ACC 591 Internal Controls Audit and Fraud Prevention & Detection 

Alchemy Inc. Case 
Fall 2018 
 
Alchemy Inc. Company Background 
Alchemy Inc. is a wholly owned subsidiary of Al Chem Corporation that is a non‐public entity. 
Alchemy Inc. recently issued public debt. The company is based in the US with a December 31 
year‐end that specializes in the processing of small gold spheres used in the aerospace industry. 
Alchemy processes approximately 60% of the spheres for Al Chem Corp. Alchemy is paid by Al 
Chem Corp. on a tolling basis which is calculated on the number of spheres processed. Revenue is 
recorded when the spheres are processed, not when they are sold. This is recorded as 
intercompany revenue on the books of both Alchemy and Al Chem Corp. Alchemy operates 
several factory locations, one in the US in Pleasantville, Michigan, and additional factories in the 
UK, India and Taiwan. Alchemy sells each sphere for $20,000 USD. Alchemy Inc. is the top sphere 
processor in the industry and also sells spheres to the US government and other aerospace 
contracts. Annual revenues are approximately $2 billion. Most customers for Alchemy spheres are 
based in the US and UK, but international sales are growing and are a steady focus for 
management’s five‐year strategic plan. 
Alchemy Inc. has an Internal Audit department that was recently put in place to comply with stock 
exchange rules. Internal Audit reports to the CEO. In 2006, when the present CEO took over, he 
dismantled the then existing Internal Audit department since he did not perceive that it added 
value. The newly formed Internal Audit department is comprised of three individuals, plus the 
director. The average number of years’ experience of this team is 2.5 years. 
Management of Alchemy Inc. has been preparing for their SOX 404 audit for several months. They 
have been signing their 302 and 906 certifications regularly. They have been working with you, the 
external audit engagement team, along the way. They are anxious now for the external auditors to 
get started auditing their controls and feel they have done an admirable job in preparing their 
documentation. They used a CAVR framework (introduced by the former Internal Audit Director 
based on his experience with one of the Big Four accounting firms) and have identified control 
weaknesses in the design of controls. They have documented the weaknesses and communicated 
them to the Audit Committee and the external auditors. 
Alchemy has a code of conduct and a whistleblower program in place. One call has occurred this 
year to the hot line regarding intercompany sales. No further details are available. 
 

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Alchemy Inc. Processing Description 
Alchemy spheres are processed using a five‐step process that includes a step called helixination. 
This process uses a spiral centrifugal micro‐sanding process which shapes the spheres to an exact 
specification. The helixination process is unique and management has applied for a patent. No 
other sphere processor has this technology, and Alchemy’s management believes this is the key 
differentiating factor to their process. 
Alchemy receives raw materials in four forms – large and small spheres, colored spheres, mostly 
green and gold in both sizes. A receiving clerk counts the spheres in the bags of raw materials as 
they are received. He compares the count with the receiving documents and records his findings 
on a log. He then moves the raw materials to the factory floor for the operator to process. Raw 
materials can only be obtained in this form. It is not possible to obtain pre‐color sorted spheres. 
The operator pours the raw materials into the holding bin. The processing begins by sorting out 
small spheres from large. Large spheres of both colors are then processed to be the correct small 
size in the curing process. Spheres entering this process pass through a contained canister. An 
operator cures the spheres by turning a crank. A counter attached to the crank tabulates the 
number of times the curing process is started. Each turn of the crank cures one large sphere 
turning it into a small one. There is no waste in the process. All large spheres are cured in this 
process. Once the large spheres are cured, all move on to the color sorting process. Small spheres 
of both colors, and therefore the correct size, pass this process and move directly to the color 
sorting process. The operator turns in the count of cured spheres daily to management. 
In the color sorting process, the operator manually sorts green spheres from gold ones. Gold ones 
are counted when the operator “clicks” a manual counter as they pass to the helixination process. 
Green ones are placed in a “non‐spec” receptacle and sold for $2,000 each. The operator manually 
counts the greens spheres, which are picked up by the shipping clerk daily. The shipping clerk 
counts them again as they are packed for shipping. 
Once the gold spheres have been helixinated, they are counted again by an automatic counter. 
The counter is a laser operated apparatus that counts the spheres that pass out of the helixinator 
and into a container. From the container, the spheres are prepared for shipping. The tolling 
revenue is recorded based on the number of spheres counted by this final counter. 
Once counted, management reconciles the count of spheres input at the beginning of the process, 
to the sum of spheres in the non‐spec receptacle and the spheres counted by the final counter.  
Spheres are valued at $20,000 each, and Alchemy process yields about a 7% output based on the 
inputs received. 

