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Accounting Internal Controls

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Discuss Accounting Internal Controls; what they are? why they exist? who regulates them? Give examples.

Identify as many internal control weaknesses as you can in this scenario, and suggest how each could be addressed. (10pts)

Emporia Middle School wants to raise money for a new sound system for its auditorium. The primary fund-raising event is a dance at which the famous disc jockey Obnoxious Ed will play classic and not-so-classic dance tunes.Tom Wickman, the music and theater instructor,has been given the responsibility for coordinating the fund-raising efforts.This is Tom's first experience with fund-raising. He decides to put the eighth-grade choir in charge of the event; he will be a relatively passive observer. Tom had 500 unnumbered tickets printed for the dance. He left the tickets in a box on his desk and told the choir students to take as many tickets as they thought they could sell for $5 each. In order to ensure that no extra tickets would be floating around, he told them to dispose of any unsold tickets.When the students received payment for the tickets, they were to bring the cash back to Tom, and he would put it in a locked box in his desk drawer. Some of the students were responsible for decorating the gymnasium for the dance. Tom gave each of them a key to the money box and told them that if they took money out to purchase materials, they should put a note in the box saying how much they took and what it was used for. After 2 weeks the money box appeared to be getting full, so Tom asked Luke Gilmor to count the money, prepare a deposit slip, and deposit the money in a bank account Tom had opened.The day of the dance, Tom wrote a check from the account to pay the DJ. Obnoxious Ed, however, said that he accepted only cash and did not give receipts. So Tom took $200 out of the cash box and gave it to Ed.At the dance Tom had Mel Harris working at the entrance to the gymnasium, collecting tickets from students and selling tickets to those who had not prepurchased them.Tom estimated that 400 students attended the dance. The following day Tom closed out the bank account, which had $250 in it, and gave that amount plus the $180 in the cash box to Principal Foran. Principal Foran seemed surprised that, after generating roughly $2,000 in sales, the dance netted only $430 in cash. Tom did not know how to respond.

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An internal control is composed of a system within a system. It plays an important role in the success of the accounting system. It protects the business from abuse and fraud and ensures that the data or information received is accurate and timely and that all the regulatory requirements are met.

The five key elements of internal control are as follows:
1) Environmental control refers to the attitude of the management and employee in a given organization. Management goals and objectives will affect employee behavior and in order to maximize productivity, it is important that management must learn to encourage the employees to achieve what they want and never mind the consequence or the internal controls that goes with it. The Human Resources (HR) department is responsible for regulating the attitudes and behavior of management and employees in an organization.
2) Risk Assessment refers to identifying and analyzing the relevant risks to achieve objectives and thus form a basis on how the risks will be managed. In any business there is always business risk and management needs to estimate their importance so that they can react accordingly. It is usually management that regulates risks but employees can also take part in day to day analysis depending on the existence of the risks and dangers in the work environment.
3) Control procedures are the policies and procedures created to make sure that the directives of management are carried out, e.g., environmental controls, risk assessment, monitoring and information communication needed to take place in the internal control process. The purpose of this procedure is to give information, e.g., inadequately trained personnel, eliminate process error that greatly affect the information and communication aspect of the business. What regulate this control are the checks and the balances that assure a business the timely, honest, ...

Solution Summary

The solution identifies and lists the internal control weaknesses of a scenario and some suggestions on how each weakness could be addressed. References included.

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Assessing control risk, internal controls, and analytical procedures

8-15 (Analytical procedures)
In audit planning the audit of Construction Industry Resources, Inc., a building supply company. You have completed analytic procedures relevant to purchases and inventory. The results of these procedures are included in Figure 8.13.

Figure 8.13. Selected Financial Information ($000)
(see attachment for figure)

Analytical procedures show that inventory turnover decreased from 31-34 days to 27 days, and gross margins declined to the lowest level in five years. What might this indicate about the risk of misstatement with respect to inventory and inventory purchases?

8-16 (Analytical procedures)
In audit planning the audit of Circuits Technology, Inc. (CTI). CTI resells, installs, and provides computer networking products (client software, gateway hardware and software, and twinax hardware) to other businesses. Figure 8.14 provides some summary information from CTI's financial statements.

