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**DRAFT** Internal Audit Report

Inventory Systems Synchronization Assessment

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September 24, 2014

This report contains confidential information and should not be shared with anyone except REIs Board, senior
management and the external auditors.
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This report contains confidential information and should not be shared with anyone except REIs Board, senior
management and the external auditors.
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Recreational Equipment, Inc.

Inventory Systems Synchronization Assessment
Internal Audit Report

EXECUTIVE SUMMARY

BACKGROUND

The Internal Audit department (IA) conducted an audit of the systems, interfaces and synchronization activities,
both programmed and manual, involved in the management of REI operational inventory. Operational inventory is
the inventory that is immediately available for customer order fulfillment and store replenishment. It is based on
available supplymerchandise on-hand at distribution centers (DCs) and retail stores, receipts and returnsand
demandretail and direct sales, pre-allocations for events, high demand and backordered merchandise, and
allocations to stores for inventory replenishment. Supply is primarily managed by SAP and the Warehouse
Management System (WM) and demand comes from multiple systemsSAP, WM, Sterling Order Management
System (Sterling) and Advanced Store Replenishment (ASR). Three additional systems are involved in the
management of operational inventoryProduct Availability and Reservation (PAR), Inventory Movement
Tracking (IMT) and AS400 Data Store (ADS). These are internally developed legacy systems required by ASR
that also have interfaces of supply and demand data and automated synchronization processes with SAP, WM
and Sterling.

Discrepancies between the systems of record for inventory quantities (WM) and account balances (SAP) occur on
an ongoing basis and require manual adjustments to inventory performed in conjunction with the Finance
department in order to correct the variances between systems. These adjustments have resulted in substantial
shrinkage costs and operational disruptions, and led to the development of a dedicated Inventory Optimization
Team, This team is comprised of a supervisor in inventory accounting and senior architects, engineers and
analysts from multiple groups within the IT organization, each of which participate in ongoing root cause analysis
and maintenance of inventory accuracy through manual effortsa function that is entirely separate from their
defined roles and job responsibilities.

Despite the considerable utilization of personnel and IT resources, WM and SAP continue to have significant
variances, resulting in ongoing inventory adjustments attributed to systems synchronization issues. These
adjustments represent a shrinkage expenditure of over $430,000 YTD through August and almost $1.9 million
since the implementation of SAP in August 2010.

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management and the external auditors.
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AUDIT OBJECTIVE

The objectives of the audit were to gain an overall understanding of the various systems, interfaces and
synchronization programs in place that can impact inventory quantities, identify relevant Process Owners for each
of these components and assess the effectiveness of the co-ops procedures and processes for identifying and
resolving discrepancies in inventory data reported from these systems.

AUDIT SCOPE

The scope of audit procedures included the following review areas:

Understand and document systems that impact inventory, as well as related interfaces and synchronization
activities, both programmed and manual. Assess governance for the flow of inventory and related systems and
synchronization activities, and identify Business Process Owners for each of these components. Evaluate the
process and system design, as well as current reporting, monitoring and reconciliation activities related to
inventory data discrepancies.

IA conducted field work from May 15th, 2014 through August 29th, 2014. Audit procedures consisted of interviews
with key personnel, performing walkthroughs of control processes and inspecting technical configurations and
supporting documentation for each of the review areas, systems and interfaces supporting the management of
operational inventory. Our work was performed in accordance with the International Standards for the
Professional Practice of Internal Auditing and testing activities were based on established best practice
frameworks, such as COSO, ITIL and COBIT, for each review area in scope.

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management and the external auditors.
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CONCLUSION

The observations noted during audit fieldwork indicate opportunities where improvements in the design and
operation of systems and control processes supporting operational inventory management will:

Reduce inventory variances, operational disruptions and the resources required to maintain inventory
accuracy

Enable more timely and effective resolution of inventory synchronization issues

Position REI for more successful management and execution of projects such as SIF or future
investments in distribution centers by improving the ongoing scalability of REIs environment.

