Question 2) Internal Controls

Ramona's Clothing is a retail store specializing in women's clothing. The store has established a liberal return policy for the holiday season in order to encourage gift purchases. Any item purchased during November and December may be returned through January 31, with a receipt, for cash or exchange. If the customer does not have a receipt, cash will still be refunded for any item under $75. If the item is more than $75, a check is mailed to the customer.

Whenever an item is returned, a store clerk completes a return slip, which the customer signs. The return slip is placed in a special box. The store manager visits the return counter approximately once every two hours to authorize the return slips. Clerks are instructed to place the returned merchandise on the proper rack on the selling floor as soon as possible.

This year, returns at Ramona's Clothing have reached an all-time high. There are a large number of returns under $75 without receipts.

a. How can sales clerks employed at Ramona's Clothing use the store's return policy to steal money from the cash register?

b. What internal control weaknesses do you see in the return policy that make cash thefts easier?

c. Would issuing a store credit in place of a cash refund for all merchandise returned without a receipt reduce the possibility of theft?

Classify the following as either advantages or disadvantages of issuing a store credit in place of cash.

A clerk could only issue a phony store credit rather than taking money from the cash register.

The store would lose less revenue if customers had to choose other store merchandise instead of getting a cash refund.

Issuing only a store credit for returns without a receipt is a stricter return policy that may affect gift-givers' purchase decisions.

Sales clerks will need to be trained to apply the new policy and write up a store credit. They will also need to be trained to handle the redemption of the store credit on future merchandise purchases.

d. Assume that Ramona's Clothing is committed to the current policy of issuing cash refunds without a receipt. Are there any changes that could be made in the store's procedures regarding customer refunds in order that would improve internal control?

Question 3) Internal Controls for Bank Lending

Pacific Bank provides loans to businesses in the community through its Commercial Lending Department. Small loans (less than $100,000) may be approved by an individual loan officer, while larger loans (greater than $100,000) must be approved by a board of loan officers. Once a loan is approved, the funds are made available to the loan applicant under agreed-upon terms. Pacific Bank has instituted a policy whereby its president has the individual authority to approve loans up to $5,000,000. The president believes that this policy will allow flexibility to approve loans to valued clients much quicker than under the previous policy.

Answer the following True or False questions related to the scenario.

All loans have the same element of risk, so it doesn't matter if the loan is large or small.

Allowing the bank president to have sole authority to grant large loans is fine since he or she is president.

Large loans present greater risk in the event of default, therefore you should have more than one person involved in making the decision to grant a large loan.

Having one person grant loans is good internal control.

Question 4) Internal Controls

One of the largest losses in history from unauthorized securities trading involved a securities trader for the French bank, Societe Generale. The trader was able to circumvent internal controls and create more than $7 billion in trading losses in six months. The trader apparently escaped detection by using knowledge of the bank's internal control systems learned from a previous back-office monitoring job. Much of this monitoring involved the use of software to monitor trades. In addition, traders were usually kept to tight trading limits. Apparently, these controls failed in this case.

Answer the following True or False questions about Societe Generale's internal controls. These will assist you in determining the weaknesses.

1. The loss could have been avoided with a number of internal controls.

2. Required vacation time may have alerted managers to the hidden losses.

3. If traders have access to the monitoring software, then the separation of duties control is violated.

4. The trader was not under managerial oversight.

Question 5) Internal Controls

An employee of JHT Holdings, Inc., a trucking company, was responsible for resolving roadway accident claims under $25,000. The employee created fake accident claims and wrote settlement checks of between $5,000 and $25,000 to friends or acquaintances acting as phony "victims." One friend recruited subordinates at his place of work to cash some of the checks. Beyond this, the JHT employee also recruited lawyers, whom he paid to represent both the trucking company and the fake victims in the bogus accident settlements. When the lawyers cashed the checks, they allegedly split the money with the corrupt JHT employee. This fraud went undetected for two years.

Answer the following True or False questions concerning the fraud.

Frauds that are perpetrated with multiple parties in different positions of control make detecting fraud more difficult.

Claims should be authorized and verified before payment is made.

The employee made sure each claim had a phony "victim."

Corrupt lawyers were brought into the fraud to act as attorneys for the claimants.

Question 6) Internal Controls

All-Around Sound Co. discovered a fraud whereby one of its front office administrative employees used company funds to purchase goods such as computers, digital cameras, and other electronic items for her own use. The fraud was discovered when employees noticed an increase in the frequency of deliveries from vendors and the use of unusual vendors. After some investigation, it was discovered that the employee would alter the description or change the quantity on an invoice in order to explain the cost on the bill.

Answer the following True or False questions about the company's internal controls. These will assist you in determining the weaknesses.

Purchases should be initiated by a requisition document.

An accounts payable clerk should match the requisition, purchase order, and invoice before any payment is made.

The invoice should have been delivered directly to the accounts payable clerk to avoid corrupting the document.

Question 7) Financial Statement Fraud

A former chairman, CFO, and controller of Donnkenny, Inc., an apparel company that makes sportswear for Pierre Cardin and Victoria Jones, pleaded guilty to financial statement fraud. These managers used false journal entries to record fictitious sales, hid inventory in public warehouses so that it could be recorded as "sold," and required sales orders to be backdated so that the sale could be moved to an earlier period. The combined effect of these actions caused $25 million out of $40 million in quarterly sales to be phony.

a. Why might control procedures listed in this chapter be insufficient in stopping this type of fraud?

b. Would an audit committee made up of representatives from senior management be effective in stopping this type of fraud?

Question 8) Internal Control of Cash Receipts

The procedures used for over-the-counter receipts are as follows: At the close of each days business, the salesclerks count the cash in their respective cash drawers, after which they determine the amount recorded by the cash register and prepare the memo cash form, noting any discrepancies. An employee from the cashiers office counts the cash, compares the total with the memo, and takes the cash to the cashiers office.

a. Identify the weak link in internal control.

b. Who should remove the cash register tapes from the register?

Question 9) Internal Control of Cash Receipts

Sergio Flores works at the drive-through window of Big & Bad Burgers. Occasionally, when a drive-through customer orders, Sergio fills the order and pockets the customer's money. He does not ring up the order on the cash register.

Identify the internal control weaknesses that exist at Big & Bad Burgers.

Can customers be part of the internal control process?

Question 10) Internal Control of Cash Receipts

The mailroom employees send all remittances and remittance advices to the cashier. The cashier deposits the cash in the bank and forwards the remittance advices and duplicate deposit slips to the Accounting Department.

a. Indicate the weak link in internal control in the handling of cash receipts.

b. How can the weakness be corrected?