ACCT 504 Case Study 2
Keller Graduate School
DeVry University

ABSTRACT
There are several internal control requirements that need to be put into place if the company decides to go public. Those principals are establishment of responsibility, segregation of duties, physical controls, independent internal verification, documentation procedures and human resource controls. Establishment of responsibility is making sure that only designated personnel has the authority to handle certain financial responsibilities. Segregation of duties is ensuring that different individuals have different responsibilities. A physical control is having the proper items that need to be secure in a place that has limited access. Independent internal verification is having individuals confirm the information that is received by various departments to make sure there is accuracy in the documents and reports that are being reported. Documentation procedures is using proper documentation to keep records accurate and having supporting evidence for the transactions that had taken place to make sure that fraud has not occurred. Human resource is handling personnel issues such vacations, conducting background checks and issuing bond personnel for the individuals who handle cash. All of these internal control principals are important to protect the company’s assets, increase the effectiveness of the operations and ensure compliance with laws and regulations. These controls also heighten the accuracy and reliability of accounting records.

The company is doing some things well. On payday, the accountant picks up checks and leaves them in his office for pick-up. He also locks up the checks into a safe in his office when he leaves for the weekend. This practice is a great example of physical controls of the paychecks to ensure that the checks are not mishandled. With the accountant using pre-numbered invoices, the documentation procedure principle is important to account for them in sequence. I would recommend that the President should approve the purchase of the indelible ink machine to print their checks, which would apply to the documentation procedure principle. Since the ink cannot be erased or washed away, this would prevent fraud in changing the payee, the amount or check number. This will protect the company from theft by the employee handling payments.
There are several internal controls that require some improvements. We must take a look at the procedures that are currently in place for petty cash. Currently, there is no way to maintain an accurate accounting on the funds and documentation needed to prove the transaction. The petty cash procedures violate the following internal control principles: segregation of duties, documentation procedures, physical controls, independent internal verification and human resource controls. The accountant has an establishment of responsibility by being the custodian of the petty cash. The accountant needs to locked the petty cash box or drawer and not allow individuals access to come or go as they please. To guarantee that documentation procedures are followed, pre-numbered cash receipts should be signed by the accountant and the individual that is receiving the payment. The accountant should make payments from the fund but a different individual should review the petty cash receipts and other documentation before replacing the funds. This will show a segregation of duties to ensure that there is proper documentation for the petty fund that has been paid out. The same individual that reviews the receipts also needs to perform independent internal verification. The company also may want to bond the employees that are handling the petty cash fund under the human resource controls.

The company had difficulty figuring out what employee had been watching pornography on the company’s computer because there are no individual passwords assigned. The internal control that was violated was physical control. The company needs to assign all of the employees their own IDs and passwords for the computers. This way the company can monitor the activities of the employees on the computers and if an issue arises, they can establish responsibility quickly. Although the president and accountant interviews and approve all of the new hires, one of the employees was a convicted felon. This violates the human resource control and they also need to have someone to assist in the new hire process by having an individual handle the background checks of all the potential employees.

The accountant is wearing too many hats as the treasurer and the controller. He is responsible for all of the financial transaction such as purchases all of the supplies and pays for these purchases. He also received the checks and completes the monthly bank reconciliation. The internal controls that are dishonored are establishment of responsibility, segregation of duties and independent internal verification. The accountant can maintain his role as controller but another individual needs to wear the hat of treasurer. The treasurer’s duties should include paying for purchases made, signing checks and receiving cash. The accountant should count the daily receipts, compares total receipts to bank deposits daily, compare checks to invoices and reconcile bank statement monthly to maintain the independent internal verification. There needs to be an employee that does the entire recording such as cash receipts and disbursements. If your company follows this suggestion, you will meet the internal control requirements and minimize the potential for fraud in your company.

1. Inform the President of any new internal control requirements if the company decides to go public. a. A key distinction of a company going public over a private company is that the public company must abide by the rules of the Security Exchange Commission. One of the tasks a new public company will undertake is providing the financial details of the entity, which will be readily available to the public – thus known as financial reporting. The Committee on Sponsoring Organizations framework is widely regarded as an appropriate and comprehensive basis to document the assessment of internal controls over financial reporting. It is important that LJB Company reviews and implements these standards.

2. Advise the President of what the company is doing right (they are doing some things well) and also recommend to the President whether or not they should buy the indelible ink machine. When you advise the President, please be sure to reference the applicable internal control principle that applies. a. There are some tasks that the company is doing well. These tasks consist of using pre-numbered invoices, and placing the payroll checks that were not retrieved into a safe. “Pre-numbering helps to prevent a transaction from being recorded more than once, or conversely, from not being recorded at all. Second, the control system should require that employees promptly forward source documents for accounting entries to the accounting department. This control measure helps to ensure timely recording of the transaction and contributes directly to the accuracy and reliability of the accounting records. (Kimmel, 341). The application of documentation procedures and physical control can be seen with the referenced tasks. Additionally, we would recommend that the company purchases an indelible ink machine to print checks. Investing in the indelible ink machine will further add to the control of checks – which intern will assist with the mitigation of risk and fraud.

3. Advise the President of what the company is doing wrong (they are definitely doing some things poorly). Please be sure to include the internal control principle that is being violated along with a recommendation for improvement. a. There are some areas that raise red flags, which cause concern. The internal control principles that need to be re-evaluated are segregation of duties, cash controls, access controls and human resource controls. We understand that LJB Company is a small company and that many of its employees have been there for several years. However, it is a disservice to the company to give so much authority to any one person. The duties of the Treasurer and Controller should not be combined. “The rationale for segregation of duties is this: The work of one employee should, without a duplication of effort, provide a reliable basis for evaluating the work of another employee” (Kimmel 339). Additionally, stricter control policy should be enacted for cash controls. “Cash is the one asset that is readily convertible into any other type of asset. It also is easily concealed and transported, and is highly desired. Because of these characteristics, cash is the asset most susceptible to fraudulent activities. In addition, because of the large volume of cash transactions, numerous errors may occur in executing and recording them. To safeguard cash and to ensure the accuracy of the accounting records for cash, effective internal control over cash is critical” (Kimmel 346). Petty cash should not be a free-for-all. b. Access controls seem to be lacking at LJB Company. Access controls limit access to programs, files, and hardware to those who require it in the performance of their duties. LJB Company should not have to force someone to admit to an issue. User access log would generate a report that cannot be called to question. c. Controls are also needed for the Human Resources department. Necessary checks would include a criminal history and background check. It can be a huge liability for LJB Company to hire a person that is in conflict with the company’s values. d. Internal control is a process designed to provide reasonable assurance about the achievement of the entity’s objective. When a company goes public, it essentially allows the gates open to the public for scrutiny. None-the-less this is not a bad thing, but LJB Company must ensure that its policies on internal control are not compromised.

References
Kimmel. Financial Accounting, 6th Edition. John Wiley & Sons.