Question

While auditing the financial statements of Petty Corporation, the certified public accounting firm of True Blue and Smith discovered that its client’s legal expense account was abnormally high. Further investigation of the records indicated the following: 

• Since the beginning of the year, several disbursements totaling $15,000 had been made to the law firm of Swindle, Fox, and Kreip. 

• Swindle, Fox, and Kreip were not Petty Corporation’s attorneys. 

• A review of the canceled checks showed that they had been written and approved by Mary Boghas, the cash disbursements clerk. 

• Boghas’s other duties included performing the end-of-month bank reconciliation. 

• Subsequent investigation revealed that Swindle, Fox, and Kreip are representing Mary Boghas in an unrelated embezzlement case in which she is the defendant. The checks had been written in payment of her personal legal fees. 

 

Required 

a. What control procedures could Petty Corporation have employed to prevent this unauthorized use of cash? Classify each control procedure in accordance with the COSO framework (authorization, segregation of functions, supervision, and so on). 

b. Comment on the ethical issues in this case. 

Answer 1

a. Control Procedures:

All checks should require the treasurer’s signature (transaction authorization).

An individual who is dispersing cash should not also be reconciling the cash account (segregation of duties).

A bonding agency can be used to verify employee integrity through background checks (supervision).

The internal auditors should perform a periodic review of expense accounts, which are frequently used to offset fraudulent transactions (accounting records). 

 

b. Ethical Issues:

Apart from the obvious lack of ethical standards by Mary Boghas, the ethical behavior of Swindle, Fox, and Kreip also comes into question. They had received numerous checks drawn upon the bank account of the Petty Corporation in payment of Mary Boghas’s legal fees.