LeapFrog 2004 Annual Report Download - page 66

In the area of cost of goods sold and inventory, we identified the following insufficient controls which we
believe constitute a material weakness in the aggregate.
• Lack of segregation of duties between our inventory and purchasing staff and possession by those
persons of broad access to our information technology systems, including access to system areas
controlling the set-up of new vendors, the creation of purchase orders, and our inventory purchasing and
receiving functions.
• Inadequate preparation and review of reconciliations of physical inventory results to inventory ledgers
and related cost of goods sold accruals.
• Inconsistent use of standard recordkeeping systems and formats to record and report inventory
transactions.
• Inadequate control procedures to determine that work-in-process inventories are correctly summarized,
estimated and recorded.
• Insufficient communication procedures between our accounts payable and operations staff regarding
returns of inventory back to our vendors.
• Inadequate input and review controls over changes to bills of materials and work orders.
• Inadequate review of purchase price and production variances included in inventories and cost of sales.
• Inadequate staffing to ensure that internal controls over reconciliations, review of account balances and
closing procedures are performed consistently and on a timely basis.
In the area of information technology controls, we identified the following insufficient controls which we
believe constitute a material weakness in the aggregate.
• Ineffective logical access and change management controls related to information technology systems,
data and programs that are used to monitor, record and transfer information. These controls relate to the
purchase of materials and components used to manufacture and assemble our products, the manufacture
and assembly of our products, the distribution, invoicing and sale of our products and the remittance of
payments by our vendors, our customers and ourselves related to these activities.
• Pervasive inadequacies in enterprise resource planning, or ERP, application controls related to
appropriate assignment of functions and segregation of duties, which allowed employees to access
system programs and data or initiate transactions inconsistent with their assigned duties. Our ERP
systems contain design deficiencies that do not adequately segregate and control access, and lack
sufficient human oversight over the assignment of system access and authorities.
• Lack of appropriate training of personnel throughout the organization causing system users to be less
effective due to insufficient understanding of the systems they manage and depend upon.
Because of the material weaknesses described in the preceding paragraphs, our management believes that,
as of December 31, 2004, our internal control over financial reporting was not effective based on the COSO
criteria.
Our independent registered public accounting firm, Ernst & Young LLP, has issued an attestation report on
management’s assessment of the Company’s internal control over financial reporting, which is included below.
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