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Solutions for Accounting Information System 12e by Marshall B. Romney Paul J. Steinbart
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CHAPTER 7 CONTROL AND ACCOUNTING INFORMATION SYSTEMS
7.1 Answer the following
questions about the audit of Springer’s Lumber & Supply
a. What deficiencies existed in
the internal environment at Springer’s?
b.
Do you agree with the decision to settle with the Springers rather than to
prosecute them for fraud and embezzlement? Why or why not?
c. Should the company have told
Jason and Maria the results of the high-level audit? Why or why not?
7.2
Effective segregation of duties is sometimes not economically feasible in a
small business. What internal control elements do you think can help compensate
for this threat?
7.3 One function of the AIS is to provide adequate controls to
ensure the safety of organizational assets, including data. However, many
people view control procedures as “red tape.” They also believe that,
instead of producing tangible benefits, business controls create resentment and
loss of company morale. Discuss this position.
7.4
In recent years, Supersmurf’s external auditors have given clean opinions on
its financial statements and favorable evaluations of its internal control
systems. Discuss whether it is necessary for this corporation to take any
further action to comply with the Sarbanes–Oxley Act.
7.5 When you go to a movie theater, you buy a prenumbered ticket
from the cashier. This ticket is handed to another person at the entrance
to the movie. What kinds of irregularities is the theater trying to
prevent? What controls is it using to prevent these irregularities?
What remaining risks or exposures can you identify?
7.6
Some restaurants use customer checks with prenumbered sequence
codes. Each food server uses these checks to write up customer
orders. Food servers are told not to destroy any customer checks; if a
mistake is made, they are to void that check and write a new one. All
voided checks are to be turned in to the manager daily. How does this
policy help the restaurant control cash receipts?
7.7 Compare and contrast the following three frameworks: COBIT, COSO
Integrated Control, and ERM.
7.8 Explain
what an event is. Using the Internet as a resource, create a list of some
of the many internal and external factors that COSO indicated could influence
events and affect a company’s ability to implement its strategy and achieve its
objectives.
7.9 Explain what is meant by objective setting and describe the four
types of objectives used in ERM.
7.10 Discuss several
ways that ERM processes can be continuously monitored and modified so that
deficiencies are reported to management.
7.1 You
are an audit supervisor assigned to a new client, Go-Go Corporation, which is
listed on the New York Stock Exchange. You visited Go-Go’s corporate
headquarters to become acquainted with key personnel and to conduct a
preliminary review of the company’s accounting policies, controls, and
systems. During this visit, the following events occurred:
1. a.
You met with Go-Go’s audit committee, which consists of the corporate
controller, treasurer, financial vice president, and budget director.
2. b.
You recognized the treasurer as a former aide to Ernie Eggers, who was
convicted of fraud several years ago.
3. c.
Management explained its plans to change accounting methods for depreciation
from the accelerated to the straight-line method. Management implied that if
your firm does not concur with this change, Go-Go will employ other auditors.
4. d.
You learned that the financial vice president manages a staff of five internal
auditors.
5. e.
You noted that all management authority seems to reside with three brothers, who
serve as chief executive officer, president, and financial vice president.
6. f.
You were told that the performance of division and department managers is
evaluated on a subjective basis, because Go-Go’s management believes that
formal performance evaluation procedures are counterproductive.
7. g.
You learned that the company has reported increases in earnings per share for
each of the past 25 quarters; however, earnings during the current quarter have
leveled off and may decline.
8. h.
You reviewed the company’s policy and procedures manual, which listed policies
for dealing with customers, vendors, and employees.
9. i.
Your preliminary assessment is that the accounting systems are well designed
and that they employ effective internal control procedures.
10. j.
Some employees complained that some managers occasionally contradict the
instructions of other managers regarding proper data security procedures.
11. k.
After a careful review of the budget for data security enhancement projects, you
feel the budget appears to be adequate.
12. l.
The enhanced network firewall project appeared to be on a very aggressive
implementation schedule. The IT manager mentioned that even if he put all of
his personnel on the project for the next five weeks, he still would not
complete the project in time. The manager has mentioned this to company
management, which seems unwilling to modify the schedule.
13. m.
