91Ó°ÊÓ

Internal Control Walt Company encountered the following situations: a. Jenny Farrell, head of the receiving department, created a fictitious company named Speedy Forms and used it to send invoices to Walt Company for business documents that Walt never ordered or received. Farrell prepared receiving reports that stated that the business documents had been received, Walt's controller compared the receiving reports to the invoices and paid each one, b. Walt Company lost one day's cash receipts. An employee took the receipts to the bank after the bank's closing hours to deposit them in the night depository slot. A creative thief had placed a sign on the slot saying it was out of order and all deposits should be placed in a metal canister placed next to the building. Walt's employee placed the deposit in the canister and left. Employees from two other companies did the same thing. Later that night, the thief returned and stole the deposits from the canister. (This is an actual case.) c. Walt Company does not prenumber the sales invoices used for over-the- counter sales. A cashier pocketed cash receipts and destroyed all copies of the related sales invoices. Required For each situation, describe any violations of good internal control procedures and identify the steps that you would take to prevent each situation.

Step by step solution

01

Identify Violations for Situation (a)

The violation in Situation (a) is a lack of separation of duties. Jenny Farrell, who managed the receiving department, was able to create a fictitious company and generate fraudulent invoices. This indicates inadequate checks and balances in the accounts payable and receiving processes.

02

Recommend Preventative Steps for Situation (a)

To prevent this issue, Walt Company should implement the segregation of duties. The person responsible for approving purchase orders should not be the one generating receiving reports or approving payments. Additionally, implementing a thorough verification process for new suppliers, including physical checks of the supplier's legitimacy, could prevent this kind of fraud.

03

Identify Violations for Situation (b)

In Situation (b), the violation is a lack of secure procedures for handling cash deposits. The company's reliance on employee discretion in ensuring the deposit is safely made led to the loss since there were no secure or verifiable deposit procedures in place.

04

Recommend Preventative Steps for Situation (b)

To prevent this, Walt Company should establish a policy where cash deposits are made within bank operating hours. Additionally, implementing a double-check system where two employees are responsible for making and verifying the deposit can add an extra layer of security.

05

Identify Violations for Situation (c)

In Situation (c), the violation is the lack of prenumbered sales invoices, which permits manipulation and loss of records when a cashier pockets cash and destroys invoice evidence.

06

Recommend Preventative Steps for Situation (c)

To address this, Walt Company should use a prenumbered sales invoice system for over-the-counter sales. This ensures that each transaction is recorded and accounted for, making it easier to spot discrepancies and reducing the opportunity for cash theft.

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Key Concepts

These are the key concepts you need to understand to accurately answer the question.

Fraud Prevention

Fraud prevention is a crucial component of internal control systems. Its primary objective is to safeguard an organization’s assets by detecting and preventing unauthorized activities. In the case of Jenny Farrell, the inadequate checks and balances allowed fraudulent invoices to go undetected.

Preventing fraud involves several key steps:

• Implementing segregation of duties, ensuring no single individual has control over all aspects of a financial transaction.
• Establishing a verification process to confirm the legitimacy of new suppliers.
• Conducting regular audits to review all processes and identify potential vulnerabilities.

Promoting a culture of honesty and transparency within the organization can also deter fraudulent activities.

Segregation of Duties

Segregation of duties is a fundamental principle of internal controls that minimizes the risk of fraud and errors. It involves dividing responsibilities among different employees or departments. This ensures no single person can complete a financial transaction alone, making it harder to commit fraud without being detected.

In the example of Jenny Farrell, she was responsible for both receiving goods and approving invoices, which is a clear violation of this principle. To correct this, duties should be separated as follows:

• The receiving department records goods as they arrive.
• The purchasing department approves the receipt of goods.
• The accounts payable team processes the payments.

By implementing segregation of duties, companies can protect themselves from fraudulent activities and improve the accuracy of financial reporting.

Cash Handling Procedures

Effective cash handling procedures are a vital aspect of internal controls, designed to protect an organization from theft and errors. In Situation (b), lack of secure deposit procedures resulted in a significant cash loss for Walt Company.

To prevent similar incidents, organizations should:

• Ensure all cash deposits are made within bank operating hours whenever possible.
• Implement a dual custody system, where two employees oversee and confirm cash deposits.
• Establish regular reconciliations to promptly detect any discrepancies.

Having detailed guidelines and training in place for employees on cash handling procedures can prevent mistakes and deter potential theft by ensuring everyone understands the correct protocol.

Sales Transaction Recording

Accurate recording of sales transactions is fundamental to maintaining financial integrity and accountability. When sales invoices are not prenumbered, as in Situation (c), it can lead to record manipulation and theft.

Implementing a prenumbered invoicing system ensures:

• Every sales transaction is recorded sequentially and accounted for.
• It becomes easier to track sales data and identify discrepancies.
• Loss due to cash theft is minimized since unauthorized deletions and modifications are quickly detected.

Training employees on the importance of accurate sales transaction recording and conducting regular reviews can further enhance control measures and ensure financial data integrity.