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Table of Contents

Financial analysis of the “Competition Bikes Inc.” company – Part 5


A.3. Risks

In situations wherein loop holes are found in internal control procedures, risks emerge eminently with cases of fraud flooding the industry because of weak internal control measures. In the given scenarios by which the company (Competition Bikes Inc.) implements an order about purchasing procedures, it evidently has a lot of factors missed out in the process. The risks of fraudulent activities may arise if those problem areas were not addressed accordingly. Fraud may come in many forms, one is the concerned individuals in accounting, purchasing and even the inventory department may commit fraud by means of intentionally manipulate financial statements, inventory data and change price information on invoices. Those are happening for real in many companies and CBI would be a victim of fraud if they will not improve their internal control process.

The fraudulent activity within the company is because of corruption among the employees is a higher cost of capital and lower stock price. This will affect the company's performance in the a long-term because the data needed on the financial statements were inaccurate, investors rely on financial statements in decision making and if the statement appears to be suspicious of fraud, chances are the investors will pull out from the company. Losing one investor will push the company to operate on a higher cost of capital and struggle to keep up with the finances during the operation. The capital market largely values internal control, if the company such as CBI loses integrity because of reporting fraudulent activities within the company along with weak internal control, will see a decline in average share price by as much as 5.7% according to Audit Integrity News (Section 404, May 16, 2006). What an unprincipled employee may take advantage of in this case is the opportunity to gain profit by means of selling of, unrecorded inventories and perhaps getting commissions for conspiring with the suppliers.

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A.3.a. Risk Mitigation

Because of the possible risks that would arise caused by weak internal control, different mitigation approach is necessary to minimize the damages. Risk management is the art of determining the level of which the risk could be controlled. The goal is not really to totally eliminate because risks are somehow persistent in nature and the only way to avoid the damages it may cause is to devise effective measures of control. Through careful analysis and evaluating exposure to risk would enable CBI to come up with cost effective ways of mitigating them. One mitigating technique is to create structures IT system that will manage all transactions and records in a sound secured environment and equipped with secured processes that will ensure data accuracy and integrity.

From the solutions presented in A.3.a Section, a data encoding system was mentioned that will keep a real time tracking of information from the time the materials were ordered until the left over materials were accounted. The importance of keeping as accurate data as possible in those operational procedures is for the company to easily determine efficiency of the production department in handling materials based on reported spoilages. Accuracy of information from purchasing order to inventory also enables the management in determining next month's budget on how much materials are needed considering the amount left in the inventory.

If inaccurate inventory was not entered into the system, the company would end up allocating budget for materials not knowing that the inventory house enough to cover a percentage of the needed materials for the following month, knowing all these things entails savings for the company and better cost control. Another way in mitigating risk is to implement strong corporate policies pertaining to the personnel's, work procedures, operational procedures, dual control and segregation of duties. In terms of policies CBI's purchasing procedures clearly had loopholes in it, especially when it comes to supplier selection, there should be a complete process work flow that should be followed in order to obtain only the most qualified supplier's.

Designation of duties as suggested in A.3.a section mentioned appointing only a particular person in the department to handle the task to eliminate confusion and miscommunication and most importantly avoid conflict of interest. Dual control refers to involvement of several departments and the decision should not only be limited to a single person which is the purchasing manager. By doing so, the responsibility is being shared across the key members of the management, that whatever the outcome of the management's decision good or bad will only be suffered to resolve by a single person but everyone who is responsible in making such decision, team work is the key element in this factor. Another way to mitigate the problem is to create a proper workflow, workflow ensures accuracy the processes were more defined. By following a concrete workflow, everyone and every department would be able to easily adapt into the system which will direct them into a more precise work pattern and therefore entails efficiency on all work outputs.

A.4. Sarbanes Oxley Compliance

Just a short background, Sarbanes and Oxley is congressional act enacted 2002 and it is mandatory for small and large businesses to comply with. This act was made to impose regulation and best financial practices for better corporate governance (, n.d.).

A.4.a. Compliance

Basically the rules of Sarbanes and Oxley Act is to ensure efficacy of internal control used by the company. In the internal controls statement, Competition Bikes Inc. only mentioned ensuring adequacy of internal control system but did appears to be not in compliance in one of the Sarbanes and Oxley Act provisions in submitting a proof of such adequacy. What needs to accompany the financial statement is not the internal control report but rather a signed statement of the company executives certifying the accuracy of the financial statement based on the internal control system standards because this is the focus of section-302 of Sarbanes and Oxley Act.

If the financial statement was not certified by the higher executive to be accurate, it means material weakness is at hand. Material weakness refers to the misstatement that may occur in the financial report. Meaning if the company has a strong internal control system, then the external auditor would be confident that the financial statement is accurate. Any irregularities in internal control occurs, it constitutes material weakness. This would lead to material misstatement and inadequate financial statement. Having said that, problems with CBI's internal control in terms of purchasing process and procedures is evident. The earlier sections of this paper tackling the area of purchasing presented a lot of weakness in internal control, therefore if not corrected will result to material weakness. Because of CBI's inadequacy in terms of internal control they did not only allowed risk to emerge but they are also subject to non-compliance violation of the Sarbanes and Oxley Act.

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A.4.b. Non-compliance actions

To bring CBI into compliance, it is better to ensure first that the IT system is well equipped with the necessary systems dedicated to making a link between purchasing, finance, production, inventory and accounting. The system would enable a more credible material for the company in financial reporting, thus complying with Sarbanes and Oxley acts would be much easier. Company policies will be reviewed including the business processes to seek loopholes and amended as needed to be aligned with the Act's policies. Once the IT system has established their part in the changes, the next thing is to implement the amended policies. Proper channeling of the information should be observed so that only the concerned individuals would have an access to delicate information regarding the changes in the procedures; otherwise it will result to the same problem with information security. The changes have to be evaluated in order to determine workability.

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