Howard Street Jewelry Accounting Case Study on Internal Controls

1. The main internal control concept the Levis ignored was segregation
of duties. No one
person should be responsible for all transactions from the beginning to the
end. Betty had too
many responsibilities that were interwoven and should have been
performed by more than one
person. She handled the cash that came in, maintained the cash receipts
and the sales
records. Another concept that this relates to is that no one individual
should perform more
than one of the following; recording transactions, authorizing transactions
and maintaining
custody over the assets. Betty was able to do all three; selling jewelry,
putting items in
layaway, recording sales, maintain cash receipts and accepted the cash.
Betty was allowed to
have incompatible duties which allowed her to commit fraud of $350,000.

2. The case states that the CPA served as their accountant for almost 40
years providing
a wide range of accounting and business issues. The responsibility that the
CPA has to
pursue this matter is dependent on the time of this fraud relating to what
services were
provided by the CPA. It is also dependent on what services the CPA is
providing now.
Assuming the CPA was only providing tax return services, as he is doing
now, than the CPA
does not have responsibility to pursue this matter.

The answer is not the same if the CPA is performing an audit, review or
compilation. The CPA
is liable in these circumstances. There are two types of liabilities that the
CPA can have;
common law liability and statutory law liability. The liability that the CPA
has in this case is
common law liability. Since it is a privately owned company, the CPA will
not have statutory
liability.

The CPA must exercise due professional care, and if the CPA was performing
one of the three
tasks mentioned, then he probably was not exercising due professional care
since this is a
small company and over $350,000 in fraud was committed. It was also
mentioned that the CPA
mentioned that there were occasional shortages in the cash receipts
records that seemed
larger than normal for a small retail business.

$350,000 is a material amount for this business and would change the users
of financial
statements viewed the financial statements. It was so material, that it
almost forced the store to
close.

3. I do not agree with dropping what I am working on to try to sell a new
client on my
services. So the answer to this question is dependent on how desperate I
am for a new client.
If I did not have a chance to prepare for the meeting and they did not have
an appointment, I
would ask the potential client to come back shortly.

There are three major reasons for sending the client away; the first is I will
not drop what I am
doing for somebody who does not have an appointment. A CPA firm is not
something that you
window shop, and the potential client could have picked up the phone to
make an appointment
instead of just walking in. This client already seems too needy and not
responsive to other
peoples schedules. This deal could be lucrative, and I would not want to
lose them to my
competition, but as I mentioned, I am not worried about somebody window
shopping for a CPA
firm.

The second reason I would send them away is because I did not have time
to prepare and I
would want to be sure that I knew enough about the industry and other
factors so I would be
able to not lose the client by sounding uneducated on the subject.

The third reason I would not see the client right away is because the
services this person
needs can wait a few hours or even days. This is not something he needs
me right away for.
Therefore, when I make them come back later, it would not be a major
inconvenience for them.

Once I did meet with them, there would be five internal control issues I
would discuss with
them. They are organizational structure, physical controls, accounting
information systems,
assignment of authority / responsibility and performance reviews.

Even though this is a very small family owned business, an organizational
structure is still
necessary. This will provide a basis for planning, directing, and controlling
operations of the
jewelry store. This organizational structure will need to separate some
responsibilities such as
authorization of transactions, record keeping for transactions and custody
of assets. The
organizational structure, if successfully implemented, should lead to
segregation of duties.

Physical controls include controls that provide physical security over both
records and other
assets. In the case of a small jewelry store, an example would be numbered
invoice sheets
(sales receipts) so any skip in numbers would indicate that an employee
may have pocketed
the cash from the sale. The number on the receipt can trace it back to who
the salesperson
was and it would be very difficult to steal cash transactions. Physical
security would be a safe
for the layaway items, or locks on the cabinets with only selected
employees having access to
the keys.

The accounting information system would provide inventory controls,
records of transactions
and the database for the financial / accounting data. The AIS can provide
daily cycle counts so
an entire storewide inventory is not needed as often. If the cycle counts are
above a certain
percentage, then the physical inventory can be delayed.

The assignment of authority and responsibility ties into the organizational
structure /
segregation of duties. The employees need to have an understanding of
what their functions
are to include, doing more may jeopardize the internal controls by
unsegregating the duties.

Performance reviews compare where the company is standing compared to
past years and to
forecasted budgets. Any deviation can imply that something may be wrong
with the internal
controls and it should be investigated further by the CPA.

Howard Street Jewelers, Inc.
1.)
The Levis overlooked both Administrative control and Accounting control
objectives. By allowing Betty to execute transactions without
Managements approval they did not satisfy Administrative controls. It is
also unclear whether there was any formal official procedure established
which Betty was required to follow.
Concerning Accounting control, the Levis first and foremost did not ensure
that transactions were recorded as necessary. Betty was apparently given
access to assets (cash and merchandise) without Management approval,
allowing her to commit prolonged acts of fraud.




QUESTIONS
1. Identify the internal control concepts that the Levis overlooked or
ignored.
One of the most blatant oversights in internal controls was the lack of
segregation of duties. A cashier should never be in a position that also
handles all cash and sales records.

2. When Mrs. Levi informed the CPA of her suspicions regarding
Betty, what responsibilities, if any, did the CPA have to pursue this
matter? Because the CPA was just doing their taxes, he doesn't have
any real responsibilities to pursue the matter any further. However, if
he suspected something was amiss he should have discussed it with
the Levi's to let them know there may be a problem. In addition to
preparing tax returns for Howard Street Jewelers, alternately assume
that the CPA (a) audited the business's annual financial statements. If
the CPA were their auditor, he would have a responsibility to bring
any hint of fraud to the attention of the audit committee. (b) reviewed
the annual financial statements. If the CPA were hired to review the
annual financial statements, he would be responsible to inform the
Levi's of any discrepancies he may find. (c) Compiled the annual
financial statements. He would be responsible to inform the Levi's of
any discrepancies found.



1. The internal control concepts that the Levis ignored were
a. Segregation of duties - No one person should be responsible for all
transactions from the beginning to the end. Betty had too many
responsibilities that were interwoven and should have been performed
by more than one person. She handled the cash that came in,
maintained the cash receipts and the sales records. Another concept
that this relates to is that no one individual should perform more than
one of the following; recording transactions, authorizing transactions
and maintaining custody over the assets. Betty was able to do all
three; selling jewelry, putting items in layaway, recording sales,
maintain cash receipts and accepted the cash. Betty was allowed to
have incompatible duties, which allowed her to commit fraud of
$350,000.
b. Physical safeguarding of assets She physically handled all the
cash that came in and had ample opportunity to skim the cash even
before any transactions were recorded.
c. Proper Authorizations Betty had authority to record and authorize
the transactions which should not have been the case. She should not
have the authority to record sales returns, or having access to
layaway or jewelry items. This authority should be given to a manager
above her.
d. Independent checks the activity performed by Betty was never
checked as there was trust placed in her.
e. Proper documentation there were problems with maintaining
proper trail documentation or with missing documentation which
should have been monitored and entered into system to keep an easy
track of instead of depending on filing papers.