Tuloak Manufacturing Company is a small manufacturer of oak porch swings. It was organized as a proprietorship by its current president and majority stockholder, Samuel Lawten. Tuloak was incorporated in 19X0 when growth of the company necessitated the raising of additional capital.

The accounting system of Tuloak is quite simple. The system has evolved over the years in response to external reporting requirements, and a strong emphasis has not been placed on internal control. The firm's relatively small size ( 49 employees) also makes effective internal control more difficult than in a larger firm.

The CPA firm of Deber \& Associates has been hired to perform the audit of Tuloak for the fiscal year ending October \(31,19 \times 0\). This is the first time that Deber has been engaged to audit Tuloak's financial statements. The partner-in-charge of the audit has reminded his staff that material weaknesses in internal control must be communicated to audit clients. The partner has concluded that a management letter should be issued to Tuloak following the audit for the year ended October 31, 19X0. The management letter sent by Deber to Tuloak is reproduced below.

Upon receipt of the management letter, Mr. Lawten asked his chief accountant, Charles Earl, to respond to the management letter. The response prepared by Mr. Earl is shown below.

Deber \& Associates, CPAs Oak Park, North Carolina Samuel Lawten, President \\ Tuloak Manufacturing Company In connection with our audit of the financial statements of Tuloak Manufacturing Company of October 31, 19X0, we reviewed various internal procedures and controls of the company in order to plan the scope of the audit. We did not make a comprehensive review for the purpose of submitting detailed recommendations. However, as a result of our review, we did observe certain areas where material weaknesses in internal controls and procedures exist. These weaknesses are itemized below and should be corrected.
Cash. Control over cash disbursements for purchases of materials is inadequate due to the fact that creditor checks are prepared by the accounts payable bookkeeper, later signed by the treasurer, then returned to the accounts payable bookkeeper for mailing to creditors.
We recommend that the checks be mailed by the treasurer rather than by the accounts payable bookkeeper.
Accounts Receivable. The extension of credit to customers is approved by the sales manager who also authorizes the write-off of delinquent accounts.
We recommend that the write-off of delinquent accounts be approved by the chief accountant.
Inventory. Purchases of raw materials are made only upon receipt of a purchase requisition signed by the production supervisor. When shipments of raw materials are received, a receiving report is signed by any available production worker in the vicinity of the receiving dock.
We recommend that the production supervisor be the only employee permitted to sign the receiving report; then the supervisor will know that the materials requisitioned have arrived.
Marketable Securities. Stock certificates related to marketable securities are kept in Mr. Lawten's office desk drawer to facilitate prompt settlement when the expected holding period is relatively short.
We recommend that all stock certificates be held in a bank safety deposit box accessible only by Mr. Lawten.
Payroll. Hourly production workers are required to punch in on a mechanical time clock each morning, then punch out at the end of the day. Presumably, they take a one-hour lunch break. Occasionally, a worker might not return from lunch, have a friend punch his card at the end of the day, and receive a full day's pay for a half-day's work.
To prevent this from happening in the future, we recommend that each employee be required to punch out and back in for lunch and that each supervisor initial the daily time cards of each employee under his/her control, thereby verifying the presence of workers for the full day.

Pursuant to your request, I am writing this memo in response to the management letter of our independent accountants, Deber \& Associates. My comments related to each of their recommendations are presented below.
Cash. I do not believe that the change in procedure recommended is necessary because the accounts payable bookkeeper cannot possibly benefit from handling the signed checks made payable to our material suppliers. Each check is supported by an approved purchase requisition, purchase order, receiving report, and vendor's invoice.
Accounts Receivable. The current system of having the sales manager approve the write-off of delinquent accounts is preferable because the sales manager is more familiar with each of the customers having delinquent accounts and thus can more accurately determine the appropriate time to write off their accounts. In addition, as chief accountant I should not be required to approve the write-off of accounts which I am responsible for maintaining.
Inventory. The auditors' recommendation that the production supervisor alone sign receiving reports is impractical because the supervisor is often supervising employees physically removed from the vicinity of the receiving dock. Such a requirement would reduce the production supervisor's effectiveness. I suggest we continue with the present system of receiving report approvals.
Marketable Securities. All stock certificates related to marketable securities are registered in the company name so putting such certificates in a bank safety deposit box is unnecessary. In addition, your desk drawer may be locked, and the advantage of convenient access more than offsets any improvement in control.
Payroll. The recommendation that hourly production workers punch out and back in for their lunch breaks would necessitate new time cards to accommodate twice as many clock entrics as are currently required. In addition, if an employee is going to miss a half day's work by having a friend punch his or her card at the end of the day under the current system, only one additional erroneous entry will be required by the friend after lunch under the proposed system.
Required:
For each of the weaknesses of internal controls and procedures identified by Deber \& Associates, discuss whether

a. The weakness identified by Deber \& Associates is substantive and should be brought to Tuloak's atiention.

b. The recommendation proposed by Deber \& Associates is a reasunable and appropriate solution.

c. The response of Charles Earl of Tuloak Manufacturing Company is satisfactory under the circumstances.

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Sincerely, Deber & Associates Memorandum TO: Samuel Lawten, President FROM: Charles Earl, Chief Accountant SUBJECT: Response to management letter from Deber & Associates