Business Processes

and Internal Controls

Tutorial 7

Faculty of Business and Law | Accounting CRICOS Provider Code 00301J

 Lecture points from lecture 6

• What were last weeks key lecture points?

Faculty of Business and Law | Accounting CRICOS Provider Code 00301J

 Lecture points from lecture 6

• Threat, exposure and likelihood

• Internal control defined

• Expected loss (=exposure * likelihood)

• Risk identification and management

Faculty of Business and Law | Accounting CRICOS Provider Code 00301J

 TQ 7.1.1

Assume that three quotes from potential vendors are to be obtained to purchase a new item values at $3,000. The
Purchasing Manager is to select one of the three new vendors. Discuss the accounting duties related to the process of
selection of new vendor which eventually will be inserted in the approved vendor list or vendor master file or supplier
master file.

Faculty of Business and Law | Accounting CRICOS Provider Code 00301J

 TQ 7.1.1

Assume that three quotes from potential vendors are to be obtained to purchase a new item values at $3,000. The
Purchasing Manager is to select one of the three new vendors. Discuss the accounting duties related to the process of
selection of new vendor which eventually will be inserted in the approved vendor list or vendor master file or supplier
master file.

The Purchasing Policy will dictate the process of vendor selection depending on the value of the transaction. As
stipulated in the Purchasing Policy, the Purchasing Manager (PM) has the authority to select the new vendor for
transactions below certain amount. Should he/she be inserting the new vendor into the approved vendor list or vendor
master file? If no why? Because the PM has the authority to select the new vendor. Who should be doing the recording
of new vendor in the approved vendor list or vendor master file? Not the purchasing agent. Who then?

Faculty of Business and Law | Accounting CRICOS Provider Code 00301J

 TQ 7.1.2

Should a purchasing agent, who is empowered to prepare and authorize purchase order, be allowed to maintain the
approved vendor list or vendor master file? Justify your answer.

Faculty of Business and Law | Accounting CRICOS Provider Code 00301J

 TQ 7.1.2

Should a purchasing agent, who is empowered to prepare and authorize purchase order, be allowed to maintain the
approved vendor list or vendor master file? Justify your answer.

No. Since the purchasing agent has authority to finalise the PO, recording of vendors in the approved vendor list or vendor
master file creates conflict of interest.

Faculty of Business and Law | Accounting CRICOS Provider Code 00301J

 TQ 7.1.3

Which area should be approving payment for vendor invoices? What kind of accounting duties does this area has in
relation to the expenditure cycle transaction? Discuss the procedure involved.

Faculty of Business and Law | Accounting CRICOS Provider Code 00301J

 TQ 7.1.3

Which area should be approving payment for vendor invoices? What kind of accounting duties does this area has in
relation to the expenditure cycle transaction? Discuss the procedure involved.

Accounts payable. Recording. Check the vendor invoice with the relevant purchase order and receiving report for valid
transaction and accurate amount

Faculty of Business and Law | Accounting CRICOS Provider Code 00301J

 TQ 7.2

Problem 7.2 (Romney text page 251 a to g)

Explain how the principle of separation of duties is violated in each of the following situations. Also, suggest one or more
procedures to reduce the risk and exposure highlighted in each example.

Faculty of Business and Law | Accounting CRICOS Provider Code 00301J

 TQ 7.2

a) A payroll clerk recorded a 40-hour work week for an employee who had quit the previous week. He then prepared a
paycheque for this employee, forged her signature, and cashed the cheque.

Faculty of Business and Law | Accounting CRICOS Provider Code 00301J

 TQ 7.2

• PROBLEM: Record time worked and to prepare the payroll cheque (custody).

Faculty of Business and Law | Accounting CRICOS Provider Code 00301J

 TQ 7.2

• PROBLEM: Record time worked and to prepare the payroll cheque (custody).

• SOLUTION: Custody of cheques should be done by a different person from the recording
duty (performed by payroll clerk).

