12-22 (Objective 12-2) The following are partial descriptions of internal controls for companies engaged in the manufacturing business:
1. When Mr. Clark orders materials, an electronic copy of the purchase order is sent to the receiving department. During the delivery of materials, Mr. Smith, the receiving clerk, records the receipt of shipment on this purchase order and then sends the purchase order to the accounting department, where it is used to record materials purchased and accounts payable. The materials are transported to the storage area by forklifts. The additional purchased quantities are recorded on storage records.
2. Every day, hundreds of employees clock in using their employee identification cards at Generous Motors Corporation. The data on these time records is used in the preparation of the labor cost distribution records, the payroll journal, and the electronic payments and payroll checks. The treasurer, Angela Lee, compares the payroll journal with the payroll records, signs the checks, and returns the payroll notifications and checks to Charles Strode, the supervisor of the computer department. The payroll checks and payment notices are distributed to the employees by Strode.
3. The smallest branch of Connor Cosmetics employs Mary Cooper, the branch manager, and her sales assistant, Janet Hendrix. The branch uses a bank account to pay expenses. The account is kept in the name of “Connor Cosmetics—Special Account.” To pay expenses, checks must be signed by Cooper or by the treasurer, John Winters. Cooper receives the cancelled checks and bank statements. She reconciles the branch account herself and files cancelled checks and bank statements in her records. She also periodically prepares reports of cash disbursements and sends them to the home office.
a. List the deficiencies in internal control for each of these situations. To identify the deficiencies, use the methodology that was discussed in this chapter.
b. For each deficiency, state the type(s) of misstatement(s) that is (are) likely to result. Be as specific as possible.
c. How would you improve internal controls for each of the three companies?*
12-23 (objective 12-3) Internal controls 1 through 5 were tested in prior audits. Evaluate each internal control independently and determine which controls must be tested in the current year’s audit of the December 31, 2016, financial statements. Be sure to explain why testing is or is not required in the current year.
1. The general ledger accounting software system automatically reconciles totals in each of the subsidiary master files for accounts receivable, accounts payable, and inventory accounts to the respective general ledger accounts. This control was most recently tested in the prior year. No changes to the software have been made since testing and there are effective controls over IT security and software program changes.
2. The accounts payable clerk matches vendor invoices with related purchase orders and receiving reports and investigates any differences noted. This control was tested in the 2015 fiscal year-end audit. No changes to this control or personnel involved have occurred since testing was performed.