Requirements
Identify 6 internal control weaknesses. For each weakness, provide a detailed recommendation for improvement to the Control Procedures (Internal Controls) using the terminology and concepts discussed in your textbook. Examples should be specific citing the facts of the case. The final analysis must follow the excel format worksheet provided.
Internal Control Assessment Small, entrepreneurial businesses find it challenging to obtain health insurance at a reasonable cost. ABC is a membership organization of small companies that negotiates with health care and insurance providers to provide health insurance at a reasonable cost to its members. Each business pays ABC a per employee membership fee. Every month each business is required to submit a payment to ABC based on its current number of employees for that month. The fee per employee is $2. ABC does not bill each business and some businesses are two to three months behind on submitting their payments. Currently, there are 2 employees at ABC. Since the organization is small, there are no written job descriptions or policies. There is an Executive Director and an Office Manager. ABC uses Peachtree Accounting for its accounting information system. Sometimes the Executive Director forgets her password so she has given it to the Office Manager as an extra precaution. Executive Director The Executive Director is responsible for recruiting new members into the organization, negotiating with health care and insurance providers, preparing payroll, and reviewing the financial information. The Executive Director reports to the Board of Directors, which is made up of 12 individuals from area health care providers, insurance agencies, and other well established large corporations (manufacturing, public accounting firms, retail). All checks are signed by the Executive Director. On the 15th and last day of each month, the employees are paid. The Executive Director prepares and signs the payroll checks for ABC. Office Manager The Office Manager is responsible for opening the mail, recording the cash receipts from the businesses in Peachtree and depositing the cash in the bank. Typically one to two checks are received each day so the Office Manager keeps the checks in the desk drawer and deposits all checks on Friday. Every other Wednesday, the Office Manger reviews the vendor invoices received, enters them into Peachtree, and prints checks. All checks are signed by the Executive Director. In addition, the Office Manager is responsible for filing and preparing office correspondence. This position reports to the Executive Director. At the end of the year, the accounting firm for ABC compiles the financial information provided and prepares a tax return. No audit is required for this private organization. The CPA on the Board of Directors is concerned about internal controls within the organization and has asked for your advice. A B D E F 1 2 Internal Controls Worksheet for Accounting Business Process: 3 Weakness/Deficiencies Control Objective* Risk Control Activity Preventive Assessment/Recommended Detective Change 4 5 6 7 9 10 11 12 13 14 15 16 - Policies, Plans, Procedures Implemented to protect a firm's assets 17 27 28 EXAMPLE BAD BENNY In the early twentieth century, there was an ambitious young man named Arthur who started working at a company in Chicago as a mailroom clerk. He was a hard worker and very smart, eventually ending up as the president of the company, the James H. Rhodes Company. The firm produced steel wool and harvested sea sponges in Tarpon Springs, Florida for household and industrial use. The company was very successful, and Arthur decided that the best way to assure the continued success of the company was to hire trusted family members for key management positions- because you can always count on your family. Arthur decided to hire his brother Benny to be his Chief Financial Officer (CFO), and placed other members of the family in key management positions. He also started his eldest son, Arthur Junior (an accountant by training) in a management training program, hoping that he would eventually succeed him as president. As the company moved into the 1920s, Benny was a model employee; he worked long hours, never took vacations, and made sure that he personally managed all aspects of the cash function. For example, he handled the entire purchasing process, from issuing purchase orders through the disbursement of cash to pay bills. He also handled the cash side of the revenue process by collecting cash payments, preparing the daily bank deposits, and reconciling the monthly bank statement. The end of the 1920s saw the United States entering its worst Depression since the beginning of the Industrial Age. Because of this, Arthur and other managers did not get raises, and in fact, took pay cuts to keep the company going and| avoid lay-offs. Arthur and other top management officials made "lifestyle" adjustments as well-e. g., reducing the number of their household servants and keeping their old cars, rather than purchasing new ones. Benny, however, was able to build a new house on the shore of Lake Michigan and purchased a new car. He dressed impeccably and seemed impervious to the economic downturn. His family continued to enjoy the theatre, new cars, and nice clothes. Arthur's wife became suspicious of Benny's good fortune in the face of others' hardships, so she and Arthur hired an accountant to review the books. External audits were not yet required for publicly- held companies, and the Securities and Exchange Commission (SEC) had not yet been formed that would happen in 1933-1934). Jim the accountant was eventually able to determine that Benny had diverted company funds to himself by setting up false vendors and having checks mailed to himself. He also diverted some of the cash payments received from customers and was able to hide it by handling the bank deposits and the reconciliation of the company's bank