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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