The observations noted during the audit are summarized into the themes below.

1. System Architecture and Operation

Management of operational inventory is highly complex, involving seven independent systems and over 40
interfaces encompassing a range of technology platforms and acquired, third party and internally developed
solutions that have been customized over time, rather than decommissioned or replaced. The architectural
complexity of systems, interfaces and synchronization processes greatly increases the likelihood of variances
between systems and makes root cause analysis and resolution of discrepancies more difficult, increasing the
personnel time and resources required to maintain the accuracy of operational inventory. The system design also
lacks automated synchronization of certain types of data flows, such as WM and SAP demand data, resulting in
ongoing manual effort required to correct the variances. In addition, there are unresolved flaws in application logic
and interface processes causing repeated communication failures between SAP and other systems, as well as
unintended behavior of certain systems when processing transactions that create operational disruptions and
require manual efforts to resolve, further extending personnel time and resources.

2. Process Governance

The overall process and activities involved in root cause analysis and reconciliation of inventory synchronization
issues is not formally defined. Management has not established policies and procedures governing the
synchronization activities and roles and responsibilities of individuals involved in maintaining the accuracy of
operational inventory. In addition, a formal systems development methodology and related development, testing,
documentation and approval requirements is not in place. This is compounded by highly constrained personnel
resources available to perform critical development and quality assurance activities, such as:

Documentation of detailed specifications for proposed solutions

Formal review and approval of design documents and development plans

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Developer code reviews

Independent quality assurance testing prior to user acceptance

Ongoing measurement and monitoring of the success of development and remediation activities

3. Monitoring and Reporting

The process for monitoring inventory variances between WM and SAP is a weekly comparison that runs on
Saturday evening and distributes a list of the articles, locations and quantities of inventory as reported by WM and
SAP at that time, and the associated variance quantities and cost for each article in the report. This comparison
process does not currently check or report variances of certain categories of inventory in SAP that are assumed to
have no financial impact. The omission of these inventory categories diminishes visibility of synchronization
issues that may provide insight as to sources of variances and lead to more effective root cause analysis. In
addition, a process is not in place to formally track synchronization issues and resolution activities over time or
retain documentation of previously identified root causes and the associated steps involved in testing and
verifying the sources of variances and corrective actions taken, recognized patterns of self-correcting variances or
business scenarios and events known to cause a disproportionate increase in the variances reported that week.
The root cause analysis and solution identification process currently requires highly specialized experience and
in-depth knowledge of the environment, which significantly diminishes cross-training capabilities and
transferability of skills required to assist in reconciliation of inventory systems synchronization issues.

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management and the external auditors.
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MANAGEMENT RESPONSE

We appreciate the effort and prolonged partnership with Internal Audit on our effort to improve our inventory
accuracy. The more significant system related findings will require a capital ask during the 2015 budgeting
process. As such, Supply Chain Systems will partner with cross functional IT teams including SAP and Sterling
teams to create opportunity statements, solution approaches, estimates, KPIs and KPI targets and submit them
into the 2015 IT Portfolio Planning process to be evaluated against all other initiatives for priority for 2015.

In a separate, and more near term work stream, the Supply Chain Systems team will perform an internal review
and recommendations document regarding process and organizational changes called out in this audit.

OBSERVATION SUMMARY
The table below is a summary of audit observations and ratings for each theme identified during the audit.
Observations & Ratings
Themes Identified
High

Medium

Low

System Architecture and Operation

Process Governance

Monitoring and Reporting

Totals

Ratings Definitions
High

The observations highlight non-existent or ineffective organizational, process,

and/or systematic controls. The observations, if left unaddressed, could increase
financial, legal, and/or operational risks to the co-op.

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management and the external auditors.
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Medium

While the observations may not have significant internal control impact, they may
expose the co-op to some financial and/or operational risks.

Low

Observations are isolated and/or minor. Observations could also be intended to

assist management in improving operational efficiency and effectiveness.

