Please read the following case and answer the SEVEN questions in the Case Requirements section (Pages 28, 29, and 30). (Do not worry about the last two about "Additional Auditing") Questions"). F

ISSUES IN ACCOUNTING EDUCATION Vol. 34. No. 2 May 2019 American Accounting Association DOI: 10.2308/iace-52375 pp. 23-39 Who's in Control of the Ark? A Study of Internal Controls in Operating and Auditing A Small Preschool Elizabeth V. Grace San Jose State University Ashley Davis The University of Oklahoma ABSTRACT: This instructional case encourages analytical thinking about internal controls in both the operations and audit of a small, not-for-profit organization. Students examine a control environment characterized by unauthorized expenditures, lack of documentation, and missing documents. Using the COSO (2013) framework, students demonstrate understanding of business processes as they identify internal control risks and deficiencies, and recommend control improvements. Auditing students additionally apply management assertions about financial transactions and assess auditor independence. Students gain practical experience in developing flowcharts of accounting processes and writing a management letter for a familiar organization: a preschool. Keywords: instructional case; internal control; flowcharts; cash auditing; not-for-profit controls; auditor independence. I. CASE S ara Green released her seat belt and sat in her car listening to the sound of children's laughter coming from the Cornerstone Church. Ken Robinson, a retiree with little finance experience, served as the Cornerstone Church treasurer and had asked Sara to perform the annual audit of the financial records of the church and its affiliated preschool, the Ark Preschool. Sara had begun her career in assurance for a small regional accounting firm and knew the demands of performing an audit. After several years of auditing, she returned to graduate school for an advanced degree. She now teaches accounting at a local university and is active in several community organizations, including the Cornerstone Church. Sara served on the church's finance committee for five years and is familiar with its operations, but recently resigned because her evening teaching responsibilities interfere with committee meetings. Knowing the demands on her time, Sara hesitated to accept the pro bono audit. Ken assured her that new, computerized bookkeeping system made record-keeping easier and offered to help her as much as needed. Sara agreed to perform the audit and now, on a warm October afternoon, she reached into the back seat of her car for the list of audit and control questions she prepared for the Ark Preschool director, who had been in her job for two years. Sara paused before closing the car door, listening to children's voices, and walked into the building. Sara's two children had attended the Ark Preschool and she stood for a moment in the hallway as memories washed over her. Sara remembered Thanksgiving dinners with her children dressed in grocery bag costumes of Native Americans and Pilgrims, Mother's Day teas with cookies made by children and teachers, and the annual fall festivals. Startled from her reverie by slamming doors, she made her way to the preschool office. Sara entered a tiny office crammed with three desks, computers, boxes, and supplies, and was surprised to see three middle-aged women waiting anxiously for her. After clearing papers from the only empty seat, Sara greeted Linda Gonzalez, the preschool director, Stacey Okada, the education administrator, and Gloria Lloyd, the office assistant. Linda and Stacey run the preschool on a daily basis and handle tuition receipts, bill payments, crying children, worried parents, and tired teachers. Gloria, the part-time office assistant and former engineer, primarily records transactions into an electronic system and reconciles bank statements. Sara had asked to meet with Linda to ask a few about organizational goals and accounting processes at the preschool, but all three wanted to take part in the conversation. December 2021 The authors thank the editor, associate editor, and reviewers whose comments greatly enriched this case. Editor's note: Accepted by Valaria P. Vendrzyk. Submitted: February 2016 Accepted: November 2018 Published Online: January 2019 Sara settled into her chair and pulled out her list of questions. After briefly explaining the importance of internal controls, she asked the staff about preschool operating, reporting, and compliance objectives. They responded that the primary operating objectives of the Ark Preschool are financial solvency, sufficient cash when needed, reduction of waste, effective scheduling of teachers to minimize overtime, and protection of preschool equipment from theft. Their financial reporting objectives include monthly budget updates, timely reconciliation of bank accounts, and reliable annual