Howard Street Jewelers free essay sample

The internal control concepts that the Levis ignored were a. Segregation of duties No one person should be responsible for all transactions from the beginning to the end. Betty had too many responsibilities that were interwoven and should have been performed by more than one person. She handled the cash that came in, maintained the cash receipts and the sales records. Another concept that this relates to is that no one individual should perform more than one of the following; recording transactions, authorizing transactions and maintaining custody over the assets. Betty was able to do all three; selling jewelry, putting items in layaway, recording sales, maintain cash receipts and accepted the cash. Betty was allowed to have incompatible duties, which allowed her to commit fraud of $350,000. b. Physical safeguarding of assets – She physically handled all the cash that came in and had ample opportunity to skim the cash even before any transactions were recorded. Alvin was not able to locate the layaway ticket in the layaway file, nor was he able to locate the sale at all in the sales records. When Betty returned to work the next day and quickly produced the layaway ticket, saying it had been in the file all along, Alvin began to rethink Mrs. Levi’s suspicions. This doubt was compounded with Betty’s explanation of never ringing up the sale as an oversight. Over the following several weeks Alvin studied the cash receipts and daily sales records. He soon realized that their trusted and long time employee, Betty, was stealing from the company and estimated her overall embezzlement at over $350,000 (Knapp, 2011). 1. Identify the internal control concepts that the Levis overlooked or ignored. The Committee of Sponsoring Organizations (COSO), formed in order to establish what businesses could do to improve financial reporting, is comprised of representatives from the Financial Executives Institute (FEI), the American Accounting Association (AAA), the Institute of Internal Auditors (IIA), the Institute of Management Accountants (IMA), and the AICPA. According to COSO the five components of internal controls include: 1. Control environment – sets the internal control tone of the company, is he foundation of all other control components, and its factors include integrity, values, competence, management philosophy of authority and responsibility, and employee development. Risk assessment – the identification and analysis of economic, industry, regulatory, and operational risk factors that jeopardize the ability of the company to reach its objectives. 3. Control activities – activities that ensure management’s directives are carried out and include approval procedures, verifications, reconciliations, performance reviews, physical inventory security and separation of duties. . Information and communication – open communication and reporting of operational, financial, and compliance information to all interested parties that is timely, reliable and relevant. 5. Monitoring – ongoing monitoring of the effectiveness of the internal control systems by internal and external evaluations, (The Internal Auditor, 2006). As is common with many small businesses, the Levis did not have any of the internal control components in place. Because it was just the four of them running the store, creating a control environment was probably not priority as ethical behavior and integrity were assumed. In assessing the risk of the company not meeting its financial objectives, the Levis most likely discussed the economy, and may have even discussed theft as a risk, but obviously did not deem employee embezzlement as a risk, or they would not have allowed Betty unrestricted access to the entire cash cycle. The most obvious and important control activity that the Levis failed to have is separation of duties. The person who physically receives the cash should never be the same person that records the cash receipt, (Association of Certified Fraud Examiners, 2002). Betty was able to receive the cash payment from a customer and never record the sale. Authorization to execute transactions, recording transactions, physical custody of assets, and periodic reconciliation of records to physical assets should each be performed by a different individual, (Louwers, Ramsay, Sinanson, Strawser, amp; Thibodeau, 2011). Information and communication happened within the Levi’s business, but it was not heeded. After Alvin did monitor Betty’s work, the daily sales and receipts records, he was able to detect the fraud. Better monitoring of inventory could have detected the fraud sooner as the unrecorded sales would have caused inventory levels to be lower than sales records indicted. Additionally, better monitoring of Betty’s unrealistic fashion and vacation trends should have been a red flag to the Levis. 2. When Lore informed the CPA of her suspicions regarding Betty, what responsibilities, if any, did the CPA have to pursue this matter? Alternatively, assume that, in addition to preparing tax returns for Howard Street Jewelers, the CPA (a) audited the business’s annual financial statements, (b) reviewed the annual financial statements, and (c) compiled the annual financial statements. SAS no. 99 and AU 316 require that an auditor detect fraud if it results in materially misstated financial statements (AICPA, 2007 and PCAOB ,2012). While no other rules require the CPA or auditor to detect fraud, statements of professional conduct such as the AICPA’s Principles of Professional Conduct, Section 56 – Article V: Due Care, require the CPA to perform their duties to the best of their ability with concern for the client’s best interest (AICPA, 2012). Therefore, only if the Levi’s CPA conducted an audit of the business’s financial statements and found the fraud to cause a material misstatement would he be obligated to further pursue the matter. However professional codes of conduct requiring him to perform his duties as CPA to the Levis should motivate him to further pursue the matter. 3. Provide the Trubeys with an overview of the key internal control issues they will face in operating a jewelry store. Identify at least five control activities you believe they should implement. Creating a control environment is the first step and foundation for all other internal control components. It is important for the Trubeys to set an example of integrity and ethics in their management style. They must set policies and procedures, such as reviewing financial data monthly, performing background checks before hiring a new employee, assigning appropriate levels of authority and responsibility, and stick to them. The Trubeys identified high dollar values of inventory and significant daily cash transactions as areas of high risk. The control activities to focus on should be activities that mitigate those identified risks. Some suggested controls activities include: * All inventory purchases need to be approved by Mr. or Mrs. Trubey. Upon receiving inventory, the physical inventory should be compared to the purchase order to ensure all items ordered arrived. * It may be prudent for the Trubeys to hire a bookkeeper. It is of utmost importance to maintain a separation of duties. For example if the cashier collects the money throughout the day, he can also count the drawer at the end of the day and take the money to the bank, but he can not be person who records the daily sales and posts the cash receipts to the books. * Check signing authority should remain with the Trubeys exclusively. In preparing accounts payable, the invoice should be accompanied by the approved purchase order and the inventory packing slip to ensure that what is being paid for was actually ordered and received. The Trubeys should review this as they are signing the checks. * Insurance policies for most jewelry stores require extensive security systems, including removing all jewelry from the floor and storing in a safe during non-operating hours. Access to the safe and combination should be minimal, limited only to the Trubeys if operationally feasible. If the store will be using a computerized point of sale system, information access levels should be established and adhered to. For example a sales clerk might be able to only look up inventory, the cashier able to ring up sales transactions, but only the Trubeys able to perform voids or returns. * A reconciliation of physical inventory to recorded inventory should be performed monthly, quarterly, semiannually, or at the very least yearly. * Bank reconciliations to the accounting records should be performed at least monthly, as well as monthly reviews of profit and loss statements. This not only reviews the performance of the sales staff and the store, but also through variance analysis ensures that all transactions are being recorded properly, such as expenses. If the Trubeys hire a bookkeeper, they will have enough people to ensure a proper separation of duties. If they are active in the business they can create the proper control environment and monitor that all policies and procedures are being adhered to. Monthly performance reviews with the staff will reinforce internal controls and help create a structured environment. People, not policies, are the key factor in maintaining effective internal controls.