Case Study: Tarheel Textiles (4 pages) (The IIA Research Foundation, Case Studies in Internal Auditing, Volume 4, 2004) Objective This case study is designed to expose students to a variety of conditions that may or may not indicate a fraud has been committed. Consideration must be given to errors that are present in a normal business environment, internal control weakness accepted by management, as well as obtaining an understanding of procedures and their long-range effect on business. Students need to understand the overall control environment and not just deal with individual procedure errors.   Required Please read all of the requirements carefully. Make sure your paper addresses each item.  Please edit and proofread your paper. It represents 25% of your course grade. This assignment is to be completed using only the materials authorized for use in this class. If you have any questions as to what is expected, please contact the instructor.  1. If you were part of the audit team, what additional questions would you ask to gather more audit evidence? . You need to focus on what is most important to this case which is how to improve the process and secondly to render an opinion on whether a fraud has been committed. You must come up with at least 15 relevant questions. You must indicate what you hope to learn from each question (i.e., what is the intent of the question) and to whom the question would be addressed.   Parts 2-3 must be written as a formal audit report. Assume you are writing your report for senior management and the audit committee of the board of directors. There are many different ways to write an audit report. You are free to choose a format which works for you. In addition to the readings and discussion in week 7, you may want to view actual audit reports on www.gao.gov or a state web site and sample audit reports on KnowledgeLeader or AuditNet. 2. What is your overall conclusion concerning the internal controls over the Loom Reclamation Program? In your opinion, has a fraud been perpetrated?  If so, what evidence supports the allegation?  Is it firm enough to convict the person(s) in court?  Please explain the rationale for your conclusions.   3. What are the ten most significant internal controls weaknesses in the Loom Reclamation Program? Give it a lot of thought. You need to write an audit comment for each item which includes your recommendation.   When you describe an internal control weakness, make sure your intended audience will be able to understand it (i.e., senior management).   Background Many of Tarheel Textiles' old Draper looms have recently been replaced with more modern and efficient weaving machines. Instead of being junked or scrapped, these surplus looms are sent by the plants to the Supply Support Division where they are stripped of all useable parts. These parts are reconditioned, stored, and placed on perpetual inventory records as used supply items. Manufacturing facilities within ...

1. Case Study: Tarheel Textiles (4 pages)
(The IIA Research Foundation, Case Studies in Internal
Auditing, Volume 4, 2004)
Objective
This case study is designed to expose students to a variety of
conditions that may or may not indicate a fraud has been
committed. Consideration must be given to errors that are
present in a normal business environment, internal control
weakness accepted by management, as well as obtaining an
understanding of procedures and their long-range effect on
business. Students need to understand the overall control
environment and not just deal with individual procedure
errors.
Required
Please read all of the requirements carefully. Make sure your
paper addresses each item. Please edit and proofread your
paper. It represents 25% of your course grade. This assignment
is to be completed using only the materials authorized for use in
this class. If you have any questions as to what is expected,
please contact the instructor.
1. If you were part of the audit team, what additional questions
would you ask to gather more audit evidence? . You need to
focus on what is most important to this case which is how to
improve the process and secondly to render an opinion on
whether a fraud has been committed. You must come up with at
least 15 relevant questions. You must indicate what you hope to
learn from each question (i.e., what is the intent of the question)
and to whom the question would be addressed.
Parts 2-3 must be written as a formal audit report. Assume you
are writing your report for senior management and the audit
committee of the board of directors. There are many different
ways to write an audit report. You are free to choose a format
which works for you. In addition to the readings and discussion

