Case 1.14 Navistar International Corporation

Case 1.14 Navistar International Corporation

Similarities and differences between management’s and the external auditor’s reporting responsibilities on internal control of public companies.

The external auditor is responsible for communicating to the audit and the management committee about any considerable deficiencies and weaknesses recognized during the auditing procedure. The internal auditor does the management’s audit. The internal auditor has a responsibility to inform the audit committee whether the internal control system is adequate and effective.  However, both have to submit written reports following professional standards. Again, both are supposed to give recommendations about any relevant issues identified in the scope of their work.

A considerable deficiency is a blend of control deficiencies, which harmfully affects the company’s capacity to approve, commence, process or document external financial data consistently in agreement with generally established accounting principles. When the control design does not allow management and employees, in the usual course of undertaking their assigned functions, to avert or notice misstatements in an appropriate basis a control deficiency is said to exist. A deficiency can be in design or operation. A design deficiency exists when an already existing control is not well designed while an operation deficiency exists when a well-designed control fails to operate as designed.

A possible weakness is a noteworthy deficiency, or a combination of noteworthy deficiencies, that may result in secluded possibilities that a possible misstatement of the annual financial reports will not be barred or detected. A good example exists when only one person controls the payroll system. It is impossible to detect any misstatement.

There were several weaknesses identified in the internal controls of Navistar’s 2005 10-K. The most important weakness reported was control environment. There was no strong application of ethics in all areas of the company especially in the internal control over financial statements. Lack of ethics in any business area is very dangerous. Failure to follow set rules and guidelines will result to misstatements as in the case of Navistar. Another important weakness identified in Navistar was the use of outdated accounting policies. The company did not have a formalized system to monitor, update, disseminate and implement GAAP-compliant accounting procedures and policies.

Another identified weakness was that the internal audit was not effective in monitoring financial reporting (Knapp 187). The internal audit is meant to determine the effectiveness of the internal control system. An effective internal audit will lead to an effective control system.  Again, duties were not adequately segregated in Navistar. In such a case, it is easy for employees to steal from the company and update the accounts to cover up the theft. Lastly, accounts reconciliations were not well maintained. This makes it hard to detect or prevent any embezzlement of funds from the company.

 

Is it possible for a company with such poor internal controls to be audited?

A company with such poor internal controls will have unreliable records. Auditing relies on records and people. It is agreeable that the employees in such a company will also not be reliable. This makes it hard for an external auditor to correctly undertake auditing. With such poor controls, the auditor will not be able to detect or unearth any fraudulent activities going on in the company. The audit report will be a misrepresentation of the company.

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