Question

You set up your own business in merchandising sector. You lease a space of 6,000 square feet to open a luxury watch shop.

The following is minimum information regarding the business:

- Specific sub-sector: Merchandising sector.

-   Business model: buying and selling luxury watches.

-   Investment by owner: $1,000,000

- You hire a shop manager, two accounting staffs who also keep the merchandise, one security officer, and 8 full-time sales assistants.

-   Business costs/expenses should have at least the following: cost of merchandise sold, rent expense, salary, utilities expense, advertising expense, interest expense, and miscellaneous expenses.

-Capital structure: must have both Investment by owner ($1,000,000) and Bank loan.

Set up an effective Internal Control System for the business using 5 different internal control elements.

Answer 1

Overview:

- Internal controls are the systems employed by a company to make sure that the integrity of financial records remains intact and in order to prevent fraud.

Internal control system to be employes:

• Leases: A space of 6,000 square feet has been leased in order to open the luxury watch shop. Internal control should be built in order to check whether the terms of covenants entered in the lease agreement are not being violated, the amount of principal, as well as interest, is being paid on time as well as proper accounting of the same is being done.
• Staff: The staff consists of a shop manager, two accounting staffs who also keep the merchandise, one security officer, and 8 full-time sales assistants. There is a big mistake in the role of giving the two accounting staffs the responsibility to also keep the merchandise because they can embezzle the merchandise and manipulate the books of accounts in order to hide the embezzlement. Therefore, internal controls should be revised in order to cover all such loopholes. Also, proper segregation of duties should be implemented and a proper check should be implemented on all the staff members
• Audit: Timely audit must be conducted in order to make sure that all the transactions occurring within the business are being reflected in the financial statements and also, whether the financial statements reflect the true and fair financial position of the entity. The auditor must remain alert to the possibility of material misstatement arising out of fraud as well as error,
• Investment:  -Capital structure: must have both Investments by owner ($1,000,000) and Bank loan. However one must note that the amount from a bank should be borrowed only if the owner's capital has been exhausted because borrowing money from a bank comes with a cost. Also, one must ensure that in case there are idle funds with the entity, the same must be employed in investments giving good return rather than holding it in cash.
• Documentation: Proper Documentation must be done in regard to investment, bank accounts, salary paid to employees, expenses paid or lease agreements in order to avoid future litigations.