Several new employees have had trouble completing some of their duties, and
they do not appear to know who to ask for help.
14. n.
Go-Go’s strategy is to achieve consistent growth for its shareholders. However,
its policy is not to invest in any project unless its payback period is no more
than 48 months and yields an internal rate of return that exceeds its cost of
capital by 3%.
15. o.
You observe that company purchasing agents wear clothing and exhibit other
paraphernalia from major vendors. The purchasing department manager proudly
displays a picture of himself holding a big fish on the deck of a luxury
fishing boat that has the logo of a major Go-Go vendor painted on its
wheelhouse.
7.2
Explain how the principle of separation of duties is violated in each of the
following situations. Also, suggest one or more procedures to reduce the risk
and exposure highlighted in each example.
a. A payroll clerk recorded a
40-hour workweek for an employee who had quit the previous week. He then
prepared a paycheck for this employee, forged her signature, and cashed the
check.
b. While opening the mail, a
cashier set aside, and subsequently cashed, two checks payable to the company
on account.
c. A cashier prepared a fictitious
invoice from a company using his brother-in-law’s name. He wrote a check
in payment of the invoice, which the brother-in-law later cashed.
d. An employee of the
finishing department walked off with several parts from the storeroom and
recorded the items in the inventory ledger as having been issued to the
assembly department.
e. A cashier
cashed a check from a customer in payment of an account receivable, pocketed
the cash, and concealed the theft by properly posting the receipt to the
customer’s account in the accounts receivable ledger
f. Several
customers returned clothing purchases. Instead of putting the clothes
into a return bin to be put back on the rack, a clerk put the clothing in a
separate bin under some cleaning rags. After her shift, she transferred
the clothes to a gym bag and took them home.
g.
A receiving clerk noticed that four cases of MP3 players were included in a
shipment when only three were ordered. The clerk put the extra case aside
and took it home after his shift ended.
h.
An insurance claims adjuster had check signing authority of up to $6,000.
The adjuster created three businesses that billed the insurance company for
work not performed on valid claims. The adjuster wrote and signed checks
to pay for the invoices, none of which exceeded $6,000.
i. An accounts payable clerk
recorded invoices received from a company that he and his wife owned and
authorized their payment.
j. A cashier created false
purchase return vouchers to hide his theft of several thousand dollars from his
cash register.
k. A purchasing agent received a
10% kickback of the invoice amount for all purchases made from a specific
vendor.
7.3 The
following description represents the policies and procedures for agent expense
reimbursements at Excel Insurance Company.
Agents submit a completed expense reimbursement form to their
branch manager at the end of each week. The branch manager reviews the expense
report to determine whether the claimed expenses are reimbursable based on the
company’s expense reimbursement policy and reasonableness of amount. The company’s
policymanual states that agents are to document any questionable expense item
and that the branch manager must approve in advance expenditures exceeding
$500.
1. After the expenses
are approved, the branch manager sends the expense report to the home office.
There, accounting records the transaction, and cash disbursements prepares the
expense reimbursement check. Cash disbursements sends the expense reimbursement
checks to the branch manager, who distributes them to the agents.
2.
To receive cash advances for anticipated expenses, agents must
complete a Cash Advance Approval form. The branch manager reviews and approves
the Cash Advance Approval form and sends a copy to accounting and another to
the agent. The agent submits the copy of the Cash Advance Approval form to the
branch office cashier to obtain the cash advance.
3.
At the end of each month, internal audit at the home office
reconciles the expense reimbursements. It adds the total dollar amounts on the
expense reports from each branch, subtracts the sum of the dollar totals on
each branch’s Cash Advance Approval form, and compares the net amount to the
sum of the expense reimbursement checks issued to agents. Internal audit
investigates any differences.
4.
Identify the internal control strengths and weaknesses in
Excel’s expense reimbursement process. Look for authorization, recording,
safeguarding, and reconciliation strengths and weaknesses.
7.3 The Gardner Company, a client of your firm, has come to you with
the following problem. It has three clerical employees who must perform
the following functions:
1. a.
Maintain the general ledger
2. b.
Maintain the accounts payable ledger
3. c.
Maintain the accounts receivable ledger
4. d.