reports to Cornerstone Church. The most important compliance objective is adherence to regulatory requirements, including wage and labor laws, federal and state income reporting regulations, and state preschool licensing requirements. Sara listened carefully and started taking notes as Linda answered questions, while Stacey and Gloria added their comments. Ringing telephones and teachers clocking out at the end of the day interrupted the interview, but Sara quickly realized all three administrators were clearly invested in the preschool and were eager to explain how it worked. Sara's notes from the interview with Linda, Stacey, and Gloria are detailed in Table 1. Downloaded from The Ark Preschool The Ark Preschool is a not-for-profit preschool that operates as an outreach ministry of the Cornerstone Church. It opened in 1985 when the first director saw a need for quality childcare in the community. Over time, the school adapted to meet the needs of families who were members of the church, as well as families in the community, and expanded operations to provide full-day childcare from infancy to school age. As an outreach ministry of the church, the preschool's purpose is to provide quality care and early education in a loving environment, and the preschool prides itself on its family feel. In its first ten years, the preschool was indeed a close-knit family given that four of the teachers were the director's daughters. The preschool has employed several directors since 1985, but the mission has remained the same: to celebrate the spirit and encourage the development of each child. A day at the preschool includes story time, alphabet and counting games, outdoor play, nature walks, water play, crafts for small motor skills, music, and singing. At any time, between 60 and 75 children are enrolled at the preschool either as full-time or part-time students. Current tuition totals $709,596 annually, an average of $59,000 per month. With current expenses of $708,459, the preschool essentially operates in break-even mode. The largest expenditures are for payroll and employee benefits, but the preschool also pays $3,200 per month for space shared with the church As is true of many not-for-profit organizations and small businesses, the Ark Preschool maintains a small administrative staff. In addition to the director and education administrator, the preschool employs 15 part-time and full-time teachers, a resource specialist, and a part-time office assistant. Both the director and administrator have early childhood education credentials and serve as substitute teachers when needed. None of the employees have backgrounds in accounting. Linda Gonzalez is responsible for the overall management of the school, including teacher hiring and training, program planning, community relations, and coordination with the sponsoring church. Linda meets quarterly with the preschool advisory board, which is comprised of five parents of preschool children, one of whom is also a church member. Linda is directly responsible to the senior minister of the Cornerstone Church and its staff-parish committee. Stacey Okada assists the director in daily activities and is responsible for general financial oversight, reviewing and preparing financial expenditures, deposits, and the transfer of funds between checking and savings accounts. The preschool recently hired Gloria Lloyd, the mother of several former students, to handle record-keeping activities and bookkeeping on a part-time basis. 1/ by Mauricio Melgarejo on 30 December 2021 The Preschool Audit From her experience on the church finance committee, Sara knows that the Comerstone Church has improved its control processes over time by segregating responsibilities, requiring documentation for expenditures, and implementing strict budget controls. She is less familiar with preschool operations and is unsure whether administrators have implemented similar improvements. Ken Robinson told Sara about payroll errors in prior years, but the preschool recently has installed an employee time clock and outsourced the preparation of payroll to a payroll-processing firm. Sara first examines three sets of payroll records by recalculating hours worked, comparing her totals to payroll summaries submitted to the processor, tracing hours calculated to processor reports, and reviewing changes to withholdings and pay rates for three sample pay periods. While there are several miscalculations of hours worked, most of them a half-hour or less, Sara is encouraged to see that payroll summaries generally are accurate. Sara knows the work to complete the audit will depend on the control system present in the preschool. She must understand transaction flows from initiation to authorization, processing, and recording in order to identify points in the preschool's processes where material misstatements could occur. Thinking about the type and effectiveness of