OBSERVATION SUMMARY CONTD

Observation

Rating

Owner

Estimated
Completion
Date

System Architecture and Operation

High

Derek Chaves, Director of Network Fulfillment

Supply Chain Systems Delivery

QX-201X

Automated Data Flows

Medium

Derek Chaves, Director of Network Fulfillment

Supply Chain Systems Delivery

QX-201X

Communications Failures

Medium

Derek Chaves, Director of Network Fulfillment

Supply Chain Systems Delivery

QX-201X

Complexity

Process Governance
4

Policies and Procedures /

Roles and Responsibilities

Medium

Derek Chaves, Director of Network Fulfillment

Supply Chain Systems Delivery

QX-201X

Resource Availability and

Utilization

High

Derek Chaves, Director of Network Fulfillment

Supply Chain Systems Delivery

QX-201X

Systems Development
Methodology

Medium

Derek Chaves, Director of Network Fulfillment

Supply Chain Systems Delivery

QX-201X

Systems Documentation

Medium

Derek Chaves, Director of Network Fulfillment

Supply Chain Systems Delivery

QX-201X

Monitoring and Reporting

8

Inventory Variance
Reporting

Medium

Derek Chaves, Director of Network Fulfillment

Supply Chain Systems Delivery

QX-201X

Trending of Variance Root

Causes and Corrections

Medium

Derek Chaves, Director of Network Fulfillment

Supply Chain Systems Delivery

QX-201X

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management and the external auditors.
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vation

Management Action Plan

m Architecture and Operation Complexity

High

independent systems and over 40 interfaces involved in the

gement of operational inventory creates an architectural complexity
reatly increases the likelihood of variances between systems and
root cause analysis and resolution of discrepancies more difficult,
sing the personnel time and resources required to maintain the
acy of operational inventory. The primary systems of record for
ory quantities and valuation (WM and SAP) currently rely on legacy
sses and systems that were originally slated for retirement when
was implemented. Three of the systems (PAR, IMT and ADS) and
alf of the interfaces are required to support ASR. In addition, the
allocations process for push allocations to stores and the WM
y demand process also currently rely on PAR, adding to the
exity of the solution.

Management Response / Action Plan:

Owner: Derek Chaves, Director of Network Fulfillment Supply Chain

Systems Delivery

Implementation Date:

ommends that management approve, provide funding and allocate

nnel resources to commence the initial discovery phase of the
sed Operational Inventory Optimization Project. The discovery phase
identify data and timing gaps that would exist between our systems
ord and legacy systems if they were to be decommissioned,
ting the planning, design and estimated cost and duration of the
iation efforts required to reduce the complexity of operational
ory management and eliminate reliance on legacy systems. The
sted funding and estimated cost of the discovery phase represents a
n of the cost attributed to inventory shrinkage resulting from systems
onization issues this year.

m Architecture and Operation Automated Data Flows

Medium

urrent architecture of systems involved in operational inventory

gement lacks automated synchronization of certain types of data
resulting in ongoing manual effort required to correct the variances.
ated synchronization of supply data exists between the systems that
ain it, but there is no automated synchronization of demand between
and SAP, resulting in ongoing manual effort to correct drift of
ional inventory.

Management Response / Action Plan:

gement should initiate planning and estimation of the time and

nnel resources required for creating demand synchronization

Implementation Date:

Owner: Derek Chaves, Director of Network Fulfillment Supply Chain

Systems Delivery

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management and the external auditors.
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sses between WM and SAP, modifying the SAP-Sterling supply

onization processes to align with SAP-WM supply synchronization
sses, and resolving the timing issues present in certain interfaces
en WM and SAP.

m Architecture and Operation Communications Failures

Medium

are unresolved flaws in application logic and interface processes

g repeated iDoc failures to and from SAP. In addition, there is
nded behavior of certain systems when processing transactions and
issues present in some of the interfaces between WM and SAP.
create operational disruptions and require manual efforts to resolve,
extending personnel time and resources.

gement should conduct root cause analysis and remediation of

that result in manual iDoc processing in SAP required to maintain
ional inventory accuracy, as well as examine and remediate the
issues present in interfaces between WM and SAP.