Figure 8.14. CTI Selected Financial Information ($000)
(see attachment for figure)

1. Calculate purchases, gross margin, inventory turn days, accounts receivable turn days, and accounts payable turn days for the years ended 20x2, 20x3, 20x4, 20x5.
2. Describe the trends identified by performing analytical procedures in the gross operating cycle, the net operating cycle, and gross margin.
3. If tolerable misstatement is $45,000 for inventory, develop an expectation range for inventory turn days.
4. With respect to inventory, what might these trends indicate about the potential misstatement in inventory?

10-31 (Components of internal control)
The chapter identified five components of internal control. Listed below are specific control policies and procedures prescribed by Suntron Company.

Management gives careful consideration to the requisite knowledge and skills personnel need at all levels of the organization.
General controls and application controls are established in the electronic data processing department.
Management acts to reduce or eliminate incentives and temptations that might lead individuals to engage in dishonest or illegal acts.
Management is alert to complaints received from customers about billing errors.
Management gives special consideration to the risks that can arise from the use of information technology in the accounting system.
Employees' responsibilities are assigned so as to avoid any individual's being in a position to both commit an error or irregularity and then conceal it.
IT management has designed controls to prevent unauthorized use of IT equipment, data files, and computer programs.
The processing of payroll includes a check on the total number of hours submitted. If more than 65 hours are reported in a weekly pay period, the transaction is printed on an exception report and put in a suspense file for additional review or additional authorization.
Suntron's internal audit staff periodically assesses the effectiveness of various ICS components.
Policy manuals, accounting and financial reporting manuals, and a chart of accounts have been developed and implemented.

Identify the components of internal control to which each policy or procedure relates.
For each item, identify one other policy or procedure for that internal control component that is not on the preceding list.

10-32 (Components of internal control)
Internal controls can be categorized using the following framework.

Control environment
Risk assessment
Information and communication
Control activities
4.1. Authorization
4.2. Segregation of duties
4.3. Information processing controls
4.3.1. Computer general controls
4.3.2. Computer application controls
4.3.3. Controls over the financial reporting process
4.4. Physical controls
4.5. Performance reviews
4.6. Controls over management discretion in financial reporting

Monitoring
Antifraud programs and controls

Following is a list of controls prescribed by Waterfront, Inc.

Management has established a code of conduct that includes rules regarding conflicts of interest for purchasing agents.
Waterfront has established a disclosure committee to review the selection of new accounting policies.
Any computer program revision must be approved by user departments after testing the entire program with test data.
The managers of each of Waterfront's manufacturing departments must review all expenditures charged to their responsibility center weekly.
The CEO, CFO, and controller review the financial consequences of business risks annually to ensure that controls are in place to address significant business risks.
Human resources focuses on ensuring that accounting personnel have adequate qualifications for work performed in billing and accounts receivable.
Security software limits access to programs and data files, and keeps a log of programs and files that have been accessed, which is then reviewed by the security manager daily.
A computer program prints a daily report of all shipments that have not yet been billed to customers.
The controller reviews sales and collections bimonthly.
The computer compares the information on the sales invoice with underlying shipping information.
Customer billing complaints are directed to internal audit for follow-up and resolution.
The documentary transaction trail for all credit sales is documented in company policy manuals.
A committee of the board of directors evaluates and monitors business risks.
Access to spreadsheets used in the financial reporting process is limited and spreadsheets are tested with test data on a quarterly basis.

Indicate the category of internal control applicable to each procedure using the framework above.
Identify an assertion to which each procedure pertains (some procedures may have a pervasive impact on multiple assertions).

11-21 (Assessing control risk)
An auditor is required to obtain a sufficient understanding of each of the components of an entity's system of internal control to plan the audit of the entity's financial statements and to assess control risk for the assertions embodied in the account balance, transaction class, and disclosure components of the financial statements.

1. Explain the reasons an auditor may assess control risk at the maximum level for one or more assertions embodied in an account balance.
2. What must an auditor do to support assessing control risk at less than the maximum level when the auditor has determined that controls have been placed in operation?
3. What should an auditor consider when seeking a further reduction in the planned assessed level of control risk?
4. What are an auditor's documentation requirements concerning an entity's system of internal control and the assessed level of control risk?

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