CASTILLO, MARGA M.

BSA 5
ACCOUNTING INFORMATION SYSTEM
Ethics, Frauds, and Internal Control
(Chapter 3, Problem 12)

(A) Using the COSO internal control model for control activities identify any potential
internal control weaknesses in the NSC system.
The Never Sink Canoe (NSC) Company Segregations of Duties Issues Control
1.) Control weakness: Transaction authorization should be separated from transaction
processing. The sales person both authorizes the sale by approving the credit worthiness
of the customer and processes it.
2.) Control weakness: Asset custody should be separate from record keeping responsibility.
The accounting clerk has cash receipts and checks writing responsibility and also sets up
A/P and A/R accounts and updates those accounts.
3.) Control weakness: Asset custody should be separate from record keeping responsibility.
The warehouse clerk has custody of inventory and record keeping responsibility for the
inventory subsidiary ledger.
4.) Accounting Records Issues Control Weakness: Adequate source documents, journals, and
ledgers need to be in place to form an audit trail. Sales staff should submit receipts for
travel expense reimbursements.
5.) Independent Verification Issues Control Weakness: Verification procedures are checks on
the accounting system to identify errors and misrepresentations. No verification
procedures exist at NSC to review sales commissions or expense reimbursements.
(B) For each weaknesses discuss the potential fraud in the system
Fraud Potential 1: Sales person can approve sales to customers with poor credit to increase
his/her commission.
Fraud Potential 2: The clerk could create a false (or overstated) AP account for a sales person or
for the clerk and then write the check. 2) The clerk could establish a lapping fraud with accounts
receivable payments.
Fraud Potential 3: The clerk could remove inventory from the warehouse, sell it, and cover the
theft by adjusting the inventory records.

Fraud Potential 4: Sales staff need only submit a form to claim reimbursement but no proof of
the actual expense. They can thus pad their expenses.
Fraud Potential 5: The fraud potential has been previously discussed regarding commissions and
expense padding. Knowing that these activities are not reviewed my management would only
embolden someone with the intent to commit fraud.

(C) Make Recommendations for Correcting each identified control weakness

Recommendation 1: NSC should implement a formal credit approval process that is independent
of the sales person.
Recommendation 2: NSC should separate the cash receipts and disbursements from the recording
of AR and AP functions.
Recommendation 3: NSC should separate the task of updating the inventory records from the
warehouse function.
Recommendation 4: NSC should require the submission of receipts for all expenses above a prespecified dollar amount.
Recommendation 5: NSC should implement procedures to review commissions and expenses
transaction for reasonableness.