Walker Books, Inc.

(Prepared by Matt Wisser, Lehigh University)

Company Background Walker Books, Inc., is currently one of the largest book distributors in the United States.

Established in 1981 in Palo Alto, California, Walker Books was originally a side project of founder and current president Curtis Walker, who at the time was employed by a local law firm. Because reading was much more than just a hobby of his, he decided to use some of his savings to buy an abandoned restaurant and convert it into a neighborhood bookstore, mainly selling used books that were donated by friends and family. When the doors first opened, Walker’s wife, Lauren, was the only employee during the week; Curtis was the only employee on the weekends. At the end of the first fiscal year, Walker Books had grossed

$20,000 in sales.

As the years passed, Curtis Walker quit the law firm and began concentrating fully on his bookstore. More employees were hired, more books were traded in, and more sales were attained each year that passed. However, during the mid-1990s, Walker was faced with two problems: many large, upscale bookstores were being built in the area, and the use of the Internet for finding and ordering books was becoming cheaper and more popular for current customers. In 1995, Walker’s sales finally started to decline. Deciding to take a risk because of the newfound competition, he closed his doors to the neighborhood, invested more money to expand the current property, and transformed his company from simply selling used books to being a distributor of new books. Publishers send books to his warehouse, in which he stores them and resells them to large bookstore chains upon request.

Walker Books, Inc., has rapidly become one of the largest book distributors in the country. Though they are still at their original location in Palo Alto, California, they distribute books to each of the 50 states and because of that, the company now sees sales of about $105,000,000 per year. When Mr. Walker is asked about his fondest memory, he always responds that he will never forget how the little bookstore, with two employees, has expanded to now have more than 145 employees.

As mentioned, all of Walker’s customers are large-chain bookstores who themselves see many millions of dollars in revenue per year. However, some of these bookstores have had bad relationships with Walker Books in the past year. There have been many disputes between them, such as books that were ordered from Walker but were never sent, poor inventory management by Walker, and the inability of Walker to provide legitimate documentation of transactions. According to projections of this year’s financials, the sour relationship that Walker Books and many of its customers have is going to take a toll on year-end revenue. Curtis Walker has stated time after time that because of his law background, he

“clearly knows the difference between right and wrong, including those of internal controls.”

You have been hired as an independent expert to inspect the internal controls currently in place at Walker Books, Inc.

Expenditure Cycle Purchases System The purchases process begins with the purchasing agent, who monitors the levels of books available via a computer terminal listing current inventory. Upon noticing a deficiency in one inventory item, the agent generates four copies of a PO: one is sent to AP, one is sent to the vendor, one is sent to the receiving department, and the last is filed within the department.

Vendors will generally ship the products within five business days of the order. When goods arrive in the receiving department, the corresponding packing slip always accompanies them. The receiving department clerk unloads the goods and then reconciles the packing slip with the PO. After unloading the goods, three copies of the receiving report are generated. One copy goes with the goods to the warehouse, another is sent to the purchasing department, and the final copy is filed in the receiving department. In the warehouse, the copy is simply filed once the goods are stored on the shelves. In the purchasing department, the clerk receives this copy of the receiving report and files it with the PO.

When the AP department receives the PO, it is temporarily filed until the respective invoice arrives from the vendor. Upon receipt of the invoice, the AP clerk takes the PO out of the temporary file and reconciles the two documents. This event triggers Walker Books to record a liability in the AP subsidiary ledger.

At the same time, a journal voucher is created and sent to the general ledger department. The documents (PO and invoice) are placed in the open AP file in the department.

Once the general ledger department receives the journal voucher, the clerk examines it for any obvious errors and then inputs the information into a terminal. Once all the information is entered into the terminal, the clerk clicks the finalize button, which permanently updates the general ledger file stored on the mainframe in the department.

Cash Disbursements System The AP clerk periodically reviews the open AP file for liabilities that are due. In order to maximize returns on invested cash yet still take advantage of vendor discounts, the clerk will pull the invoice two days before its applicable due date. Upon finding an open AP file in need of payment, the clerk prepares a check for the amount due as per the invoice. The AP ledger is also updated by the AP clerk. The check number, dollar amount, and other pertinent data are recorded in the check register. The check is subsequently sent to the cash disbursements department. The invoice is then discarded as it no longer has any relevant information that hasn’t already been recorded elsewhere.

When the cash disbursements clerk receives the unsigned check, she examines it to ensure that no one has tampered with any of the information and that no errors have been made. Because she is familiar with all of the vendors that Walker deals with, she can identify any false vendors or any payment amounts that seem too high or too low for that particular vendor. Assuming everything looks good, she signs the check using a signature block that displays the name of the assistant treasurer, Tyler Matthews. Matthews’s signature is the only one that can be put onto a check for it to be deemed valid. The cash disbursements clerk then photocopies the check for audit trail purposes.

Once the check is signed, it is sent directly to the supplier. The photocopy of the check is marked as paid and then filed in the cash disbursements department. The clerk then creates a journal voucher, which is sent to the general ledger department. Once the general ledger department receives the journal voucher, the clerk inputs the information into the terminal, which permanently updates the general ledger file.

Required:

a. Create a data flow diagram of the current system.

b. Create a document flowchart of the existing system.

c. Analyze the internal control weaknesses in the system. Model your response according to the six categories of physical control activities specified in SAS 78.

d. Prepare a system flowchart of a redesigned computer-based system that resolves the control weaknesses you identified.