8.

Control Weaknesses
For the past 11 years, Elaine Wright has been an employeeof the Star-Bright Electrical Supply
store. Elaine is a very diligent employee who rarely calls in sick and takes her vacation days
staggered throughout the year so that no one else gets bogged down with her tasks for more than
one day. Star-Bright is a small store that employs only four people other than owner. The owner
and one of the employees help customers with their electrical needs. One of the employees
handles all receiving, stocking, and shipping of merchandise. Another employee handles the
purchasing, payroll, inventoryand accounts payable functions. Elaine handles all of the point-of-
sale cash receipts and prepares the daily depositsfor the business. Furthermore, Elaine opens the
mail and deposits all cash receipts (about 30% of the total daily cash receipts). Elaine also keeps
the AR records and bills the customer who purchase on credit.
Required:
a. Point out any control weaknesses you see in the above scenario

• A fundamental element of internal control is the segregation of certain key duties. The basic
idea underlying SOD is that no employee or group of employees should be in a position both
to perpetrate and to conceal errors or fraud in the normal course of their duties. In general,
the principal incompatible duties to be segregated are: Custody of assets. Authorization or
approval of related transactions affecting those assets. Recording or reporting of related

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transactions.
 The scenario clearly shows that the entity has a weak internal control. Receiving revenue

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funds (checks or cash) and approving write-off of receivables, are incompatible duties.
Employees may have the power to negate established controls often an employee in a

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supervisory position may have this power in an otherwise sound system. Documented
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oversight by a higher level of management will help lessen the possibility of abuse.
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 Segregation of duties serves as a deterrent to fraud and concealment of error because of

the need to recruit another individual's cooperation, via collusion, to conceal it. Lack of
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proper segregation of duties may result in an audit criticism if it creates a material

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weakness in the internal control structure. If a deficiency in an internal control is thought to be of 

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material weakness, this means that it could lead to a material misstatement in a company's financial 
statements.
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b. List some recommendations to remedy any weaknesses you have found working under
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the constraint that no additional employees can be hired.

i. They should separate transaction authorization from transaction processing. The

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significance of this separation is clear when one considers the possible inconsistency in
objectives between the individual sales person and the organization. Often sales staff
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compensation is based on their sales levels.

ii. Employees responsible for purchases or disposals of fixed assets should not have access
to record transactions in the fixed asset ledger. Asset custody should be separate from the
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record-keeping task. In the sales-order processing system, the inventory warehouse clerk
with the custody of the physical assets should not also maintain the inventory records.
Similarly, the cash receipts clerk should not record the receivables.
iii. Segregation of duties is a deterrent to fraud because it requires collusion with another person to perpetrate a fraudulent  
act.  The
record-keeping functions must be carefully divided. Specifically, the subsidiary
ledgers, the journals, and the general ledger should be separately maintained. An
individual with total record keeping responsibility, in collusion with someone with asset
custody, is in the position to perpetrate fraud. By separating these tasks, collusion must
involve more people, which increases the risk of detection and is therefore less likely to
occur.

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