New Phone Inc., a diversified manufacturer, has five divisions that operated throughout the United States and Costa Rico.

New Phone Inc., a diversified manufacturer, has five divisions that operated throughout the United States and Costa Rico. New Phone Inc. has historically allowed its divisions to operate autonomously. Corporate intervention occurred only when planned results were not obtained. The corporation’s management has high integrity, but the board of directors and audit committee are not very active. New Phone Inc. has a policy of hiring competent and aggressive people. The company has a code of conduct, but there is little monitoring of compliance employees. Management is somewhat conservative in terms of accounting principles and practices, but employee compensation packages depend highly on performance. New Phone Inc. does not have an internal audit department, and it relies on your firm to review the controls in each division.

Cheryl Smith is the general manager of the Intercept Division. The Intercept Division produces a variety of standardized parts for small smart phones. Smith has been the general manager for the last seven years, and each year he has been able to improve the profitability of the division. She is compensated based largely on the divisions’ profitability. Much of the improvement in profitability has come through aggressive cost cutting, including a substantial reduction in control activities over inventory. The periodic FIFO method of accounting for inventory is used.

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During the last year a new competitor, Deflector Inc., entered Intercept’s markets and has offered substantial price reductions, intense marketing and friendly customer service in order to grab market share. Smith has responded to the competitor’s actions by matching the price cuts and increasing customer service in the hope of maintaining market share. Smith is very concerned because he cannot see any other areas where costs can be reduced so that the division’s growth and profitability can be maintained. If profitability is not maintained, her salary and bonus will be reduced.

Smith has decided that one way to make the division more profitable is to manipulate inventory because it represents a large amount of the division’s balance sheet. She also knows that controls over inventory are week. She views this inventory manipulation as a short-run solution to the profit decline due to the competitor’s price cutting. Smith is certain that once the competitor stops cutting prices or goes bankrupt, the misstatements in inventory can be corrected with little impact on the bottom line.

Using bullet points evaluate the strengths of New Phone Inc.’s control environment. Using bullet points evaluate the weaknesses of New Phone Inc.’s control environment. What factors in New Phone Inc.’s control environment have led to and facilitated Smith’s manipulation of inventory.