Question

You set up your own business in merchandising sector in Scranton, PA - opening a luxury watch shop on 1/1/2020.

The following is related information about the business:

-   Specific sub-sector: Merchandising sector.

-   Location: Scranton, PA

-   Business model: merchandiser - buying and selling luxury watches.

-   Investment by owner: $1,000,000

- You hired a shop manager. In order to handle different aspects of business, you had one employee responsible for the purchasing, receiving, and storing of watches purchased. A second employee is responsible for the maintenance of account receivable records and collection from customers. A third employee has responsibility for personal records, timekeeping, preparation of payrolls, and distribution of payroll checks. As a part of his job, the shop manager would do some internal control functions. In addition, you hired one security officer, and 4 full-time sales assistants.

Requirements:

1. Based on information given above, identify at least 3 internal control weaknesses that the company has – be specific and explain why those are weaknesses.

2. Set up an effective Internal Control System for your business using 5 different internal control elements. Be very specific with each element.

Answer 1

Weakness in the Exisitng system:

1. Single person is handling purchases and receipt of Goods, maintaining Payable and also writing checks to them.
2. Single person handling books of accounts payable as well their collections.
3. Single person handling attendance, keeping track of time record and writing checks for salary payments.
4. All internal control functions handled by one single person.

All the above weaknesses lack segregation of duties and effective supervision.

The internal control using the five elements would include:

• Building a internal control enviornment: Framing out an environment where in work of one employee is effectively supervised with proper separation of work to be established. Employees who handle assets shall not handle it's records. Also making the employees ethically responsible and building a sense of integrity should be made.
• Assessment of the Risk: As evaluated above, the present system is very much prone to risk of loss of assets in several ways. Thus a proper evaluation of flow of the business to assess the potential risk factors to be made. Once the potential risks are identified controls have to framed and put in place. Periodically these controls have to be assessed to check of they're adequate or requires any improvement.
• Control activities: Separating the activities between employees viz he who handles goods shall not handle books, he who handles books shall not write checks, he who maintains attendance shall not write salary checks. Implementing a system where work of one employee come under supervision of another automatically as a part and parcel of work. Documentation of internal controls and making manager overall responsible for the effectiveness and efficiency of the controls.
• Flow of information: Communication is key success factor in any effective internal control enviornment. So system wherein any information is effectively communciated between employees so they can dishcarge their duties diligently to be implemented. Also a system where communication of any loopholes in the controls identified by any employee to be implemented  
• Effective supervision: The biggest drawback of the present system is lack of monitoring. Hence the proposed system where one person's work gets under supervision of another. This will make early detection of errors and fraud in the system.