Management Response / Action Plan:

Owner: Derek Chaves, Director of Network Fulfillment Supply Chain

Systems Delivery

Implementation Date:

ss Governance Policies and Procedures / Roles and Responsibilities

Medium

ntly, Inventory Accounting substantially relies on the analysis

cted by IT in order to quantify the valuation of adjustments made
inventory systems synchronization issues. In addition, the Inventory
zation Team currently operates on a largely informal basis, although
are coordinated and there is a general process followed for
ying and addressing inventory variances. A lack of established
s and procedures governing the root cause analysis process,
onization activities and roles and responsibilities:

Management Response / Action Plan:

Owner: Derek Chaves, Director of Network Fulfillment Supply Chain

Systems Delivery

Diminishes cross-training capabilities and transferability of skills

Implementation Date:
Prevents optimal utilization of new and currently available
personnel resources
Requires highly specialized experience and in-depth knowledge of
the environment to effectively contribute to the root cause analysis
and solution identification process.

gement should establish policy and procedural documentation

bing the root cause analysis process and activities involved in
ng inventory synchronization issues, previously identified root
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management and the external auditors.
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s and business scenarios that create inventory variances, known

ns of self-correcting inventory variances, as well as the steps
ed during previous root cause analyses and the associated
tive actions taken. The policy documentation should be updated
rly and utilized to cross-train other members of the Inventory
zation Team, as well as other qualified and available IT personnel
emed appropriate by management.

ss Governance Resource Availability and Utilization

High

nded the weekly Inventory Optimization Team meetings throughout

ration of this audit, and noted that there appears to be a significant
on in available personnel qualified to assist in the design,
pment, testing or acceptance of changes implemented to resolve
ory synchronization issues. Due to the highly constrained available
ces, there are critical functions related to solution design,
pment and quality assurance that are not consistently performed,
as documentation of detailed specifications for proposed solutions,
review and approval of design documents and development plans,
per code reviews, independent quality assurance testing prior to
acceptance, and ongoing measurement and monitoring of the
ss of development and remediation activities.

Management Response / Action Plan:

Owner: Derek Chaves, Director of Network Fulfillment Supply Chain

Systems Delivery

Implementation Date:

issues have led to instances where solutions developed to address

ory synchronization issues inadvertently introduced technical errors
ata discrepancies into the production environment, as there was a
f independent validation of development efforts, test cases and
prior to implementation. In turn, this leads to increased demands
eady over-extended personnel and increases the risk that changes
implemented in the production environment that do not operate as
ed, which may lead to additional complications and inventory
ces if not identified timely.

gement should actively seek fulfillment of an independent quality

ance function for changes to WM, related interfaces and legacy
ms. The SAP COE has a dedicated Quality Assurance group, and
nction was leveraged in the past for developed changes to WM, but
resources were re-assigned after the acquisition of the Bedford DC,
urrently there are no plans to add WM to the QA in-scope systems.
ition, management should establish a process of cross-training and
er of knowledge and skills required to design or validate test cases
esults, create datasets that accurately validate the logic of the
sed solution during testing, document and communicate QA test
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and exceptions, and assist with the design and verification of

sed solutions.

ss Governance Systems Development Methodology

Medium

gement has not established a formal methodology and documented

s and procedures governing systems development and change
gement activities. Systems development and change management
documentation is limited to high-level process flow diagrams of the
oint production control process for migrating changes to the
ction environment. This increases the risk that solution design,
t initiation and related development, testing, quality assurance and
cceptance activities will not be executed in a consistent manner in
ent with organizational goals, best practices or established
ards. In addition, without a defined systems development and
e management methodology in place, there is less assurance that
es to critical systems will be properly authorized, approved,
mented and documented.

