees. Consequently,
morale has suffered and absenteeism has increased, particularly among the newer employees.
Our hourly production workers are not the only staff to feel the pinch. The company has also
consolidated its management staff in the area. For example, the Materials Manager and Quality
Assurance Manager positions at this plant have been consolidated with two of the other plants
in the area. This has put an added burden on the managers, who now have to travel among
plants and supervise additional employees.
CONCLUSION
You have completed your production and cost overview, interviews, major system
walk-throughs, and documentation of controls. You are preparing your preliminary assessment
of the plants controls and are preparing to test its production and scrap operations. You are
satisfied, based on the results of your preliminary work, that the plant appears to be operating on a
reasonably efficient basis despite the uncertainty the plant employees are facing. However, your
professional training has taught you to be skeptical of all controls and processes until they have
been tested. You hope the results of your tests will be consistent with the results of your preliminary
work and interviews.
CASE QUESTIONS
1.

2.

3.

4.

How would you characterize the Knoxville plants controls over its operations using a
COSO framework? In your evaluation, consider company and operating factors in addition
to procedural controls. Evaluate and identify any control risks associated with the
companys scrap operations. Categorize your risks according to management assertions
relating to its scrap transactions (occurrence, completeness, accuracy, classification, and
cutoff ).
Using elements of the Fraud Triangle, as described in forensic accounting/auditing texts
and adopted by SAS 99, evaluate the potential for fraud in Wilcoxs operations. Make
certain you consider the company and operating issues that impact the plant in addition to
specific procedural controls. What key fraud factors (if any) do you see present, and what
might account for them?
Is there any evidence of fraud in the scrap operations? Support your evaluation through the
use of analytical procedures and corroborating evidence. Your manager has requested that
you quantify the amount of any fraud you think is present. Would your evidence be
convincing to management that a problem exists?
Identify any internal controls and/or operational changes you would make to improve the
plants controls over scrap and its plant operations. Quantify the potential benefits of any
suggestions you make.

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373

CASE LEARNING OBJECTIVES AND IMPLEMENTATION GUIDANCE

Introduction and Learning Objectives
SAS 99 (AICPA 2002) requires auditors to explicitly consider the likelihood of fraud in
planning and conducting an audit. This consideration includes an evaluation of unexpected
relationships that are identified by analytical procedures. The authors survey of widely used
auditing textbooks suggests that the relationship between financial and nonfinancial data receives
little attention and thus is likely not to be often considered in the classroom.
This case, which is based on an actual company, can be used to demonstrate the importance of
internal controls in a nonfinancial process, and the relationship of financial and nonfinancial data
when performing analytical reviews and in evaluating the likelihood of fraud in a manufacturing
environment.
At the conclusion of the case, students should be able to demonstrate proficiency with four key
learning objectives:
1.
2.
3.
4.

Identify and evaluate the likelihood of fraud in a manufacturing process using a SAS 99
framework.
Understand the relationship between financial and nonfinancial factors when performing
analytical procedures.
Evaluate internal controls for a manufacturing process.
Understand the importance of professional skepticism in evaluating evidence.

