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This tutorial explains how the principle of separation of duties is violated in different scenarios and suggests procedures to minimize risks and exposure. Examples include payroll fraud, cash theft, fictitious invoices, inventory theft, and more.
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AQ 7.1Problem 6.2 (a) to (f) (Romney p237) • 6.2 Explain how the principle of separation of duties is violated in each of the following situations. Also suggest one or more procedures to reduce the risk and exposure highlighted in each example.
AQ 7.1 • a. A payroll clerk recorded a 40-hour workweek for an employee who had quit the previous week. He then prepared a paycheck for this employee, forged her signature, and cashed the check.
AQ 7.1 • a. Segregation of duties is violated here by combining the functions of recording time worked and preparing paycheques.
AQ 7.1 • b. While opening the mail, a cashier set aside, and subsequently cashed, two checks payable to the company on account.
AQ 7.1 • b. The functions of opening the mail and endorsing cheques payable to the company should be organizationally independent. However, the clerk opening the mail can still pocket the cheques, never giving the authorized endorser a chance to be involved. For this reason, many companies have the mail opened by two people or have those opening the mail video taped.
AQ 7.1 • c. A cashier prepared a fictitious invoice from a company using his brother-in-law’s name. He sent an electronic payment for the invoice to his brother-in-law.
AQ 7.1 • c. The functions of authorizing payment of invoices and preparing cheques for signature should be organizationally independent.
AQ 7.1 • d. An employee of the finishing department walked off with several parts from the storeroom and recorded the items as having been issued to the assembly department.
AQ 7.1 • d. No employee should be permitted free access to the storeroom (a custodial function) and also access to the inventory ledger (a recording function).
AQ 7.1 • e. A cashier cashed a check from a customer in payment of an account receivable, pocketed the cash, and concealed the theft by properly posting the receipt to the customer’s account in the accounts receivable ledger.
AQ 7.1 • e. Custody of the cheques and posting to the Accounts Receivable Ledger should be organizationally independent.
AQ 7.1 • f. Several Customers returned clothing purchases over a week` s time. Instead of putting the returned clothing into return bin to be put back on the rack, a clerk put the clothing in a separate bin under some cleaning rags. After her shift, she transferred the clothes to a gym bag and took them home.
AQ 7.1 • f. All purchase returns should be documented by preparing a customer receipt and recording the return in a purchase returns journal. • No cash or credit can be given without the return being authorized by a supervisor and recorded in the data files recorded in the cash register. • The purchase returns area should be kept clean and orderly so that returns cannot be "hid" among excess returns. • Employees should not be allowed to have gym bags or other personal items that could conceal stolen items in work areas.
AQ 7.2Problem 6.2 (g) to (k) (Romney p 237) • g. A receiving clerk noticed that four cases of MP3 players were included in a shipment when only three were ordered. The clerk put the extra case aside and took it home after his shift ended.
AQ 7.2 • g. Purchase orders sent to the receiving area should not indicate how many items or cases were ordered (blank PO),thus helping ensure that all shipments are counted, recorded and quality verified. The purchasing department should reconcile items received against items ordered.
AQ 7.2 • h. An insurance claims adjuster had check signing authority of $6,000. The agent created three businesses that subsequently billed the insurance company for work not performance on legitimate insurance claims. The agent signed the check s for the invoices. The invoiced never exceeded $6,000.
AQ 7.2 • h. The functions of signing checks for invoices and approving vendors should be organizationally independent. • In addition, payments should not be made to anyone that is not on the approved vendor list. • Controls should be put into place to endure that employees cannot add an unauthorized or unapproved vendor to the vendor master file.
AQ 7.2 • i. An accounts payable clerk recorded invoices received from a company that he and his wife own and authorized their payments
AQ 7.2 • i. The functions of recording invoices and approving vendors should be organizationally independent. • In addition, clerks should only be allowed to purchasegoods and services from approved vendors. • Controls should be put into place to ensure that employees cannot add an unauthorized or unapproved vendor to the vendor master file.
AQ 7.2 • j. A cashier created false purchase return vouchers to hide his theft of several thousand dollars from his cash register.
AQ 7.2 • j. Purchase return vouchers should be authorized by a supervisor rather than the clerks (custody function).
AQ 7.2 • k. A purchasing agent received a 10% kickback of the invoice amount for all purchases made from a specific vendor.
AQ 7.2 • k. Vendors should only be allowed to purchase goods and servicesfrom approved vendors. • Controls should be put into place to endure that employees cannot add an unauthorized or unapproved vendor to the vendor master file. • Vendor performance with respect to reliability, quality of goods, and prices charged should be tracked and periodically reviewed. Prices should periodically be compared to those charged by other vendors to make sure they are fair, competitive, and reasonable. • Analytical procedures can be performed to track the percentage of business a purchasing agent gives to vendors.
AQ 7.3 The XYZ Company has discovered it has a serious internal control problem. The impact associated with this problem is $2 million and the likelihood is 10%. Two internal control procedures have been suggested to deal with this problem. Procedure A would cost $50,000 and reduce likelihood to 4%. Procedure B would cost $60,000 and reduce likelihood to 2%. If both procedures were implemented likelihood would be reduced to one fifth of 1%.
AQ 7.3(a)From this information complete the following table:
AQ 7.3(a) Expected Loss = Risk x Exposure = 0.1 x $2,000,000 = $200,000 10% $2,000,000 $200,000 4% $2,000,000 $80,000 $120,000 $70,000 $50,000 2% $2,000,000 $40,000 $160,000 $60,000 $100,000 $2,000,000 $4,000 0.2% $196,000 $110,000 $86,000
AQ 7.3 (b) From these calculations which procedure (if any) should be implemented? Justify your answer.
AQ 7.3 (b) Procedure B should be implemented as it has the highest net benefit. Care must be taken with these discussions, however, because the numbers used are estimates. The net benefit figures are only as good as the estimates used to produce them.
AQ 7.3 (c) List any other factors that may need to be considered in addition to these calculations when making a decision about what control procedures should be implemented?
AQ 7.3 • (c) Other important factors 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 matter strictly on the basis of estimated costs and benefits. • However, if ABC is a small corporation, then a loss of this magnitude could threaten their continued existence, and it may be worthwhile to incur extra costs (as a form of insurance premium) to reduce the risk of loss to the smallest possible level.
AQ 7.4 Problem 6.7 (Romney page 239) • Consider the following two situations 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 acts as fraudulent nor 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 fir industrial tools to the gross profit for personal tools. Noting a significant difference, she investigated and uncovered the employee theft.
AQ 7.4 Problem 6.7 (Romney page 239) • Consider the following two situations 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 invoiced for payment when they arrived, 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.
AQ 7.4 • Required For the situations presented, describe the recommendations the internal auditors should make to prevent similar problems in the future. (CMA, adapted)
AQ 7.4 Situation 1 • Implement and communicate a policy regarding the theft of company goods and services and the repercussions associated with theft. • Allow employees to purchase tools at cost from the company.
AQ 7.4 Situation 2 • Implement a better segregation of duties. The company controller should not be able to order, ship, and authorize payment for inventory. • Require all inventory purchases to be initiated by the purchasing department. • Require all inventory payments to be supported by proper supporting documents such as receiving reports signed by authorized personnel. • Require special authorization for shipments to locations not typically used.