Management Response / Action Plan:

Owner: Derek Chaves, Director of Network Fulfillment Supply Chain

Systems Delivery

Implementation Date:

gement should establish formal policies and procedures governing

velopment and management of changes, including:
Documentation and approval requirements for proposed solutions
Review activities and approvals required to initiate development
Development environments, coding standards, version control and
change migration systems involved in systems development
Developer testing activities, independent code reviews and
approval requirements for migration to the QA environment
Review and approval of proposed test cases and datasets utilized
for QA testing
Independent verification of test cases, data and results prior to
implementation in production
Documentation and approval requirements for migration to the
production environment

ss Governance Systems Documentation

Medium

cal documentation related to the systems, interfaces and data flows

ed in operational inventory management lacks detailed design and

Management Response / Action Plan:

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management and the external auditors.
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cal specifications and is not maintained in a current state, consistent

or centralized repository. This creates additional dependence on
individuals with highly specialized experience and in-depth
edge of the environment, increases the risk of configuration
mentation failing to reflect current system configuration, reduces
erability of skills and impairs managements ability to train or acquire
ed personnel resources to augment the over-extended team of
uals involved in maintaining the accuracy of operational inventory.

Owner: Derek Chaves, Director of Network Fulfillment Supply Chain

Systems Delivery

Implementation Date:

gement should establish an agreed-upon and standardized approach

cumenting system and interface functional specifications and a
ss for ensuring that system documentation is updated whenever
es are implemented that affect one of these components, including:
Business process requirements and overall solution design (high
level process overview / business driver / assumptions)
Systems, programs, tables and interfaces involved
Programming nature for interface solutions, including data types,
programming language and feeds to other systems
Processing logic and output

oring and Reporting Inventory Variance Reporting

Medium

WM-SAP weekly variance reporting process does not include certain

ories of inventory in SAP in its synchronization check, which
shes visibility of synchronization issues that may provide insight as
rces of variances and lead to more effective root cause analysis.
ically, Goods Receipt Valuated Blocked Stock (GRVB) and Sales
Stock are not sent to SAP for synchronization validation and are
d from the distributed report. Discussions with the Inventory
zation Team indicated that capturing variances in GRVB Stock
be meaningful and help enable the identification of patterns and
rios causing ongoing synchronization issues.

Management Response / Action Plan:

Owner: Derek Chaves, Director of Network Fulfillment Supply Chain

Systems Delivery

Implementation Date:

gement should examine the current WM-SAP variance reporting

ss logic and evaluate the efforts required to add GRVB Stock to the
onization check and distributed report, as well as appropriate timing
erations for the process redesign, testing and implementation,
ering the required resources and personnel availability.

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oring and Reporting Trending of Variance Root Causes and Corrections

Medium

cess is not in place to formally track synchronization issues and

tion activities over time or retain documentation of previously
ed root causes and the associated steps involved in testing and
ng the sources of variances and corrective actions taken, recognized
ns of self-correcting variances or business scenarios and events
to cause a disproportionate increase in the variances reported that
The root cause analysis and solution identification process currently
es highly specialized experience and in-depth knowledge of the
nment, which significantly diminishes cross-training capabilities and
erability of skills required to assist in reconciliation of inventory
ms synchronization issues.

Management Response / Action Plan:

Owner: Derek Chaves, Director of Network Fulfillment Supply Chain

Systems Delivery

Implementation Date:

junction with the assignment of authority, roles and responsibilities

e Inventory Optimization Team and Inventory Accounting,
gement should define a process and documented procedure
shing a centrally maintained log of identified root causes, business
rios and known patterns of self-correcting inventory variances, as
s the steps followed during the root cause analysis activities and the
ated corrective actions taken. The log should be maintained
ately from the Waypoint ticketing system, and should be updated as
ce root causes are identified and utilized to cross-train other
ers of the Inventory Optimization Team, as well as other qualified
vailable IT personnel as deemed appropriate by management.

This report contains confidential information and should not be shared with anyone except REIs Board, senior
management and the external auditors.
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