Internal Control Processes Complete the following problems, which will help you apply your knowledge about detecting a potential fraudulent activity: Case

Internal Control Processes Complete the following problems, which will help you apply your knowledge about detecting a potential fraudulent activity: Case 50 on page 217.Case 51 on page 218.Problems attached 50.
Joe Frecaso was recently hired as the controller for Larson Cement Company after the previous
controller was killed in a boating accident in Biscayne Bay. That controller had been with the company
since it first opened its doors. Joe spends most of his time in the back office that has a panoramic view
of “the yard” where the company trucks constantly come and go throughout the day.
Larson is a privately held company owned by the same family for 40 years. The company delivers
concrete to construction sites throughout Miami/Dade County area. Frank Larson, the son of the original
CEO, runs the company. Joe and his two staff accountants; Betty Ladrone, the treasurer; and her three
staff members support the company’s operations. There is also a secretary, front-office staff of three, an
operations supervisor, and a sales staff of seven.
Larson Company normally sells to most contractors on credit. Betty supervises the credit approvals and
reviews and handles bill payments, collections, and the bank accounts. Joe has responsibility for the
bank reconciliations, accounts receivables, and the accounting records in general including the financial
reports.
This morning the company secretary thumbed through the incoming mail as was her custom. There was
a stack of about 30 envelopes, many of them obviously containing checks from customers paying on
their accounts. She mentally prepared herself to separate the envelopes into several different piles. She
would route each pile to the appropriate person: Frank, Joe, Betty, and Sara Martillo, the head of sales.
One envelope caught her eye. It was from the bank, but it wasn’t thick enough to be a bank statement.
In fact, after feeling the letter, she concluded that it contained only a single page inside, part of which
she tried to see through the small clear window on the front of the envelope that revealed the
company’s name and address.
She looked almost sideways through the envelope’s window to get a better look. There was a message
in red letters, but because of the angle, she couldn’t read what it said. That was enough, however, for
her to make a decision: The letter should go straight to Frank. He had given her strict instructions to
route any unusual-looking mail directly to him.
About the time that the unusual looking enveloped arrived on Frank’s desk, Joe was pouring over last
month’s combined bank statement. It was out of balance by $1,104.35. He just scratched his head,
sighed, took a sip of his coffee, and remembered that the current month’s bank statement had just
arrived and was sitting unopened, propped up against his computer monitor. Then the phone rang. It
was Frank calling.
“I want to know what’s going on,” said Frank in an almost accusatory voice. “Our operations bank
account is overdrawn by some $14,000!
Frank was pretty sharp when it came to financial matters. His education included an MBA degree with
an accounting concentration, and he had worked as the controller of Larson Cement when he was
younger.
Within seconds after Joe hung up the phone, Frank appeared in his doorway looking angry. “I want the
bank statements right now.”
Joe tried to maintain his professional demeanor, but his chest tightened. “Don’t look at me,” he said. “I
don’t write the checks.”
Frank returned to his office, opened the current month’s combined bank statement, and began
thumbing through canceled checks. He stopped at one check for $2,500 paid to a Mary Waters. “Mary
Waters, who are you?” he mumbled to himself.
Frank was a hands-on CEO and knew all of the company’s vendors, and he had never heard of Mary
Waters before. He looked at the endorsement on the back of the check. The checked had been
deposited into a New York bank account.
Nervously, Frank spread the checks out on the table. Right away, several other checks paid to Mary
Waters popped out and stared at him. Now was is sure that something was wrong: No vendor is paid
more than once a month. So, he grabbed the phone and called Joe again.
Joe answered on the first ring. In a thundering voice, Frank said, “Joe, we’ve got a problem.”
Joe remained quiet and waited for what seemed like a long time and became more nervous because it
appeared that he was supposed to know what the problem was.
“That’s not a good sign,” he thought.
Frank pounded Joe with questions about Mary Waters.
“We’ll call Betty,” Joe finally said. “She’s the one with the checkbook.”
“No,” said Frank. “I want you to do a complete audit of her office, and I want a hidden video camera set
up in a position to record everything she does at her desk.”
“But what if someone else in her office stole the checks?”
“That’s not possible,” replied Frank. “She keeps the checkbooks locked up at all times in her safe, and
she’s the only one besides me with the combination.”
“Ok, I’ll start the investigation.”
a. Evaluate how well Frank and Joe have handled the problem.
b. Evaluate Larson Cement’s internal control processes as they apply to this case.
51.