The teaching notes discuss relevant skill sets that support each of these learning objectives.
Implementation Guidance
The case has been used in one instructors undergraduate auditing classes for four years (six
sections) and in another instructors class for two years (two sections). The instructors using the
case assign it after the students are grounded in the audit process through internal control evaluation
and fraud. Students should have a foundation in risk assessment, analytical procedures, internal
control, evidence, and fraud (both financial reporting and misappropriation of assets). The
instructors find that having the class review recent SEC enforcement actions relating to fraud and
professional literature, in such journals as The Journal of Accountancy and Fraud, enables the
students to better understand how frauds relating to financial reporting and misappropriation of
assets can and do occur. This background may enable students to better address the issues in the
case.
The case can be assigned individually or in teams of students. The authors find that team
assignments generally result in higher and more confident levels of class participation, as the
students have had the opportunity to talk through the solutions with someone before class. The case
is assigned as homework approximately one week (two class periods) before it is reviewed in class
so that the students have time to complete the calculations and adequately review the manufacturing
process. Students (working individually or in teams) each submit one summary outline. The
submission is intended to provide assurance that the students have given the case sufficient
consideration before the class discussion.
The case and discussion questions may be covered in one 75-minute class period. Exhibit 7
provides an example of how the instructors allocate class time to the case. The schedule gives the
instructor time to introduce and to recap the case. The questions are sequenced so that students
move from a general evaluation of control risk at the plant level and review of internal controls over
scrap collection to an assessment of the likelihood of fraud and an estimation of the fraud amount.
The sequence is intended to demonstrate how weakness in controls, when combined with incentives
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374

EXHIBIT 7
Example of Time Allotted to Case Coverage
Question/Topic
Case Introduction and Overview

Minutes
Allotted
10

General Discussion Topics




# 1Risk Assessment

10




# 2Fraud Assessment

15




# 3Quantification of Fraud

20





# 4Recommendations

10





Wrap-up

10

Overview and comment that case is based on an actual

company.
Discussion of the importance of internal controls to all
aspects of an organization.
Discussion of qualitative issues impacting the controls
as gleaned from the interviews with management and
review of company shift in cultural philosophy.
Discussion of the adequacy of the controls over
operations.
Discussion of the adequacy of controls over scrap
based on assertions with emphasis given to the
completeness assertion.
Application of fraud triangle in assessing the
likelihood of fraud due to employee theft.
Relating the adequacy of controls noted in Question 1
to the opportunity for fraud.
Review of how analytical procedures relating
production to financial information (expected
production based on standards versus actual scrap
shipments and scrap recovery) could identify a fraud.
Quantification of potential amount of fraud by
reviewing the calculations on an electronic spreadsheet.
Discussion of the strength of the evidence.
Brief discussion of how the fraud was uncovered in
the actual company and steps that were taken after
fraud was discovered.
Discussion of recommendations relating to control
procedures.
Discussion and quantification of potential operational
improvements.
Brief overview of what the company actually
implemented.
Reiteration of the importance of control to all aspects
of a business and discussion of professional skill sets
required to be an effective auditor.

and rationalization, can lead to fraud in a real-world setting. The final question provides an
opportunity for students to provide value-added recommendations to help an organization improve
its profitability through strengthening its controls.
Student Feedback
At the conclusion of the case, the instructors distribute an assessment form that students
complete anonymously and return the following class period. The students assess their learning
based on six statements that are related to the learning objectives discussed above. The assessment
form, which was revised for the fall 2009 classes, is presented in Exhibit 8.
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Operational and Financial Factors to Assess Risk and Identify Fraud

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EXHIBIT 8
Wilcox Scrap Case Learning Assessment Instrument
At the conclusion of the Wilcox Scrap Case, I ask students to assess the extent to which the Wilcox Case has
enabled them to better understand audit issues relating to internal control and fraud. Please circle the degree to
which you agree or disagree with the following statements. Your response is anonymous and will be used to
improve the case. Please submit your assessment at the beginning of the next class. I will summarize the results
and review them with the class. Thank you for your response.

1.

The case enabled me to better understand the interrelationship between controls and fraud.
1. Disagree
2. Disagree Somewhat 3. Neutral 4. Agree Somewhat 5. Strongly Agree

2.

The case enabled me to better understand the importance of relating nonfinancial factors to financial
factors when evaluating financial information.
1. Strongly Disagree 2. Disagree
3. Neutral 4. Agree
5. Strongly Agree

3.

The case enabled me to better understand how to evaluate internal controls.

1. Strongly Disagree 2. Disagree
3. Neutral 4. Agree

4.

