Question

Suppose The Right Rig Dealership is opening a regional office in Omaha. Cary Regal, the office manager, is designing the internal control system. Regal proposes the following procedures for credit checks on new customers, sales on account, cash collections, and write-offs of uncollectible receivables:

• The credit department runs a credit check on all customers who apply for credit. When an account proves uncollectible, the credit department authorizes the write off of the accounts receivable.

• Cash receipts come into the credit department, which separates the cash received from the customer remittance slips. The credit department lists all cash receipts by customer name and amount of cash received.

• The cash goes to the treasurer for deposit in the bank. The remittance slips go to the accounting department for posting to customer accounts.

• The controller compares the daily deposit slip to the total amount posted to customer accounts. Both amounts must agree.

Recall the components of internal control. Identify the internal control weakness in this situation, and propose a way to correct it.

Short answer

Answer

Segregation of Duties, a part of internal control is missing in this case. Duties should be segregated between credit appraisal team and treasury team or accounting team.

Step-by-step solution

Internal controls

Internal controls are the systems used by an organization to manage risk and diminish the occurrence of fraud.

Analysis of Cary Regal designed internal control system

Credit department runs the credit rating for customer, collects the cash from the customer and authorise for written off in case of uncollectable.

The credit appraisal team should have no access to treasury team or accounting team, and the accounting team or treasury team should not be in a position to grant credit to customers.

Any lapse in the above control may leads to employee theft or Fraud.

Lapse/weakness in internal control system

Segregation of Duties is not maintained since credit department having access to cash and can authorise for written-off. This may have a change that credit department employee, he or she could pocket money received from a customer. The employee

could then label the customer’s account as uncollectible, and the company would stop billing that customer. In this scenario, the employee may have covered his or her theft.

Correction in internal control system

Segregation of Duties has to be maintained and credit department should not have access to cash. Treasury or accounts department have to handle the cash receipts.