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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.
PROBLEM: Segregation of duties is violated here because the payroll clerk had the
ability to record time worked and to prepare the payroll check (custody). This
allowed the payroll clerk to both commit and conceal the fraud. The payroll clerk
ignored the authorization process or had the authority to authorize the payment.
b. While opening the mail, a cashier set aside, and subsequently cashed, two checks
payable to the company on account.
PROBLEM: The cashier who opened the mail had custody of the cash. The cashier
opening the mail can pocket the checks and forge a signature, never giving the
authorized endorser a chance to be involved. For this reason, many companies have
the mail opened by two people or have those opening the mail videotaped.
law’s name. He wrote a check in payment of the invoice, which the brother-in-
law later cashed.
PROBLEM: Segregation of duties is violated here because the cashier had the
ability to both write the check (custody) and approve the invoice for payment
(authorization).
c. 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.
PROBLEM: Employees can commit and conceal fraud when they have access to
physical inventory (custody) and to inventory records (recording).
d. 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.
PROBLEM: The cashier had custody of the checks and was responsible for posting
(recording) to the accounts receivable ledger.
e. 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.
PROBLEM: The clerk was authorized to accept the return, grant credit, and had
custody of the inventory. It is also possible that the clerk may have had responsibility
to record the returns, but did not do so to cover the theft.
SOLUTION: All purchase returns should be documented by preparing a customer
f. 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.
PROBLEM: The receiving clerk had custody of arriving goods, counted the goods,
and compared the count to a purchase order. The problem is that, while the receiving
clerk did not record the purchase order, she did have access to a document that
showed the amount ordered. This allows her to steal any excess items shipped
without having to record anything to conceal it.
g. 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.
PROBLEM: The adjuster had authorization to add vendors to vendor master file,
authorization to write checks up to $6,000, and had custody of the signed the checks.
Apparently, the adjuster also had some recording duties (maintaining the vendor
master file).
i. An accounts payable clerk recorded invoices received from a company that he
and his wife owned and authorized their payment.
PROBLEM: The accounts payable clerk had recording duties and he authorized
payments.
j. A cashier created false purchase return vouchers to hide his theft of several
thousand dollars from his cash register.
PROBLEM: The cashier had recording (creating return vouchers), custody (cash in
the cash register), and authorization (authorize the return of goods) duties.
k. A purchasing agent received a 10% kickback of the invoice amount for all
purchases made from a specific vendor.
PROBLEM: The purchasing agent has both recording (prepare the purchase order)
and authorization (select a vendor from a list of authorized vendors) duties. The
purchasing agent gets custody to cash when the vendor gives her the kickback.
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 policy manual
states that agents are to document any questionable expense item and that the branch
manager must approve in advance expenditures exceeding $500.
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.
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.
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.
Identify the internal control strengths and weaknesses in Excel’s expense
reimbursement process. Look for authorization, recording, safeguarding, and
reconciliation strengths and weaknesses. (CMA Examination adapted)
Strengths
Weaknesses
Authorization
Excel has a formal statement of policies and
procedures for agent reimbursements.
There is no limit on the agent’s total weekly
expenditures or cash advances.
Expense reports must be approved by the
Branch Manager prior to payment.
Expense reimbursement checks are sent to the Branch
Manager for distribution rather than to the agent. This
allows the Branch Manager to submit a fictitious
expense reimbursement for a former agent or one on
vacation and then cash the check.
Recording
Accounting receives approved expense
reports and cash advance forms. This
facilitates the correct recording of all
authorized transactions.
The Branch Manager does not retain a copy of expense
reports or cash advances for audit purposes.
The expense report is not checked for mathematical
accuracy.
Safeguarding
Expense reimbursement checks are issued by
the cash disbursements department.
A copy of the Cash Advance Approval form should be
sent to the Branch Office Cashier so it can compare it
with the one submitted by the agent.
Cash disbursements are made only after
receipt of an approved expense report or
Cash Advance Approval form.
Supporting documentation is not required for all
expenditures.
Reconciliation
Internal Audit compares reimbursement
checks with expense report totals less cash
advances in the home office.
Reconciliation differences are investigated.
There is no reconciliation of Branch Office Cashier
disbursements with Cash Advance Approval forms.
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:
a. Maintain the general ledger
b. Maintain the accounts payable ledger
c. Maintain the accounts receivable ledger
d. Prepare checks for signature
e. Maintain the cash disbursements journal
f. Issue credits on returns and allowances
g. Reconcile the bank account
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
All five of the unsatisfactory pairings below involve custody of cash and a recording
function that would allow a fraud perpetrator to conceal a theft.
1. General ledger - cash receipts. With custody to cash, this person could steal
cash receipts and conceal the theft by recording a fictitious entry in the General
Ledger to credit (reduce) the balance of the cash account by the amount stolen.
a. 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.
