4Case Study 2-Internal Control

If the company decides to go public, there are some internal controls requirements that the company needs to meet. They are: establishment of responsibility, segregation of duties, documentation procedures, physical controls, independent internal verification, and human resource controls. Each of the five components of an internal control system is important. Base on the information provided, there are some things that the company is doing well. First, there is only one person who handles the tax position. This is “establishment of responsibility”; According to the text: control is most effective when only one person is responsible for a given task. By doing this, if there is anything wrong with the tax preparation, the President knows exactly who’s responsible for it. Second, this company uses pre-numbered checks. Pre-numbered checks help to prevent a transaction from being recorded more than once, or from not being recorded at all. This is a good way to apply “documentation procedures” into internal control system. More, the President is doing well when both he and the accountant interview and approve all of the new hires. This activity makes the hiring progress fair and honest. Because the accountant cannot hire someone base on his personal interest. However, there are numerous things that the company is doing poorly, and they definitely need to improve them. First, they have one accountant, also this accountant is serving as Treasurer and Controller. This is a serious issue, because this accountant is handling three tasks: accountant, treasurer and controller. This conflict with rules of “segregation of duties”, also all three tasks are related to each other, there are a lot of room for the accountant to possibly fake the income and expense. According to the text, making one individual responsible for related activities increases the potential for errors and irregularities. Indeed, he all purchases all the supplies and pays for these purchases. Again, there is no segregation of duties. To improve this situation, President needs to hire a Treasurer and a Controller separately. Also, the President should stop letting the Accountant purchase all the supplies and pays for these purchases. He should hire an entry level employee to place all the orders for the company and he needs to hire a secretary to pay for the purchases. After the employee places the order, he/she should give the original receipt to the secretary, at meanwhile, he/she should give the copy of the receipt to Accountant for record. Then the secretary can pay the purchases base on the receipt and always under the President’s approval. If the President is too busy, he can assign it to Treasurer, and then the secretary needs to always get approval from Treasurer. Indeed, this Accountant should no longer receive the checks and completes the monthly bank reconciliation alone. In order to have a better internal control, there should be always two people other than the Accountant to open the envelopes of the checks or receive checks. This activity can significantly reduce the risk of one individual potentially takes the check and cash it for personal use. Once the envelope has been opened or the check has been received, the President should require them to write “deposit only” on the back of the check, because there is no bank will cash the check if there is “deposit only” on the back. Once they receive the checks, they can give them to the Secretary for deposit. After Secretary deposits the checks, she should always give the copies of deposit slips to the Accountant so the Accountant can complete monthly bank reconciliation. All the weakness of this company from above is about “segregation of duties”, “establishment of responsibility” and “documentation procedures”. Besides these three components, I also strongly recommend “independent internal verification”. For example, the President should verify the bank statement with the monthly bank reconciliation from the Accountant periodically or on a surprise basis. Moreover, this company is doing poorly when all employees have access to the petty cash in a desk drawer and all they asked is to place a note if they use any. The President should let Office Manager to be in charge of the petty cash. Under this segregation of duties, the Office Manager is the only one responsible for the petty cash. Also, the Office Manager should write down who, when and how much for every transaction. Also, there is lack of physical control of the check when the checks are picked up by the Accountant and left in his office for pick-up. The Accountant should lock the pay checks into a safe as soon as he arrive office, not before weekend. There is also weakness in human resource control in this company. First, each employee should have their own log on ID and password for computer. This will let the management know who uses the internet for how long and exactly what website. When employee knows the management has access to know the history of internet usage, it’s less likely for him to use internet base on personal interest. Importantly, this company HR department did not do a good background check when they’re hiring. If HR find an employee had been served time for molesting children, there is no way they would hire him, and it wouldn’t be any future problems. HR should always do a background check when they’re hiring, this will reduce employee theft and fraud as well as reduce the chance of hiring dishonest employees. Two tips are: check to see whether job applicants actually graduated from the schools they list; never use the phone numbers they provided for previous employer reference, they always should look it up themselves. Last, it comes to the decision whether or not the President should buy an indelible ink machine. It is an investment for the company asset but a machine does have depreciation. Yes, an indelible ink machine is a good way to reduce the chance of a dishonest employee to change the pay check amount or change the payable names. However, if the President makes all the improvements, the company will improve significantly in internal control, so it reduces the potential of fraud and employee theft. So it really depends on the President’s budget. But my recommendation is there is no need to purchase the indelible ink machine.