Question

9-18. Gayton Menswear (Risk Assessment and Control Procedures)

The Gayton Menswear company was founded by Fred Williams in 1986 and has grown steadily over the years. Fred now has 17 stores located throughout the central and northern parts of the state. Since Fred was an accounting major in college and worked for a large regional CPA firm for 13 years prior to opening his first store, he places a lot of value on internal controls. Further, he has always insisted on a state-of-the art accounting system that connects all of his stores’ financial transactions and reports.

Fred employs two internal auditors who monitor internal controls and also seek ways to improve operational effectiveness. As part of the monitoring process, the internal auditors take turns conducting periodic reviews of the accounting records. For instance, the company takes a physical inventory at all stores once each year, and an internal auditor oversees the process. Chris Domangue, the most senior internal auditor, just completed a review of the accounting records and discovered several items of concern. These were:

• Physical inventory counts varied from inventory book amounts by more than 5% at two of the stores. In both cases, physical inventory was lower.

• Two of the stores seem to have an unusually high amount of sales returns for cash.

• In 10 of the stores gross profit has dropped significantly from the same time last year.

• At four of the stores, bank deposit slips did not match cash receipts.

• One of the stores had an unusual number of bounced checks. It appeared that the same employee was responsible for approving each of the bounced checks.

• In seven of the stores, the amount of petty cash on hand did not correspond to the amount in the petty cash account.

  Requirements

  1. For each of these concerns, identify a risk that may have created the problem.
  2. Recommend an internal control procedure to prevent the problem in the future.

Answer 1

Internal Control is required so that transactions having direct impact on financial statement show fair an true view. Its testing is important to derive whether controls in place are effectively or not.

In this case, Control related to inventory management is at stake, which clearly depicts that same is not able to curb the following risks:

a. Unauthorized recording of physical stock without recording in stock register

b. Quality Degradation / Loss of Market share :Quality check is not appropriate in place while recording / inward of material at warehouse leads to sale return

c. Sale return is only in cash, Non issue of Credit note / sale return receipt lead to loss of material. as same will not be recorded against which Sale return can be verified.

d. Loss of Cash : One authorized person for banking transaction lead to unmatch of bank and cash deposit slip.

e. Single Person making transaction: Chances of fraud increase

f. Penalty for Bounce back charges , Non availability of outsource funds (Bank / FI)

g. Non recording of all transactions

In nut shell Risk is severe as it will lead to loss of material as well as cash.

2. Recommended Internal Contorl:

1. Maker Checker Control

2. Counting by Store keeper before keeping in Physical ward. ( Two Steps verification at entry gate / Store keeper)

3. Quality Check Control at Store Manager Level.

4. Approval As per Approving authority (Gate Inward/ Store Book Maintenance/ Physical keeping of records)

5. Bank receipt must have signature of Cash recorder. / need to be filled by cash keeper only before sending to bank. Or same slip need to be affixed with every bank deposit slip having bank seal, before recording need to be verified by manager of Cash recorder.

6. Petty Cash expenses documented, chronological recording is preferable, by giving EOD petty cash balance.

7. Maintain frequency for stock checking at internal level; report should be approved by the Manager and variance need to be reported.