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Meklit Girma

Rachel Grande
Abosede Olofi
Mie Rattanawatkul
Case Study Assignment: Phoenix House
1. Identify and explain the internal control weaknesses of Phoenix House. Provide
suggestions as to how to correct each of these weaknesses.
Phoenix House had several internal control weaknesses which lead to the company experiencing
a fraud problem. We identified internal control weaknesses such as conflict of interest, balancing
risks and controls regarding segregation of duties, and weaknesses with how the board of
directors are handling certain situations.
Conflict of Interest:
One of the internal control weaknesses of Phoenix House is conflict of interest. Conflict of
interest is a term used to describe the situation in which a public official or fiduciary who,
contrary to the obligation and absolute duty to act for the benefit of the public or a designated
individual, exploits the relationship for personal benefit, typically pecuniary
(TheFreeDictionary 2015). The director, Nora Sadstone, hired her husband to paint the resident
apartments. Noras husband was paid as an independent contractor and the amount paid to him
was greater than one would normally be paid. Nora now has a personal benefit resulting from her
husbands contract with the Phoenix House. The biggest factor to this internal control weakness
is the lack of oversight by the Board of Directors at the Phoenix House. The Board, nor anyone
else, reviews Noras work and she is free to commit funds for any housing related project and
anything else she pleases. To correct this internal weakness, the Board of Directors should
oversee Noras work and create a process where they can ensure that conflict of interest is not in
occurrence. The hiring process of an independent contractor should be approved by the Board
and chosen with objectivity, so relatives of employees would not be contracted to perform any
projects for the Phoenix House.
Balancing Risks and Controls - Segregation of Duties:
The failure to segregate the duties of disbursing, recording and reconciling checks is a critical
mistake for any business, big or small. The lack of segregation of duties grants an individual the
ability to consistently commit and conceal their fraud for longer periods of time. Nora Sadstone
took advantage of her position as a trusted employee and defrauded her employer for several
months. This fraud would have been much harder to commit if her duties were properly
segregated to others within the organization. Nora had the responsibility of signing checks to
cover expenditures as well as the responsibility of initially authorizing those expenditures.
Therefore, she has the ability to take advantage of her authority and approve an expenditure that
does not exist in the books. Nora could sign the check for that expenditure after it gets approved
by the bookkeeper, and she can deposit those funds into her own personal account. Phoenix
House is a relatively small company, but there are still several ways to solve this issue. For
example, a Board member can look over the documents relating to the expenditure, and after

making sure all information is reviewed to the best of their knowledge, he or she can sign the
checks periodically, on a specified basis. There should always be a second signer for internal
control purposes, and each check should be logged and documented under efficient means.
Ultimately, there may be no one right answer to this issue, the solution is unique to each
company based on size and employees. The first step should be to identify where exactly the
segregation of duties conflicts exist through a risk-based examination of its key business
processes. Phoenix House should ask questions like, What are the tasks being performed in each
business area? Who is performing these tasks? Who has access to perform these tasks within the
financial application? Answering these questions would be the initial step in correcting major
deficiencies in the proper segregation of duties.
Board of Directors:
Many of the internal control issues stem from Nora not being accountable for her actions.
Phoenix placed too much confidence in Nora that she would be a responsible and honest
employee. Phoenix had a lack of oversight by the board of directors because no one was over
seeing some of Noras actions such as how many hours she was truly working, what payroll
checks she was signing, and payments she was making on the company credit card.
Nora was allowed to keep track of her own work hours and submit those hours to payroll. Since
Nora did not have a supervisor keeping track of how many hours she actually worked, she was
able to work less hours for the same amount of pay. Nora also never repaid an advance that she
received and took extra compensation for unused vacation time. Noras activities could have
been monitored by a supervisor on a daily basis. Nora could have also kept a time-sheet to
indicate where she was and how many hours she was at that specificied area.
Furthermore, Nora approves and signs her own payroll checks. This can cause issues because if
her paychecks were incorrect in any way, there is a possibility that she would accept a paycheck
that might have been for too high of an amount. The board should have more involvement when
it comes to the authorization to sign payroll checks.
Another activity that Nora abuses is her unlimited use of the company credit card without any
evidence of what she is purchasing. The Board should require Nora show monthly bank
statements and actual documentations that support all the transactions that take place on the
company credit card.
2) How should the Directors hours worked or not worked be supported? Devise a system
to account for the Directors hours.
The system that can be implemented in order to account for the directors hours should be a time
card system that electronically stamps the time that the director or any other employees arrive
and/or leave work. The system/software should require all employees including the director to
clock in at the beginning of his or her shift and also at the end, and any day that an employee
does not clock in his or her pay will be deducted in place for all employees.
The software should also require, each employe including the director to give a brief narrative of
what kind of work he or she performed every hour and to give a daily (minimum) and a weekly
(maximum) summary of how many hours were allocated to a type of work. This will help
increase accountability for all employees. A report should be generated by the software and these