Prepare checks for signature
5. e.
Maintain the cash disbursements journal
6. f.
Issue credits on returns and allowances
7. g.
Reconcile the bank account
8. h.
Handle and deposit cash receipts
Assuming equal abilities among the three employees, the company
asks you to assign the eight functions to them to maximize internal control.
Assume that these employees will perform no accounting functions other than the
ones listed.
a. List four possible
unsatisfactory pairings of the functions
b. State how you would distribute the functions
among the three employees. Assume that with the exception of the nominal
jobs of the bank reconciliation and the issuance of credits on returns and
allowances, all functions require an equal amount of time.
7.5 During a recent review, ABC Corporation discovered that it has a
serious internal control problem. It is estimated that the impact associated
with this problem is $1 million and that the likelihood is currently 5%. Two
internal control procedures have been proposed to deal with this problem.
Procedure A would cost $25,000 and reduce likelihood to 2%; procedure B would
cost $30,000 and reduce likelihood to 1%. If both procedures were implemented,
likelihood would be reduced to 0.1%.
7.6 The
management at Covington, Inc., recognizes that a well-designed internal control
system provides many benefits. Among the benefits are reliable financial
records that facilitate decision making and a greater probability of preventing
or detecting errors and fraud. Covington’s internal auditing department
periodically reviews the company’s accounting records to determine the
effectiveness of internal controls. In its latest review, the internal audit
staff found the following eight conditions:
1. 1.
Daily bank deposits do not always correspond with cash receipts.
2. 2.
Bad debt write-offs are prepared and approved by the same employee.
3. 3.
There are occasional discrepancies between physical inventory counts and
perpetual inventory records.
4. 4.
Alterations have been made to physical inventory counts and to perpetual
inventory records.
5. 5.
There are many customer refunds and credits.
6. 6.
Many original documents are missing or lost. However, there are substitute
copies of all missing originals.
7. 7.
An unexplained decrease in the gross profit percentage has occurred.
8. 8.
Many documents are not approved.
For each of the eight conditions detected by the Covington
internal audit staff:
<a. Describe a possible cause
of the condition.
b. Recommend
actions to be taken and/or controls to be implemented that would correct the
condition.
7.7 Consider the following
two situations:
For the situations presented, dDescribe the recommendations the
internal auditors should make to prevent the following problems.
Situation 1: Many employees of a firm that manufactures small
tools pocket some of the tools for their personal use. Since the quantities
taken by any one employee are immaterial, the individual employees do not
consider the act as fraudulent or detrimental to the company. The company
is now large enough to hire an internal auditor. One of the first things
she did was to compare the gross profit rates for industrial tools to the gross
profit for personal tools. Noting a significant difference, she investigated
and uncovered the employee theft.
Situation 2: A manufacturing firm’s controller created a
fake subsidiary. He then ordered goods from the firm’s suppliers, told them to
ship the goods to a warehouse he rented, and approved the vendor invoices for
payment when they arrived. The controller later sold the diverted
inventory items, and the proceeds were deposited to the controller’s personal
bank account. Auditors suspected something was wrong when they could not
find any entries regarding this fake subsidiary office in the property, plant,
and equipment ledgers or a title or lease for the office in the real-estate
records of the firm
7.8 Tralor Corporation
manufactures and sells several different lines of small electric components.
Its internal audit department completed an audit of its expenditure processes.
Part of the audit involved a review of the internal accounting controls for
payables, including the controls over the authorization of transactions,
accounting for transactions, and the protection of assets. The auditors noted
the following items:
1. 1.
Routine purchases are initiated by inventory control notifying the purchasing
department of the need to buy goods. The purchasing department fills out a
prenumbered purchase order and gets it approved by the purchasing manager. The
original of the five-part purchase order goes to the vendor. The other four
copies are for purchasing, the user department, receiving for use as a
receiving report, and accounts payable.
2. 2.
For efficiency and effectiveness, purchases of specialized goods and services
are negotiated directly between the user department and the vendor. Company
procedures require that the user department and the purchasing department
approve invoices for any specialized goods and services before making payment.
3. 3.
