Mark Hobson, a CGA and CIA, is an internal auditor employed by Comstock Industries. He is just completing an audit of the Avil Division conducted during the first five weeks of the year. The Avil Division is one of three manufacturing divisions in Comstock and manufactures inventories to supply about 50% of Comstock’s sales. In addition to the manufacturing divisions, Comstock has two marketing divisions (domestic and international) and a technical service division that offers world-wide technical support. Each customer is assigned to the most suitable manufacturing division which functions as the supplier for that customer. The manufacturing division then approves the customer’s credit, ships against orders obtained by the sales representatives, and collects the customer receivables when due. This allows order-to-order monitoring of customer credit limits against customer orders received.

Findings

Two items that came to his attention during the audit concern Mark: There is a material dollar amount of inventory of part number A2 that is still carried on the Avil books, despite the fact that the Fast-tac machining component in which part A2 was used is now considered first generation and is no longer manufactured. Company policy requires an immediate write-off of all obsolete inventory items. Some accounts receivable still carried as collectible were over 180 days old. All receivables are due in 30 days, which is standard for the industry. Mark believes that many of these old accounts are uncollectible. The division manager’s administrative assistant, Brenda Wilson, performed the aging of accounts receivable, rather than the division accountant, as is standard practice. (The division accountant refused to discuss the circumstances of Brenda’s actions or either of the issues which arose during the audit.)

The auditee’s comments

Mark scheduled a meeting with Brenda and discussed the above concerns. “Well, Mark,” Brenda responded, “I know that policy requires that obsolete inventories be written off, but thatpart A2 is just not being used at present. We might start to make those Fast-tac components again. Whoknows? Wide ties are coming back again, aren’t they? Fast-tac could too. There are plenty of customers, especially in developing nations, who are finding those newer generation machines pretty expensive to maintain. I mean, there is a policy that states obsolete inventories should be written off, but there is no policy defining an obsolete part. “And as for those receivables,” Brenda continued, “that is certainly a judgment call, too. Who knows if those receivables will be collected? We’re in a slight recession now. When things pick up, we’ll probably collect a few. There isn’t even a policy in this division on writing off receivables — I checked: nothing says I have to write them off. So who are you to say I have to?” Mark argued: “Brenda, you know those parts will never be used. And you know those receivables are bad.” “Look, Mark,” Brenda finally bargained, “it’s only a few weeks from the close of the year. Let’s leave these items as they are until after the close so that everyone gets their bonuses. Then, I promise I’ll take a fresh look at both inventories and receivables. I’ll write them down after year end, after the financial reports are issued. No one will know. And, after all, who’s to be hurt?”

Mark continued his audit, drafted his report containing findings related to the inventory and receivables, and reviewed the draft report with the division manager, Hal Wright. Hal was visibly disturbed. “Gee, Mark, this couldn’t have come at a more awkward time. Our figures just got audited by the external auditors — there was a guy out here for our inventory count in November and Brenda sent her aging of the year-end receivables to corporate headquarters. No one up there, in our group or on the external audit team was the least bit critical. If you go raising problems particularly now, the external auditors will catch us writing off inventory and receivables. They’ll adjust profit and there will be hell to pay, for all of us. And, Mark, this is no clear-cut issue, either. I mean, I can see how you can write a report calling for clearer policy, but never one calling for specific write-downs. That’s way out of your jurisdiction. But still, I promise, we’ll look at all this afterour statements are accepted. Right now, I feel the managers of this division have worked their hearts out and Intend to fight to protect what little bonuses they have coming. If we write down as you suggest, those bonuses will go and the stockholders will lose too. Earnings per share will drop like a rock. They might even close this division. Now you don’t want that, do you?” “Well, Hal, I could word my findings as they are in the draft but include your response….” Hal was suddenly angry. “What? And let the audit committee decide the issue? They have nothing to do with this. They accepted the external auditors’ report. If you want to make the audit committee happy, you’ll accept it too and leave this adjustment stuff alone.”

The internal audit director

Concerned, Mark delayed finalizing his report and discussed the draft with Gail Wu, director of internal audit. Gail was not trained as an auditor and was promoted to director of internal audit from the treasury division of corporate finance so that she might develop a better understanding of operating relationships. Still, Gail is very smart and Mark has always respected her opinion. The discussion was by telephone, with Mark still at the Avil Division headquarters and Gail at the corporate office. “Mark, Hal is right. If you blow the whistle on management bonuses this year, we can forget all the goodwillthat I’ve been struggling to build for our department. It will all go out the window.” Mark responded, “I know you’ve been trying to put us on a better footing with management, Gail, but Hal is intractable. As far as he is concerned, the only finding he will accept in the report is that of deficient policy, with nothing mentioned about the inventory or receivables needing adjusting.” “Well, do what you have to do,” Gail ended the discussion. “But I insist that you submit a report that Halagrees to and has signed. I don’t want to upset anyone, then have to try to explain my report to the board when everyone is complaining about the effect on the results and the bonuses.”

QUESTIONS

I. Statement of the Problem

A. Refer to The IIA's Code of Ethics. Identify three specific Rules of Conduct relevant to this case. Using the Rules of Conduct you identify the context, discuss the ethical issues raised in the case.

B. Discuss how the ethical dilemma Mark faces might have been avoided. In other words, discuss specific things Comstock's management and/or the internal audit function might have done to reduce the rish ok such a situation arising.

C. Clearly indicate what you would do if you found yourself in Mark's position