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7.10 Discuss several ways that ERM processes can be continuously monitored and
modified so that deficiencies are reported to management.
1Have a special team or internal auditing perform a formal or a self-assessment ERM
2Supervise effectively, including training and assisting employees, correcting errors,
3Use Responsibility Accounting Systems such as budgets, quotas, schedules, standard
4Use risk analysis and management software packages to review computer and
5Track purchased software to comply with copyrights and protect against software
6 Have periodic external, internal, and network security audits to assess and monitor
7Have a chief security officer (CSO), who is independent of the information system
8
9Use forensic investigators, who specialize in fraud detection and investigation, to help
10 Install fraud detection software to help ferret out fraud, such as illegal credit card use,
11 Use a fraud hotline so people witnessing fraudulent behavior can report it
SUGGESTED SOLUTIONS TO THE PROBLEMS
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:
a You met with Go-Go’s audit committee, which consists of the corporate controller,
b You recognized the treasurer as a former aide to Ernie Eggers, who was convicted
c Management explained its plans to change accounting methods for depreciation
d You learned that the financial vice president manages a staff of five internal
e You noted that all management authority seems to reside with three brothers, who
f You were told that the performance of division and department managers is
g You learned that the company has reported increases in earnings per share for
m Several new employees have had trouble completing some of their duties, and they
n Go-Go’s strategy is to achieve consistent growth for its shareholders. However, its
o You observe that company purchasing agents wear clothing and exhibit other
a You met with Go-Go’s audit committee, which consists of the corporate
controller, treasurer, financial vice president, and budget director.
PROBLEM: Section 301 of the Sarbanes-Oxley Act of 2002 (SOX) applies to
SOLUTION: All members of the audit committee should be members of the Board
of Directors. They must also be independent of the company – meaning none of the
b. You recognized the treasurer as a former aide to Ernie Eggers, who was
convicted of fraud several years ago.
PROBLEM: Because the position of corporate treasurer involves managing cash and
other financial assets, it is critical that the position be filled with someone of
unquestioned commitment to integrity and ethical values. This question presents
SOLUTION: Though you may not have specific information linking the corporate
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.
PROBLEM: Why would a company want to move from an accelerated depreciation
SOLUTION: The company should have a logical and defensible reason for changing
accounting methods, other than just to increase net income and the stock price. The
d. You learned that the financial vice president manages a staff of five internal
auditors.
PROBLEM: The internal audit function is not organizationally independent of the
SOLUTION: Organization structure and board of director requirements dictates that
e. You noted that all management authority seems to reside with three brothers,
who serve as chief executive officer, president, and financial vice president.
PROBLEM: The dominance of an organization’s management by one or a few
individuals is an aspect of management’s philosophy and operating style that might
SOLUTION: It is important to evaluate carefully this situation to determine if it
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.
PROBLEM: This indicates a possible problem with management’s human resource
standards and their methods of monitoring performance. Subjective evaluation
SOLUTION: It is important to evaluate carefully this situation to determine if it
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.
PROBLEM: Management’s philosophy and operating style, as well as their
commitment to integrity and ethical values, can be tested when a company faces
SOLUTION: Because many frauds have been perpetrated to prop up earnings, this
h. You reviewed the company’s policy and procedures manual, which listed policies
for dealing with customers, vendors, and employees.
PROBLEM: One of the methods of assigning authority and responsibility is a
SOLUTION: A policies and procedures manual should contain much more than
what is indicated. The manual should explain proper business practices, describe the
i. Your preliminary assessment is that the accounting systems are well designed
and that they employ effective internal control procedures.
PROBLEM: Even though you believe that the accounting systems are well designed,
SOLUTION: You cannot rely on the internal controls procedures being effective
j. Some employees complained that some managers occasionally contradict the
instructions of other managers regarding proper data security procedures.
PROBLEM: It does not appear that there is a clear line of authority and
SOLUTION: Achieving adequate security and control over an organization’s data
k. After a careful review of the budget for data security enhancement projects, you
feel the budget appears to be adequate.
PROBLEM: This item does not appear to be a problem. Your careful review
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.
PROBLEM: The firewall implementation schedule is not feasible.
SOLUTION: Management’s philosophy and operating style should be carefully
m. Several new employees have had trouble completing some of their duties, and
they do not appear to know who to ask for help.
PROBLEM: Employee training and support appear to be rather weak. Companies
SOLUTION: Good human resource standards require that training programs
n. Go-Go’s strategy is to achieve consistent growth for its shareholders. It also
has a policy 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%.
PROBLEM: Go-Go’s risk appetite, although aggressive, appears to be grounded in
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.
PROBLEM: Gifts from vendors can unduly influence purchasing agents to buy more
SOLUTION: Part of management’s philosophy and operating style should be the
creation of an organizational culture that stresses integrity and commitment to ethical
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
SOLUTION: These three functions should be segregated. One person should
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
SOLUTION: While the cashier can get away with this fraud for a few weeks or
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.
PROBLEM: Segregation of duties is violated here because the cashier had the
SOLUTION: The functions of authorizing invoices for payment and preparing
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.
PROBLEM: Employees can commit and conceal fraud when they have access to
SOLUTION: This can be prevented by restricting storeroom access to authorized
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.
PROBLEM: The cashier had custody of the checks and was responsible for posting
SOLUTION: Custody of the checks and posting to 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.
PROBLEM: The clerk was authorized to accept the return, grant credit, and had
SOLUTION: All purchase returns should be documented by preparing a customer
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.
PROBLEM: The receiving clerk had custody of arriving goods, counted the goods,
SOLUTION: Purchase orders sent to the receiving area should not indicate how
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.
PROBLEM: The adjuster had authorization to add vendors to vendor master file,
SOLUTION: The functions of signing checks for invoices, approving vendors, and
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
SOLUTION: The functions of recording invoices and authorizing payments should
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
SOLUTION: These three duties should be performed by three separate people. A
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)
SOLUTION: Purchasing agents should only be allowed to purchase goods and
