AC557 Unit 7 Control Deficiency Evaluation Memo Example

Four Findings, Graded Alone and Together: A Unit 7 Deficiency Evaluation Memo for a Scrap Recycler

[Student Name]

Purdue University Global

AC557: Internal Control Design, Development, and Evaluation

Unit 7 Deficiency Evaluation Memo

[Instructor Name]

[Date]

Rookwood Metal Recovery, its parent and every figure are composite; the standard, guidance and framework cited are real.

Memorandum

To: Parent company SOX program office From: Rookwood internal control team Date: July 24 Re: Evaluation of control deficiencies, Rookwood scrap purchasing

Definitions

The standard sets out three levels. At the lowest, a deficiency, a control is designed or performed in a way that leaves employees unable, in their ordinary work, to stop or catch misstatements in time. A significant deficiency is a deficiency, or a group of them, that falls short of a material weakness but still deserves the notice of those who oversee financial reporting. A material weakness is a deficiency, or a group, serious enough that a material misstatement might not be stopped or caught in time, where might means a chance that is more than remote (Public Company Accounting Oversight Board, 2007).

Severity depends on two questions: how likely the control failure is to result in a misstatement, and how large the misstatement could be. It does not depend on whether a misstatement actually occurred (Securities and Exchange Commission, 2007).

Context in Figures

Rookwood buys about $210 million of scrap a year and carries about $18 million of scrap inventory at any month-end. The parent's consolidated materiality for the year is $25 million.

The Four Findings

Finding 1, override review (C-07). Three of forty yard-days failed, and the override report omits overrides entered after midnight. Overrides add about $310,000 a year above posted prices. The control addresses the accuracy of purchases and, through cost, the valuation of inventory. Likelihood of misstatement: reasonably possible. Magnitude: the overrides themselves are small, but an unreviewed override can also hide a wrong grade or a fictitious premium, and over a year the exposure could reach a few million dollars. Severity alone: deficiency, approaching significant.

Finding 2, grade photo (C-03). Photos are taken after unloading, so they cannot show the load as received. Grading drives both the price paid and the grade at which inventory is carried. Rookwood buys roughly 200 million pounds of nonferrous metal a year. If graders upgrade one load in twenty by one grade, at an average price difference of 30 cents a pound, the annual effect is about $3.0 million of purchases at too high a cost. Likelihood: reasonably possible, given the incentive the Unit 1 post identified. Severity alone: deficiency.

Finding 3, kiosk loading (C-11). One person loads the kiosk using a shared second code. The exposure is cash shortage, capped at the cash in the kiosks, about $90,000 at any time, and detected within a day by the daily reconciliation. Severity: deficiency.

Finding 4, scale checks at Kiln Street (C-02). The monthly calibration was missed in March and April. The scales were found within tolerance in May. The maximum likely effect is small, since scales drift slowly. Severity: deficiency.

Findings 1, 2 and 4 all affect the same thing, the cost at which scrap enters inventory, so they must be evaluated together, because each control was meant to back up the others and with all three weak at once nothing checks the price paid for a load.

Evaluation in Aggregate

Taken together, findings 1, 2 and 4 leave the accuracy of purchases and the valuation of inventory without an effective preventive or detective control at the load level. The combined exposure, upgraded grades, unreviewed overrides and minor weight error, is estimated at up to about $6 million a year in the worst plausible case. That is well below consolidated materiality of $25 million, and the parent's own consolidated reviews would detect a misstatement approaching that size. The memo therefore does not conclude that a material weakness exists. But the combination merits the attention of the audit committee, because it concerns the main cost line of a subsidiary and involves management override risk. The aggregate is a significant deficiency. Finding 3 is evaluated separately and remains a deficiency.

Why Not a Material Weakness

The case for a material weakness rests on management override: the general manager's instructions reached the system under operators' logins, and an override culture can make any load-level control unreliable. That concern is real and is carried into the control environment evaluation. It does not by itself raise the magnitude of possible misstatement to a material level for the consolidated statements, which is what the definition requires.

Communication

The significant deficiency will be reported to the parent's audit committee and to the external auditor. All four findings are referred for remediation in Unit 9 (Committee of Sponsoring Organizations of the Treadway Commission, 2013).

References

Committee of Sponsoring Organizations of the Treadway Commission. (2013). Internal control: Integrated framework. COSO.

Public Company Accounting Oversight Board. (2007). An audit of internal control over financial reporting that is integrated with an audit of financial statements (Auditing Standard No. 5). PCAOB.

Securities and Exchange Commission. (2007). Commission guidance regarding management's report on internal control over financial reporting under Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (Release No. 33-8810). SEC.