Question

 

Question: Levon Helm was a kind of one-man mortgage broker. He would drive around Tennessee

looking for homes that had second mortgages, and if the criteria were favorable,

he would offer to buy the second mortgage for “cash on the barrelhead.”

Helm bought low and sold high, making sizable profits. Being a small operation, he

employed one person, Cindy Patterson, who did all his bookkeeping. Patterson was an

old family friend, and he trusted her so implicitly that he never checked up on the ledgers

or the bank reconciliations. At some point, Patterson started “borrowing” from

the business and concealing her transactions by booking phony expenses. She intended

to pay it back someday, but she got used to the extra cash and couldn’t stop. By the

time the scam was discovered, she had drained the company of funds that it owed to

many of its creditors. The company went bankrupt, Patterson did some jail time, and

Helm lost everything.

Requirements

1. What was the key control weakness in this case?

2. Many small businesses cannot afford to hire enough people for adequate separation

of duties. What can they do to compensate for this?

Answer 1

 

Step 1: Definition of the internal control

Internal control is a process by which the company can manage its internal activities.

Step 2: Missing internal control

The critical internal control missing is the separation of duties because Patterson is the only employee in the company, and he manages everything in the company. Patterson has all the power of accounting and accessing the record of the books. He uses these duties in the wrong way.

Step 3: Small businesses’ problem

Small businesses did not have enough money to hire many employees for different positions. To solve this problem, small businesses can hire employees only for the most critical places, and the company can take the help of a pre-screening test to check the employees’ background

Separation of duties is a type of internal control in which the company separates the responsibilities between two or more employees