Midwest Computer Components Inc. 08.07.

01

CASE STUDY NO. 08.07

MIDWEST COMPUTER
COMPONENTS INC.
Julie Joy was driving on Interstate 80 to get to her office in downtown Omaha and was
thinking about her visit to the Wichita plant scheduled for the next week. Just two weeks ago, she
had taken over as the Director of Internal Audit at the Midwest Computer Components Inc. (MCC).
Ms. Joy has nine years of internal auditing experience and holds both the CPA and the CIA
certificates. The previous internal audit chief had quit the job recently, citing lack of support from
the operating management. However, the Board of Directors assured Julie that she would receive
full support and co-operation from the Board and the operating management.
Midwest Computer Components Inc. manufactures computer monitors, keyboards,
computer boxes (both tower and desktop), and modems (both external and internal). These four
products are sold all over the nation and in a few overseas markets as well. Gate 2000, ZS Systems,
and DL Computers account for almost 50 percent of MCC's sales and the remaining sales are made
to other smaller computer manufacturers, specialty computer stores, mail order firms, and regular
retail outlets. MCC operates plants in Omaha, NE, Eagan, MN and Wichita, KS in the U.S. and
four years ago, a fourth plant was opened in Mexico City to take advantage of the inexpensive
labor available in Mexico. Ninety percent of the items manufactured in Mexico City are shipped
back to the U.S. and the remaining ten percent are sold in Mexico. MCC advertises its products in
computer magazines and on the Internet. It also advertises over the television to a limited extent.
Its stock is traded on the American Stock Exchange, under the ticker symbol MCCINC.
A total of 900 plant workers and 15 supervisors are employed in the three plants at U.S.
sites and another 360 workers are employed in Mexico. The U.S. workers are affiliated with the
Associated Computer Component Manufacturers Union. An office staff of 40, a sales force of 20,
five managers, and a purchasing staff of 10 are employed in the U.S. The Mexican plant has 12
sales and office personnel. There are three supervisors responsible for 360 Mexican workers, one
Chief Accountant, and one Vice President (in-charge for all Mexican operations) in Mexico. The
top management in the U.S. includes 6 Vice Presidents, the Controller, the Director of Internal
Audit/ the Director of EDP department and the President and CEO, Mr. Jack Butler. Mrs. Butler,
the CEO's wife, is a major stockholder in the corporation and she owns 15 percent of MCC's equity
stock. Major policy decisions are made by the Board of Directors. The President and the Vice
Presidents are responsible for day-to-day operations of the firm. The internal audit department
operates out of Omaha (which is also the Home Office for MCC) and four staff auditors report to
Julie Joy, the Director of Internal Audit. The internal auditors visit all the four plant locations at
least once every year for audit purposes.
During the last four years (1992-1995), the firm has shown increasing sales and profits. All
supervisors and the upper management participate in a generous bonus plan, which is based on the
reported annual earnings. In 1995, MCC's common stock was doing reasonably well on the Wall
Street. MCC management has been bullish and has predicted an average of 15 percent growth in
earnings for the next two years - 1996 and 1997. However, many new competitors have entered
the computer component market in the last two years. One of them, operating out of Kansas City
has been making a big effort to take a part of the market share away from MCC, by offering rock
bottom prices on keyboards, monitors and modems to Gate 2000 and ZS Systems. A customer has
 Midwest Computer Components Inc. 08.07.02

sued MCC alleging that MCC had violated its warranty policy and is asking for damages.
Moreover, the U.S. economy after showing growth in GDP for five straight years (1991-1995),
might slow down in 1996-1997. Mrs. Butler owns 80 percent of Omaha Electronics. MCC
purchases all the electronics components required for the modems from Omaha Electronics.
In addition to domestic competition, MCC is facing stiff, new competition from overseas
firms as well. Many of its bigger customers are examining the opportunity to set up or have already
set up assembly units in far eastern countries such as Malaysia, India and China. These far eastern
countries have an abundance of engineers and other skilled professionals and they work for very
low wages. Computer components such as keyboards, modems and boxes can also be obtained in
these countries at very competitive prices. An added attraction of setting up plants in these
countries include the opportunity to tap their vast market potential. While MCC customers will try
to sell about 75 percent of their production in these far eastern countries, still they want to ship
back to U.S. the remaining 25 percent of their production. This is expected to adversely impact
MCC sales.
MCC has definite plans to expand its product line and has already done a feasibility study
to manufacture "internal fax systems" in its Omaha plant. To finance this expansion, the firm has
plans to make a new bond offering of 20 million dollars in early 1997. However, to make the new
bond issue successful, MCC has to achieve the projected 15 percent increase in earnings for the
year 1996. Computer component industry is in a mature market and the new competition will make
it rather difficult for MCC to reach its sales target in the 1996. To increase sales, MCC has been
granting liberal credit facilities to many of its customers. Nearly 95 percent of its total sales is on
credit. MCC is also pouring money into research and development to come up with better quality
products.
The Vice President in charge of the Mexican plant had fifteen years experience in the
computer component industry. However, he has relatively few experienced managers reporting to
him. The Vice President in charge of the Mexican plant had fifteen years experience in the
computer component industry. However, he has relatively few experienced managers reporting to
him. While the Chief Accountant has an accounting degree, he is still in the process of obtaining
his professional certification. There are three accounting clerks, handling all accounting
functions - cash handling, all journals, all ledger accounts and all reconciliations. The absence of
sufficient qualified accounting personnel has resulted in lack of proper separation of duties within
the accounting department. Absence of qualified engineers has thrust more responsibility on the
three supervisors in the Mexican plant - they are each responsible for 120 workers.
A few years ago, an Audit Committee was formed to fulfill the listing requirements
imposed by the American Stock Exchange. However, the overall attitude of the management and
the Audit Committee towards internal control and the internal audit has been less than supportive.
The previous internal audit chief had focused a great deal on compliance issues. The internal
auditors spent most of their time doing detailed checking of specific account balances in the
income statement and balance sheet. This did not sit well with the management and they have not
been appreciative of the lack of value added by the internal auditors. The new Internal Audit Chief,
Julie Joy, will report to the Audit Committee instead of Mr. Butler, the President and CEO. This
new arrangement is supposed to increase the organizational clout of the internal audit department.
However, Mr. Butler and the Vice Presidents are not very pleased with this new arrangement.

Required
1. Assume you are the Internal Audit Director at MCC. Identify the risk factors you would
consider while developing your audit priorities and audit work schedules.
2. How would you change the attitude of the management?
 Midwest Computer Components Inc. 08.07.03

3. How would you educate the audit staff and refocus their efforts to increase value of internal
audit?

Note: This case is designed in such a way that it enables students to apply the concepts discussed
in the Statement on Internal Auditing Standards 9, "Risk Assessment" (IIA, 1991). This case is
based on the concepts found in the "Diamond Battery Company" case (Coopers and Lybrand,
1987).

References
The Institute of Internal Auditors, Statement on Internal Auditing Standards No. 9, (SIAS 9),
"Risk Assessment", 1991.

Coopers and Lybrand Foundation, Excellence in Audit Education: Learning Objectives and Case
Studies, "Diamond Battery Company" 1987.