problems 2, Role of Internal Aug; CMA 1290 4-¥g ee Leigh Industries has an j consisting of a direcor se! 7 ee of internal audit, Dianebe 5 the corporate controller, who rece i al ineial aude reports. nadine cos f » ies of all department ff auditors, In the past, the compa have relied on’ the work department to a substantia eee Bauer has b being affected by the weer 2 fanetion i iB y the nonaudit work be; formed by the department. This possible hertz objectivity could result in more extensive testing and analysis by the external auditors, The per centage of nonaudit work performed by the internal auditors has steadily increased to about 25 percent of the total hours worked. A sample of five recent nonaudit activities follows. © One of the internal auditors assisted in the preparation of policy statements on internal control. These statements included such things as policies regarding sensitive pay- ments and the safeguarding of assets. © Reconciling the bank starements of the corpo- ration each month is a regular assignment of one of the internal auditors. The corporate controller believes this strengthens the inter- nal control function because the internal auditor is not involved in either the receipt oF the disbursement of cash. ; © The internal auditors are asked to review the for relevance and annual budget each year pela reasonableness before the budget | approved. At the end of each month, Te corporate controller's staff analyzes the FO" ances from budget and prepares &xP 00) tions of these variances. These vivant explanations are then reviewed PY - nal audit staff. ; been © One of the internal auditors te initial involved in the design, installations cory operation of a new COMPUT TT concerne system, ‘The auditor was prima? ory and impleme with the design and imple nal accounting controls 35 evalua runs, n of these controls during the test The internal auditors are sometimes asked to make the accounting, entries for complex transactions as the employees in the accounting department are not adequately trained to handle such transactions, The cor. Porate controller believes this gives an added Measure of assurance to the accurate record- ing of these transactions. Required: a. Define objectivity as it relates to the internal audit function. b. For each of the five nonaudit activities pre- sented, explain whether the objectivity of Leigh Industries’ internal audit department has been materially impaired. Consider each situation independently, ¢. The director of internal audit reports directly to the corporate controller. Does this reporting relationship affect the objectivity of the inter- nal audit department? Explain your answer, d. Would your evaluation of the five situations in Question b change if the director of inter- nal audit reported to the ~udit committee of the board of directors? Explain your answer. 3. Segregation of Function CMA 1288 3-22 An effective system of internal control includes the segregation of incompatible duties. Some of the examples presented represent incompatible duties. Comment on the specific risks (if any) that are caused by the combination of tasks. a. The treasurer has the authority to sign checks bur gives the signature block to the assistant treasurer to run the check-signing machine. b. The warehouse clerk, who has custodial responsibility over inventory in the war house, may authorize disposal of damaj goods. c. The sales manages, who works on commis- sion based on gross sales, approves credit and has the authority to write off uncol- lectible accounts. ; d, The shop foreman submits time cards and distributes paychecks to employees. The accounting clerk posts to individual account receivable subsidiary accounts and ed Scanned with CamScannerae Chapter 1 Auditing, Assuran Performs the reconciliation of the subsi oy ledger and the general ledger control account. 4. Segregation of Duties CMA 1288 3-23 Explain why each of the following combinations of tasks should, or should not, be separated to achieve adequate internal control. a. Approval of bad debt write-offs and the rec- onciliation of accounts payable subsidiary ledger and the general ledger control account. b. Distribution of payroll checks to employees and approval of sales returns for credit. ©. Posting of amounts from both the cash receipts and the cash disbursements journals to the general ledger. 4. Distribution of payroll checks to employees and recording cash receipts in the journal. ¢. Recording cash receipts in the journal and preparing the bank reconciliation. 5. Internal Control CMA Adapted 1289 3-4 Oakdale, Inc., is a subsidiary of Solomon Publishing and specializes in the publication and distribution of reference books. Oakdale’s sales for the past year exceeded $18 million, and the company employed an average of 65 employees, Solomon periodically sends a member of its internal audit department to audit the opera. tions of each of its subsi jaries, and Katherine Ford, Oakdale’s treasurer, is currently working with Ralph Johnson of Solomon's internal audit staff. Johnson has just completed a review of Oakdale’s investment cycle and prepared the fol. lowing report. General Throughout the year, Oakdale has made both short-term and long-term fnvestments in secari, ties all securities are registered in the company’s ‘name. According to Oakdale's bylaws, long-tecm investment activity must be approved by it board of directors, while short-term investmnens activity may be approved by either the president or the treasurer. Transactions oe Oakdale has a computer link with its broker; thus, all