Rich Skywark is the owner of Skywark Hardware and Electric, a family owned business, in the
College Station, Pennsylvania, area. His business consists of over-the-counter retail sales and
discounted sales of building materials to local contractors. Sales to contractors consist mostly of
specialized lumber and electrical supplies that are not available through the area’s larger
suppliers of building materials and electrical parts.
Most contractor customers have established accounts and place orders over the phone or the
Web. However, contractors also visit the store to make purchases, sometimes purchasing on
account and other times paying in cash. Retail customers pay only in cash.
Next to the front door is a long glass counter area with items that are sold from both inside the
counter and the wall behind it. Two cash registers sit on the counter, and at least one of the
two is open and in operation at all times during business hours.
Skywark’s bookkeeper is Mark Hansen, who works alone and maintains all accounting records,
including accounts receivables and accounts payable. He also manages the checkbook, payroll,
cash deposits to the bank, and all tax-related matters. He maintains all accounting records in
Intuit Quickbooks®, the well-known computerized accounting system that is popular among
small and medium-size businesses.
Rich was happy he had hired Mark the year before because before Mark, he had had a string of
successive bookkeepers who each worked for a few months and then quit. In recent months,
Mark had become moody and difficult to work with. Whenever Rich asked him a question
about something, Mark would become irritated.
“I know how to do my job,” Mark would say.
Rich just shrugged off Mark’s irritable disposition, mainly out of fear of losing one more
accountant.
Jill Evans worked the front cash register most of the time. She was a long-time trusted
employee who knew the store and the business inside and out. At the end of each day, Page
219she made sure that cash drawers reconciled with the internal totals inside the cash
registers. She then bundled up the day’s cash and checks for each register, sealed them in
envelopes, wrote the totals on the outside of each envelope, and forwarded the envelopes to
Mark for recording and deposit.
Sometimes contractors with accounts stopped in the store to make payments on their
accounts. Most of the time Jill was there to accept their payments and give them handwritten
receipts from a receipt book, always leaving a carbon copy behind. If Jill wasn’t there, however,
anyone else could accept contractors’ checks or cash and write them a receipt from the receipts
book. Mark periodically picked up the receipts book for review as well as cash and checks
collected from customers. He usually kept the receipts book for only a few minutes.
Right outside Mark’s office was a large bull pen where three commissioned salespersons
worked. They bid on large jobs, signed contracts, and collected deposit checks and sometimes
payments on account. They would forward collected funds to Mark for deposit. They kept
permanent copies of the contracts in their desk drawers.
Rich didn’t place a lot of faith in income statements and balance sheets. He mainly kept his eyes
on the monthly sales figures, which were the figures that made him start to worry. Mark’s most
recent monthly report showed that sales were off by about $100,000. He knew this couldn’t be
right because sales had been better than ever.
“You must have made a mistake with the sales number,” he said to Mark. “I know when things
are better and when things are worse.”
Rich expected Mark to get irritated as he usually did, but to his surprise, Mark merely said,
“Perhaps so; let me check it and get back to you tomorrow.”
The next day Mark appeared with a new version of the report. This time the month-to-month
sales had increased by about $50,000.
Trying to keep Mark from becoming irritated, Rich smiled and said, “Seems more reasonable.
What was the problem?”
Mark just shrugged his shoulders, Rich nodded, and the meeting ended.
When Rich got back to his office, he received a call from the phone company saying that the
phone bill hadn’t been paid and was about to be cut off. It seemed that Mark was really
screwing up. First there was the error in the sales numbers and now an unpaid phone bill.
Rich usually didn’t pay much attention to the bank and routine bills, but in this case, he decided
to login to his online banking service to see whether the check for the phone bill had been paid.
After Rich logged into to the online banking system, he was surprised that the balance in the
operations account was only $48,245.12. This was much below Skywark’s normal target balance
of $100,000. He was really beginning to worry. That night he went to the office alone and
studied Mark’s financial reports for the previous three months. What he found wasn’t good:
The numbers showed that sales had been steadily declining for the previous three consecutive
months.
He then glanced at his phone and noticed that he had one voicemail message waiting. Someone
must have called him after he had left for a late lunch at 4:30 P.M. The caller’s message follows:
“Hello, this is Winston Dansforth from the Pennsylvania Department of Revenue. I need to
meet with you privately as soon as possible to clear up an issue relating to your payroll taxes.”
The caller then left his phone number with a request for a call back between 9:00 A.M. and 5:00
P.M. Rich recognized it as a landline number in Harrisburg, the state capital. He’s probably not a
field agent, he thought, or he wouldn’t have requested a call back to his office.
Rich then shifted his attention back to Mark. It looked like he was getting ready to lose still
another bookkeeper. It didn’t matter. Action was needed.