2. in week 7, you may want to view actual audit reports on
www.gao.gov or a state web site and sample audit reports on
KnowledgeLeader or AuditNet.
2. What is your overall conclusion concerning the internal
controls over the Loom Reclamation Program? In your opinion,
has a fraud been perpetrated? If so, what evidence supports the
allegation? Is it firm enough to convict the person(s) in court?
Please explain the rationale for your conclusions.
3. What are the ten most significant internal controls
weaknesses in the Loom Reclamation Program? Give it a lot of
thought. You need to write an audit comment for each item
which includes your recommendation. When you describe an
internal control weakness, make sure your intended audience
will be able to understand it (i.e., senior management).
Background
Many of Tarheel Textiles' old Draper looms have recently been
replaced with more modern and efficient weaving machines.
Instead of being junked or scrapped, these surplus looms are
sent by the plants to the Supply Support Division where they are
stripped of all useable parts. These parts are reconditioned,
stored, and placed on perpetual inventory records as used
supply items.
Manufacturing facilities within Tarheel route all of their
purchase orders for Draper loom parts through the Supply
Support Division. This includes orders made out to Draper
Company and all other vendors from whom Draper parts can be
purchased. Supply Support reviews its inventory records (and
will hold the order for no more than one day) to determine the
availability of used parts generated from the loom stripping
program. If parts are available within Tarheel, the purchase
order to the vendor is altered and the Supply Support Division
ships the available parts automatically to the ordering plant.

3. The altered purchase order is then sent to the vendor.
This program has resulted in substantial savings to Tarheel.
Also, many of these older parts are in short supply and are,
therefore, difficult to obtain within a reasonable delivery
time.Operation
The Loom Reclamation Program operates as follows:
Receiving
1. Plant sends to the Supply Support Division all surplus Draper
looms. These looms may or may not be operative, but would
have been scrapped at the plant, or otherwise disposed of, had
they not been shipped to Supply Support.
2. Plant prepares a shipping document, which accompanies each
shipment of looms. This shipping document lists each asset
shipped, identified with the Tarheel fixed asset tag number.
3. The shipping plant prepares the necessary reports to transfer
these surplus items to the Supply Support Division fixed assets
ledger.
4. The looms are transferred, unloaded, and placed in a 3-1/2
acre fenced-in field.
5. Shipping documents are sent to the administrative office,
where looms listed on the shipping document are compared to
the quarterly printout received from Corporate Accounting
which lists all assets transferred to Supply Support during the
quarter.
6. The administrative area keeps a manual listing of looms.
This list is reconciled quarterly with the computer-generated
fixed asset ledger received from Corporate Accounting.
Loom Teardowns
1. Looms are torn down daily (as many as time permits). The
teardown process includes:
- Removing the Tarheel Textile asset tag number.
- Stripping the asset of all useable parts.
- Reconditioning these parts.

4. - Storing any salvageable metal and the residue (or carcass) in
a central area. The residue is usually the loom frame and some
useable pieces of metal.
2. A Loom Teardown Report is prepared weekly. The report
lists by identification tag number each loom torn down during
the week. Sometimes, however, tag numbers are missing
from the looms--many of the looms are old and thus the tags
have been jarred loose or have fallen off during shipment.
3. This report is sent to the Administrative Office where it is
used to authorize removal of these looms from the fixed assets
accounting records. The tag number identifies assets on the
ledger.
4. The loom parts salvaged as a result of the loom teardown are
collected. A quality control person reviews each part to
determine whether it is reusable as is, needs to be
reconditioned, or should be sold as scrap metal. The reusable
parts are eventually sent to the Supply Room and placed on
perpetual inventory records for accountability.
Sale of Reconditioned Loom Parts
Written Customer Orders:
1. The computer generates a shipping document based on a
written customer order. The customer may be a Tarheel Textiles
plant or another company.
2. The shipping document is reviewed in the Supply Room. If
inventory records indicate reconditioned Draper loom parts are
available in bins, these parts will be used to fill the order. If
inventory records show no parts available, the Supply Room
Clerk copies these part numbers/descriptions on a sheet of

