Manipulating budgets and bonuses

Internal Auditor, Dec, 1997

An internal audit of a joint venture project uncovered an unusual amount of coding errors. The outside partner who performed the audit concluded that many charges assigned to the joint venture project actually belonged to another project. The accounting department checked with the engineer in charge, who admitted his mistake, blaming it on fatigue, workload, or simple carelessness. Since the errors were obvious and the financial impact on the company was negligible., the coding error adjustments did not require additional review or authorization. They were promptly corrected.

Later, an internal auditor was conducting a review to identify potential internal control weaknesses. The auditor noticed more coding errors by the same engineer. The mistakes were highly unusual for the engineer, who had a solid reputation for his knowledge of project details. Also, the coding errors were difficult to explain because the project names, numbers, and locations were not similar. Upon further investigation, the auditor discovered that the coding errors occurred only when a project was reaching its authorized budget limit. The auditor also found that the engineer received an annual performance bonus when he completed projects under budget.

Soon after he denied the implication that he was manipulating the budget to receive a bonus, the engineer voluntarily resigned as part of the organization's downsizing initiative. Management has since modified the bonus program to reduce the possibility of manipulation. Procedures also have been established to improve budget and accounting adjustment controls.

PORTLAND CHAPTER

THE LEVELING EFFECT

When the audit team planned their year-end financial audit work, they noticed that one of the divisions had not varied from their "planned quarterly operating income" in three years. Coincidentally, the last internal audit of the organizations divisional financial statements also had occurred three years ago. The audit team decided they would discover how this division, which was divided into nine territories, managed such a feat.

Throughout the discussions and the normal audit work, no evidence was uncovered to explain this phenomenon, especially since similar divisions experienced significant variances. On the fourth day of the investigation, the auditors expanded their detailed analysis of the accounts receivable trial balance. The auditors noticed that the last account within each of the nine territories was generically-named. These accounts always seemed to have an even balance and never had a shipping/sales journal entry. After obtaining the entry detail for these nine accounts, the auditors learned that the accounts were used to level reported income. In fact, the description for the entries actually indicated that purpose.

If income in a particular quarter was excessive, the leveling accounts absorbed the surplus. Likewise, if the division fell short, an adequate amount was pulled from the account to cover the shortage. The auditors reported their discovery, and the responsible associate was eventually terminated.

CINCINNATI CHAPTER

OLD CHECKING ACCOUNTS

During a review of the company's treasury function, the internal auditor found a small checking account entitled "land account." The auditor also discovered that the bank that maintained the land account was different from the one that handled the company's other accounts. When asked about the account, the treasury staff claimed that they didn't know much about it. Feeling both skeptical and pessimistic, the auditor arranged a meeting with the manager responsible for the account.

The manager indicated he had inherited the land account 10 years earlier when he took over the department. However, because no one ever discussed the account with him, the manager assumed there were no problems. He was mistaken.

The auditor found that the company had lost at least $7,500 in bank fees per year for 10 years due to an insufficient monthly balance in the account. The auditor recommended that the manager switch to a "zero balance account," whereby no funds would be carried in the account until a check was presented to the bank for deposit. The auditor also recommended that the checks, which contained ineffectual language intended to restrict endorsement, be revised by the legal department.

PORTLAND CHAPTER

AN INCENTIVE TO FUDGE

The service agreement between the organization and the contractor included two performance-based incentive clauses. The first was based on the cost per document processed, and the second was based on the cost per kilobyte transmitted. Achievement of both incentives would allow for an increase in the contractor's monthly pay.

While reviewing the incentive calculations, which were computed and submitted by the contractor, the auditor discovered that the contractor used estimated costs, rather than actual costs, in the calculations. The auditor also confirmed that the calculations were based on the calendar year, rather than the actual 12-month period specified by the contract. When the auditor recomputed the incentive calculations, she determined that total costs had been understated by $96,000.