Question

Levon Helm was a kind of one-person mortgage broker. He would drive around Tennessee looking for homes that had second mortgages, and if the criteria were favorable, he would offer to buy the second mortgage for “cash on the barrelhead.” Helm bought low and sold high, making sizable profits. Being a small operation, he employed one person, Cindy Patterson, who did all his bookkeeping. Patterson was an old family friend, and he trusted her so implicitly that he never checked up on the ledgers or the bank reconciliations. At some point, Patterson started “borrowing” from the business and concealing her transactions by booking phony expenses. She intended to pay it back someday, but she got used to the extra cash and couldn’t stop. By the time the scam was discovered, she had drained the company of funds that it owed to many of its creditors. The company went bankrupt, Patterson did some jail time, and Helm lost everything

Requirements

1. What was the key control weakness in this case?
2. Many small businesses cannot afford to hire enough people for adequate separation of duties. What can they do to compensate for this?

Short answer

1. There was no separation of duties between cash disbursementsand recording transactions.
2. Small businesses must beaware of the risks and vulnerabilitiesof their business.

Step-by-step solution

Meaning of Mortgage

A mortgage loan can be an advance used to purchase real estate, such as a domestic or commercial building. The bank registers a contract with the province where the property is found as part of the loan application process. If the borrower does not make the specified instalment, the contract pays the bank a security interest within the home.

(1) Meaning of crucial control in the case

Cindy was able to keep her activities under wraps since there was no distinction between the tasks of allocating funds and noting transactions in the notebook. Additionally, the owner was not reviewing the payments or the bank reconciliations. He probably would have discovered the deception right away if he had looked at those documents.

(2) Explaining how small businesses can compensate

Small firms must first be conscious of their weaknesses and hazards. Owners must then personally evaluate and authorize all cash-related transactions. Reviewing bank reconciliations is a crucial step in keeping cash under control.