Faculty of Business and Law | Accounting CRICOS Provider Code 00301J

 TQ 7.2

b) While opening the mail, a cashier set aside, and subsequently cashed, two cheques payable to the company on account.

Faculty of Business and Law | Accounting CRICOS Provider Code 00301J

 TQ 7.2

• PROBLEM: Cashier has custody of the cash, as well as potential to endorse the cheques (authorisation), and
record their receipt.

Faculty of Business and Law | Accounting CRICOS Provider Code 00301J

 TQ 7.2

• PROBLEM: Cashier has custody of the cash, as well as potential to endorse the cheques (authorisation), and
record their receipt.

• SOLUTION: Cashier should only have the custodial duty.

Faculty of Business and Law | Accounting CRICOS Provider Code 00301J

 TQ 7.2

c) A cashier prepared a fictitious invoice from a company using his brother-in-law’s name. He wrote a cheque in payment
of the invoice, which the brother-in-law later cashed.

Faculty of Business and Law | Accounting CRICOS Provider Code 00301J

 TQ 7.2

• PROBLEM: Cashier has custody of the cheque, and can approve the invoice for payment (recording).

Faculty of Business and Law | Accounting CRICOS Provider Code 00301J

 TQ 7.2

• PROBLEM: Cashier has custody of the cheque, and can approve the invoice for payment.

• SOLUTION: Since the cashier has the custody of asset duty (control over cheques), the approval should be
from another source (e.g. A/P. Note: for the expenditure transactions, A/P has the recording duty).

Faculty of Business and Law | Accounting CRICOS Provider Code 00301J

 TQ 7.2

d) An employee of the finishing department walked off with several parts from the storeroom and recorded the items in
the inventory ledger as having been issued to the assembly department.

Faculty of Business and Law | Accounting CRICOS Provider Code 00301J

 TQ 7.2

• PROBLEM: Employees have access to inventory (custody) and inventory records

(recording).

Faculty of Business and Law | Accounting CRICOS Provider Code 00301J

 TQ 7.2

• PROBLEM: Employees have access to inventory (custody) and inventory records

(recording).

• SOLUTION: Restrict access to inventory recording. Physical access needs improvement.

Procedure to ensure all necessary source documents are in place.

Faculty of Business and Law | Accounting CRICOS Provider Code 00301J

 TQ 7.2

e) A cashier cashed a cheque from a customer in payment of an account receivable, pocketed the cash, and concealed the
theft by properly posting the receipt to the customer’s account in the accounts receivable ledger.

Faculty of Business and Law | Accounting CRICOS Provider Code 00301J

 TQ 7.2

• PROBLEM: The cashier had (custody) of the cheques and was posting (recording) to the ledger.

Faculty of Business and Law | Accounting CRICOS Provider Code 00301J

 TQ 7.2

• PROBLEM: The cashier had (custody) of the cheques and was posting (recording) to the ledger.

• SOLUTION: Since the cashier should have the custody of assets duty, the recording needs to be done by the A/R
personnel.

Faculty of Business and Law | Accounting CRICOS Provider Code 00301J

 TQ 7.2

f) Several customers returned clothing purchases. Instead of putting the clothes into a return bin to be put back
on the rack, a clerk put the clothing in a separate bin under some cleaning rags. After her shift, she transferred
the clothes to a gym bag and took them home.

Faculty of Business and Law | Accounting CRICOS Provider Code 00301J

 TQ 7.2

• PROBLEM: The clerk was (authorized) to accept the return, grant credit, and had (custody) of the inventory.

Faculty of Business and Law | Accounting CRICOS Provider Code 00301J

 TQ 7.2

• PROBLEM: The clerk was (authorized) to accept the return, grant credit, and had (custody) of the inventory.

• SOLUTION: Require documentation of all returns (e.g. Receiving report). Have supervisor perform
authorisation function.

