Question

A small air conditioning repair and parts supply company employs 25 workmen who perform services tasks and 3 office staff: One of the office staff, Harold Jones, has been with the company since it opened its doors. During that time, he has earned the trust of the owner and has proven to be a diligent employee who often works late, occasionally comes in on weekend for no additional pay, and hasn’t taken a substantial vacation in over 10 years. Instead, he staggers his vacation days throughout the year to avoid the need for a replacement and ensuring that none of the other office staff is burdened with his work. Harold’s primary tasks include:

Responsible for POS cash and credit sales Bills those customers who purchase on credit Opens the mail and posts cash receipts to AR records, and Prepares the daily cash deposits for the business.

Another office worker, Mike Larkin, handles purchasing of inventory and supplies from vendors, stocking, shipping merchandise, updating inventory records, and writing checks to vendors in payment of purchases. The third office staff member, Mary Smith, performs the payroll transactions including, recording employee time and attendance, preparing paychecks, posting payroll payments to employee accounts, and performing general ledger updates.

Required

1. Discuss the risks inherent in the scenario.

2. Make control recommendations to mitigate the risks under the constraint that no additional employees can be hired.

Answer 1

The observed risks in the scenario are as following:

1. Harold Jones staggering his vacations so not to give an opportunity for replacement triggers his likeliness of  indulging into fraud.
2. Harold Jones is handling cash receipts as well as its records. Hence chances that cash receipts are either never recorded or wrongly recorded are higher.So, no supervision or segregation of duties found.
3. Cash deposits and payments are made by single person without any proper authorization from any other person.
4. Single person handles inventory, receipts and issues, purchases and even payments. Hence no supervision or segregation of duties.
5. Employee attendance,timings and paychecks are written by the same person. Since all are computed, computations can be manipulated easily. Moreover, authorisation of payment controls are also absent. Induction of dummy workers, wrong payments related frauds are highly probable.

These risks can be mitigated by implementation of following internal controls:

1. Segregation of duties: No person handling the asset shall handle its records. Hence person who receives cash shall be separated from who records it. Who makes payment shall be separated from who enters/writes it. Who writes shall be separate from who authorizes it. Who records attendance shall not write checks and make payments
2. Supervision: Work of one person shall automatically come under supervision of the other. Hence, the organisation structure shall be reformed to make this possible. It will help in early detection of fraud and errors too.
3. Authorisation for payment: Every Payment shall be properly authorised by a higher personnel and then be made out. This will only make system have valid payments and reduce unauthorized payments.
4. Implementation of rotation of assignments: Employees tend to understand ambiguities in the system when when work for a longer time in it. Thus they can abuse such ambiguities to their advantage. This precipitates fraud. To prevent such a thing, implementing a system of job rotation within the organisation can help.
5. Encourage taking leaves or implement mandatory holiday: By this, the employer can assign a substitue employee to carry out business functions required due to the absence of the employee. Further, this can help in determining if the employee was making any frauds.
6. Surprise Checks: Whether fear of or worry about, surprise checks on cash will impose a sense of responsibility among employees to not cause any frauds. Also helps in early discovery of the cash related frauds too.