Question

FINANCIAL ACCOUNTING

CASE STUDY

Alan Smith is currently part of a university work experience program. His job placement is at the municipal transit center. His supervisor is responsible for the recording and distribution of monthly transit passes to authorized vendors throughout the city. The vendors pay €50 per bus pass and sell them for €55. His job is to prepare a monthly reconciliation of the transit passes including the quantity sold, the number actually distributed, the unsold passes, and the cash proceeds. He is unable to reconcile the past two months. The bus passes are sequentially numbered and, in checking the sequence, he notices that numbers 9750 to 9820, 11012 to 11750, and 22000 to 22440 cannot be accounted for. He brings this to the attention of the supervisor, who tells him that reconciliations are never done; the job was created by her superior “to give him something to do” and he is told not to worry about it.

QUESTIONS

1. What is the main objective of internal control and how is it accomplished?

2. Why should recordkeeping of assets be separated from custody over the assets?

3. Quantify the potential error that the missing bus passes could create. Should the findings be reported?

Answer 1

Answers :

Q1. The main objective of internal control are as follows:

1. Operations: Internal controls help an organization operate at peak efficiency when it comes to finances, personnel and business procedures. They also aid organizations in loss prevention and future projections.
2. Reporting: Internal controls make all types of reporting more accurate, financial or otherwise. Their objective is to identify problems, solve them and then prevent them in the future, all while documenting things thoroughly and accurately.
3. Compliance: Internal controls aim to ensure that a company is in compliance with all internal and external rules and regulations that pertain to its industry. This includes everything from manufacturing to labor laws, branding and even OSHA standards.

Overall Benefits of Internal Controls

The objectives of internal controls go beyond preventing fraud and theft. When done correctly, they can help reduce risk, waste and abuse. These audits prove a company's compliance with applicable laws and regulations, protect its resources against loss due to mismanagement and maintain reliable financial data.

Any company big or small can benefit from internal controls. However, small businesses are more vulnerable to fraud and experience higher median loss compared to established companies. Corruption, employee theft and data omission from financial records are common. For this reason, small business owners need to be extra careful to perform internal controls on a regular basis.

Q2 Separation of record keeping of assets from custody of assets:

1. Separate custody of assets from accounting.
   This is the most important type of separation because it protects an organization from fraud. A good accounting system enables an individual to trace a transaction from beginning to end i.e., 'having a good audit trail'.
   When one person performs both functions, that person may dispose of assets, such as cash, checks, inventory, or equipment, for personal gain and remain undetected by adjusting accounting records to relieve himself or herself of responsibility for the asset i.e., 'covering the trail'.
   Examples of inadequate separation of duties include:

       A cashier in a major cashiering or subcashiering station who is also responsible for preparing deposits or making accounting entries to the operating ledger.
       An invoice transaction inputter and/or approver who is also responsible for handling the distribution of vendor checks.
       An invoice transaction inputter and/or approver who is also responsible for handling the receipt of ordered goods.
       An individual who distributes student financial aid refund checks and who is also responsible for making adjustments to student accounts.
       A storeroom manager who distributes supplies and is also responsible for making adjustments to inventory records.

2. Separate authorization of transactions from custody of related assets.

   Wherever possible, persons who authorize transactions should be prevented from controlling the related asset.
   Examples of inadequate separation of duties include:

       An invoice transaction authorizer who is also responsible for handling checks.
       A transaction authorizer of student financial aid refunds who is also responsible for distributing refund checks to students.
       A cashier who can also void transactions without further approval.
       A transaction inputter who adds newly hired employees to the Payroll-Personnel System and who is also responsible for distributing payroll checks.

3. Separate duties within the accounting function.

   One person should not be responsible for recording a transaction from inception to its posting in the ledger. This may permit unintentional errors from being detected and corrected.
   Examples of inadequate separation of duties include:

       A transaction inputter or approver who is also responsible for processing journal vouchers adjusting the operating ledger.
       A transaction inputter or approver who is also responsible for making adjustments to related subsidiary ledger records, such as accounts receivable, accounts payable, deposits, and travel advances.
       A transaction inputter or approver who is also responsible for reviewing the operating ledger for discrepancies and budget variances.
       A cash deposit preparer/reviewer who is also responsible for investigating debit and credit advices received from the bank (or for investigating over/short situations reported by the Major Cashiering Station).

4. Separate operational responsibility from record keeping responsibility.

   Having the a person responsible for inputting or approving transactions or reviewing the operating ledger and also preparing financial reports and analysis introduces the risk of results being biased to show improved performance

Q3. Quantification of potential error that the missing bus passes can create :

There are total 6 passes which are missing from the records which implies embezzlement of profit of € 30 ( € 5 * 6 passes)

This loss of profit should be indicated in the auditor's report