Audit Engagement

To: Pat Johnson

From: PWC

Date: March 12, 2003

Subject: Assessment of Exton Industries, Inc.

Dear Ms. Johnson:

I have recently reviewed the Control Environment Questionnaire for Exton Industries, Inc. After evaluating the evidence collected by our staff member, I have come up with an assessment of the fraud risks. From the evidence gathered, I have concluded that Exton Industries has a weak control environment. Overall, it will not do an effective job of preventing fraudulent activities.

While evaluating Exton Industries, I had to consider how the control environment would prevent misstatements arising from misappropriation of assets and fraudulent financial reporting.

The controller, CFO, and CEO review all financial reports before releasing them. Another area to consider was the assignment of authority and responsibility. Because three different people review the financial reports, it's easier to identify any mistakes that may have been made which in turn reduces the chances of misappropriation in fraudulent reporting. Through conversation with employees it was noted that proper responsibility and delegation of authority were assigned and the proper information appeared to be considered in developing responsibilities. Written job descriptions and standards also exist. Since proper responsibility and delegation of authority and written job descriptions and standards exist the, the chances of fraudulent activities are reduced.

Other issues to consider were management's commitment to competence and human resource policies and procedures. During the hiring process, management makes sure the potential employee possesses the proper knowledge and skills to carry out the job adequately. Upon hiring, the new employee is made aware of his or her responsibilities and management's expectations of them. In addition supervisors conduct annual reviews. The company's previous success also shows that employees have the required skills and knowledge. Discussions with employees indicated that they are made aware of the consequences if they perform ineffectively and/or do not fulfill their responsibilities. Exton Industries has effective controls in their commitment to competence and human resource department's hiring and review process.

Overall, the control environment of the board of directors and audit committee will prevent misstatements arising from misappropriation of assets and fraudulent financial reporting. The boards consists of both outside and inside members, who are sufficient in subject matter, have the knowledge, industry experience and time to serve on the board and they receive monthly financial statements. The audit committee privately discusses relevant issues with external auditors and conducts annual reviews of audit functions and activities. However, there were three issues that could lead to misstatements arising from fraudulent financial reporting or misappropriation of assets. The first issue is the fact that the board is supposed to address management's adherence to the code of conduct and it was noted that a code exists but the board does not take specific actions related to adherence. The second and third issues are that the board is supposed to issue directives to management detailing specific actions to be taken and oversee and follow up as needed. It was noted that neither one of these practices were observed.

From the evidence gathered, it seems as though Exton Industries' control environments for their organizational structure, integrity and ethical values and management's philosophy and operating style are weak and may not prevent fraudulent activities. The new management team encourages managers to cut through red tape whenever possible, employees stated that in prior years communications channels were observed whereas now, they are more formal and less candid and the new management team