The case enabled me to better understand how to apply SAS 99 in determining the likelihood of fraud.
1. Strongly Disagree 2. Disagree
3. Neutral 4. Agree
5. Strongly Agree

5.

The case enabled me to better understand how to apply and interpret analytical procedures.
1. Strongly Disagree 2. Disagree
3. Neutral 4. Agree
5. Strongly Agree

6.

The case enabled me to better understand the role of professional skepticism in evaluating evidence.
1. Strongly Disagree 2. Disagree
3. Neutral 4. Agree
5. Strongly Agree

5. Strongly Agree

The information is summarized and presented to the classes the following class meeting.
During the review, students are invited to comment as to what they have learned and to share any
recommendations as to how to improve the case. The discussion of the assessment and request for
comments is intentional to build student confidence in making recommendations, something they
will be expected to do as professionals. Student participation has been very good. The results for the
fall 2009 classes are presented in Exhibit 9. Only the 2009 results are presented, as the instructors
implemented a new assessment form. The results of prior class assessments are consistent. The
results are nonscientific.
Student responses were positive and generally support the learning objectives. Students
indicated that they gained a better knowledge of the relationship between internal controls and
fraud. Student responses related to the case are summarized below:





Students indicated that although they were reasonably confident in their understanding of
analytical procedures relating to financial information, the case expanded their awareness of
the use of analytical procedures in a nonfinancial setting. They indicated the use of
production information was particularly useful because it used an actual company to
demonstrate how analytical procedures can be used to identify potential problems.
Students indicated the case provided a real-world setting that helped them better understand
the importance of internal controls.
Students indicated they had developed a better understanding of how control weaknesses
can contribute to fraud. They indicated the case enhanced their understanding because it
added realism to what appeared to be a somewhat theoretical discussion in the auditing text.

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EXHIBIT 9
Summary of Student Responses2009

Statement

Average
Rating

% Students
Agreeing or
Strongly Agreeing

Students
Responding

4.23

87.9%

66

4.26

86.4%

66

4.06

80.0%

65

4.24

89.4%

66

4.08

79.4%

63

4.48

90.9%

66

1. The case enabled me to better understand the

interrelationship between controls and fraud.
2. The case enabled me to better understand the
importance of relating nonfinancial factors to financial
factors when evaluating financial information.
3. The case enabled me to better understand how to
evaluate internal controls.
4. The case enabled me to better understand how to
apply SAS 99 in determining the likelihood of fraud.
5. The case enabled me to better understand how to
apply and interpret analytical procedures.
6. The case enabled me to better understand the role of
professional skepticism in evaluating evidence
Students Attending = 72.
Student Responses = 66.




Students indicated they gained an appreciation of professional skepticism. Virtually all the
students indicated they had accepted the reconciliation of the containers and the statements
of the material handlers, as discussed by the materials manager, at face value. Responses
indicated that the learning came after we discussed the case in class.
Students indicated they learned how to use information to quantify weaknesses and add
value to their recommendations.
Students indicated they gained an appreciation of how to corroborate findings. The missing
scrap containers could reasonably corroborate the amount of the discrepancy between
expected and reported scrap shipments.
TEACHING NOTES

Teaching Notes are available only to full-member subscribers to Issues in Accounting

Education through the American Accounting Associations electronic publications system at http://
aaapubs.org/. Full-member subscribers should use their usernames and passwords for entry into the
system where the Teaching Notes can be reviewed and printed. Please do not make the Teaching
Notes available to students or post them on websites.
If you are a full member of AAA with a subscription to Issues in Accounting Education and
have any trouble accessing this material, then please contact the AAA headquarters office at info@
aaahq.org or (941) 921-7747.

REFERENCES
American Institute of Certified Public Accountants (AICPA). 2002. Consideration of Fraud in a Financial
Statement Audit. Statement of Auditing Standards 99. New York, NY: AICPA.

Issues in Accounting Education

Volume 26, No. 2, 2011

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