UNITED STATES GENERAL ACCOUNTING OFFICEDALLAS REGIONAL OFFICEROOM iO.

1512 COMMERCE STRTDALLAS, TEXAS

75201

OCT 1 197
Mr. Hal R. Hopkins

Superintendent
Federal Prison Industries, Inc.
Federal Correctional Institution
Texarkana, Texas 75501
Dear Mr. Hopkins:
We have completed an examination of the financial statementsof Federal Prison Industries, Inc. (FPI), Texarkana, Texas, for thefiscal year ended June 30, 1971. The examination was made pursuant
to the Government Corporation Control Act (31 U.S.C. 841).
Our review, which was completed in September 1971, was made inaccordance with generally accepted auditing standards and included
such tests of accounting records and financial transactions as weconsidered.necessary in view of the nature and volume of transactions
and the effectiveness of internal controls. Since internal auditors
had not made a review since November 1969, we gave special attention
to the internal controls exercised by FPI, Texarkana.
Our findings included several deficiencies which we believe
indicate a need for improvement by FPI in the administration andreview of its accounting functions. We were unable to ascertain theaccuracy and reliability of the June 30, 1971, Inventory Certificatesbecause of the numerous deficiencies we found in the accounting forinventories. The inventories were reported to be $95,692. The
deficiencies were discussea with you and institution officials at theconclusion of our review. Details are presented below for your consideration and appropriate action.
Need for improvement in accounting forand internal control over inventories
Our examination of fiscal year 1971 inventory records for thetire reconditioning factory and furniture factory and discussions
with FPI employees disclosed deficiencies in the procedures forX~150THi~J ANNIVERSARY 1921-1971

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taking annual physical inventories, writing off variances foundbetween inventory records and the physical inventories, and making
adjustment to inventory control accounts in the general ledger.
At the time of our review, signficiant variances between the inventory records and the physical inventory existed for several itemsof raw materials and supplies. In addition, we found a lack ofinternal control over the receipt and storage of materials. In ouropinion these deficiencies, discussed further below, indicate a needfor improvement by FPI in its accounting for and internal control
over inventories.
Based on our review and discussions with FPI employees, we foundthat physical inventories were taken, but, contrary to acceptableprocedures for taking physical inventories, receipts and issues ofmaterials were continued without proper controls and employees
responsible for taking the physical inventories had access tobalances shown on stock records. In order to provide proper control
and assure accurate counts, we believe that physical inventories
should be taken when receipts and issues can be properly controlled
and, ideally, when production is at a minimum, and by employees who
do not have access to stock record balances.
Variances between physical inventory counts and stock recordbalances were written off without adequate verification of the inventory counts and a determination that all receipts and issues had beenposted. For example,' over $1,800 was written off the stock recordbalance of finished goods for the tire reconditioning factory to makeit agree with the results of the physical inventory. FPI employees
advised us that no further verification of the finished goods inventory
was made in this instance. We were also advised that because of thelack of time, only two or three items of raw materials and supplies
were recounted to verify the accuracy of the physical inventories.
The write-off of variances between inventory counts and stock
records is an acceptable procedure for making inventory adjustments.
However, we believe that items showing substantial variances should
be recounted and a determination made that all receipts and issues
have been posted prior to adjustment to assure the accuracy of theinventory records.
The general ledger control account for the tire reconditioning
factory finished goods was further reduced by more than $1,100 inorder to make the ledger agree to the total of individual stock recordbalances. FPI employees advised us that the reasons for the differences
between the general ledger and the stock record balances were not determined prior to the write-off. We believe that inventory adjustments

-3-should not be made until the reasons for the differences have been
determined, to the extent practicable, and that such adjustments shouldbe properly supported.
We found that variances between the inventory records and thephysical inventory existed for 15 of 22, or 68 percent, of the items
included in our test count of raw materials and supplies. The deficiencies cited above could be a contributing factor to some of thedifferences we found. In addition, the FPI business manager advised
us that some of these variances existed because inmates (1) failed
to record issues from the storerooms, (2) recorded some issues incorrectly, or (3) did not record items returned to the storerooms. In
our opinion the warehouse should be more closely controlled, andstock record clerks should be more carefully supervised in order
to assure accurate recording of inventory transactions.
In our review of internal controls we noted that the storekeeper
who was responsible for the receipt of materials had access to purchase orders showing quantities ordered, unit prices, and total costs,
at the time material was received. Good internal control requiresthat independent counts be made of merchandise received. We suggestthat quantities be omitted from the storekeeper's copy of the purchaseorder to help assure that such counts are made.
Our review disclosed that several raw material items were storedin open spaces in the factories where proper control could not beexercised by the storekeeper. We also found that lockable storerooms
were not always locked in the absence of the storekeeper. These
practices indicate a further lack of internal control and should becorrected.
In our opinion, the deficiencies discussed above do not represent
sound accounting practices or good internal control and warrant
special consideration.
We suggested that a complete physical inventory, taken in accordance with acceptable inventory procedures, be performed in the near
future in order to establish the accuracy of inventory records. We
further suggested that adequate internal controls be instituted
over the inventories to prevent a recurrence of the deficiencies
discussed. You concurred with these suggestions and promised totake corrective action. We would appreciate your comments and areport on the results of the physical inventory.