buy and sale orders are transmitted ce, and Internal Com ero" ically. Only individuals with autho, electro may initiate certain tyes of trays’ passwort purchases and sales of short-term got tions. Mtge year were made by the treasure fits vr, ewo purchases and one sale of loq® adeimartes were executed by the tease by the Board. The president, having onlin. iehorzation access coal transactions, was je aummoprove a sale of a long-term securiy, Te preseden is given access to authorize all transac Fons engaged in by the firm. Because the trey, ter is listed with the broker as the company, Contact, all revenue from these investments ig received by this individual, who then forward the checks to accounting for processing, Documentation Purchase and sales authorizations, along with brokers’ advice, are maintained in an electronic file with authorized access by the treasurer Brokers’ advice is received verbally on the phone, and this advice is noted on a broker advice form, This form is filed by the treasurer. The certificates for all long-term investments are kept in a safe deposit boy at the local bank; only the president of Oakdale has access to this box. An inventory of this box was made, and all certificates were accounted for. Certificates for short-term invest- ments are ‘kept in a locked metal box in the accounting office. Other documents, such as long- (ort contracts and legal agreements, are also kept inthis box. There are three keys to the box, held by the president, treasurer, and the acconntite able ate accounting manager's key is av require dec accounting. Personnel, should they Of invest mets Kept in this box. Certificates receive af AY fake up to. four weeks (0 electronic inven: ro nase Of the investment. An pas sconetony list is kept perpetually. a receive q str ¥ Accounting personnel ce Heeasurer The ar ransaetion sheet from a ing manager all he lent, treasurer, and aceon update this inve Ve Passwords to access a Accounting manager is ot tion for two of the current 0 ocumentat inv ‘estments could not be located Scanned with CamScannerthis box; the account i "gm explained that some ofthe inveggneon °F for such short periods of time that eae “ al documentation is not always prot eae 8 Provided by ‘Accounting Records Deposits of checks for interest and divi dends earned on investments are recorded by the accounting department, but these checks could not be traced to the cath receipts journal maintained by the in vidual who normally opens, stamps, and logs incoming checks. These amouris me journalized monthly to an account for investment revenue. Electronic payments for investment purchases are authorized by the treasurer. If the amount is in excess of $15,000, an authorization code given by the treasurer or president is necessary. Each month, the accounting manager and the treasurer prepare the journal entries required to adjust the short-term investment account. There was insutf cient backup documentation attached to the journal ¢:.iries reviewed to trace all transactions; however, the balance in the account at the end of last month closely approximates the amount shown on the statement received from the broker. The amount in the long-term investment account is correct, and the transactions can be clearly traced through the docu- mentation attached to the journal entries. No attempts are made to adjust either account to the lower of aggregate cost oF market. Required: To achieve Solomon Publi jee tive of sound internal control, the cont Pany believes the following four contro are basic for an effective syste™ accounting control. , © Authorization of transaction © Complete and accurate recor * Physical control © Internal verification 4 Describe the purpose of © four controls listed above: ishing’s objec 5 J keepin ach of the b. Identify. arca in Oakdale’s invest- n tent Procedures that violates each of He four controls listed above. i cach of the violations identified, describe how Oakdale can correct Internal Control CMA 1290 4.2 Arlington Industries manufactures and sells component engine parts for large industrial equipment. The company employs over 1,090 workers for three shifts, and most employees work over. time when necessary. Arlington has had major growth in its production and has purchased a mainframe computer to han- dle order processing, inventory manage- ment, production planning, distribution operations, and accounting applications. Michael Cromley, president of Arlington, suspects that there may be internal con- trol weaknesses due to the quick imple- mentation of the computer system. Cromley recently hired Kathleen Luddy as the internal control accountant. Cromley asked Luddy to review the payroll processing system first. Luddy has reviewed the payroll process, interviewed the individuals involved, and compiled the flowchart shown on the next page. The following additional information concerns payroll processing: ‘@ The personnel department determines the wage rate of all employees at Arlington. Personnel starts the process by sending an authorization form for adding an employee to the payroll to Marjorie Adams, the pay- roll coordinator. After Adams inputs formation into the system, the automatically determ ¢ and shift differential updating the this computer the overti rates for the individ payroll master files / fe Arlingcon uses an external service to provide monthly paycoll cx upalaes. ‘The company ree gnetic tape every month, which the data process- fing department installs (o update the payeoll master file for tax calculations. Scanned with CamScanner 37