Question 1

Failure to collect cash on credit sales is a threat in the revenue cycle. What controls
can be used to help neutralize this threat?

Answer:
Both accounts receivable and cash flows should be monitored. Segregation of duty
controls should always be implemented and monitored for compliance. Also, a control
used to deal with accounts receivable (which directly impacts cash flow) is to use an
accounts receivable aging schedule. This schedule lists customer account balances by
length of time outstanding and provides information for estimating bad debts. It can
also assist in evaluating credit policies and specific customer credit limits. Also, a
cash budget can be used to provide a more precise estimate of cash inflows (cash
collected from sales) and cash outflow (outstanding payables). An organization can be
alerted to a pending cash flow shortage, thus enabling it to secure short-term financing
at competitive rates to deal with the problem in a timely manner.

Question 2
Give internal control recommendations for each threat in the sales/collection process.
Threat 1: Sales to customers with poor credit

Threat 2: Shipping errors

Threat 3: Theft of inventory

Threat 4: Failure to bill customers

Threat 5: Billing errors

Threat 6: Theft of cash

Threat 7: Posting errors in updating accounts receivable

Threat 8: Loss of data

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Answer:
Threat 1: Sales to customers with poor credit controls: Having an independent credit
approval function and maintaining good customer accounting can help to prevent problems.

Threat 2: Shipping errors Controls: Reconciling shipping notices with picking tickets (lists);
bar-code scanners; and data entry application controls will help to catch these errors.

Threat 3: Theft of inventory Controls: Secure the location of inventory and document
transfers; release only with valid shipping orders; have good accountability for picking and
shipping; and finally, periodically reconcile records with a physical count.

Threat 4: Failure to bill customers Controls: Separating shipping and billing and
pre-numbering of shipping documents helps along with reconciliation of all sales documents.

Threat 5: Billing errors Controls: Reconciliation of picking tickets (lists) and bills of lading
with sales orders; data entry edit controls; and price lists may prevent billing errors.

Threat 6: Theft of cash Controls: Segregation of duties is essential to prevent this serious
problem (the following duties should be separate: handling cash and posting to customer
accounts; handling cash and authorizing credit memos and adjustments; issuing credit
memos and maintaining customer accounts); use of lockboxes for receipts and EFT for
disbursements; mailing customer statements monthly; use cash registers in retail operations
where cash payments are received; deposit cash daily in the bank; and have the bank
reconciliation function performed by independent third parties.

Threat 7: Posting errors in updating accounts receivable Controls: Use of editing and batch
totals is essential here.

Threat 8: Loss of data Controls: Regular backups are essential with one copy stored off-site;
and logical and physical access controls to prevent leakage to competitors and irregularities.

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Question 3
Since opening its doors in Hawaii two years ago, Oriental Trading has enjoyed
tremendous success. Oriental Trading purchases textiles from Asia and resells them to
local retail shops. To keep up with the strong demand, Oriental Trading is expanding
its local operations, including a new information system to handle the tremendous
increase in purchase.
The following is a summary of your interview with department supervisors who
interact with the acquisition/payment system:

A purchase requisition is sent from the inventory system to Sky Ishibashi, a

purchasing department clerk. Sky prepares a purchase order using the vendor and
inventory files and mails it to the vendor. The vendor returns a vendor
acknowledgement to Sky indicating receipt of the purchase order. Sky then sends a
purchase order notification to Elei Mateaki, an accounts payable clerk.
When the receiving department accepts vendor goods, the inventory system sends Elei
a receiving report. Elei also receives invoices from the various vendors. He matches
the invoices with the purchase order notification and receiving report and updates the
accounts payable master file. Elei then sends a payment authorization to the
accounting department. There, Andeloo Nonu prepares and mails a check to the
vendor. When the check is issued, the system automatically updates the accounts
payable master file and the general ledger.

Required: complete the level 0 DFD acquisition/payment system at Oriental Trading

with the missing words:
Inventory file, vendor file, 1.0 prepare purchase order & notification, 2.0 update
accounts payable, vendor, inventory system, 3.0 pay vendor, accounts payable master
file, general ledger.

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 Inventory Vendor
File File

1.0
Prepare
Purchase
Order &
Notification
Purchase Order
Purchase Requisition

Vendor
Acknowledgement Inventory
Vendor
System
P.O. Notification
Vendor
Invoice
Receiving Report

2.0 Receiving Reports

Update
Accounts
Payable Purchase Orders

Vendor Invoices
Accounts
Payable
Payment Authorization
Master
File

Check 3.0
Pay Vendor

General
Ledger

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Question 4:
As the internal auditor for No-Wear products, you have been asked to document the
company’s payroll processing system. Based on your documentation, No-Wear hopes
to develop a plan for revising the current system to eliminate unnecessary delays in
paycheck processing. The head payroll clerk explained the system:

The payroll processing system at No-Wear Products is fairly simple. Time data are
recorded in each department using time cards and clocks. It is annoying, however,
when people forget to punch out at night, and we have to record their time by hand. At
the end of the period, our payroll clerks enter the time card data into a payroll file for
processing. Our clerks are pretty good – though I’ve had to make my share of
corrections when they mess up the data entry.
Before the payroll file is processed for the current period, human resources send us
personnel changes, such as increases in pay rates and new employees. Our clerks
enter this information into payroll file. Usually, when mistakes get back to us, it’s
because human resources is recording the wrong pay rate or an employee has left and
the department forgets to remove the record.
The data are processed and individual employee paychecks are generated. Several
reports are generated for management – though I don’t know what they do with them.
In addition, the government requires regular federal and sate withholding reports for
tax purposes. Currently, the system generates these reports automatically, which is
nice.