Accounts payable maintains a list of employees who have purchase order approval
authority. The list was updated two years ago and is seldom used by accounts
payable clerks.
4. 4.
Prenumbered vendor invoices are recorded in an invoice register that indicates
the receipt date, whether it is a special order, when a special order is sent
to the requesting department for approval, and when it is returned. A review of
the register indicated that there were seven open invoices for special
purchases, which had been forwarded to operating departments for approval over
30 days previously and had not yet been returned.
5. 5.
Prior to making entries in accounting records, the accounts payable clerk
checks the mathematical accuracy of the transaction, makes sure that all
transactions are properly documented (the purchase order matches the signed
receiving report and the vendor’s invoice), and obtains departmental approval
for special purchase invoices.
6. 6.
All approved invoices are filed alphabetically. Invoices are paid on the 5th
and 20th of each month, and all cash discounts are taken regardless of the
terms.
7. 7.
The treasurer signs the checks and cancels the supporting documents. An
original document is required for a payment to be processed.
8. 8.
Prenumbered blank checks are kept in a locked safe accessible only to the cash
disbursements department. Other documents and records maintained by the
accounts payable section are readily accessible to all persons assigned to the
section and to others in the accounting function.
RRReview the eight items listed and decide whether they
represent an internal control strength or weakness
1. a.
For each internal control strength you identified, explain how the procedure
helps achieve good authorization, accounting, or asset protection control.
For each internal control weakness you identified, explain why
it is a weakness and recommend a way to correct the weakness
7.7 Lancaster Company makes electrical parts for contractors and
home improvement retail stores. After their annual audit, Lancaster’s auditors
commented on the following items regarding internal controls over equipment:
1. 1.
The operations department that needs the equipment normally initiates a
purchase requisition for equipment. The operations department supervisor
discusses the proposed purchase with the plant manager. If there are sufficient
funds in the requesting department’s equipment budget, a purchase requisition
is submitted to the purchasing department once the plant manager is satisfied
that the request is reasonable.
2. 2.
When the purchasing department receives either an inventory or an equipment
purchase requisition, the purchasing agent selects an appropriate supplier and
sends them a purchase order.
3. 3.
When equipment arrives, the user department installs it. The property, plant,
and equipment control accounts are supported by schedules organized by year of
acquisition. The schedules are used to record depreciation using standard
rates, depreciation methods, and salvage values for each type of fixed asset.
These rates, methods, and salvage values were set 10 years ago during the
company’s initial year of operation.
4. 4.
When equipment is retired, the plant manager notifies the accounting department
so the appropriate accounting entries can be made.
5. 5.
There has been no reconciliation since the company began operations between the
accounting records and the equipment on hand.
Identify the internal control weaknesses in Lancaster’s system,
and recommend ways to correct them.
7.10
The Langston Recreational Company (LRC) manufactures
ice skates for racing, figure skating, and hockey. The company is located in
Kearns, Utah, so it can be close to the Olympic Ice Shield, where many Olympic
speed skaters train.
Given the precision required to make skates, tracking
manufacturing costs is very important to management so it can price the skates
appropriately. To capture and collect manufacturing costs, the company acquired
an automated cost accounting system from a national vendor. The vendor provides
support, maintenance, and data and program backup service for LRC’s system.
LRC operates one shift, five days a week. All manufacturing data
are collected and recorded by Saturday evening so that the prior week’s
production data can be processed. One of management’s primary concerns is how
the actual manufacturing process costs compare with planned or standard
manufacturing process costs. As a result, the cost accounting system produces a
report that compares actual costs with standards costs and provides the
difference, or variance. Management focuses on significant variances as one
means of controlling the manufacturing processes and calculating bonuses.
Occasionally, errors occur in processing a week’s production
cost data, which requires the entire week’s cost data to be reprocessed at a
cost of $34,500. The current risk of error without any control procedures is
8%. LRC’s management is currently considering a set of cost accounting control
procedures that is estimated to reduce the risk of the data errors from 8% to
3%. This data validation control procedure is projected to cost $1,000 per
week.
7.11 Spring Water Spa
Company is a 15-store chain in the Midwest that sells hot tubs, supplies, and
accessories. Each store has a full-time, salaried manager and an assistant
manager. The sales personnel are paid an hourly wage and a commission based on
sales volume.
