a Control strengths in Spring
Water’s sales/cash receipts
b Type of
control
activity
c Problems avoided/Risks mitigated by the
controls
cash register tapes are
reconciled.
e. How might Spring Water improve its system of controls?
The bank reconciliation should be performed by someone other than the manager
who makes the deposits.
Sales people should never be allowed to authorize credit sales. At Spring Water, the
Warehouse personnel should have electronic read-only access to daily sales orders
to control and facilitate customer order pick-up and/or delivery.
Warehouse personnel should scan-in the bar codes of all sales-return merchandise.
7.12 PriceRight Electronics (PEI) is a small wholesale discount supplier of electronic
instruments and parts. PEI’s competitive advantage is its deep-discount, three-day
delivery guarantee, which allows retailers to order materials often to minimize
in-store inventories. PEI processes its records with stand-alone, incompatible
computer systems except for integrated enterprise resource planning (ERP)
inventory and accounts receivable modules. PEI decided to finish integrating its
operations with more ERP modules, but because of cash flow considerations, this
needs to be accomplished on a step-by-step basis.
It was decided that the next function to be integrated should be sales order
processing to enhance quick response to customer needs. PEI implemented and
modified a commercially available software package to meet PEI’s operations. In an
effort to reduce the number of slow-paying or delinquent customers, PEI installed
Web-based software that links to the Web site of a commercial credit rating agency
to check customer credit at the time of purchase. The following are the new sales
order processing system modules:
•Sales. Sales orders are received by telephone, fax, e-mail, Web site entry, or
•Credit. When orders are received from new customers, the system automatically
•Warehousing. Warehouse personnel update the inventory master file for inventory
•Shipping and receiving. Shipping and Receiving accepts inventory and sales orders
•Accounting. Billing prices all sales orders received, which is done approximately 5
days after the order ships. To spread the work effort throughout the month,
(CMA exam adapted)
a. Identify the internal control strengths in PEI’s system
The automated customer credit limit system suggests a new customer’s credit limit on a real-time
basis. The Credit Manager establishes credit limits for new customers on a daily basis so that
new credit-worthy customers can have their orders filled in a timely manner.
Real-time customer credit checks before orders are processed.
b Identify the internal control weaknesses in PEI’s system, and suggest ways to correct
them.
Weakness 1: The Credit Department only checks the accounts receivable aging report at
Correction: Revise the aging report process to produce an exception report whenever a
Weakness 2: Customer credit requests for sales returns are not compared to materials
Correction: Require the credit manager to receive an acknowledgement from Shipping
Weakness 3: Warehouse personnel have responsibility for updating inventory records for
Correction: Create a purchasing function to update the inventory master file for
Weakness 4: Receiving does not prepare a Returned Goods report.
Correction: Receiving should record all purchase returns and prepare a Returned Goods
Weakness 5: Warehouse personnel have responsibility for updating inventory records for
Correction: Have the warehouse create a daily purchases returned report for all returned
Weakness 6: Inventory is not counted when received and then counted again when
Correction: Count and compare inventory counts as inventory enters the company and as
Weakness 7: Billing is not done until 5 days after shipping.
Correction: Billing should be more prompt in billing for goods shipped. This gives
SUGGESTED SOLUTIONS TO THE CASE
7.1 Nino Moscardi, president of Greater Providence Deposit & Trust (GPD&T), received
an anonymous note in his mail stating that a bank employee was making bogus loans.
Moscardi asked the bank’s internal auditors to investigate the transactions detailed in
the note. The investigation led to James Guisti, manager of a North Providence
branch office and a trusted 14-year employee who had once worked as one of the
bank’s internal auditors. Guisti was charged with embezzling $1.83 million from the
bank using 67 phony loans taken out over a three-year period.
Court documents revealed that the bogus loans were 90-day notes requiring no
collateral and ranging in amount from $10,000 to $63,500. Guisti originated the loans;
when each one matured, he would take out a new loan, or rewrite the old one, to pay
the principal and interest due. Some loans had been rewritten five or six times.
The 67 loans were taken out by Guisti in five names, including his wife’s maiden
name, his father’s name, and the names of two friends. These people denied receiving
stolen funds or knowing anything about the embezzlement. The fifth name was James
Vanesse, who police said did not exist. The Social Security number on Vanesse’s loan
application was issued to a female, and the phone number belonged to a North
Providence auto dealer.
Lucy Fraioli, a customer service representative who cosigned the checks, said Guisti
was her supervisor and she thought nothing was wrong with the checks, though she
did not know any of the people. Marcia Perfetto, head teller, told police she cashed
checks for Guisti made out to four of the five persons. Asked whether she gave the
money to Guisti when he gave her checks to cash, she answered, “Not all of the time,”
though she could not recall ever having given the money directly to any of the four,
whom she did not know.