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Alchemy Inc. Audit Committee Policy 
1. The Audit Committee is independent from management. 
2. Three of the six Audit Committee members own no shares Alchemy Inc. 
3. None of the Audit Committee members serve on the Audit Committees of other public 
companies. 
4. The Audit Committee charter meets all NYSE requirements. 
5. The Audit Committee meets with their external auditors at least quarterly and signs the 
Engagement Letter. 
6. Internal Audit reports to the Audit Committee who determines the compensation and 
monitors the Internal Audit plan. 
7. Two Audit Committee members are considered “financial experts.” 
8. The Audit Committee minutes reflect timing of the meetings, review of the financial 
statements and a discussion of any unusual transactions. 

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Alchemy Inc.
 
Internal Audit Report
March 9, 2018

Audit Objective:
As previously communicated to the Audit Committee, we will undertake an audit of the company’s
compliance with hiring and promotion policies as documented in HR Policy # 404. As such, we will
audit compliance with HR Policy # 404 as it relates to factories located in the US and Taiwan
during the calendar year 2017. Also, at the specific request of Chris B. Ready, CEO, we will also
conclude on the locations’ readiness for management’s assertions for Sarbanes-Oxley section 404.

The audit took place between January 7, 2018 and February 26, 2018.

Our audit procedures were designed to address the following significant issues related to HR policy
# 404:
1. HR Policy # 404 requires a background investigation for all employees hired in key
operational and financial statement roles.
2. HR Policy # 404 requires a physical examination, inclusive of an eye examination, for all
management personnel and factory workers prior to hiring.
3. Confirmation of previous employment history.
4. Valid social security card for US employees.
5. Annual employee performance evaluation.
6. Promotions approved by regional operations manager for factory employees.
7. Completion of code of conduct compliance and conflicts of interest.
8. Execution of product confidentiality agreement.

Testing Criteria:
During the period of our last audit in this area related to HR Policy # 404 (last audit performed was
in fiscal 2005) the US factories and factories in Taiwan had new hires of 400 employees and 65
promotions. We judgmentally selected 12 new hires and 4 promotions for testing and compliance
with HR Policy # 404 – 6 employees in the US and 10 employees in Taiwan. We could not
physically travel to Taiwan, so we requested copies of personnel files for testing.

Procedures performed were as follows:

1) Verification of background checks – made sure background check report was in file.
2) Verification of obtaining medical records – made sure medical records were in files.
3) Determined that the files included information of previous employment history.
4) Examined copy of social security card.
5) Verified that file indicates that performance evaluation has taken place within the past year
and that such evaluations support promotion, as appropriate.
6) Verified that employee has read the code of conduct and signed the confidentiality agreement
through discussion with HR Manager.

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Findings:
HR Policy # 404:
Based upon the audit work performed, we have concluded that on an overall basis the US and
Taiwan factories have complied with HR Policy # 404. It is noted; however, that at the factory
location in Pleasantville, Michigan, we noted that the one of the plant operators, C.J. Ready – hired
May 15, 2010, did not have a completed medical file pursuant to HR Policy # 404. While there was
a record from the attending physician on the physical examination, the eye examination record
could not be found – although there was a slip of paper indicating that the form had been checked
out. We discussed this matter with the plant manager and were informed that this must be an
isolated incident as all medical records are reviewed and approved prior to hiring – furthermore,
C.J. Ready has 20/20 vision. Since we did not find any other exceptions, we conclude that this is an
isolated incident and in fact there was an indication that the record had been checked out, therefore
we do not take exception to the missing record of exam.