controls at the preschool, the risk of material misstatement, and the audit procedures she would need to perform, Sara reviews her notes (see Table 1). The preschool staff answered her questions TABLE 1 Internal Control Interview Questions and Answers Questions Answers Do families receive a tuition bill? Who prepares Each month Gloria (part-time bookkeeper) prepares and emails every family a bill it? How often are families billed? that details the current month's payment due. Who records tuition receipts in the student Stacey (education administrator) prepares a list of receipts. Gloria compares list of accounts? receipts with amounts invoiced, records payments in student accounts in subsidiary ledger, and files the list of receipts. How do parents pay tuition? By check? Cash? Most pay by check, but at least one family pays with cash. Automated bank payments? Is tuition paid in person? By mail? Some parents mail payments, but most of them drop off payments when they bring their children to school. If administrators are in the office, parents pay in person; otherwise, they use the locked drop-box on the office door. Stacey or Linda (preschool director) usually removes payments from the drop-box, but sometimes Gloria does also. Are receipts given? Only if a parent asks for one, but that almost never happens. Explain the process for handling tuition Linda endorses checks with a stamp and prepares the deposit. Stacey checks payments and deposits. deposits for accuracy and Linda walks the deposits to the bank, which shares the same parking lot. Tuition is deposited on the day received, unless payment is received after the bank closes. All undeposited cash and/or checks are kept in a locked desk drawer. Linda deposits them when the bank reopens. Gloria records deposits in the general ledger. Is the fee schedule published on the internet The internet fee schedule correct. Discounts are given to siblings of current correct? Are any discounts given? Are they students, employees' children, and children of church members. Some standard for all children? scholarships are given based on need, but there is no formal policy. Is there a petty cash fund? What are its uses? Not exactly. Many parents don't want to bring in separate payments for field trips or Who has access? Where is it kept? gymnastics classes, so they are billed for these extra activities along with tuition. Still, teachers need cash for entrance fees and gas, so we withdraw cash from the bank in advance and hold it in a cash box we keep locked in a cabinet. Stacey and Linda have access to the cash, usually less than $30. Does the preschool allow any automated There is only one automated payment for Yelp. We receive an email invoice but withdrawals from its bank account? Is an don't print it out. The Yelp account is in the preschool's name. invoice received? Are all automated payments for accounts in the preschool's name? Do you require an invoice for all payments? Are Most of the time. We pay Don Cuesta for gym and motion classes without an there any exceptions? invoice. Most bills are received by mail. Who approves payment of invoices? No one. Stacey prepares checks when invoices are received. Who has check signing authority? Linda, Stacey, and Gloria can sign, but usually Stacey prepares and signs the checks. Stacey marks the invoices as paid and Gloria records the disbursements. Stacey files paid invoices. Where are unused checks stored? In a locked desk drawer. Describe the policy on reimbursement of Teachers and office staff should get prior approval for purchases, but there is no expenses. Is there a limit on dollar amounts? formal process or form required. They usually talk with Linda for approval. There is no limit on the amount if Linda has approved the purchase. Either Linda or Stacey decides what budget account to be charged. How are purchases of books, play equipment, Linda approves and places orders. Linda also orders and approves routine purchases and supplies handled? of supplies such as construction paper, glue, crayons, etc. Cornerstone Board of Trustees approves purchases of equipment Discuss any open accounts in the preschool's There are only two open accounts: a teacher supply company and a grocery store. name. All office staff members have cards that allow them to charge purchases at these two stores. Purchases on open account generate a receipt, which is usually matched against a monthly bill before payment. (continued on next page) TABLE 1 (continued) Questions Answers Who has preschool ATM cards? What is the purpose of the cards? Is there a restriction on the size of withdrawals? Is prior authorization required? The preschool has three bank accounts: checking, business savings, and money market accounts. Who has authority to transfer funds between accounts? How often are transfers made? Is a dedicated computer used to make transfers? Is it password protected? Are the