1.

A purchasing agent for a home improvement center is also part owner in a wholesale

lumber company. The agent has sole discretion in selecting vendors for the lumber sold

through the center. The agent directs a disproportionate number of purchase orders to his

company which charges above-market price for its products. The agent’s financial

interest in the supplier is unknown to his employer. What type of fraud is this and what

controls can be implemented to prevent or detect the fraud? Ethically, the purchasing

agent should report that he is part owner in a lumber company that the home

improvement center is using. The fact that the agent is involved in both businesses is a

conflict of interest. The agent is purchasing the lumber from the company he is part of

because he is doing what is in his best interest not the company’s. In an attempt to

prevent or detect the fraud the company should require quotes from multiple vendors

when purchasing lumber. There should be a committee or a top level executive who

makes the final decision of which vendor to use. Even if the agent does not disclose his

involvement with the lumber company, which he should, the fact that more than one

person is involved in the decision making for the home improvement center will cause

the lumber company to not be the approved vendor because their cost is too high.

2. 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 reconciliation of the accounts receivable

subsidiary ledger and the general ledger control account. The same person could

approve bad debt write-offs and reconcile the accounts receivable subsidiary

ledger and the general ledger control account. If the person in control of these two

duties was working with someone who received payments then the duties should
 be separated because one could choose to write off a bad debt even though

payment had been received for the debt.

b. Distribution of payroll checks to employees and approval of employee time cards.

The distribution of payroll checks and approval of employee time cards should

not be performed by the same individual. If an employee leaves the company and

the same individual is in control of time cards and distributing paychecks, that

individual can continue to submit a time card for the employee who no longer

works for the company. When payroll checks are given out, the supervisor can

keep that check and then cash it.

c. Posting of amounts from both the cash receipts and the cash disbursements

journals to the general ledger. The same individual could complete both of these

tasks. The individual is taking information that has been provided by someone

else and posting from the journal to the ledger. This individual does not have

access to the cash.

d. Writing checks to vendors and posting to the cash account. These are two separate

functions. Accounts payable, which is a liability, would be the department that is

writing checks to vendors and the cash account is an asset. If the same person did

both of these tasks it would not be a conflict because one duty deals with paying

vendors and the other with receiving payments.

e. Recording cash receipts in the journal and preparing the bank reconciliation. The

duties of recording cash receipts in the journal and preparing the bank

reconciliation should absolutely not be completed by the same individual. For

instance, if I am responsible for both duties then I could make the decision not to
 record a cash receipt in the journal. By not recording the cash receipt in the

journal I can keep that money and never deposit into the bank. Therefore, when

reconciling the bank accounts there would be no discrepancy because the receipt

was never recorded or deposited into the bank account.

3. While auditing the financial statements of Petty Corporation, the certified public

accounting firm of Trueblue and Smith discovered that its client’s legal expense account

was abnormally high. Further investigation of the records indicated the following:

a. Since the beginning of the year, several disbursements totaling $ 15,000 had been

made to the law firm of Swindle, Fox, and Kreip.

b. Swindle, Fox, and Kreip were not Petty Corporation’s attorneys.

c. A review of the canceled checks showed that they had been written and approved

by Mary Boghas, the cash disbursements clerk.

d. Boghas’s other duties included performing the end of month bank reconciliation.

e. Subsequent investigation revealed that Swindle, Fox, and Kreip are representing

Mary Boghas in an unrelated embezzlement case in which she is the defendant.

The checks had been written in payment of her personal legal fees.

i. Required:

ii. a. What control procedures could Petty Corporation have employed to

prevent this unauthorized use of cash? Classify each control procedure in

accordance with the SAS 78/ COSO framework (authorization,

segregation of functions, supervision, and so on) Mary should not have

been the only signer on the cash disbursement check or Mary should not

have been allowed to write and approve the checks. The checks should
 have been approved and authorized by another member of the staff

(authorization). Petty Corporation should choose to separate the duties of

reconciling the bank account at month end and writing and approving cash

disbursement checks. There should at least be two individuals involved in

these duties. One person should not be writing and approving the checks.

If Petty Corporation used access control and done a background check on

Mary they would have seen that she was involved with an embezzlement

case. Once Petty Corporation discovered Mary’s case they would most

likely deny her access to their assets. If Mary was caught embezzling once

why would she not do it again?

iii. Comment on the ethical issues in this case. Mary should have disclosed

her embezzlement case to the Petty Corporation. Although Mary is

entitled to privacy this is something that should have been disclosed to the

Petty Corporation. Also, if Swindle, Fox, and Kreip are not the lawyers for

Petty Corporation then why would they receive checks from them to go

towards Mary’s legal fees? If I worked for Swindle, Fox, and Kreip I

would question why no one was ever asked about the situation.

4. The kickback is a form of fraud often associated with purchasing. Most organizations

expect their purchasing agents to select the vendor that provides the best products at the

lowest price. To influence the purchasing agent in his or her decision, vendors may grant

the agent financial favors (cash, presents, football tickets, and so on). This activity can

result in orders being placed with vendors that supply inferior products or charge

excessive prices. 
a. Required: Describe the controls that an organization can employ to deal with

kickbacks.

b. Classify each control as preventive, detective, or corrective. Preventive controls

would be creating a code of ethics for the company and include that it is

unacceptable and a violation of company policy and procedure to accept

kickbacks. Management or human resources should ensure each employee

receives, reads, and acknowledges he or she understands the company policy and

code of ethics. There are a number of red flags that may indicate kickbacks are

being received. In order to detect kickbacks management or an auditor should

review bids from vendors to see which vendor was selected and why.

Management should be involved in the purchasing from vendors. It would be

easier to detect kickbacks before it became too large of a problem if more than

one individual was involved in selecting a vendor. Also, it would be helpful to

detect kickbacks if the selected vendor’s bid was compared to fair market value

for the same items from other companies. If the selected vendor’s pricing is much

higher that would be questionable. Corrective measures to eliminate kickbacks

would be to reprimand the employee who was accepting the kickbacks. The

consequences an employee may face are termination or prosecution. The code of

ethics and company policy clearly states that kickbacks are not allowed. The

policy should also state that disciplinary action will occur if an employee is found

to be accepting kick backs.