Evaluation of Internal Controls

The Never Sink Canoe (NSC) company is a small manufacturer of high quality canoes, pontoons, and fishing craft, It sells its products to sporting good stores throughout the northeast United States and parts of Canada. NSC began as a small family owned company that served a local market. Over the years it expanded its market through the use of seasonal sales force employees. the sales staff work on straight commission and travel extensively while taking orders from customers at sporting outlets and trade shows during the water sports and fishing season. All sales are on credit and payment is due within 30 days after being billed. In late fall when the season ends, the temporary sales personnel are laid off until the following spring. Employee turnover is high with approximately 50% of the laid-off sales staff returning the following year. NSC's revenue and expense procedures associated with their sales force activities are as follows: The salesperson takes an order, reviews the customer's credit worthiness, and submits the approved order to the accounting clerk at the main office who calculates the sales commission to be remitted and promptly writes a check to the salesperson. The clerk then sets up an account receivable for the customer. The clerk also receives cash in payment of customer accounts and updates the related customer AR records. The order is then sent to the billing department, where the sale is recorded and the customer is billed. Finally, the order is sent to the warehouse where the items are selected, packaged and shipped to the customer. The warehouse clerk then updates the inventory subsidiary ledger to reflect the shipment. Sales staff periodically submit travel expense reimbursement claims on hard copy forms to the accounting clerk. NSC policy requires sales staff to keep receipts, but they are not required to submit them with the reimbursement forms. The clerk prepares an account payable for each salesperson based on their reimbursement form and twice each month writes checks them for the amount indicated in their individual AP account. After the end of the past season, and after the temporary employees had been laid off, NSC financials showed a substantial rise in sales compared to previous years. These increases were, however, offset to a great extent by a high rate of product returns. Furthermore, travel expenses were disproportionately high compared with previous years.

Required

a) Using the COSO internal control model for control activities (e.g., transaction authorization, segregation of duties) identify and potential internal control weaknesses int he NSC system.

b) For each weakness discuss the potential for fraud in the system.

c) Make recommendations for correcting each identified control weakness.