You, PA, have been assigned as in charge auditor of a long-time audit client of your firm, Mikla Tool Inc. (MTI). MTI is owned by George Mikla, an experienced machinist. George established the business over 20 years ago, and it has grown into a $10 million a year business, with an excellent reputation for high quality machined parts. MTI has regular clients in the automobile parts sector and in the health care sector. The company has recently begun producing parts for environmentally friendly products, such as recycling containers. This is due to the business' versatility in dealing with a variety of metals as well as plastics using both manually controlled and machine controlled (computerized) equipment. The following description is based upon your review of prior files, and planning discussions with personnel at MTI.
Equipment suppliers have helped MTI develop efficient operations, by providing sample programs for standard operations and by providing training to employees. One of the suppliers unfortunately sent sample programs that had been infected by a virus. George's daughter, Tiffany, had to cleanse the servers and each of the machines using her copy of the anti-virus software. When contacted, the supplier did not know that the software was infected, and apologized profusely!
The company's four CAD/CAM terminals and printers are connected to the company's central local area network. The local area network is maintained by Toni Lee, the owner of a computer shop conveniently located three blocks away. All computer equipment, software and supplies are now purchased from Mr. Lee, who is responsible for attaching and maintaining equipment, upgrading software, and maintaining user profiles on the network. To reduce the amount of Mr. Lee's work as network administrator, he has set up passwords by function.
There is one user identification code (userid) and password for accounting (shared by Tiffany, George and the accounting clerk, Isabel). The plant supervisors share another userid that is used for production control and to initiate the timekeeping system every morning. A separate userid and password allowing for only enquiry into the job costing system has also been set up, and can be used by all employees.
A standard routine has been set up to back up the accounting systems. Either Tiffany or the accounting clerk inserts one of seven tape cartridges into the system at the end of the day (they are labelled with the day of the week), so that the company has a full set of accounting
backups for the week. Tiffany keeps these in her office. These are particularly important, since during the last office move, two years ago, the original software for the accounting system was misplaced.
The network has two central servers, eleven user stations, and five printers. The user stations are set up as follows: four CAD/CAM, two time keeping, two production planning and control, two accounting and one for George.
A good working relationship is extremely important for satisfying some of the company's larger customers. MTI has paid for computer equipment for each of the supervisors, so that they have fully functioning computers at home. If a rush job requires weekend work, then these senior personnel can work at home to get the necessary quoting or design work completed. Since the 'at home' systems are identical to the office systems Mr. Lee simply copied across the MTI systems to the home computers. Files can be easily taken home and then brought back to the office using thumb drives. It is understood that when times are slower, a day off can be taken to compensate for this weekend work.
It is almost ten years ago that Tiffany arranged for the implementation of the network, and the purchase of the standard integrated accounting packages (general ledger, order entry/accounts receivable, purchases/payable and payroll), and for the purchase of the job costing and time keeping systems. A variety of reports are printed daily, weekly, or monthly from the job costing system which are used for monitoring employee hours, the status of the jobs, the costs accumulated for particular jobs, and the work in progress inventory.
The weekly report of hours from the job costing system is approved by the production supervisors, and is used as an input source for hours worked into the payroll system. The accounting clerk enters the hours into the accounting system, so that weekly payroll cheques and reports can be produced. The accounting clerk handles most data entry.
Tiffany is really pleased with their accounting clerk, Isabel, who has been with the company for three years. She insists that fate had a hand in getting Isabel working for MTI. Isabel had been 'pounding the pavement,' having recently immigrated, and had no Canadian business experience. Her accounting skills were rudimentary, but she quickly learned the accounting software, and has reorganized the filing systems. Tiffany considers her as indispensable. When Isabel goes on holiday, many things just don't get done! Tiffany can do the payroll in a pinch, but accounts payable and cash disbursements are always done by Isabel. If she's away, suppliers are simply told to wait, or Tiffany issues a manual cheque for recording later. Isabel is very good at clearing queries from suppliers, and ensuring that new suppliers are set up properly. The purchasing supervisor and his staff rely on Isabel, for she checks the account allocation of purchases and makes any necessary corrections.
Tiffany or George are signing officers, although Tiffany realizes that she checks supporting materials more thoroughly than George, who usually just queries Isabel verbally about larger purchases.
In the past, MTI's audit has been entirely substantive. However, your partner has decided that with MTI's growth, it is time for the company to consider adding additional internal controls. Accordingly, he has asked you to draft a management letter, to be addressed to George and Tiffany.
Required:
A) Prepare a draft management letter, clearly identifying the weaknesses (W), impact or implications of the weaknesses (I), and recommendations for improvement (R).
[The following is a theory question that does not require examples from the case, although examples could be used.]
B) Explain how the control environment and general IT (information technology) controls are related. Describe the impact of the control environment and of general IT controls upon different types of application controls and upon the audit process.
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