5. paper.
3. This sheet of paper goes to the Loom Teardown Supervisor.
Crewmembers will go out to looms in the field and strip the
needed parts from the looms.
4. These parts are sent to the Supply Room, along with the piece
of paper, for review and to make ready for shipment.
5. The Shipping Supervisor loads goods onto the truck. He
checks against Notice of Shipment to assure accuracy of
loading.
6. The loaded truck leaves premises.
Telephone Orders:
1. Verbal orders received from customers, either by the Supply
Room or the Loom Teardown Supervisor, are handled similarly
except that no written customer order exists. All information is
written on an order form.
2. The two supervisors coordinate selection of parts, either from
Supply Room bins or stripped from looms in the field.
3. After the parts have been pulled and the order is ready for
shipment, the Supply Room Supervisor contacts the
Administrative area so that a shipping document may be
prepared, based on the items listed on the order form.
4. The shipping document is sent to the Shipping Supervisor.
5. The Shipping Supervisor loads goods onto the truck. He
checks against the Notice of Shipment to assure accuracy of
loading.
6. The Shipment leaves the premises by Tarheel Textile truck,
customer truck, or common carrier.
Disposal of Residues and Scrap Metal
1. The Loom Teardown Supervisor usually receives customer
orders verbally. Johnstone & Company is the primary customer
to whom Tarheel sells loom residues and scrap metal. A
company representative will often come to Tarheel, select loom
residues and scrap parts he wants to purchase from those
available, and supervise the loading of his truck.

6. 2. The Loom Teardown Supervisor calls the Administrative
Area and requests a shipping document be prepared since
Company policy prohibits any vehicle from leaving the premises
without a Notice of Shipment. The Supervisor gives the office
all the information necessary to prepare the document.
3. The truck leaves the premises from the loom field through the
main gate.
Situation
1. The Telephone Call
Mr. Arthur Thomas, the buyer in Corporate Purchasing
responsible for the disposal of Tarheel Textiles' surplus assets
(including the sale of all parts from the Supply Support
Division), received a telephone call from a person who stated he
had previously worked for Tarheel Textiles. The caller alleged
that the Supervisor of the Loom Teardown Program at Tarheel's
Supply Support Division was instructing employees to locate
64" X-3 Draper looms and load them onto trucks without a valid
customer order. The caller, who refused to identify himself,
stated he had been fired from his job at the Supply Support
Division because he "knew too much about what was going on."
Mr. Thomas contacted the Director of Corporate
Purchasing (his superior), the Supply Support Division Manager
and Director of Corporate Security. An investigation ensued,
and the information on the following pages was obtained from
various sources.
A Corporate Security investigator visited the Supply
Support complex. The security survey disclosed that:
a. The entire area was fenced, and the fences were in good
repair.
b. The main entrance gate and the gate to the field of looms
could be locked.
c. The field of looms was located approximately 400 feet from

7. the main gate. Surplus electric motors had also been placed in
this field.
d. Administrative/Accounting Offices were located directly
across from the loom field.
e. No safety or fire hazards existed.
f. No security persons, guards, or watchmen were used at the
site.
g. The main gate opens onto a relatively busy intersection.
A review of the Supply Support Division personnel records
revealed that only one person had been involuntarily terminated
since the inception of the Loom Reclamation Program. The
security investigator contacted this individual and reported he
firmly believed that this person did not place the telephone call
to Mr. Thomas. In addition, in order to facilitate his
understanding of the situation, the investigator obtained the
Organization Chart.
2. The Loom Teardown Crew
While at the location, the Corporate Security investigator
interviewed some of the members of the Loom Teardown Crew.
Leon Curtis, a crewmember, spoke first. Leon, now a part-time
employee, is a retired loom mechanic from a nearby Tarheel
plant and has been employed by Tarheel for 35 years. "Every
day Shaw (Loom Teardown Supervisor) had us looking all over
the field for 64" X-3 Draper looms. And that's no easy job
either, especially when the looms are stacked on top of each
other, so close together and 8 or 9 in every row. He wouldn't
tell us why and wouldn't ever take `no' for an answer. None of
us knew of
any customer order for those looms. We would load the looms
onto a truck with other items Johnstone wanted--loom residues,
scrap parts, and sometimes even reconditioned parts. Johnstone
kept a truck in the Loom Teardown Area between pick-ups. We
loaded scrap metal onto his truck each day. A fellow from
Johnstone & Company would come by, usually every Friday.

