Question 1

For each of the weaknesses, make proper internal control recommendations to correct the
weakness.

1) Making a credit sale to a customer who is already four months behind in making
payments on his account.

2) Writing off a customer’s accounts receivable balance as uncollectible to conceal the

theft of subsequent cash payments from that customer.

3) Shipments are not reconciled to sales orders, resulting in sending customers the wrong
items.

4) Theft of checks by the mailroom clerk, who then endorsed the checks for deposit into
the clerk’s personal bank account.

5) Loss of all information about amounts owed by customers in New York City because
the master database for that office was destroyed in a fire.

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Answer
1) Up-to-date credit records must be maintained to control this problem. During the
credit approval process, the credit manager should review the accounts receivable aging
schedule to identify customer’s with past-due balances to prevent additional sales to those
customers. Alternatively, the computer system could be programmed to determine if the
customer had any past due balances over a specified length of time (such as 60 days). If
not, the sale would be approved. If they had a past-due balance, a notice could be sent
to the credit manager who could review the sale and make a decision about extending
additional credit.

2) The problem usually occurs because the same individual writes off accounts and
processes cash payments. Therefore, the best control procedure to prevent this problem is
to separate the function of authorizing write-offs of uncollectible accounts from the
function of handling collections on account.

3) The system should be configured to match shipping information to sales orders and
alert the shipping employees of any discrepancies.

4) In order to cover up this theft, the mailroom clerk has to be able to alter the accounts
receivable records. Otherwise, a customer who is subsequently notified that they are
past due will complain and provide proof that they sent in payment. Therefore, the
critical control is to segregate duties so that whoever opens the mail does not have the
ability to maintain customer accounts.

If accounts receivable updates the records based on a cash receipts pre-list instead of the
actual checks, the mailroom clerk could conceivably lap payments. To prevent this, the
cash receipts pre-list could be compared to the checks before the list is sent to accounts
receivable. The checks should not be sent to accounts receivable as the accounts
receivable clerk could perform the lapping.

5) Data: Regular backups with copies being stored off-site.

Hardware and software: Hot or cold site arrangements for both
Recovery: Disaster recovery plan developed, tested, and in place

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Question 2
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 four 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.
3. There are occasional discrepancies between physical inventory counts and
perpetual inventory records.
4. Alterations have been made to physical inventory counts and to perpetual
inventory records.

Required:
Recommend actions to be taken and/or controls to be implemented that would correct the
each of the above four conditions.

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Answer:

a. Possible Cause b. Recommendation to Correct

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

Timing difference between when cash
is received and when deposited in the
bank
- Cash is received after the day’s bank
deposit is prepared and sent to the
bank.
- Bank credits bank deposits received
after a certain hour on the next day.
Cash receipts are being stolen
Make two deposits for each day’s receipts.
An employee who does not handle cash
receipts daily reconciles each day’s cash
receipts per book with deposits per bank
List cash received each day; compare it to
daily cash deposits.
Have 2 people involved in cash receipts if
practical. If only one can be involved,
video tape the receipts process.

Have an employee who does not handle

receipts do all reconciliations.

Bad debt write-offs are prepared

and approved by the same
employee.
Require all bad debt write-offs to be
Collusion between customers and the approved by a second employee.
employee writing off the bad debts.

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Occasional discrepancies between
physical inventory counts and
perpetual inventory records.

Unauthorized access to physical Limit physical and logical access to the

inventory and/or inventory records. inventory records to authorized employees.

Require that all adjustments to inventory

records be approved by a responsible
official.

Inventory theft by employees Count all inventory when received at the

warehouse and at the storeroom; reconcile
the counts.

Count inventory to be shipped before it is

removed from the storeroom, when received
by shipping, and when shipped; reconcile
counts.

Bar codes and RFID tags to facilitate counts

Hold storeroom employees responsible for

all inventory losses.

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Alterations to physical inventory
counts and perpetual inventory
records

Unauthorized access to inventory Limit physical and logical access to the

records. inventory records to authorized employees.

Require that all adjustments to inventory

records be approved by a responsible
official.
Fraud Examine physical inventory counts and
perpetual inventory records for evidence of
fraud

Terminate any employees that commit fraud