An Auditor’s Dilemma
Sorting through a stack of invoices, Alison Lloyd’s attention was drawn to one from Ace Glass Company. Her responsibility as the new internal auditor for Gem Packing was to verify all expenditures, and she knew that Ace had already been paid for the June delivery of the jars that are used for Gem’s jams and jellies. On closer inspection, she noticed that the invoice was for deliveries in July and August that had not yet been made. Today was only June 10. Alison recalled approving several other invoices lately that seemed to be misdated, but the amounts were small compared with the $130,000 that Gem spends each month for glass jars. ”I had better check this out with purchasing,” she thought.
Over lunch, Greg Berg, the head of purchasing, explained the system to her. The jam and jelly division operates under an incentive plan whereby the division manager and the heads of the four main units–sales, production, distribution and purchasing—Receive substantial bonuses for meeting the quota in pretax profits for the fiscal year, which ends on June 30. The bonuses are about one-half of the annual salary and constitute one-third of the managers’ total compensation. In addition, meeting quota is weighted heavily in evaluations, and missing even once is considered to be a death blow to the career of an aspiring executive at Gem. So the pressure on these managers is intense. On the other hand, there is nothing to be gained from exceeding the quota. An exceptionally good year is likely to be rewarded with an even higher quota te next year because quotas are generally set at corporate head-quarters by adding 5 percent to the previous year’s results.
Greg continued to explain that several years ago, after the quota had been safely met, the jam and jelly division began prepaying as many expenses as possible—not only for glass jars but for advertising costs, trucking charges, and some commodities, such as sugar. The practice has continued to grow, and sales also help out by delaying orders until the next fiscal year or by falsifying delivery dates when a shipment has already gone out. “Regular suppliers like Ace
Glass knows how we work,” Greg said, “and they send the invoices for July and August at my request.” He predicts that Alison will begin seeing more irregular invoices as the fiscal year winds down. “Making quota gets easier each year,” Greg observed, “because the division gets an ever-increasing head start, but the problem of finding ways to avoid going too far over quota has become a real nightmare.” Greg is not sure, but he thinks that other divisions are doing the same thing. “I don’t think corporate has caught on yet, “he said, “but they created the system, and they’ve been happy with the results so far. If they’re too dumb to figure out how we’re achieving them, that’s their problem.
Alison recalled that upon becoming a member of the Institute of Internal Auditors, she agreed to abide by the IIA code of ethics. This code requires members to exercise “honesty, objectivity, and diligence” in the performance of their duties but also to be loyal to the employer. However, loyalty does not include being a party to any “illegal or improper activity.” As an internal auditor, she is also responsible for evaluating the adequacy of the effectiveness of the company’s system of financial control. But what is the harm of shuffling a little paper around? She thinks. Nobody is getting hurt, and it all works in the end.
3. Explain the ethical principles by means of examples cited from the case.