8. He would look over the parts on the lot for anything else he
wanted to buy and would exchange trucks."
A second crewmember, Harvey Jolly, appeared somewhat
ill at ease. He was a lanky fellow with thinning hair, about 45
years of age. He was constantly smoking a cigarette. Harvey
said, "I've thought something crooked was up for quite a while,
ever since Bob Johnstone started coming over here occasionally
instead of the usual guy. A couple of times Shaw and Johnstone
would leave for lunch in Shaw's Corvette, and they wouldn't
come back until 3:00 p.m. No, you can't tell me something
wasn't happening."
Danny Burton, a young crewmember about 19 years old,
interjected, "We aren't the only ones who knew something
wasn't right. Ask Clark Danley (a Supply Support Division
Engineer). He can tell you a lot more than we can. Anyway,
I've always wondered why Tarheel Textiles would even think
about hiring somebody with a criminal record."
Harvey Jolly spoke again. "It's difficult keeping up with
all these parts, especially when you tear down as many as 12 or
14 looms a week. Take the brass, for instance. We put all the
brass pieces in separate baskets, and entire baskets will
sometimes disappear during weekends. We try to keep track of
all the parts, especially after we steam clean, repair, and repaint
them. But with so many parts, it's really hard."
Leon Curtis said, "We're really glad to be able to talk to
you about this. We've been talking about it among ourselves
but didn't know whom to turn to. It just isn't right for us to
work hard and try to do the best we can at our jobs, when
somebody else is doing just the opposite."
The Security investigator thanked each crewmember for
his cooperation and urged them to contact him if they thought of
anything further.

9. 3. Alan Shaw
The Security investigator and Supply Support Manager
interviewed Alan Shaw, the Supervisor of the Loom Teardown
Program. Mr. Shaw is 36 years old and married. He and his
wife are expecting their second child shortly. Shaw is a very
outgoing and congenial person and makes friends easily. Many
have said Shaw is a "natural" manager and works well with
people. Past performance evaluations have indicated that his
only shortcomings are his impatience and quick temper.
When confronted with the charges, Mr. Shaw denied any
wrongdoing and demanded proof of the allegations. Shaw said,
"I've always followed established procedures and tried to do
things properly. But you just can't watch everybody all of the
time, and I trust my employees to do the right thing." Shaw
stated, "I've never had any trouble in the three years I've
worked with Tarheel Textiles or with anybody I've ever worked
for. I'm a hard worker. You know I've worked a lot of overtime
hours in order to get the job done. I even had to request gate
keys so I could work at night in order to keep up with my
workload. I would be foolish to do anything to jeopardize my
career with Tarheel, especially since my family and I have just
moved into a new house."
Two days later Mr. Shaw requested a meeting with the
Supply Support Manager. Shaw stated that this situation had
cast suspicion upon him, that his employees could never have
confidence in him again, and that he wasn't sure he wanted to
work for a company that would accuse him of such things. Alan
Shaw asked to be suspended of all job responsibilities, pending
the result of the investigation.
The Supply Support Manager was disappointed; he thought
Mr. Shaw had always performed well, had a lot of potential, and
was a "diamond in the rough." But he had no alternative but to

