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Internal Control & auditing of financial statement

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1). Alternative Distributor Corp., a distributor of groceries and related products,
is headquartered in Medford, Massachusetts.

During a recent audit, Alternative Distributor Corp. was advised that existing internal
controls necessary for the company to develop reliable financial statements were inadequate.
The audit report stated that the current system of accounting for sales, receivables,
and cash receipts constituted a material weakness. Among other items, the report focused
on non-timely deposit of cash receipts, exposing Alternative Distributor to potential loss
or misappropriation, excessive past due accounts receivable due to lack of collection
efforts, disregard of advantages offered by vendors for prompt payment of invoices, absence
of appropriate segregation of duties by personnel consistent with appropriate control
objectives, inadequate procedures for applying accounting principles, lack of qualified
management personnel, lack of supervision by an outside board of directors, and overall
poor recordkeeping.

(a) Identify the principles of internal control violated by Alternative Distributor

(b) Explain why managers of various functional areas in the company should be concerned
about internal controls.

2).You are a loan officer for Lakeland Bank of Port Washington. Edmund Jeffries,
president of E. Jeffries Corporation, has just left your office. He is interested in an 8-year
loan to expand the company's operations. The borrowed funds would be used to purchase
new equipment. As evidence of the company's debt-worthiness, Jeffries provided you with
the following facts.
2007 2006
Current ratio 3.1 2.1
Asset turnover ratio 2.8 2.2
Cash debt coverage ratio .1 .2
Net income Up 32% Down 8%
Earnings per share $3.30 $2.50

Jeffries is a very insistent (some would say pushy) man. When you told him that you
would need additional information before making your decision, he acted offended, and
said, "What more could you possibly want to know?" You responded that, at a minimum,
you would need complete, audited financial statements.

(a) Explain why you would want the financial statements to be audited.

(b) Discuss the implications of the ratios provided for the lending decision you are to
make. That is, does the information paint a favorable picture? Are these ratios relevant
to the decision?

(c) List three other ratios that you would want to calculate for this company, and explain
why you would use each.

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Solution Preview

Internal controls are implemented by organizations to ensure accurate financial reporting, maintain compliance with regulatory laws, protecting physical and intangible resources, and effective control of organizations operational activities. Internal controls play a major role in enhancing organizational performance, hence it is considered to be sound business practice for organizations to continuously evaluate and strengthen its internal controls. Some economist attribute the slumping United States (US) economy to a complex set of social and economic factors; one of which is poor management of internal control systems (Sahlman, 2009).
Consider the flawed internal control system at Alternative Distributor Corporation (ADC) revealed by the audit conducted on the organization. The audit indicated the organization failed to ensure accuracy in its accounting and operating data hence did not pass the test of reliability (Strauss, 2003). Unreliable accounting record keeping for sales, receivables and cash receipts are key material weakness which creates issues in determining the financial condition of the organization. The issues facing the company include: 1) The inability to accurately project cash flows, 2) The inability to accurately calculate and manage financial ratios of the firm, 3) Inability to determine profitability and organizational performance.
A second internal control principle violated by ADC is the inability to effectively maximize capital resources by protecting against waste and inefficiency. The audit reports indicated evidence of non timely deposits of cash receipts which has an adverse impact of cash flow and potential business opportunities. In addition, failure to appropriately manage the receivable assets due to untimely and inefficient collection methods impacts the bottom line of the organization in the short and long term (Strauss, 2003). Failure to take advantage of payment terms offered by vendors indicates flaws in the organization's payment terms policy because of loss of the potential return on capital which results in waste of capital resources.
A key internal control principle violated by ADC is the failure to appropriately segregate duties. The segregation of duties ensures appropriate checks and balances thus preventing fraud. Duties should be segregated in such way that different employees are responsible for different elements of related activities especially when it entails recordkeeping and authorization. It is critical that the company institute a systematic process for authorizing transactions to ensure synergy in operations, reliability of data and efficiency.
The organization's lack of appropriate procedures for applying accounting principles is a major violation of internal controls because of the inability to accurately report accounting ...

Solution Summary

Internal control and auditing of financial statements are examined.