accounts. Eventually, Jim determined that Benny had embezzled about $ 500,000 (in 1930 dollars). If we assume annual compounding of 5% for 72 years, the value in today's dollars would be about $ 17.61 million! Arthur was furious, and sent Benny "away." Arthur sold most of his personal stock holdings in the company to repay Benny's embezzlement, which caused him to lose his controlling interest in the company, and eventually was voted out of office by the Board of Directors. Jim, the accountant, wrote a paper about his experience with Benny (now referred to as "Bad Bad Benny" by the family). Jim's paper contributed to the increasing call for required annual external audits for publicly-held companies. Arthur eventually reestablished himself as a successful stockbroker and financial planner. Benny "disappeared" and was never heard from again. B C D E F G 1 2 Internal Controls Worksheet for Accounting/Business Process: Control Objective* Risk Control Activity 3 1 Accurate Financial Accounting Statements High Hiring Competent Personnel 4 Benny was made CFO, brother to President Benny was the CFO and it seems that Arthur trusted him completely, with little to no supervision. 2 Accurate Financial Accounting Statements Medium to High Rotating Duties 5 3 Benny did not take vacations Accurate Financial Accounting Statements Medium to High Mandatory Vacations 6 Preventive Assessment/Recommende /Detective d Change Preventive Hire a qualified CFO, with experience and reputation, not based on being family Benny did everything in accounting, hire Detective additional staff to take on Benny's day to day accounting work Employees in Accounting and Finance Detective must take annual vacations of 1-2 weeks out of the office Must implement a separation of duties. As a CFO it is fine to manage Cash Preventive Receipts and Cash Payments, but other employees should have performed these tasks and reported into the CFO position. Preventive/ Separate the creation of vendors from the . Detective Accounts Payable/check writing function men's Need to separate Bank Reconciliation Preventive/ function from employees who deposit cash and/or make payments to suppliers Detective to ensure that all the cash is controlled and properly accounted for. 4 Benny managed all aspects of the Cash function Safe Guarding Assets/Accurate Financial Statements Extremely High Risk!!!!! Separating Responsibilities for Related Operations 7 5 Benny created new vendors and made payments Safe Guarding Assets/Accurate Financial Statements Extremely High Risk!!!!! Separating Operations, Custody of Assets, and Accounting 8 6 Benny wrote checks, received cash payments and reconciled banks statements Safe Guarding Assets/Accurate Financial Statements Extremely High Risk!!!!! Proofs and Security Measures 9 10 Other: RED FLAGS!!!!!!!!!!!!!!! Or things that don't make sense Depression Era, extremely high unemployment and pay cuts for executives Benny is building a new house, while others are cutting expenses. Benny is purchasing a new car while others are cutting back to keep there employees working. Arthur's wife was the one who noticed. His clothing was always nice and expensive 11 Internal Control Assessment Small, entrepreneurial businesses find it challenging to obtain health insurance at a reasonable cost. ABC is a membership organization of small companies that negotiates with health care and insurance providers to provide health insurance at a reasonable cost to its members. Each business pays ABC a per employee membership fee. Every month each business is required to submit a payment to ABC based on its current number of employees for that month. The fee per employee is $2. ABC does not bill each business and some businesses are two to three months behind on submitting their payments. Currently, there are 2 employees at ABC. Since the organization is small, there are no written job descriptions or policies. There is an Executive Director and an Office Manager. ABC uses Peachtree Accounting for its accounting information system. Sometimes the Executive Director forgets her password so she has given it to the Office Manager as an extra precaution. Executive Director The Executive Director is responsible for recruiting new members into the organization, negotiating with health care and insurance providers, preparing payroll, and reviewing the financial information. The Executive Director reports to the Board of Directors, which is made up of 12 individuals from area health care providers, insurance agencies, and other well established large corporations (manufacturing, public accounting firms, retail). All checks are signed by the Executive Director. On the 15th and last day of each month, the employees are paid. The Executive Director prepares and signs the payroll checks for ABC. Office Manager The Office Manager is responsible for opening the mail, recording the cash receipts from the businesses in Peachtree and depositing the cash in the bank. Typically one to two checks are received each day so the Office Manager keeps the checks in the desk drawer and deposits all checks on Friday. Every other Wednesday, the Office Manger reviews the vendor invoices received, enters them into Peachtree, and prints checks. All checks are signed by the Executive Director. In addition, the Office Manager is responsible for filing and preparing office correspondence. This position reports to the Executive Director. At the end of the year, the accounting firm for ABC compiles the financial information provided and prepares a tax return. No audit is required for this private organization. The CPA on the Board of Directors is concerned about internal controls within the organization and has asked for your advice. A B D E F 1 2 Internal Controls Worksheet for Accounting Business Process: 3 Weakness/Deficiencies Control Objective* Risk Control Activity Preventive Assessment/Recommended Detective Change 4 5 6 7 9 10 11 12 13 14 15 16 - Policies, Plans, Procedures