Subject:

Assume the role of the accountant. memo to Chuck Breezy, the president, analyzing the weaknesses in internal control and suggest improvements. Provide a quantitative analysis of the effects on net income in 2010 and 2011 after establishing the new "reward incentive based on net sales" and raising "the initial credit level for new customers"

This is the handout that goes along with the directions:

2. Breezy Company

(This case was prepared by Elizabeth Morris, Lehigh University.)

Breezy Company of Bethlehem, Pennsylvania, is a small wholesale distributor of heating and cooling fans. The company deals with retailing firms that buy small-to medium quantities of fans. The president, Chuck Breezy, was very pleased with the marked increase in sales over the past couple of years. Recently, however, the company's accountant informed Chuck that although net income has increased, the percentage of uncollectibles has tripled. Due to the small size of the business, Chuck fears he may not be able to sustain these increased losses in the future. He has asked his accountant to analyze the situation.

Background

In 1998, the sales manager, John Breezy, moved to Alaska, and Chuck hired a young college graduate to take over the position. The company had always been a family business and, therefore, measurements of individual performance had never been a large consideration. The sales levels had been relatively constant because John had been content to sell to certain customers with whom he had been dealing for years. Chuck was leery about hiring outside of the family for this position. To incentive based on net sales. The new sales manager, Bob Sellmore, was eager to set his career in motion and decided he would attempt to increase the sales levels. he recruited new customers while keeping the old clientele. After one year, Bob had proved himself to Chuck, who decided to introduce an advertising program to further increase sales. This brought in orders from a number of new customers, many of whom Breezy had never done business with before. The influx of orders excited Chuck so much that he instructed Jane Breezy, the finance manager, to raise the initial credit level for new customers. This induced some customers to purchase more.

Existing System

The accountant wrote up a comparative income statement to show changes in revenues and expenses over the last three years, shown in Exhibit A. Currently, Bob is receiving a commission of 2 percent of net sales. Breezy Company uses credit terms of net 30 days. At the end of previous years, bad debt expense amounted to approximately 2 percent of net sales. As the finance manager, Jane performs credit checks. In previous years, Jane had been familiar with most clients and approved credit on the basis of past behavior. When dealing with new customers, Jane usually approved a low credit amount and increased it after the customer exhibited reliability. With the large increase in sales, Chuck felt that the current policy was restricting a further rise in sales levels. He decided to increase credit limits to eliminate this restriction. This policy, combined with the new advertising program, should attract many new customers.

Future

The new level of sales impresses Chuck and he wishes to expand, but he also wants to keep uncollectibles to a minimum. He believes the amount of uncollectibles should remain relatively constant as a percentage of sales. Chuck is thinking of expanding his production line but wants to see uncollectibles drop and sales stabilize before he proceeds with this plan.

Required:

Analyze the weaknesses in internal control and suggest improvements.

Based on the problem, we've identified three internal control weaknesses namely, 1.)Authorization of control, 2.) Terms of trade and lastly, 3.) Reward Incentives.

For Authorization of Control

We suggest that they set credit limits based on outside credit verification for initial credit limits. We also encourage them to establish decision criteria to increase credit limit such as examining payment history because inappropriate credit limits may be a reason that bad debt expense is increasing disproportionately with sales

For Terms of Trade

We suggest that they offer sales discounts for early payment and charge a finance charge for payments not made within 30 days.

For Reward Incentives

Instead of using net sales, use net sales less uncollectible accounts.