While we did not note exceptions to promotion procedures, we did want to point out that Joe Bozo,
supervisor of quality control and output reconciliation, was promoted to this position on June 1,
2015, only after being with the company for three months. Because of the short duration of
employment, there was not a record of performance evaluation in his personnel file. We also want
to mention that the background investigation of Mr. Bozo was not the original but rather a copy.
We discussed this matter with Ben Eze, regional operations manager, and he assured us that he had
personally been consulted on this promotion, and while not having met Mr. Bozo, saw no reason
not to promote him. Mr. Eze indicated that there had been a freeze on external hires at this time and
due to a vacancy in this position when Ms. Rightway, prior supervisor of quality controls and
output reconciliation had resigned, the factory had to promote from within and Mr. Eze seemed like
the logical person. We do not take exception to this matter as it seems to be an isolated incident.

Audit Conclusions:
For the time period selected and the locations subject to testing we believe that controls and
procedures surrounding HR Policy # 404 are being adhered to.

Commentary on Sarbanes-Oxley 404:

We have reviewed the documentation of design of internal controls and have performed certain
testing of operating effectiveness at both the US and Taiwan factories. Based on the results of our
work (see appendix A), we believe that internal controls are properly designed and are operating
effectively.

Pat B. Wright
Director, Internal Audit
March 9, 2018

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Appendix A - Sarbanes-Oxley Testing Results/Observations

1. Some documentation was difficult to review, but it was apparent from discussing with
employees and our knowledge of the business that the company does have sufficient processes
documented. Immaterial for further work.
2. We noted that the US factory had not calibrated the quality sensors in the helixinator since
May 2016. The sensors provide an accuracy control over gold spheres ensuring they meet
specifications. However, since there have been no returns or exceptions noted, further work is
waived.
3. The Pleasantville factory has not reconciled certain count meters in several months (last
reconciliation was June 2016). We asked J.E. Entrie, CFO, about this matter and were told
that there haven’t been any adjustments to revenues in years and she was not too concerned
about this matter. J.E. Entrie did indicate that she would look into this matter and did not
believe that this matter was material. Considered an isolated incident.
4. At the Pleasantville factory, the entrance gates did not have locks.
5. Joe Bozo’s prior work experience was limited to working at the local county fair as a booth
operator.
6. Had Internal Audit checked into this matter in greater detail, they would have learned that Ms.
Rightway, in her exit interview, had made an anecdotal comment regarding input/output
reconciliations not being performed timely, but no further action had been taken by the HR
manager.
7. The memo prepared by the director of Internal Audit raises questions about the effectiveness
of the Audit Committee.

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Alchemy Inc. 
FILE MEMORANDUM
FEBRUARY 28, 2018

On February 27, 2018, I met with Chris B. Ready, CEO of Alchemy Inc. The purpose of this
meeting was to review with Chris the draft report of our recently completed audit of HR Policy #
404 compliance at the company’s US and Taiwan factory locations. I had concerns over some of
the audit team’s findings and wanted to explore those findings with Chris prior to completion of our
report. I thought that certain of our findings should be brought to the attention of the Audit
Committee and our external auditors. Since I report directly to C. B. Ready, I believed this was the
appropriate thing to do.

After I reviewed my findings with Chris, I was informed that “these findings must be contained.” At
first, I didn’t understand as I always was of the opinion that our company’s leadership fully
supported “doing the right thing.” Chris indicated that he had been getting quite a bit of “flack” from
the board and especially the Audit Committee to “get this Sarbanes matter right at any cost.” Chris
also indicated that he had been assuring the Audit Committee that there was nothing to worry
about – in fact he said that he had been signing the quarterly 302 and annual 906 certifications
regularly and that this report could possibly call into question many “unpleasant” consequences.

He said that he did not view any of the findings as significant and that he did not want the appendix
attached to the report and to modify the report language. I did not know what to do. This was my
direct supervisor telling me to intentionally alter our audit findings.

This memo is prepared to memorialize my meeting with Chris B. Ready and to document the fact
that I intend to report this matter through the company’s hot line. I do not know what else to do. I
feel like the Audit Committee “tolerates me” and so I don’t think I can turn to them. I just hope that
someone picks this matter up off of the hot line. I feel like there is so much pressure on me to
make it look like the company’s controls are something other than what they are. But I need the
job. The hot line call should take care of matters.

Pat B. Wright
Director, Internal Audit
February 28, 2018
 
 

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