Question

You are an employee at a full-service bookkeeping and auditing firm called Accounting Solutions. Accounting firms are often asked to perform consulting services for clients. Your new client, Auto Parts Unlimited, is seeking a loan for an expansion project and their lender has asked about the business control and documentation procedures. Bob, the owner of Auto Parts Unlimited, has asked for your help. You visit Auto Parts Unlimited, talk with employees, and make the following observations:

1. Betty, the purchasing manager, orders the merchandise, checks in the merchandise when it arrives, verifies that it is accurate, and then approves payment for the order.
2. You notice the purchase orders and sales invoices are not pre-numbered. You are told this is because pre-numbering the forms costs more.
3. You also notice that, to save time, the sales clerk takes orders throughout the day and enters all sales orders at the end of the day. At this time, he prepares the deposit and delivers it to the bank.
4. Jack is a long term and trusted employee of the business. He is responsible for all sales returns. He knows the products well and grants returns at his discretion.
5. Sally, the bookkeeper, has not taken a vacation in three years.
6. The owner, Bob, is very busy and overwhelmed by paperwork. He has checks brought to him twice a week and stamps his signature on them.

After your visit, you prepare a memo to Bob addressing the importance of internal control procedures and make suggestions for improvement. In correct memo format, address these topics:

• Explain the importance of good internal control procedures and summarize the elements of internal control.
• Individually address each of your observations and recommend a control activity to solve the internal control issue. Use the elements of internal control to support your recommendations.

Answer 1

MEMORANDUM

TO - BOB

FROM - ACCOUNTING SOLUTIONS

SUBJECT - INTERNAL CONTROL

This memo is with reference to the observations made during our visit to your store. Before getting into detailed matters, I would like to talk you through the importance of having internal control procedures set up in day to day business.

Sound or strong internal controls are essential in any business as they help the business in staying healthy and achieving key business objectives such as safeguarding assets (preventing them from fraud or theft), accomplishing operational efficiency (can foster efficiency through automation of manual controls), maintaining compliance (allow organization to meet regulatory requirements) etc.

Key elements of internal control include,

1) Control environment - Management philosophy and operating style, and assignment of authority and responsibility fall under the control environment umbrella.

2) Risk Assessment - Risk assessment is the evaluation of your business flow and exposure to risk. A number of risks are present for all organizations on a daily basis. It’s essential to identify and analyze these risks in order to prevent an adverse event from occurring. You should perform risk assessments continuously.

3) Control Activities - Control activities are the policies and procedures of your business. Activities include top-level reviews, and segregation of duties.

4) Information and communication - Clear lines of communication shouldn’t just flow from management to employees, but from employees to management so that each member of the team can successfully carry out their responsibilities.

5) Monitoring - Monitoring is the process of assessing your internal control performance. The board should evaluate management and supervisory activities, the budget and all other financial documents.

Coming to the observations and recommended controls to be put in place -

Absence of segregation of duties - A purchase manager himself/herself place the order, receives the order, checks for the merchandise received. or a sales clerk himself taking all the orders and collecting deposits and going to bank himself. This is where there is absence of internal control. Control activities are required here to ensure there is segregation of duties. Internal check system should be in place where work of one person is checked independently in course of work of another person.

Absence of sequentially numbered documents - The benefits of having sequentially numbered documents or invoices far outweigh its costs and therefore should be made mandatory. They help monitoring and flow of documentation during each process.

Adequate risk management - Sending employees on leaves once a year should be made mandatory so as to allowing another person to fill his shoes and see whether any inadequacies or incompetences are discovered. The longer a person is in the same position, the more chances of him/her taking advantages of loop holes in the system.

Lastly, as a owner, you need to ensure that there is sufficient communication between you and your employees so the employees are at all times aware that their work is being frequently asked or checked upon.

I hope the above solution is what you were looking for. For any further queries or doubts in the solution, please feel free to drop a comment. Please do leave a positive feedback, Thank you :)