Question

1. The ABC Company, a client of your firm, has come to you with the following problem. it has three clerical employees who must perform the following functions:
   1. Maintain the general ledger
   2. Maintain the accounts receivable ledger
   3. Issue credits on returns and allowances
   4. Reconcile the bank account
   5. Handle and deposit cash receipts

Assuming equal abilities among the three employees, the company asks you to assign the five functions to them to maximize internal control. Assume that these employees will perform no accounting functions other than the ones listed.

Explain the concept of adequate segregation of accounting duties. List four possible unsatisfactory pairings of the functions. Discuss and using life examples to support your decisions.

1. General ledger - cash receipts.
2. Accounts receivable ledger - cash receipts.
3. Bank reconciliation - cash receipts.
4. Credits on returns and allowances - cash receipts.

Answer 1

Answer:

a All five of the unsatisfactory pairings below involve custody of cash and a recording function that would allow a fraud perpetrator to conceal a theft.

1.      General ledger - cash receipts. With custody to cash, this person could steal cash receipts and conceal the theft by recording a fictitious entry in the General Ledger to credit (reduce) the balance of the cash account by the amount stolen.

2.      Accounts receivable ledger - cash receipts. With custody to cash, this person could steal cash receipts and conceal the theft by recording a fictitious entry in the Accounts Receivable Subsidiary Ledger to reduce a customer’s accounts receivable balance by the amount stolen.

3.      Bank reconciliation - cash receipts. With custody to cash, this person could steal cash receipts and conceal the theft by falsifying (recording) the bank reconciliation.

4.   Credits on returns and allowances - cash receipts. This person could authorize (authorization) or record false credit memos (recording) to customers who are making a payment and steal the customer payments (custody).

5.   Accounts payable ledger - prepare checks for signature. A person with both of these responsibilities could create fictitious payables (recording) and then write and cash checks to pay them (custody).

6.      Maintain accounts receivable - issue credit memos – this combines authorization and recording. A person with both of these responsibilities could write off accounts for friends.

b.      Any distribution that avoids all of the above unsatisfactory combinations and spreads the workload evenly is acceptable. The key is not to have anyone with both custody and a recording function that could be used to conceal a theft. One such combination is:

First employee                   accounts payable ledger, accounts receivable ledger, bank reconciliations

Second employee              general ledger, disbursements journal, credits on returns and allowances

Third employee                 prepare checks for signature, cash receipts