The company uses electronic cash registers to record each
transaction. The salesperson enters his or her employee number at the beginning
of his/her shift. For each sale, the salesperson rings up the order by scanning
the item’s bar code, which then displays the item’s description, unit price,
and quantity (each item must be scanned). The cash register automatically
assigns a consecutive number to each transaction. The cash register prints a
sales receipt that shows the total, any discounts, the sales tax, and the grand
total.
The salesperson collects payment from the customer, gives the
receipt to the customer, and either directs the customer to the warehouse to
obtain the items purchased or makes arrangements with the shipping department
for delivery. The salesperson is responsible for using the system to determine
whether credit card sales are approved and for approving both credit sales and
sales paid by check. Sales returns are handled in exactly the reverse manner,
with the salesperson issuing a return slip when necessary.
At the end of each day, the cash registers print a sequentially
ordered list of sales receipts and provide totals for cash, credit card, and
check sales, as well as cash and credit card returns. The assistant manager
reconciles these totals to the cash register tapes, cash in the cash register,
the total of the consecutively numbered sales invoices, and the return slips.
The assistant manager prepares a daily reconciled report for the store
manager’s review.
Cash sales, check sales, and credit card sales are reviewed by
the manager, who prepares the daily bank deposit. The manager physically makes
the deposit at the bank and files the validated deposit slip. At the end of the
month, the manager performs the bank reconciliation. The cash register tapes,
sales invoices, return slips, and reconciled report are mailed daily to
corporate headquarters to be processed with files from all the other stores.
Corporate headquarters returns a weekly Sales and Commission Activity Report to
each store manager for review.
Please respond to the following questions about Spring Water Spa
Company’s operations:
7.12 PriceRight Electronics (PEI) is a small wholesale discount
supplier of electronic instruments and parts. PEI’s competitive advantage is
its deep-discount, three-day delivery guarantee, which allows retailers to
order materials often to minimize in-store inventories. PEI processes its
records with stand-alone, incompatible computer systems except for integrated
enterprise resource planning (ERP) inventory and accounts receivable modules.
PEI decided to finish integrating its operations with more ERP modules, but
because of cash flow considerations, this needs to be accomplished on a
step-by-step basis.
It was decided that the next function to be integrated should be
sales order processing to enhance quick response to customer needs. PEI
implemented and modified a commercially available software package to meet
PEI’s operations. In an effort to reduce the number of slow-paying or
delinquent customers, PEI installed Web-based software that links to the Web
site of a commercial credit rating agency to check customer credit at the time
of purchase. The following are the new sales order processing system modules:
§ Sales. Sales orders are
received by telephone, fax, e-mail, Web site entry, or standard mail. They are
entered into the sales order system by the Sales department. If the order does
not cause a customer to exceed his credit limit, the system generates multiple
copies of the sales order.
§ Credit. When orders are
received from new customers, the system automatically accesses the credit
rating Web site and suggests an initial credit limit. On a daily basis, the
credit manager reviews new customer applications for creditworthiness, reviews
the suggested credit limits, and accepts or changes the credit limits in the
customer database. On a monthly basis, the credit manager reviews the accounts
receivable aging report to identify slow-paying or delinquent accounts for
potential revisions to or discontinuance of credit. As needed, the credit
manager issues credit memos for merchandise returns based on requests from
customers and forwards copies of the credit memos to Accounting for appropriate
account receivable handling.
§ Warehousing. Warehouse personnel
update the inventory master file for inventory purchases and sales, confirm
availability of materials to fill sales orders, and establish back orders for
sales orders that cannot be completed from stock on hand. Warehouse personnel
gather and forward inventory to Shipping and Receiving along with the
corresponding sales orders. They also update the inventory master file for
merchandise returned to Receiving.
§ Shipping and receiving. Shipping and Receiving
accepts inventory and sales orders from Warehousing, packs and ships the orders
with a copy of the sales order as a packing slip, and forwards a copy of the
sales order to Billing. Customer inventory returns are unpacked, sorted,
inspected, and sent to Warehousing.