Implemented to protect a firm's assets 17 27 28 EXAMPLE BAD BENNY In the early twentieth century, there was an ambitious young man named Arthur who started working at a company in Chicago as a mailroom clerk. He was a hard worker and very smart, eventually ending up as the president of the company, the James H. Rhodes Company. The firm produced steel wool and harvested sea sponges in Tarpon Springs, Florida for household and industrial use. The company was very successful, and Arthur decided that the best way to assure the continued success of the company was to hire trusted family members for key management positions- because you can always count on your family. Arthur decided to hire his brother Benny to be his Chief Financial Officer (CFO), and placed other members of the family in key management positions. He also started his eldest son, Arthur Junior (an accountant by training) in a management training program, hoping that he would eventually succeed him as president. As the company moved into the 1920s, Benny was a model employee; he worked long hours, never took vacations, and made sure that he personally managed all aspects of the cash function. For example, he handled the entire purchasing process, from issuing purchase orders through the disbursement of cash to pay bills. He also handled the cash side of the revenue process by collecting cash payments, preparing the daily bank deposits, and reconciling the monthly bank statement. The end of the 1920s saw the United States entering its worst Depression since the beginning of the Industrial Age. Because of this, Arthur and other managers did not get raises, and in fact, took pay cuts to keep the company going and| avoid lay-offs. Arthur and other top management officials made "lifestyle" adjustments as well-e. g., reducing the number of their household servants and keeping their old cars, rather than purchasing new ones. Benny, however, was able to build a new house on the shore of Lake Michigan and purchased a new car. He dressed impeccably and seemed impervious to the economic downturn. His family continued to enjoy the theatre, new cars, and nice clothes. Arthur's wife became suspicious of Benny's good fortune in the face of others' hardships, so she and Arthur hired an accountant to review the books. External audits were not yet required for publicly- held companies, and the Securities and Exchange Commission (SEC) had not yet been formed that would happen in 1933-1934). Jim the accountant was eventually able to determine that Benny had diverted company funds to himself by setting up false vendors and having checks mailed to himself. He also diverted some of the cash payments received from customers and was able to hide it by handling the bank deposits and the reconciliation of the company's bank accounts. Eventually, Jim determined that Benny had embezzled about $ 500,000 (in 1930 dollars). If we assume annual compounding of 5% for 72 years, the value in today's dollars would be about $ 17.61 million! Arthur was furious, and sent Benny "away." Arthur sold most of his personal stock holdings in the company to repay Benny's embezzlement, which caused him to lose his controlling interest in the company, and eventually was voted out of office by the Board of Directors. Jim, the accountant, wrote a paper about his experience with Benny (now referred to as "Bad Bad Benny" by the family). Jim's paper contributed to the increasing call for required annual external audits for publicly-held companies. Arthur eventually reestablished himself as a successful stockbroker and financial planner. Benny "disappeared" and was never heard from again. B C D E F G 1 2 Internal Controls Worksheet for Accounting/Business Process: Control Objective* Risk Control Activity 3 1 Accurate Financial Accounting Statements High Hiring Competent Personnel 4 Benny was made CFO, brother to President Benny was the CFO and it seems that Arthur trusted him completely, with little to no supervision. 2 Accurate Financial Accounting Statements Medium to High Rotating Duties 5 3 Benny did not take vacations Accurate Financial Accounting Statements Medium to High Mandatory Vacations 6 Preventive Assessment/Recommende /Detective d Change Preventive Hire a qualified CFO, with experience and reputation, not based on being family Benny did everything in accounting, hire Detective additional staff to take on Benny's day to day accounting work Employees in Accounting and Finance Detective must take annual vacations of 1-2 weeks out of the office Must implement a separation of duties. As a CFO it is fine to manage Cash Preventive Receipts and Cash Payments, but other employees should have performed these tasks and reported into the CFO position. Preventive/ Separate the creation of vendors from the . Detective Accounts Payable/check writing function men's Need to separate Bank Reconciliation Preventive/ function from employees who deposit cash and/or make payments to suppliers Detective to ensure that all the cash is controlled and properly accounted for. 4 Benny managed all aspects of the Cash function Safe Guarding Assets/Accurate Financial Statements Extremely High Risk!!!!! Separating Responsibilities for Related Operations 7 5 Benny created new vendors and made payments Safe Guarding Assets/Accurate Financial Statements Extremely High Risk!!!!! Separating Operations, Custody of Assets, and Accounting 8 6 Benny wrote checks, received cash payments and reconciled banks statements Safe Guarding Assets/Accurate Financial Statements Extremely High Risk!!!!! Proofs and Security Measures 9 10 Other: RED FLAGS!!!!!!!!!!!!!!! Or things that don't make sense Depression Era, extremely high unemployment and pay cuts for executives Benny is building a new house, while others are cutting expenses. Benny is purchasing a new car while others are cutting back to keep there employees working. Arthur's wife was the one who noticed. His clothing was always nice and expensive 11
