Governance, Business Ethics, Risk Management, and Internal Control

Exercise 1
Each of the following internal controls has been taken from a standard internal
control questionnaire for assessing control risk in the payroll and personnel
cycle.

1. Approval of department heard or foreman on timecards is required

before preparing payroll.
2. All prenumbered timecards are accounted for before beginning data
entry for preparation of checks.
3. The payroll accounting software application will not accept data input for
an employee number not contained in the employee master file. 4. Persons
preparing the payroll do not perform other payroll duties (timekeeping,
distribution of checks) or have access to payroll data master files or cash.
5. The computer calculates gross and net pay based on hours inputted and
information in employee master files, and payroll accounting personnel
double-check the mathematical accuracy on a test basis.
6. All voided and spoiled payroll checks are properly mutilated and
retained.
7. Personnel requires an investigation of an employment application from
new employees. Investigation includes checking the employee’s
background, former employers, and references.
8. Written termination notices, with properly documented reasons for
termination, and approval of appropriate official are required. 9. All
checks not distributed to employees are returned to the treasurer for
safekeeping.
10.On-line ability to add employees or change pay rates to the payroll
master file is restricted via passwords to certain human resource
personnel.

Required:
a. For each internal control, identify a specific misstatement that is likely to
be prevented if the control exists is effective.
1. Incorrect timecards submitted by an employee, where the arrival time to
work has been tampered with.
2. Omitted or duplicate timecard entries.
3. Compensation provided to individuals who do not actually exist as
employees.
4. Unauthorized access and tampering with payroll data or checks.
5. Calculation errors in payroll.
6. Unauthorized re-use of voided checks.
7. Hiring employees with hidden or fraudulent backgrounds. 8.
Terminations that occur without proper authorization or explanation. 9.
Improper holding or inappropriate use of undistributed checks without
authorization.
10.Unauthorized entry into payroll master files or alterations to pay rates.

b. For each internal control, list a specific misstatement that could result from
the absence of the control.
1. Unauthorized or unverified time entries may lead to incorrect payments.
2. An employee will not receive compensation for a specific time period.
3. An employee has the potential to tamper with the records by labeling
entries as void in the books then encash the check.
4. An employee has the ability to manipulate payroll checks and create
inaccuracies, potentially leading to a multitude of errors.
5. Calculation errors may go unnoticed.
6. If voided checks are not adequately defaced and securely kept, they
might be vulnerable to misuse.
7. Individuals with uncertain or questionable backgrounds may go
unnoticed among the employees.
8. Terminations that occur without proper authorization or explanation.
9. Undistributed checks may not be properly secured.
10.Individuals without proper authorization may gain access to and make
changes to master files.

c. For each internal control, identify one audit test that the auditor could use
to uncover misstatements resulting from the absence of the control. 1. Select
a sample of timecards and verify the approvals from department heads or
foremen.
2. Compare the quantity of prenumbered timecards with the total number
of employees to confirm that they correspond.
3. Verify the system's functionality by trying to input a non-existent employee
number and confirm that it is rejected.
4. Examine access logs and the separation of responsibilities to guarantee
that payroll personnel do not have access to master files or cash. 5. Select
a sample of payroll calculations and recalculate them to ensure
accuracy.
6. Examine voided checks to confirm they have been mutilated and
retained in accordance with the policy.
7. Review employment files for new employees to ensure background
checks are conducted as required.
8. Inspect termination notifications to ensure they have been accurately
 documented and authorized as required.
9. Confirm that all undistributed checks are returned to the treasurer as per
policy.
10.Conduct a review of access controls to identify any unauthorized
alterations in the payroll master file and confirm that only authorized HR
personnel are permitted to make such changes.

Exercise 2

The division of the following is meant to provide the best possible controls for the
Meridian Paint Company, a small wholesale store.

1. Assemble supporting documents for general and payroll cash

disbursements. +
2. Sign general cash disbursement checks. +
3. Input information to prepare checks for signature, record checks in the
cash disbursement journal, and update the appropriate master files. + 4.
Mail checks to suppliers and deliver checks to employees. + 5. Cancel
supporting documents to prevent their reuse. +
6. Approve credit for customers included in the customer credit master file. +
7. Input shipping and billing information to bill customers, record invoices in
the sales journal, and update the accounts receivable master file. + 8. Open
the mail and prepare a prelisting of cash receipts. + 9. Enter cash receipts
data to prepare the cash receipts journal and update the accounts
receivable master file. +
10.Prepare daily cash deposits. +
11.Deliver daily cash deposits to the bank. +
12.Assemble the payroll timecards and input the data to prepare payroll
checks and update the payroll journal and payroll master files. + 13.Sign
payroll checks. +
14.Update the general ledger at the end of each month and review all
accounts for unexpected balances.
15.Reconcile the accounts receivable master file with control account and
review accounts outstanding more than 90 days.
16.Prepare monthly statements for customers by printing the accounts
receivable master file; then mail the statements to customers.
17.Reconcile the monthly statements from vendors with the accounts
payable master file.
18.Reconcile the bank account.