10. suspend Mr. Shaw.4. The Johnstone & Company Visit
Mr. Arthur Thomas, Corporate Buyer, and a Corporate
Security investigator visited Johnstone & Company for the
purpose of interviewing key employees who might provide
pertinent information. Johnstone & Company was the customer
to whom the majority of loom residues and surplus loom parts
were sold. The company deals primarily with the sale of scrap
and junk metal, but also markets converted looms and other
textile machinery.
Because of their long-standing business relationship,
Arthur Thomas asked to speak privately with Mr. Gordon
Johnstone, President of Johnstone & Company, before the
Security investigator questioned him. After a 45-minute
discussion, the Security investigator joined them.
Mr. Johnstone vehemently denied knowledge of any
wrongdoing. He stated he had not given any financial
inducement to Tarheel employees for shipping any completed
looms or other parts. He said, "Loom residues and scrap parts
are brought onto my lot in a Johnstone & Company truck from
Tarheel Textiles. The items are unloaded and placed in the
"junk field" with all other scrap metal. We don't check each
item received to an invoice from your company. We just don't
have the time and don't consider it necessary. I have been
conducting business with Tarheel Textiles for over 10 years,
and our methods and approaches have never been questioned.
Our ethics, I assure you, are above reproach."
The investigator asked to speak with Mr. Johnstone's son,
who was associated with the business as a Vice President of
Sales. Mr. Johnstone replied, "Bob is not here at present;
however, I see no reason for your talking to him. No member of
my family has ever been associated with any disreputable
business transaction. My son and I are both active members of
local civic organizations. Your innuendos are not appreciated,
and I don't think we have anything else to discuss."

11. Mr. Thomas and the security investigator thanked Mr.
Johnstone for his assistance. As they were leaving, the
investigator noticed that the Draper identification plates had
been removed from some of the Tarheel loom residues on the
lot.
5. The Inventory
Corporate Security reviewed its findings to date with the
Director of Corporate Purchasing and the Supply Support
Manager. All concurred that a physical inventory of looms in
the field needed to be taken. Written procedures were
developed and included the following:
a. The inventory would be taken by total count only, not by
individual type/size loom. An exception was that all 64" X-3
looms would be identified separately.
b. Each loom would be tagged when counted.
c. The total number of looms in each row was to be written on a
separate tag and attached to the loom at the end of each row.
d. All tags must be accounted for.
e. Instructions were to be discussed with all persons
participating in the inventory-taking process prior to starting.
Approximately 2,700 looms were counted, and 42 man-
hours were needed to take the inventory. Reconciliation of the
overall physical count to quantities on inventory records
disclosed a net shortage of 59 looms. (There was a 72-unit
shortage of looms that had not yet been stripped. A gain of 13
looms residues was disclosed.)
The variance relating to 64" X-3 looms was isolated:
34 looms on inventory records
(5) looms on hand in field
29 loom shortage

12. 6. The Inventory Record Review
The Administrative/Accounting Office also did some
investigative work:
a. A reconciliation of loom residues invoiced since inception of
the program (approximately 24 months) to looms removed from
the fixed asset ledger, taking into consideration residues
currently on hand, revealed a shortage of 38 looms.
b. Accounting personnel stated that the possibility of poor
record keeping, especially in the first months of the program,
and inaccurate preparation of Loom Teardown Reports could
explain a portion of this variance.
c. Sixteen Tarheel Textile fixed asset identification tags were
located in Mr. Shaw's desk drawer and toolbox. These appeared
to have been accumulated over a period of time. Accounting
personnel traced these tag numbers to the fixed asset ledger: all
numbers were identified with 64" X-3 Draper looms.
d. No customer invoices for brass had been issued during the
last 12 months.
e. No 64" X-3 Draper looms were listed on shipping documents
which supported shipments made during the last six months.
7. Other Pertinent Information
The average market value for these Draper looms is $750.
Converted looms can sell for as much as $7,500. The value of
parts varies, but ranges from $2 to $70. Johnstone & Company
has been paying Tarheel Textiles $75 to $100 for each loom
residue purchased.
a. Approximately two pounds of brass can be salvaged from
each stripped loom. This brass can be sold to a local dealer for
53 cents/pound.
b. The 64" X-3 Draper loom parts may be used in converting
looms to air-jet looms, which are more efficient and utilize
newer technologies.
c. In recent months, Johnstone & Company has also been

13. purchasing reconditioned loom parts in addition to scrap metal.
d. Cathy Shaw, wife of the Draper Area Supervisor, works as a
billing clerk in the Supply Support Accounting Office.
e. Leventhal Parts & Supply Company also purchases a small
percentage of loom residues and unusable parts, but only offers
Tarheel Textiles $50 per residue.