Physical access needs to be improved.

Faculty of Business and Law | Accounting CRICOS Provider Code 00301J

 TQ 7.2

g) A receiving clerk noticed that four cases of MP3 players were included in a shipment when only three were
ordered. The clerk put the extra case aside and took it home after his shift ended.

Faculty of Business and Law | Accounting CRICOS Provider Code 00301J

 TQ 7.2

• PROBLEM: The receiving clerk has (custody) of arriving goods, and performs the reconciliation (recording)
function.

Faculty of Business and Law | Accounting CRICOS Provider Code 00301J

 TQ 7.2

• PROBLEM: The receiving clerk has (custody) of arriving goods, and performs the reconciliation (recording)
function.

• SOLUTION: Use a blind or blank PO (i.e., the quantity ordered is not shown on this P.O). The purchasing
department should reconcile items received against items ordered. (Compensating control)

Faculty of Business and Law | Accounting CRICOS Provider Code 00301J

 TQ 7.3

The XYZ Company has discovered it has a serious internal control problem. The impact associated with this problem is $2
million and the likelihood is 10%. Two internal control procedures have been suggested to deal with this problem.
Procedure A would cost $50,000 and reduce likelihood to 4%. Procedure B would cost $60,000 and reduce likelihood to
2%. If both procedures were implemented likelihood would be reduced to one fifth of 1%.

Faculty of Business and Law | Accounting CRICOS Provider Code 00301J

 TQ 7.3 - Solution

a) From this information complete the following table:

Control Revised Reduction in Cost of Net Benefit

Risk Exposure
Procedure Expected Loss Expected Loss Control(s) (Cost)

Without
N/A N/A N/A
procedure

Both

Faculty of Business and Law | Accounting CRICOS Provider Code 00301J

 TQ 7.3 - Solution

a) From this information complete the following table:

Control Revised Reduction in Cost of Net Benefit

Risk Exposure
Procedure Expected Loss Expected Loss Control(s) (Cost)

Without
10% N/A N/A N/A
procedure

A 4%

B 2%

Both 0.2%

Faculty of Business and Law | Accounting CRICOS Provider Code 00301J

 TQ 7.3 - Solution

a) From this information complete the following table:

Control Revised Reduction in Cost of Net Benefit

Risk Exposure
Procedure Expected Loss Expected Loss Control(s) (Cost)

Without
10% $2,000,000 N/A N/A N/A
procedure

A 4% $2,000,000

B 2% $2,000,000

Both 0.2% $2,000,000

Faculty of Business and Law | Accounting CRICOS Provider Code 00301J

 TQ 7.3 - Solution

a) From this information complete the following table:

Expected Loss = Risk x Exposure = 0.1 x $2,000,000 = $200,000

Control Revised Reduction in Cost of Net Benefit

Risk Exposure
Procedure Expected Loss Expected Loss Control(s) (Cost)

Without
10% $2,000,000 $200,000 N/A N/A N/A
procedure

A 4% $2,000,000

B 2% $2,000,000

Both 0.2% $2,000,000

Faculty of Business and Law | Accounting CRICOS Provider Code 00301J

 TQ 7.3 - Solution

a) From this information complete the following table:

Expected Loss = Risk x Exposure = 0.1 x $2,000,000 = $200,000

Control Revised Reduction in Cost of Net Benefit

Risk Exposure
Procedure Expected Loss Expected Loss Control(s) (Cost)

Without
10% $2,000,000 $200,000 N/A N/A N/A
procedure

A 4% $2,000,000 $80,000

B 2% $2,000,000 $40,000

$4,000
Both 0.2% $2,000,000

Faculty of Business and Law | Accounting CRICOS Provider Code 00301J

 TQ 7.3 - Solution

a) From this information complete the following table:

Expected Loss = Risk x Exposure = 0.1 x $2,000,000 = $200,000

Control Revised Reduction in Cost of Net Benefit

Risk Exposure
Procedure Expected Loss Expected Loss Control(s) (Cost)

Without
10% $2,000,000 $200,000 N/A N/A N/A
procedure

A 4% $2,000,000 $80,000 $120,000 $50,000

B 2% $2,000,000 $40,000 $160,000 $60,000

$4,000 $196,000 $110,000

Both 0.2% $2,000,000

Faculty of Business and Law | Accounting CRICOS Provider Code 00301J

 TQ 7.3 - Solution

a) From this information complete the following table:

Expected Loss = Risk x Exposure = 0.1 x $2,000,000 = $200,000

Control Revised Reduction in Cost of Net Benefit

Risk Exposure
Procedure Expected Loss Expected Loss Control(s) (Cost)

Without
10% $2,000,000 $200,000 N/A N/A N/A
procedure

A 4% $2,000,000 $80,000 $120,000 $50,000 $70,000

B 2% $2,000,000 $40,000 $160,000 $60,000 $100,000

$4,000 $196,000 $110,000 $86,000

Both 0.2% $2,000,000

Faculty of Business and Law | Accounting CRICOS Provider Code 00301J

 TQ 7.3

b) From these calculations which procedure (if any) should be implemented? Justify your answer.

Faculty of Business and Law | Accounting CRICOS Provider Code 00301J

 TQ 7.3

b) From these calculations which procedure (if any) should be implemented? Justify your answer.

• Procedure B should be implemented.

Faculty of Business and Law | Accounting CRICOS Provider Code 00301J

 TQ 7.3

c) List any other factors that may need to be considered in addition to these calculations when making a decision about
what control procedures should be implemented?

Faculty of Business and Law | Accounting CRICOS Provider Code 00301J

 TQ 7.3

c) List any other factors that may need to be considered in addition to these calculations when making a decision about
what control procedures should be implemented?

• Legal requirements

• Size of the entity relative to the exposure

• Future plans

• Availability of sharing risk e.g. insurance.

• Compensating controls

Faculty of Business and Law | Accounting CRICOS Provider Code 00301J

 Revision questions

Faculty of Business and Law | Accounting CRICOS Provider Code 00301J

 Revision Question 1

1. To achieve effective segregation of duties which of the following accounting related functions
must be segregated?

a) Control, recording, and monitoring

b) Authorisation, recording, and custody

c) Control, custody, and authorisation

d) Monitoring, planning, and recording

Faculty of Business and Law | Accounting CRICOS Provider Code 00301J

 Revision Question 1

1. To achieve effective segregation of duties which of the following accounting related functions
must be segregated?

a) Control, recording, and monitoring

b) Authorisation, recording, and custody

c) Control, custody, and authorisation

d) Monitoring, planning, and recording

Faculty of Business and Law | Accounting CRICOS Provider Code 00301J

 Revision Question 2

2. For good internal control over customer remittances, the mailroom clerk should separate the
cheques from the remittances advices and send the customer payments to which department?

a) Billing

b) Accounts Receivable

c) Cashier

d) Sales

Faculty of Business and Law | Accounting CRICOS Provider Code 00301J

 Revision Question 2

2. For good internal control over customer remittances, the mailroom clerk should separate the
cheques from the remittances advices and send the customer payments to which department?

a) Billing

b) Accounts Receivable

c) Cashier

d) Sales

Faculty of Business and Law | Accounting CRICOS Provider Code 00301J

 Revision Question 3

3. The likelihood that a threat or hazard will actually occur is a(n):

a) threat

b) exposure

c) risk

d) phenomenon

Faculty of Business and Law | Accounting CRICOS Provider Code 00301J

 Revision Question 3

3. The likelihood that a threat or hazard will actually occur is a(n):

a) threat

b) exposure

c) risk

d) phenomenon

Faculty of Business and Law | Accounting CRICOS Provider Code 00301J