Required:
You are to divide the accounting-related duties 1 through 18 among Robert
Cruz, James Santos, and Bill Reyes. All of the responsibilities marked with a cross
(+) are assumed to take about the same amount of time and must be divided
equally between Robert and James. Both employees are equally competent.
Bill, who is president of the company, is not willing to perform any functions
designated by a dagger and will perform only a maximum of two of the other
functions.

Robert Cruz and James Santos:

1. Assemble supporting documents for general and payroll cash
disbursements.
2. Sign general cash disbursement checks.
3. Input information to prepare checks for signature, record checks in the
cash disbursement journal, and update the appropriate master files. 4.
Mail checks to suppliers and deliver checks to employees. 5. Cancel
supporting documents to prevent their reuse.
6. Approve credit for customers included in the customer credit master file.
7. Input shipping and billing information to bill customers, record invoices in
the sales journal, and update the accounts receivable master file. 8. Open
the mail and prepare a prelisting of cash receipts.
9. Enter cash receipts data to prepare the cash receipts journal and update
the accounts receivable master file.
10.Prepare daily cash deposits.
11.Deliver daily cash deposits to the bank.
12.Assemble the payroll timecards and input the data to prepare payroll
checks and update the payroll journal and payroll master files. 13.Sign
payroll checks.

Bill Reyes:
14.Update the general ledger at the end of each month and review all
accounts for unexpected balances.

Robert Cruz:
15.Reconcile the accounts receivable master file with control account and
review accounts outstanding more than 90 days.
18. Reconcile the bank account.

James Santos:
16.Prepare monthly statements for customers by printing the accounts
receivable master file; then mail the statements to customers.
17.Reconcile the monthly statements from vendors with the accounts
 payable master file.
Exercise 3

Recently, while eating lunch with your family at a local cafeteria, you observe a
practice that is somewhat unusual. As you reach the end of the cafeteria line,
an adding machine operator asks how many persons are in your party. He then
totals the food purchase on the trays for all of your family and writes the number
of persons included in the group on the adding machine tape. He hands you
the tape and asks you to pay when you finish eating. Near the end of the meal,
you decide you want a piece of pie and coffee so you return to the line, select
your food, and again go through the line. The adding machine operator goes
through the same procedures, but this time he staples the second tape to the
original and returns it to you.

When you leave the cafeteria, you hand the stapled adding machine tapes to
the cash register operator, who totals the two tapes, takes your money, and
puts the tapes on spindle.

Required:
a. What internal controls has the cafeteria instituted for its operations?

Internal Controls in the Cafeteria”

1. Meal Verification – When customers enter the cafeteria, an adding
machine operator asks for the number of persons in their group. This
control is in place to ensure that the bill is accurate on the group size. It
prevents customers from attempting to pay for fewer people than are
actually dining together.
2. Adding Machine Tapes – After the group’s food is selected, the operator
totals the food purchase on an adding machine tape. The tape includes
the items selected and their respective prices. This provides a clear record
of the transaction and allows for a cross-check of items and pricing
accuracy.
3. Stapling Tapes – The adding machine operator staples the second tape to
the original, creating a combined record of the purchases for that group.
This action creates an audit trail, making it challenging for customers to
manipulate or alter their bills. It also allows for a straightforward cross
verification between the original and additional purchases.

b. How can manager of the cafeteria evaluate the effectiveness of the

controls?
To evaluate the effectiveness of these controls, the cafeteria manager can: 1.
Regular Audits – Periodically review adding machine tapes and compare
them to the number of customers served. Investigate discrepancies and
 identify potential issues with meal verification or billing.
2. Comparison – Compare the total sales recorded on the adding machine
tapes with the cash collected at the register. This helps in verifying the
accuracy of the billing process.
3. Customer Feedback – Customer feedback and complaints can provide
insights into any issues with the system, such as incorrect billing.

c. How do these controls differ from those used by most cafeterias?

This cafeteria’s system differs from most cafeterias in that it:
1. Requires an adding machine operator to verify and record the number of
persons in each group.
2. Provides adding machine tapes to customers to self-record their
purchases.
3. Staples the tapes together for a clear audit trail.

d. What are the costs and benefits of the cafeteria’s system?

Costs:
1. Employing adding machine operators increases labor costs, as you need
staff to perform this task.
2. Purchasing and maintaining adding machines, tapes, and staples have
associated costs.
3. Training staff and customers to use this system properly may require time
and resources.

Benefits:
1. The system reduces the risk of underpayment or overpayment, improving
billing accuracy.
2. Stapling the tapes together creates an audit trail, discouraging attempts
at fraud and enhancing accountability.
3. Allowing customers to track their purchases and the billing process can
enhance their dining experience and satisfaction.