Question

Simon Blank Construction Company has two divisions. The president (Chris Simon) manages the roofing division. Simon delegated authority and responsibility for management of the modular manufacturing division to John Gault. The company has a competent accounting staff and a full-time internal auditor. Unlike Simon's procedures, however, Gault and his secretary handle all bids for manufacturing jobs, purchase all materials without competitive bids, control the physical inventory of materials, contract for shipping by truck, supervise the construction activity, bill the customer when the job is finished, approve all bid changes, and collect the payment from the customer. With Simon's tacit approval, Gault has asked the internal auditor not to interfere with his busy schedule. Give this scenario a letter grade based on risk management through internal controls and identify two potential frauds that could occur based on the current structure. Suggest at least one improvement to reduce the risk of fraud.

Answer 1

In the given scenario, the internal controls in the modular manufacturing division are very weak.

John Gault and his secretary handle all the work in the department including purchasing all the materials without any competitive bids, control the physical inventory of materials,entering into contract for shipping by truck,supervision of the construction activity, billing the customer when the job is finished, approving all bid changes and collecting the payment from the customer.

There is no check on their activities. They can easily indulge in fraud activities without anyone knowing about it.

Potential frauds based upon current structure -

1. John Gault and his secretary could team up and purchase the material at a price higher than the market price from their known suppliers and share the price difference among themselves.

2. John Gault can misplace some inventory by showing excess quantity issued to production than the actual quantity issued.

Suggested improvement to reduce the risk of fraud -

1. Currently all the responsibilities lies with Mr. John. He has the freedom to do anything the way he wants. The resposibilities in the department must be segregated with other individuals in the department instead of only Mr. John handling all the activities.

2. Transactions involving high funds should require written approval by Mr. Chris Simon.