Review the article below and answer the bold questions entitled, "Who’s in Control of the Ark? A Study of Internal Controls in Operating and Auditing A Small Preschool."

Explain two internal controls the school is implementing well, two internal controls the school could improve on, and two internal controls that could open the door to fraud. Make sure all internal controls are from the accounting information system (AIS) framework.

The Preschool Audit

From her experience on the church finance committee, Sara knows that the Cornerstone 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 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 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 numbers. She confirms year-end bank balances, and examines a cut-off statement in January. Sara lists the audit procedures she performs, see Panel A of Table 2. She summarizes her concerns on a legal pad, presented in Panel B.

No employee should handle a transaction from beginning to end.

• Separate cash handling from record keeping.
• Centralize cash handling as much as possible.
• Record cash receipts on a timely basis.
• Make deposits daily.
• Encourage customers to review receipts.
• Make all expenditures by check or electronic funds transfer.
• An employee not handling cash should prepare monthly bank reconciliations.
• An appropriate administrator should review the reconciliations monthly.
• Compare cash receipts and disbursements to forecasted amounts and budgets.

Using the exceptions noted, Sara begins listing cost-effective control procedures that the preschool could implement (See Table 2, Panel C).

She pauses, leaning back in her chair and thinking about the children, teachers, and parents at the preschool, as well as the congregation at Cornerstone Church. She has read news reports of other schools using state funds for employee vacations, mortgage payments, and shopping sprees. She believes the director and administrators are caring people, but Sara is concerned about their lack of accounting and financial expertise. She worries that there is no clear definition of responsibilities. Sara is reasonably confident that no fraudulent activity has taken place, but knows the preschool needs to implement additional controls.

II. CASE REQUIREMENTS

• What are the responsibilities of the Ark management to the Cornerstone Church for cash receipts and disbursement cycles? What are the management assertions related to cash receipt and disbursement cycles (occurrence, accuracy, completeness, cut-off, and classification)?
• To whom is Sara responsible in performing the Ark Preschool audit? What are the auditor's objectives in auditing cash?
• Carefully read Sara's interview of preschool administrators, see Table 1. Using [ 1], identify the principles of effective control and associated risks that could threaten preschool objectives. See Table 3 for a template.
• What control improvements could reduce the risks of misstatement or fraud identified? Identify at least two improvements, in addition to the ones already suggested, in each of the categories Sara describes in Panel C of Table 2.
• Recognizing that the preschool is a small business with budget constraints, write a letter to Linda Gonzalez that identifies the control improvements you consider to be the most important in each of the following areas: authorization controls, segregation of functions, supervision, accounting records, access controls, and independent verification. Do not list all of the control improvements you suggested; rather, discuss those you believe would be most effective and cost sensitive.[ 1] A management letter template appears in Table 4.
• Using flowchart symbols provided in your text, develop a revised flowchart of the cash receipts cycle, implementing improvements suggested in Requirement 4.[ 2]
• Using flowchart symbols provided in your text, develop a revised flowchart of the cash disbursements cycle, implementing improvements suggested in Requirement 4.

Graph: TABLE 3 COSO (2013) Principles of Effective Internal Control

Graph: TABLE 4 Management Letter Template

Additional Auditing Questions

• Of the control risks identified in Requirement 3, select and explain one significant deficiency and one material weakness.
• Does Sara meet AICPA standards of independence? Explain.

The authors thank the editor, associate editor, and reviewers whose comments greatly enriched this case.

Editor's note: Accepted by Valaria P. Vendrzyk.

III. CASE LEARNING OBJECTIVES AND IMPLEMENTATION GUIDANCE

Critical Thinking

One primary learning objective of this case is to foster development of critical-thinking skills in accounting students. The [ 6] and the [ 5] identify critical-thinking skills as a key competency needed by accounting professionals. Business complexity, transaction speed, technology, and the global span of operations require that accountants possess not only technical accounting ability, but also general business acumen and analytical abilities. In a study of competencies leading to success in public accounting, [ 9] present evidence that critical-thinking competency is a key metric in evaluating performance of professionals.