computers used also for email? All three staff members have their own cards, but Stacey never uses hers. Mainly they are used to get cash for field trips, purchase supplies and food for the children, and buy small teacher gifts. There is no restriction on the size of transactions, but Linda approves card use in advance. Any of the office staff can transfer funds with debit cards, but only Linda and Stacey can transfer funds online. Funds are transferred to keep only the amount needed for disbursements in the checking account. Almost all transfers occur online. No. There are three computers in the office and transfers can be made on either Linda's computer or Stacey's. The computers are used for email and internet purchases also, but both of them have security software installed and are password protected. Wi-Fi is password protected also. The door is not locked when the preschool is open. Sometimes the office is unattended but not for very long periods of time. Gloria reconciles the bank account each month and files the reconciliation. Is the office door locked? Is the office left unattended? Who reconciles the checking account? How often? What is done with checks outstanding for many months? Describe how payroll is processed. There really is no formal policy. What is the role of the preschool board? All employees, except for Linda, use a clock to record time. Stacey totals biweekly payroll amounts, and employees review and sign their summaries. Linda reviews the payroll numbers. Payroll amounts are sent online to ADP for processing by either Stacey or Linda, using passwords that change periodically. ADP tracks vacation and sick pay totals to date, writes checks, and prepares W-2 forms. Linda documents any payroll changes using information from withholding forms. The church Staff Parish Committee is required to authorize changes in pay rates. After Linda and Stacey review payroll amounts from ADP, checks are disbursed manually. Payroll records are kept in a locked file and access is controlled somewhat. Advisory only. The Staff Parish Committee of Cornerstone Church hired Linda and she reports directly to the senior pastor. Linda attends a weekly staff meeting with the senior pastor. Vacation is based on how long an employee has been working. The preschool closes for one week in late August and one week between Christmas and New Year's. The maximum number of vacation days, in addition to these two weeks, is three weeks. All three staff members are involved in most of the management and accounting activities. When one is absent, the others step in to handle the job. The exception is Gloria. They generally wait for her to come back from vacation to reconcile bank accounts. How many weeks of vacation does each employee receive? Who handles preschool responsibilities when an office staff member is on vacation? together, generally agreeing with responses, but sometimes correcting each other. Concerned with interview responses and overlapping responsibilities among preschool staff, Sara draws flowcharts of preschool cash receipt and disbursement processes detailed in Exhibits 1 and 2. Sara turns to reconciliations of bank statements, which Gloria completes on a monthly basis. Using bank statements and the preschool check register, Sara reconciles the December 31 cash account and finds that it agrees with Gloria's reconciliation. She verifies disbursements against requests for payment or a bill and documentation of expenditures by using the monthly check register. Beginning with the January bank statement and the preschool electronic ledgers, she matches bank disbursements and deposits with amounts recorded in the preschool records and supporting documentation. She knows the preschool has entered into automatic payments for recurring disbursements for advertising through Yelp, an online publisher of crowd-sourced business reviews, but frowns at several ATM payments that lack any documentation. Sara examines the check register and supporting documentation for transactions recorded in January after the year-end close, and accounts for all check EXHIBIT 1 Existing Case Receipts Cycle Flowchart Bookkeeper - Gloria Preschool Director - Linda Education Administrator - Stacey Customer Customer Customer 3 Payment in Person Receive Payment in Person or Drop bas Receive Payment in Person or Dropbox Receive Paymentin Mailor from Office Stat Check or Cash Tuition invoice Checkor Cash Checkor Cash Tuition invoice 04 Tuition Invoice List of Receipt Tuition invoice Prepare List of Receipts Endorse/Stamp Checks for Depost Checkor Cash List of Receipt Compare List of Receipts to Tuition inweices Tuition Invoice Endorsed Checkor Cash ho Update An Subsidiary Ledger AVR Prepare Depost dary Ledger List of Receipts Deposit Slip Endered Check or Cash Check Deposit for ACCURY Tuition invoice Deposit Slip Endorsed Check or Cash Depot Receipt Locked Desk D Bank Open? NO Yes Deposit