weekly reports should be sent to the director for review with the directors records to be provided
to the board of directors for review.
With these system in place, each employee including the director will feel like their every action
is being monitored by the board of directors. This might take some time and lots of resources to
implement but this will remind Phoenix house about the lack of internal control it once had and
help ensure that the proper controls are implemented to protect the integrity of the facility.
3) Comment on the thoroughness of the fraud audit. If you believe the auditors should have
done more, what should they have done and how should they have done it? State and keep
in mind the fraud triangle.
It is not a requirement for auditors to support an opinion and the engagement letter determines
the work performed (Bolt-Lee, C.E., Kern, S., 2015). While completing a fraud audit, the auditor
should gather evidence not only relating to the fraud, but also relating to legal processes directed
towards the fraud (AICPA, 2015). We believe the fraud audit was performed correctly
considering the limitation on determining the monetary amount of the fraud. The thoroughness of
the fraud is very difficult to measure because there was no description of the procedures
performed by the auditors. There was no more information than the amount that was stolen
($27,000), and it was believed that Sally was the only fraudulent individual. There was no desire
for further investigation or further evidence gathering. Nora Sadstone was also guilty of fraud,
and her actions superseded those of Sallys overtime, but because her fraudulent activities
werent exposed, there were no consequences. Nora and her husband filed for bankruptcy; filing
for bankruptcy would have been a red flag to the court if they chose to pursue the fraud further.
However, Nora shredded many documents that would have indicated her involvement in the
fraud, and that alone could hinder any further investigation by the court.
Triangle of Fraud
Characteristics of the fraud triangle: incentive, opportunity, and rationalization (Association of
Certified Fraud Examiners, 2015).
The engagement team should have asked the question If someone were to commit fraud, how
would it be done or what motive would someone have to commit fraud? Nora had recently filed
for personal bankruptcy giving her every motive. Nora also had all the responsibility when it
came to handling the money. If the engagement team would have realized that Nora had motive
and the ability to compete fraud there would have been a less likely chance that she could have
competed the fraud.
Assessing Controls to Management Override issues
Interviewing employees within the firm would have brought to light on the improper actions of
the director. Since management is often in a position to override controls in order to commit
loopholes and/or any financial-statement fraud, the auditors should have tested for management
override of control as mentioned in the beginning of this paragraph.

References
AICPA, AICPA Code of Professional Conduct, retrieved on November 17, 2015.
AICPA, Consideration of Fraud in a Financial Statement Audit, retrieved on November 17,
2015.
Association of Certified Fraud Examiners. (2015). The Fraud Triangle. Retrieved from
http://www.acfe.com/fraud-triangle.aspx on November 17, 2015.
Bolt-Lee, C.E., Kern, S, Highlights of fraud research, Journal of Accountancy, November
2015.
Mathers, R.A., Schrock, N., (2014). Practical approaches to common conflicts of interest.
Retrieved from http://www.thetaxadviser.com/issues/2014/may/tpr-may14.html on November 17,
2015.
TheFreeDictionary.com, Conflict of Interest, retrieved on November 17, 2015.
Whittington, R.O., Pany, K. (2015). Professional Ethics. In Principles of Auditing & Other
Assurance Services (pp. 35-66). New York, NY: McGraw Hill Education.
Whittington, R.O., Pany, K. (2015). Professional Standards. In Principles of Auditing & Other
Assurance Services (pp. 35-66). New York, NY: McGraw Hill Education.