§ Accounting. Billing prices all
sales orders received, which is done approximately 5 days after the order
ships. To spread the work effort throughout the month, customers are placed in
one of six 30-day billing cycles. Monthly statements, prepared by Billing, are
sent to customers during the cycle billing period. Outstanding carry forward
balances reported by Accounts Receivable and credit memos prepared by the
credit manager are included on the monthly statement. Billing also prepares
electronic sales and credit memos for each cycle. Electronic copies of invoices
and credit memos are forwarded to Accounts Receivable for entry into the
accounts receivable master file by customer account. An aging report is
prepared at the end of each month and forwarded to the credit manager. The
general accounting office staff access the accounts receivable master file that
reflects total charges and credits processed through the accounts receivable
system for each cycle. General accounting runs a query to compare this
information to the electronic sales and credit memo and posts the changes to
the general ledger master file.
7.1 Nino
Moscardi, president of Greater Providence Deposit & Trust (GPD&T),
received an anonymous note in his mail stating that a bank employee was making
bogus loans. Moscardi asked the bank’s internal auditors to investigate the
transactions detailed in the note. The investigation led to James Guisti,
manager of a North Providence branch office and a trusted 14-year employee who
had once worked as one of the bank’s internal auditors. Guisti was charged with
embezzling $1.83 million from the bank using 67 phony loans taken out over a
three-year period.
Court documents revealed that the bogus loans were 90-day notes
requiring no collateral and ranging in amount from $10,000 to $63,500. Guisti
originated the loans; when each one matured, he would take out a new loan, or
rewrite the old one, to pay the principal and interest due. Some loans had been
rewritten five or six times.
The 67 loans were taken out by Guisti in five names, including
his wife’s maiden name, his father’s name, and the names of two friends. These
people denied receiving stolen funds or knowing anything about the
embezzlement. The fifth name was James Vanesse, who police said did not exist.
The Social Security number on Vanesse’s loan application was issued to a
female, and the phone number belonged to a North Providence auto dealer.
Lucy Fraioli, a customer service representative who cosigned the
checks, said Guisti was her supervisor and she thought nothing was wrong with
the checks, though she did not know any of the people. Marcia Perfetto, head
teller, told police she cashed checks for Guisti made out to four of the five
persons. Asked whether she gave the money to Guisti when he gave her checks to
cash, she answered, “Not all of the time,” though she could not recall ever
having given the money directly to any of the four, whom she did not know.
Guisti was authorized to make consumer loans up to a certain
dollar limit without loan committee approvals, which is a standard industry
practice. Guisti’s original lending limit was $10,000, the amount of his first
fraudulent loan. The dollar limit was later increased to $15,000 and then
increased again to $25,000. Some of the loans, including the one for $63,500,
far exceeded his lending limit. In addition, all loan applications should have
been accompanied by the applicant’s credit history report, purchased from an
independent credit rating firm. The loan taken out in the fictitious name would
not have had a credit report and should have been flagged by a loan review
clerk at the bank’s headquarters.
News reports raised questions about why the fraud was not
detected earlier. State regulators and the bank’s internal auditors failed to
detect the fraud. Several reasons were given for the failure to find the fraud
earlier. First, in checking for bad loans, bank auditors do not examine all
loans and generally focus on loans much larger than the ones in question.
Second, Greater Providence had recently dropped its computer services
arrangement with a local bank in favor of an out-of-state bank. This changeover
may have reduced the effectiveness of the bank’s control procedures. Third, the
bank’s loan review clerks were rotated frequently, making follow-up on
questionable loans more difficult.
Guisti was a frequent gambler and used the embezzled money to
pay gambling debts. The bank’s losses totaled $624,000, which was less than the
$1.83 million in bogus loans, because Guisti used a portion of the borrowed
money to repay loans as they came due. The bank’s bonding company covered the
loss.
The bank experienced other adverse publicity prior to the
fraud’s discovery. First, the bank was fined $50,000 after pleading guilty to
failure to report cash transactions exceeding $10,000, which is a felony.
Second, bank owners took the bank private after a lengthy public battle with
the State Attorney General, who alleged that the bank inflated its assets and
overestimated its capital surplus to make its balance sheet look stronger. The
bank denied this charge.
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