In the morning, Rich called Mark into the conference room next to Mark’s office. Rich brought
Jill, his front cashier and most trusted employee, with him for moral support. The three sat at
the conference table, and without a word, Rich placed copies of the financial reports for the
previous three months on the center of the table.
“What’s going on around here?” Rich asked Mark in a tone of voice that failed to hide his anger.
“Things don’t seem right.”
“Are you accusing me of something?” asked Mark.
Rich thought for a moment, and then replied: “Yes, actually, I am. The bank account is short,
your sales reports are making no sense, you didn’t pay the phone bill, and now I’ve had a call
from the Department of Revenue.”
Mark’s face turned red. There was no stopping his irritability from erupting into anger. “I’ve had
enough of you and this place,” he yelled. “I quit.”
The conversation ended with Mark jumping up and storming out the door. Rich felt a gutwrenching feeling pass through his body. The day was the 18th of the month and without an
accountant, he had no way to send out monthly statements when the end of the month rolled
around.
Rich immediately asked Jill to box up everything in Mark’s desk and told her, “Don’t let him
back in here again if I’m not around. Make him wait up front in the store.”
Rich then changed the alarm code and called the alarm company and changed the password.
He told the company that Mark was no longer authorized to access the building.
The next day, Rich moved Mark’s computer to his own office. He had tossed and turned all
night long, unable to sleep, trying to put all the pieces together. He had come to the conclusion
that everything pointed to Mark’s embezzling funds.
In reviewing Mark’s computer, Rich came across a document file named complaint. docx in the
electronic recycle bin. Inside was a letter addressed to the Department of Revenue with a
carbon copy indicated for the Internal Revenue Service. The letter read as follows:
To Whom It May Concern:
I work for Rich Skywark, the owner of Skywark Hardware and Electrical. The business is located
in the College Station area, and its address is
125 Union Street
Contoville, PA
Phone number 717-555-5555
I’m writing to inform you that Rich Skywark is systematically stealing payroll taxes. Instead of
remitting the funds as he’s required to do, he’s sending you false reports and instead using the
money to pay his personal monthly bills, and I strongly suspect that he’s been skimming some
of the cash receipts in anticipation of the business shutting down. He’s months behind in paying
many of his bills and creditors and is on the verge of financial collapse. I’m sure that in the end
you will end up being cheated out of a lot of taxes.
Another thing that Skywark has been doing is overbilling the city on its orders with the store.
This guy is a real crook. He would sell his own grandmother for a hundred dollars.
I suggest that you investigate quickly because he’s been doing this for a long time, and very
soon it will be too late for you to recover anything.
I would appreciate very much if you keep this tip in confidence. Skywark is a ruthless man, and
he still owes me back pay.
Sincerely,
Mark Hansen
After Rich read the letter, it began to dawn on him that things were much worse than he had
imagined. An hour later, two people in suits, Muttley Hammer and Janice Boracho, showed up
at the front counter. They flashed badges, identified themselves as agents from the
Department of Revenue, and told him they wanted to ask some questions.
“I’ll be happy to meet with you, but not here,” said Rich. “Let’s do this in my attorney’s office.”
Muttley did all the talking: “If you don’t cooperate, we’ll seek an immediate order to freeze all
your assets and bank accounts. We need answers to our questions right now, no waiting. You
don’t have to talk to us, but you’ll have to suffer the consequences if you don’t.”
Rich answered their questions and explained to them that Skywark’s payroll taxes were not
segregated in a separate account, the story about his accountant quitting, and that all of his
bank accounts were in the local area. Then they gave him a long list of documents that they
wanted him to produce within seven days: financial statements, bank statements, and detailed
payroll records.
Muttley and Janice seemed completely uninterested in hearing about Mark and Rich’s suspicion
that the man could have embezzled the payroll tax money. “That’s your problem,” is all that
Muttley would say.
Two days after the interview, things got worse. When Rich arrived at the office at the start of
the day, there was a letter from the bank on his desk: the company’s unsecure line of credit had
been frozen. When he called his usual contact at the bank, he was told that this had happened
because “the IRS has filed liens against your personal and business properties.”
Rich called his outside CPA, who quickly confirmed that the lien had been filed for back payroll
taxes. “You should have received a notice,” said the CPA.
This was the first that Rich had heard about any problem with the IRS. He met with his attorney,
who advised him to hire an independent forensic accountant to investigate Mark.
a. Evaluate Skywark’s internal controls.
b. Evaluate how well Rich handled the problem with Mark.

Purchase answer to see full
attachment