Case Study 2 -Internal Control
Due by Sunday of week 5, 11:59PM, Mountain Time
LJB Company, a local distributor, has asked your accounting firm to evaluate their system of internal controls because they are planning to go public in the future. The President wants to be aware of any new regulations required of his company if they go public so he met with a colleague of yours at a local restaurant. The President of the company explained the current system of internal controls to your colleague. Your colleague has since been promoted to a tax position so she has passed on the information below so you can generate recommendations for the partner at your accounting firm to share with the President of LJB Company.
Since LJB Company is a relatively lean organization, they have a lot of faith in their long-term employees. They have one accountant who serves as Treasurer and Controller which streamlines many of their processes. In this dual role, he purchases all of the supplies and pays for these purchases. He also receives the checks and completes the monthly bank reconciliation. The accountant is so busy that the company handles petty cash a bit differently. All employees have access to the petty cash in a desk drawer and are asked to only place a note if they use any of the cash.
The accountant has recently started using pre-numbered invoices and wants to buy an indelible ink machine to print their checks. The President is waiting to hear from you if this is a necessary purchase before authorizing.
On payday, the checks are picked up by the accountant and left in his office for pick-up. Before he leaves for the weekend, he will move the checks into a safe in his office.
The President is still quite embarrassed because he had to fire one of his employees for viewing pornography on a company computer. He later found out this individual was a convicted felon who served time for molesting children. The company had a hard time getting the employee to admit it was him because the company does not assign individual passwords. The President expressed his frustration because both he and the accountant both interview and approve all of the new hires.
Required:
Based on the above information, prepare a Word document to address the following: 1. Inform the President of any new internal control requirements if the company decides to go public. (7 points).

LJB Company must satisfy the Sarbanes-Oxley Act of 2002 internal control requirement in order to go public and to prevent future operational irregularities and fraud. Even though the company has a good faith on its employees there are several internal controls that need to be implemented to avoid situations that motivate employees to commit fraudulent actions such as the need of many to feed their family or to pay an expensive treatment for an ill relative. For instance, in the way that the company handles petty cash can motivate employees to take advantage to get easy money without being caught. LJB Company also needs prevent opportunities to commit fraud by having weak internal controls. By developing the following principles of internal control, LJB Company can remove opportunities and motivations to commit fraud.

a- Establishment of Responsibility:
One person should not be responsible for more than one task. The company should create a structure that limits the authority and responsibility. Written policies and procedures need to be created in order to provide guidance to employees in carry out their duties. b- Segregation of Duties:
Duties must be divided among different people in order to reduce the risk of inappropriate activities such as fraud. For example, for patty cash the company should assign two people signatures for approval and not just simple notes. c- Documentation Procedure:
LJB Company should require the original receipt and a valid explanation in order to approve petty cash. d- Physical control:
Implementing information system controls in which each employee will have a personal username and password to control misusing of the companies’ computer system. e- Independent Internal Verification:
Having internal control editors will help the company to evaluate the effectiveness of its internal control system. f- Human Resource Controls:
The company should conduct a thorough background check to every hired employee to reduce the change that situations like hiring a convicted felon will not occur again.

2. Advise the President of what the company is doing right (they are doing some things well) and also recommend to the President whether or not they should buy the indelible ink machine. When you advise the President, please be sure to reference the applicable internal control principle that applies. (13 points).

Good things: a- It is a great practice that the accountant and treasurer have the control of the checks and monthly bank reconciliation only if there are two different people who serves as an accountant and a treasurer. The Reconciling the Bank Account ensures that all the items entered into the balance per books agree with what the balance per bank statement shows. This practice will help to control deposits in transit (the bank statement balance to understate the company's actual cash balance), outstanding checks (company records may include a number of checks that do not appear on the bank statement), errors (each transaction on the bank statement should be double-checked) and bank memoranda (“trace bank memoranda to the depositor’s records”).

b- Faith and trust in their long-term employees is good because employees will build up confidence in the company and will develop loyalty toward the company so employees may support the company’s future decisions. However, having faith in long term employees is quite different than empowering those employees.

c- It is a good practice that that the company has already established petty cash funds. However, the company should have the original support documentations. This will make small transactions a lot easier to the company.

d- Moving checks into a safeguard in the accountant office is a good practice because it will help to prevent any fraudulent activity. It is the accountant responsibility to keep the checks in a safe place and to give it to the employees.

e- It is a good practice having employees such as the accountant or management involve in the hiring process.

I recommend the President to authorize the purchase of indelible ink machine. The company should have the necessary equipment to go public and this machine will help the company to keep track of every invoice issue by the company and preventing invoices alterations. As it is stated above, the commit of a fraud just requires motivation and opportunity and the usage of this machine guarantees that anyone in the company or even outside the company will be able to make fake invoices. Altering invoices is a criminal activity and tampering invoices will make easier for those criminals to fake invoices which will result in loss of money and incorrect balance statements. In other words, the purchasing of indelible ink machine will be a good asset for the company which will stop the falsification of invoices.

3. Advise the President of what the company is doing wrong (they are definitely doing some things poorly). Please be sure to include the internal control principle that is being violated along with a recommendation for improvement. (20 points)

Internal controls can help the management to plan up, organize, direct and control personnel. So even though I said that having a good faith in long term employees is good to develop loyalty toward the company; it is also important to limit the authority of those employees. It is very risky to have one person empowered of two completely different roles at the same time and it is even worse that there is not any other person assigned to check and control this person activities. In other words, the accountant and treasure positions should not be assigned to the same person because it violates what is known in internal controls as segregation. The segregation of authority will reduce the risk of fraudulent actions and even the company insolvency.

Also the way that the company is currently handling petty cash usage is very risky since employees have access to the petty cash in a desk drawer and just place a note if they use any of the cash. This particular way, gives to the employees to take more cash than what is reported on the note which will make very difficult to find the person responsible for the petty cash funds shortage.

Failure to conduct a thorough background check will result in the hiring of unwanted employees such as hiring a convicted felon. Also the failure to assign personal logins and password to each employee may motivate employees to use the company computers for personal activities or wrongdoing activities. This activity makes difficult to track the employees who are misusing the computer system.

Recommendations:
- The company should limit authority and should clearly define the employees responsibilities and duties. For instants, the company should assign one person to be responsible for the accountant position, another person for the treasure position and a different person for the hiring process. The company currently has too much power reside just in one person which violates the principles of internal control.

- Petty should be handle quite different to avoid fraudulent activities. For example, when employees need some cash to pay for something; the employee must fill out a petty cash voucher indicating the amount of cash and the purpose of the expenditure. The employee (custodian) takes the petty cash voucher and presents it to two different people for approval and then takes the voucher to the person responsible to give the cash.

- Once the accountant picks the checks, he should keep them into the safe all the time to prevent the steeling of the checks.

- The company should conduct background checks and if possible contact the applicant’s previous job to avoid hiring a convicted felon. The management should be involved in the hiring process.

- Personal logins and passwords should be assigned to each employee in order to monitor employees’ computer usage.