-4-Inadequate basis for distribution of manufacturingcosts to jobs in the furniture factory
Our examination of cost of sales for the furniture factory
disclosed that the basis of allocating labor costs to individual jobs
on monthly job analyses was inadequate. Monthly labor variances,which resulted from differences between standard and actual laborcosts, were allocated on an equal basis to each unit produced by
the various jobs. Because labor costs are not the same for different
type items, this basis of allocating the labor variance could significantly distort the charges to the various jobs. Furthermore, overhead
costs are distributed to the individual jobs as a percentage of laborcosts. Therefore any misstatements of labor costs for the jobs will
result in additional misstatements of job costs. Misstatements ofoverhead costs could be substantial. For example, overhead rates
averaged 496 percent of labor costs during the last 6 months of fiscalyear 1971.
If the costs allocated to the individual jobs are inaccurate,then the value of job analyses as a production management tool isessentially lost. We believe that to assure accurate costs forindividual jobs, any distribution of labor variance should be proportionate to the standard labor costs established for each type offurniture, or by any other equitable basis which FPI can establish.
At the conclusion of our review, you acknowledged this deficiency
and agreed to establish an acceptable basis for distributing laborand overhead costs to the jobs produced by the furniture factory.
Compliance with FPI Washington instructions
FPI treated the cost for relocation of the tire reconditioning
factory as a capital improvement; whereas instructions by the FPI
Washington office required that the cost be accumulated as a deferredcharge and amortized over 24 months. This treatment resulted in aminor overstatement of the buildings and improvements account andan understatement of the expenses charged for the period.
Overstatement of accounts payable andunliquidated obligations
Our examination disclosed that accounts payable at June 30, 1971,
were overstated by $2,637 because of errors in computing contingent
annual leave payable. Increases and decreases in contingent annual
leave payable for employees who transferred from FPI during the year
were not considered when making the computation. In addition,

incorrect balances for the beginning of the year were used on computing the increase in contingent annual leave payable for fiscalyear 1971.
The FPI business manager promised to correct these errors andto establish a procedure which will provide for accurate computationsof contingent annual leave payable.
Unliquidated obligations were overstated by $5,413 because oferrors in reporting open FPI purchase orders.
As corrective action has already been taken or promised concerning these matters, we are making no recommendations at this time.
Other deficiencies noted
Our review disclosed several other deficiencies which we believe
further indicate a need for improvement by FPI in the administration
and review of its accounting functions. These matters are summarized
briefly below.
--We found several instances where inmates made incorrect postings
to the general ledger or misclassified expenditures. Theseerrors were not detected by accounting personnel in the business office.
--In two instances, accounts payable by FPI were allowed toremain outstanding for 2 and 6 months after the vendors'
invoices had been received.
--Incorrect posting of accruals for the month of June 1971, tothe Reserve For Transportation account resulted in an
overstatement of that account and an understatement of theAccrued Accounts Payable account amounting to $4,263. TheTransportation Register was not reconciled to the generalledger, therefore this error was not detected. Because
both of these accounts are subsidiary to the overall Accounts
Payable account the error does not affect the total of theaccount. However, it does illustrate the need to reconcile
subsidiary records to the general ledger.
--Errors made in the preparation of Standard Form 225, Reporton Obligations, resulted in an understatement on that reportof net unpaid obligations amounting to $43,309.

-6---Although not occurring during the period covered by ourreview, we were informed that during the months of Julyand August 1971, that due to deficient filing procedures
established by the business office for the tire reconditioning factory, all documents related to an unknown number oforders were lost after the completed reconditioned tires
were shipped to FPI customers. FPI followed a practice ofaccumulating all copies of all documents in a single folder
until the tires were shipped, at which time the folder wasforwarded to the business office for recording and billing.
Some of these folders disappeared before any documents
could be removed. As a result, FPI does not know who toinvoice, or the value involved. We do not know the valueof the tires, but were informed by the Shop Foreman that hebelieved it to be substantial.

We wish to acknowledge the courtesies and cooperation shown our
representatives during the review. We would appreciate your comments
and advice as to any further action taken on the matters discussed
herein.
Copies of this letter are being sent to the Assistant Attorney
General for Administration, Department of Justice; the Commissionerof Industries, Federal Prison Industries, Inc.; and the Warden,
Federal Correctional' Institution, Texarkana, Texas.
Sincerely yours,W. H. Sheley/..
Regional Mafr er