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7.8 Tralor Corporation manufactures and sells several different lines of small electric
components. Its internal audit department completed an audit of its expenditure
processes. Part of the audit involved a review of the internal accounting controls for
payables, including the controls over the authorization of transactions, accounting for
transactions, and the protection of assets. The auditors noted the following items:
1 Routine purchases are initiated by inventory control notifying the purchasing
2 For efficiency and effectiveness, purchases of specialized goods and services are
3 Accounts payable maintains a list of employees who have purchase order approval
4 Prenumbered vendor invoices are recorded in an invoice register that indicates the
5 Prior to making entries in accounting records, the accounts payable clerk checks
6 All approved invoices are filed alphabetically. Invoices are paid on the 5th and
7 The treasurer signs the checks and cancels the supporting documents. An original
8 Prenumbered blank checks are kept in a locked safe accessible only to the cash
Review the eight items listed and decide whether they represent an internal control
strength or weakness
a For each internal control strength you identified, explain how the procedure
helps achieve good authorization, accounting, or asset protection control.
b For each internal control weakness you identified, explain why it is a weakness
and recommend a way to correct the weakness
Adapted from the CMA Examination
# a. Why it is a strength b. Why it is a weakness b. Recommendation to
correct weakness
1 User authorization means the
A purchase order copy should not be used
The receiving report is prepared
2
4 Numbering and recording
control over invoices and
helps ensure their recording in
accounting records.
Failure to follow-up on open invoices
lack of follow-up.
A periodic review and
5 The transaction audit helps
minimize errors and helps
ensure that only properly
authorized transactions are
recorded.
7 Proper separation of duties
exists
8 Proper protection of blank
checks (locked safe only
Unlimited access to cash disbursement
documents (other than blank checks)
or a loss of assets - as well as improper or
inaccurate accounting or destruction of
records.
A policy limiting access to and
physical protection of accounts
7 Lancaster Company makes electrical parts for contractors and home improvement
retail stores. After their annual audit, Lancaster’s auditors commented on the
following items regarding internal controls over equipment:
1 The operations department that needs the equipment normally initiates a
2 When the purchasing department receives either an inventory or an equipment
3 When equipment arrives, the user department installs it. The property, plant, and
equipment control accounts are supported by schedules organized by year of
4 When equipment is retired, the plant manager notifies the accounting department
5 There has been no reconciliation since the company began operations between the
Weakness Recommendation
1 No authorization form describing the
2 Equipment purchases over a certain
The purchase requisition should include an item
and management approval.
3 Purchase requisitions for fixed assets
4 No mention of pre-numbered purchase
requisitions or purchase orders.
Authorized equipment acquisitions should be processed
Pre-numbered purchase requisitions and purchase orders
should be used so that all documents can be accounted for.
5 Plant engineering is not inspecting
6 Equipment is not tagged and controlled
Machinery and equipment should be subject to normal
All new machinery and equipment should be assigned a
control number and tagged at the time of receipt.
Machinery and equipment accounting procedures,
9 Equipment retirement schedules are
Equipment retirement schedules, which provide
Periodically, a physical inventory of fixed assets should be
7.10 The Langston Recreational Company (LRC) manufactures ice skates for racing,
figure skating, and hockey. The company is located in Kearns, Utah, so it can be
close to the Olympic Ice Shield, where many Olympic speed skaters train.
Given the precision required to make skates, tracking manufacturing costs is very
important to management so it can price the skates appropriately. To capture and
collect manufacturing costs, the company acquired an automated cost accounting
system from a national vendor. The vendor provides support, maintenance, and data
and program backup service for LRC’s system.
LRC operates one shift, five days a week. All manufacturing data are collected and
recorded by Saturday evening so that the prior week’s production data can be
processed. One of management’s primary concerns is how the actual manufacturing
process costs compare with planned or standard manufacturing process costs. As a
result, the cost accounting system produces a report that compares actual costs with
standards costs and provides the difference, or variance. Management focuses on
significant variances as one means of controlling the manufacturing processes and
calculating bonuses.
Occasionally, errors occur in processing a week’s production cost data, which
requires the entire week’s cost data to be reprocessed at a cost of $34,500. The
current risk of error without any control procedures is 8%. LRC’s management is
currently considering a set of cost accounting control procedures that is estimated to
reduce the risk of the data errors from 8% to 3%. This data validation control
procedure is projected to cost $1,000 per week.
a. Perform a cost/benefit analysis of the data-validation control procedures.
Without
Control
Process
With
Control
Process
Net
Difference
Expected
Cost of Production Data Reprocessing $34,500 $34,500
Risk of Data
b. Based on your analysis, make a recommendation to management regarding the
control procedure.
c The current risk of data errors without any control procedures is estimated to be
8%. The data control validation procedure costs $1,000 and reduces the risk to
3%. At some point between 8% and 3% is a point of indifference—that is, Cost of
reprocessing the data without controls = Cost of processing the data with the
controls + Cost of controls. Use a spreadsheet application such as Excel Goal Seek
to find the solution
Solution: 6%
Without
Control
Process
With
Control
Process
Net
Difference
Expected
Goal Seek Setup:
Goal Seek Solved:
7.11 Spring Water Spa Company is a 15-store chain in the Midwest that sells hot tubs,
supplies, and accessories. Each store has a full-time, salaried manager and an
assistant manager. The sales personnel are paid an hourly wage and a commission
based on sales volume.
The company uses electronic cash registers to record each transaction. The
salesperson enters his or her employee number at the beginning of his/her shift. For
each sale, the salesperson rings up the order by scanning the item’s bar code, which
then displays the item’s description, unit price, and quantity (each item must be
scanned). The cash register automatically assigns a consecutive number to each
transaction. The cash register prints a sales receipt that shows the total, any discounts,
the sales tax, and the grand total.
The salesperson collects payment from the customer, gives the receipt to the customer,
and either directs the customer to the warehouse to obtain the items purchased or
makes arrangements with the shipping department for delivery. The salesperson is
responsible for using the system to determine whether credit card sales are approved
and for approving both credit sales and sales paid by check. Sales returns are handled
in exactly the reverse manner, with the salesperson issuing a return slip when
necessary.
At the end of each day, the cash registers print a sequentially ordered list of sales
receipts and provide totals for cash, credit card, and check sales, as well as cash and
credit card returns. The assistant manager reconciles these totals to the cash register
tapes, cash in the cash register, the total of the consecutively numbered sales invoices,
and the return slips. The assistant manager prepares a daily reconciled report for the
store manager’s review.
Cash sales, check sales, and credit card sales are reviewed by the manager, who
prepares the daily bank deposit. The manager physically makes the deposit at the
bank and files the validated deposit slip. At the end of the month, the manager
performs the bank reconciliation. The cash register tapes, sales invoices, return slips,
and reconciled report are mailed daily to corporate headquarters to be processed with
files from all the other stores. Corporate headquarters returns a weekly Sales and
Commission Activity Report to each store manager for review.
Please respond to the following questions about Spring Water Spa Company’s
operations: (CMA exam adapted)
a. The fourth component of the COSO ERM framework is risk assessment. What
risk(s) does Spring Water face?