Required: prepare a level 0 DFD to document the payroll processing system at

No-Wear Products with the following missing words:
Human resources department, 1.0 process employee timecards, operating departments,
payroll file, employee, 3.0 generate paycheck, 4.0 generate payroll reports,
management, government agencies, 2.0 update payroll file,

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Question 5:
Lancaster Company makes electrical parts for contractors and home improvement retail
stores. After their annual audit, Lancaster’s auditors commented on the following items
regarding internal controls over equipment:

1. The operations department that needs the equipment normally initiates a

purchase requisition for equipment. The operations department supervisor
discusses the proposed purchase with the plant manager. If there are sufficient
funds in the requesting department’s equipment budget, a purchase
requisition is submitted to the purchasing department once the plant manager
is satisfied that the request is reasonable.

2. When the purchasing department receives either an inventory or an equipment

purchase requisition, the purchasing agent selects an appropriate supplier and
sends them a purchase order.

3. When equipment arrives, the user department installs it. The property, plant,
and equipment control accounts are supported by schedules organized by year
of acquisition. The schedules are used to record depreciation using standard
rates, depreciation methods, and salvage values for each type of fixed asset.
These rates, methods, and salvage values were set 10 years ago during the
company’s initial year of operation.

4. When equipment is retired, the plant manager notifies the accounting

department so the appropriate accounting entries can be made.

5. There has been no reconciliation since the company began operations

between the accounting records and the equipment on hand.

Required: identify the internal control weaknesses in Lancaster’s system, and

recommend ways to correct them.

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Answer:
Weakness
1. No authorization form
describing the item to be
acquired, why it is needed,
expected costs, and benefits.
2. Equipment purchases over a
certain amount are not reviewed equipment. Large purchases should be
and approved by top approved by top management
management.
3. Purchase requisitions for fixed
assets are intermingled with
requisitions for inventory, even
though they are very different
purchases. This results in a
lack of control over the much
more expensive equipment
acquisitions.
4. No mention of pre-numbered
purchase requisitions or
purchase orders.
5. Plant engineering is not
inspecting machinery and
equipment upon receipt.
6. Equipment is not tagged and
controlled to prevent theft.
7. Plant engineering is not helping
with the equipment
Recommendation
The purchase requisition should include an item
description, why the item is needed, estimated
costs and benefits, account code, useful life,
depreciation method, and management approval.
Large sums of money can be spent on
Authorized equipment acquisitions should be
processed using special procedures and purchase
orders.
Copies of equipment purchase orders should be
distributed to all appropriate departments so they
can be monitored.
Pre-numbered purchase requisitions and
purchase orders should be used so that all
documents can be accounted for.
Machinery and equipment should be subject to
normal receiving routines. In addition, plant
engineering should inspect the machines to
make certain the correct item was delivered and
that it was not damaged in transit.
All new machinery and equipment should be
assigned a control number and tagged at the time
of receipt.
Plant engineering should help with the
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 installations. equipment installations to ensure expensive
equipment is not damaged.

8. Machinery and equipment Machinery and equipment accounting

accounting policies, including
depreciation, have not been
updated to make certain that the
most desirable methods are
being used.
procedures, including depreciation, must be
updated periodically to reflect actual experience,
changes in accounting pronouncements, and
income tax legislation.

9. Equipment retirement Equipment retirement schedules, which provide

schedules are not reconciled information on asset cost and accumulated
periodically to general ledger depreciation, should be reconciled to general
control accounts. ledger control accounts at least yearly.

Periodically, a physical inventory of fixed assets

should be taken and reconciled to the equipment
retirement schedule and the general ledger
control account.

Question 6
Traffic accidents increase for many commuters in Philadelphia and result in a series of
legal and insurance steps. There are more than 70,000 automobile accidents reported
each year in Philadelphia, and the city’s police department prepares a report for each
accident. Accident reports are necessary for insurance companies to process claims
and ultimately pay settlements to their customers. Until recently, processing an
accident report was a costly, time-consuming process, taking up to six weeks for a
paper copy to become available. Thanks to the efforts of a unique public/private
partnership and the power of Internet technology, Philadelphia accident reports are
now available to insurance companies in less than one week.

Required:
How would workers in the case have used the SDLC to make the changes described?

Answer:
In the accident reporting system, workers would have identified a need for faster,
more reliable information (initiation / planning).
They would ask system users and potential users about desirable qualities in the new

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system (requirements analysis).
Based on those requirements, designers would lay out database specifications,
prototypes of screen layouts and other elements of the system (design).
A team would use those specifications to build the system (build),
after which it would be tested by a group of users (test).
After further revision based on testing feedback, the system would be deployed
throughout the organization (implementation).
Finally, the system would be run, maintained and updated as necessary (operations /
maintenance).

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