As the internal auditor for a large savings and loan association, you are concerned about segregation of duties for a wholly owned real estate investment subsidiary. The subsidiary, despite several million dollars in assets, operates from the main office of the parent. The parent company administers all purchasing, payroll, and personnel functions. The subsidiary’s board of directors consists entirely of selected officers of the parent.

The real estate investment subsidiary’s activities consist primarily of buying, developing, and selling real estate, with some development projects involving joint ventures with contractors. The president and two vice presidents handle day-to-day operations.

The president also acts as a liaison with the parent. Each vice president has his or her own projects to manage.

All invoices and itemized statements requiring direct payment or reimbursement to contractors or vendors are delivered to one of the two vice presidents for review and approval. After they are approved, the staff accountant prepares checks and then has one of the vice presidents sign them. After they are signed, the checks are returned to the staff accountant for mailing and filing of the supporting documentation.

The staff accountant keeps all blank checks.

All customer payments on notes and accounts receivable originating from the sale of real estate are remitted to one of the two vice presidents and then forwarded to the staff accountant, who records the payment and prepares the deposit slip. The deposit may be given to the parent’s accounting department or to a teller of the parent.

If the subsidiary experiences a cash shortage, a promissory note is prepared by the staff accountant and signed by the president or one of the vice presidents. The staff accountant submits the promissory note to the parent and awaits receipt of the funds. The staff accountant is responsible for billing customers and advising management when payments are due. The staff accountant reconciles the bank statement once a month.

The staff accountant prepares monthly financial statements, including the accrual of interest receivable and the capitalization of certain interest charges. The financial statements are prepared to reflect the substance of both joint ventures and subsidiary operations. The board of directors reviews the financial statements.

Required:

a. Identify specific areas in which segregation of duties is inadequate, and suggest ways in which segregation could be improved.

b. If segregation were adequate, how would the auditor gather evidence to test the actual segregation of duties during normal operation?