978-0134474021 Chapter 7 Solutions Manual Part 3

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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

Recording

Safeguarding

Advance Approval form.

Reconciliation

the home office.

Reconciliation differences are investigated.

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

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

1. General ledger – cash receipts. With custody to cash, this person could steal

2. Accounts receivable ledger – cash receipts. With custody to cash, this person

3. Bank reconciliation – cash receipts. With custody to cash, this person could

4. Credits on returns and allowances – cash receipts. This person could

5. Accounts payable ledger – prepare checks for signature. A person with both

6Maintain accounts receivable – issue credit memos – this combines

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.

Any distribution that avoids all of the above unsatisfactory combinations and spreads

the workload evenly is acceptable. The key is not to have anyone with both custody

and a recording function that could be used to conceal a theft. One such combination

is:

7.5 During a recent review, ABC Corporation discovered that it has a serious internal

control problem. It is estimated that the impact associated with this problem is $1

million and that the likelihood is currently 5%. Two internal control procedures have

been proposed to deal with this problem. Procedure A would cost $25,000 and reduce

likelihood to 2%; procedure B would cost $30,000 and reduce likelihood to 1%. If

both procedures were implemented, likelihood would be reduced to 0.1%.

a. What is the estimated expected loss associated with ABC Corporation’s internal

control problem before any new internal control procedures are implemented?

b Compute the revised estimate of expected loss if procedure A were implemented, if

procedure B were implemented, and if both procedures were implemented.

Control

Procedure Risk Exposure

Revised

Expected

Loss

Reduction in

Expected Loss

Cost of

Control(s)

Net

Benefit

(Cost)

c Compare the estimated costs and benefits of procedure A, procedure B, and both

procedures combined. If you consider only the estimates of cost and benefit, which

procedure(s) should be implemented?

Considering only the estimated costs and benefits, procedure B should be implemented

d What other factors might be relevant to the decision

Another important factor to consider is how critical the $1,000,000 loss would be to

ABC Corporation.

If ABC is a multi-billion dollar corporation, then they can afford to evaluate this

However, if ABC is a small corporation then a loss of this magnitude could

eUse the Goal Seek function in Microsoft Excel to determine the likelihood of occurrence

without the control and the reduction in expected loss if the net benefit/cost is 0. Do this

for procedure A, procedure B, and both procedures together

7.6 The management at Covington, Inc., recognizes that a well-designed internal control

system provides many benefits. Among the benefits are reliable financial records that

facilitate decision making and a greater probability of preventing or detecting errors

and fraud. Covington’s internal auditing department periodically reviews the

company’s accounting records to determine the effectiveness of internal controls. In

its latest review, the internal audit staff found the following eight conditions:

1 Daily bank deposits do not always correspond with cash receipts.

2 Bad debt write-offs are prepared and approved by the same employee.

For each of the eight conditions detected by the Covington internal audit staff:

a. Describe a possible cause of the condition.

b. Recommend actions to be taken and/or controls to be implemented that would

correct the condition. Adapted from the CMA Examination

# a Possible Cause b. Recommendation to Correct Condition

1Daily bank deposits do not always

correspond with cash receipts.

Timing difference between when cash is

received and when deposited in the bank

Cash receipts are being stolen

Make two deposits for each day’s receipts.

List cash received each day; compare it to daily

cash deposits.

2Bad debt write-offs are prepared and

approved by the same employee.

3Occasional discrepancies between physical

inventory counts and perpetual inventory

records.

Inventory theft by employees

Count all inventory when received at the warehouse

and at the storeroom; reconcile the counts.

4Alterations to physical inventory

counts and perpetual inventory

records

5Many customer refunds and credits.

6Many original documents are missing

or lost. However, there are substitute

copies of all missing originals.

7An unexplained decrease in the gross

profit percentage has occurred.

inventory losses.

Require the approval of a responsible party before

8Many documents are not approved.

7.7 Consider the following two situations:

For the situations presented, describe the recommendations the internal auditors

should make to prevent the following problems. Adapted from the CMA Examination

Situation 1: Many employees of a firm that manufactures small tools pocket some of

the tools for their personal use. Since the quantities taken by any one employee are

immaterial, the individual employees do not consider the act as fraudulent or

detrimental to the company. The company is now large enough to hire an internal

auditor. One of the first things she did was to compare the gross profit rates for

industrial tools to the gross profit for personal tools. Noting a significant difference,

she investigated and uncovered the employee theft.

Implement and communicate through proper training a policy regarding the theft of

company goods and services and the repercussions associated with theft.

Situation 2: A manufacturing firm’s controller created a fake subsidiary. He then

ordered goods from the firm’s suppliers, told them to ship the goods to a warehouse

he rented, and approved the vendor invoices for payment when they arrived. The

controller later sold the diverted inventory items, and the proceeds were deposited to

the controller’s personal bank account. Auditors suspected something was wrong

when they could not find any entries regarding this fake subsidiary office in the

property, plant, and equipment ledgers or a title or lease for the office in the

real-estate records of the firm