Guisti was authorized to make consumer loans up to a certain dollar limit without
loan committee approvals, which is a standard industry practice. Guisti’s original
lending limit was $10,000, the amount of his first fraudulent loan. The dollar limit was
later increased to $15,000 and then increased again to $25,000. Some of the loans,
including the one for $63,500, far exceeded his lending limit. In addition, all loan
applications should have been accompanied by the applicant’s credit history report,
purchased from an independent credit rating firm. The loan taken out in the fictitious
name would not have had a credit report and should have been flagged by a loan
review clerk at the bank’s headquarters.
News reports raised questions about why the fraud was not detected earlier. State
regulators and the bank’s internal auditors failed to detect the fraud. Several reasons
were given for the failure to find the fraud earlier. First, in checking for bad loans,
bank auditors do not examine all loans and generally focus on loans much larger than
the ones in question. Second, Greater Providence had recently dropped its computer
services arrangement with a local bank in favor of an out-of-state bank. This
changeover may have reduced the effectiveness of the bank’s control procedures.
Third, the bank’s loan review clerks were rotated frequently, making follow-up on
questionable loans more difficult.
Guisti was a frequent gambler and used the embezzled money to pay gambling debts.
The bank’s losses totaled $624,000, which was less than the $1.83 million in bogus
loans, because Guisti used a portion of the borrowed money to repay loans as they
came due. The bank’s bonding company covered the loss.
The bank experienced other adverse publicity prior to the fraud’s discovery. First, the
bank was fined $50,000 after pleading guilty to failure to report cash transactions
exceeding $10,000, which is a felony. Second, bank owners took the bank private after
a lengthy public battle with the State Attorney General, who alleged that the bank
inflated its assets and overestimated its capital surplus to make its balance sheet look
stronger. The bank denied this charge.
1. How did Guisti commit the fraud, conceal it, and convert the fraudulent actions
to personal gain?
Commit: James Guisti, a trusted 14-year employee and manager of a Greater
Conceal: He made the loans out to five people: his wife using her maiden name, his
Convert: He had a subordinate, customer service representative Lucy Fraioli, cosign
2 Good internal controls require that the custody, recording, and authorization
functions be separated. Explain which of those functions Guisti had and how the
failure to segregate them facilitated the fraud.
Authorization: Guisti was authorized to make consumer loans up to $10,000 (later
Custody: Guisti was able to commit the fraud because he was able to obtain custody
Recording: Nothing in the case write-up indicates that Guisti had any recording
3 Identify the preventive, detective, and corrective controls at GPD&T and discuss
whether they were effective.
Preventive: All bank loans exceeding Guisti’s limit ($10,000, then $15,000 and then
Detective: State regulators and the bank’s internal auditors failed to detect the fraud.
Corrective: The bank bonded (an insurance policy on an employee’s honesty) its
4 Explain the pressures, opportunities, and rationalizations that were present in
the Guisti fraud.
Pressures: Guisti was a frequent gambler and needed the money to pay gambling
debts.
Opportunities: As the Branch Manager, Guisti could override some internal controls
Rationalization: No information is given on how or why Guisti rationalized his fraud
5 Discuss how Greater Providence Deposit & Trust might improve its control
procedures over the disbursement of loan funds to minimize the risk of this type
of fraud. In what way does this case indicate a lack of proper segregation of
duties?
Loan funds should generally not be disbursed in cash. Better control would be
Customer service representatives generally should not co-sign checks to borrowers
without first verifying their existence.
6 Discuss how Greater Providence might improve its loan review procedures at
bank headquarters to minimize its fraud risk. Was it a good idea to rotate the
assignments of loan review clerks? Why or why not?
A system should be in place at the bank’s headquarters to maintain data on all
outstanding bank loans. This system should flag all loans that have been made in
Approved loans for which there is no credit report should be flagged and scrutinized.
Bank headquarters could send a letter to each new borrower thanking them for their
Rotating the assignments of loan review clerks may have made it more difficult for
7. Discuss whether Greater Providence’s auditors should have been able to detect
this fraud.
Audits are not guaranteed to detect fraud. It is too costly for auditors to examine
The case notes that Guisti was a former auditor. Therefore, he would have been very
If auditors had any indication that Guisti was heavily involved in gambling activities,
they should have examined his accounts very carefully. However, the case gives no
indication that the auditors were ever aware of Guisti’s penchant for gambling.
8. Are there any indications that the internal environment at Greater Providence
may have been deficient? If so, how could it have contributed to this
embezzlement?
There are three indications of potential deficiencies in the bank’s control
environment.
Controls may have been deficient during the computer services changeover.
The bank pled guilty to a felony three years prior to discovery of the fraud, which
The state’s charges of an inflated balance sheet suggest the possibility that the
While one indicator of a deficient internal environment may be tolerable, three begins