The [ 6] defines critical thinking as "the ability to link data, knowledge, and insight together from various disciplines to provide information for decision making." The National Postsecondary Education Cooperative on Assessment ([19]) categorizes seven dimensions of critical thinking: interpretation, analysis, evaluation, inference skills, presenting arguments, reflection skills, and dispositions. Public accounting professionals interviewed by [ 9] include examples of critical-thinking competencies: recognition of problem areas and need for additional information, ability to see the big picture, ability to think ahead, and ability to transfer knowledge from one situation to another. While there is no common definition, critical thinking generally involves the analysis and evaluation of an issue or situation in order to form a judgment or make a recommendation.

One stream of accounting education literature examines various developmental approaches to improve critical-thinking abilities (see [16]; [13]). [26] summarize the research and identify several developmental themes in common, regardless of approach: critical-thinking skills can be arranged from less to more cognitively complex; less complex skills must be developed before higher skills can be achieved; cognitive skills develop slowly; most college students operate at cognitive levels too low to develop critical thinking; and students need sustained opportunities to develop critical thinking.

Another stream of accounting education literature examines teaching methods that facilitate development of critical thinking. [20] posit that passive learning, typified by in-class lecture and routine problem solving, promotes memorization and the one-right-answer syndrome, while rewarding the quiet non-thinker. [27] maintain that active, experiential learning strategies are more conducive to developing critical-thinking skills. [10] finds learning objectives involving complex skills require teaching methods that promote active learning on the part of students. [18] cite case methods as experiential teaching methodologies that are instrumental in promoting critical-thinking skills. Other proponents of experiential learning believe it provides a context that leads to transferable learning. For example, [24] find cognitive conflict enhances learning that transfers across domains, a component of critical thinking.

Yet another stream of accounting education literature examines the effects of teaching methodology affects student perceptions of accounting and the competencies demanded by the profession, including critical thinking. For example, [15] questions whether teaching formats are associated with student perceptions of accounting careers and skills needed for success in accounting. Students in lecture formats have negative perceptions about critical thinking and accounting, while students using mini-cases have more positive perceptions of accounting and their expectations about careers are more in alignment with competencies demanded in practice.

Understanding of Business Processes

A second primary learning objective of this case is to develop understanding of key business processes and the flow of information in an organization. This understanding is vital to both managers who are operating a business and auditors who are examining its financial records. The Sarbanes-Oxley Act of 2002 ([25]) requires managers and auditors attest to the effectiveness of internal controls; Auditing Standard 2201 requires auditors understand the flow of transactions; and, the [22] requires adequate documentation of internal controls in its top-down approach.

While auditors use narrative descriptions, questionnaires, and flowcharts to document business processes, [11] find an increased use of systems diagrams to document internal control and information flows in an organization after passage of the Sarbanes-Oxley Act. [21],15) recommends enhancing student understanding by "introducing cases with real-world concepts that students will need to understand as they enter the workplace, such as ... a grasp of processes and how data flows through an organization, so that they know the right questions to ask clients." This current case develops competency in process documentation using document flowcharts.

This case integrates internal control and cash audit concepts and has three main features: it uses information from a real business; it develops competency in process documentation using document flowcharts; and it facilitates broader thinking as students must identify deficiencies in internal control and propose control improvements. After fully investing in this case, students in either an accounting information systems (AIS) or financial audit class should be able to:

• Describe management responsibilities for financial statements and management assertions regarding cash receipts and disbursements. (Questions 1 and 2; 10–15 minutes).
• Explain and apply [12] principles of effective internal control. (Q3; 20–30 minutes).
• Analyze cash receipt and disbursement processes for control deficiencies and recommend improvements to control procedures. (Q4; 20 minutes).
• Translate descriptions of accounting processes into flowcharts or a management letter. (Q5–7; 45 minutes).

Additionally, students using this case in a financial audit class should be able to:

• Apply concepts of material weaknesses and significant deficiencies. (Q1; 10–15 minutes).
• Assess auditor independence. (Q2; 10 minutes).

Intended Courses and Implementation

This field-researched case is based on interviews with the individuals mentioned in the case and data from the Ark Preschool financial records. It concentrates on internal control issues examined in introductory AIS and information technology audit courses. The case provides a vehicle for instructors to develop [12] principles of internal control, apply the principles in identifying risk and control deficiencies, evaluate existing processes, and propose control improvements.

We have assigned the case in the last quarter of an AIS course to illustrate controls in revenue and expenditure cycles. It also could be used as a course-long assignment using the first three questions as early-semester assignments on control and the remaining questions assigned toward the end of the semester to illustrate controls over.