Stice Chap 1

EXERCISES

1–1. 1. False. Comprehensive income relates only to nonowner changes in equity.

2. True.
3. False. The tendency to recognize unfavorable events early is an example of
conservatism.
4. False. The conceptual framework focuses on the needs of external users of financial
information, primarily investors and creditors.
5. False. Concepts Statements are not considered authoritative pronouncements in the
sense of establishing, superseding, or amending present GAAP.
6. True.
7. False. Recognition involves boiling down all the estimates and judgments into one
number and using that one number to make a journal entry. Disclosure skips
the journal entry and relies on a financial statement note to convey the
information to users.
8. False. Changing business conditions and activities might warrant a change in
accounting method to make financial statements more useful and informative.

1–2. 1. i, j 6. h
2. e, k, n 7. c
3. b 8. i
4. a 9. d
5. l 10. n

1–3. 1. General objective of providing useful information for decision makers. The statements
should include information that is of value to present and potential investors and
creditors, as well as other external decision makers. In addition, the information
disclosed should be sophisticated enough that those with a reasonable understanding
can study and understand the information. The most important aspect of this objective
for financial reporting is to provide information that investors and creditors need to
make economic decisions.
2. Objective of providing information for assessing prospective cash flows. Because
investors and creditors are interested primarily in future cash flows, the financial
disclosures should provide them with information that will help them assess the future
cash flows. The information should provide some clues as to amounts, timing, and risk
of future cash flows.
3. Objective relating to providing information about the enterprise’s economic resources.
The financial statements of a company should provide information about the financial
strengths and weaknesses and the liquidity and solvency of the firm.
4. Objective of providing information about the enterprise’s performance and earnings.
The company should provide information about its earnings. This should include a
disclosure of the components of earnings.
1–3. (Concluded)

5. Objective of assessing future cash flows. In addition to reporting earnings, the

enterprise should provide information about the cash flows for the period. This
information should include sources and uses of cash. Sources and uses of cash
should include information about the operating, investing, and financing activities of
the company.

1–4. 1. b, i, j 6. k
2. i, b 7. i, b
3. k 8. c
4. a, d, g, l 9. a, d, f
5. h 10. g, i, l

1–5. 1. Relevance versus Faithful Representation. The fair value of the building may
provide more relevant information to decision makers, but fair value estimates are
not as free from error as historical cost information.
2. Comparability versus Consistency. A change to the prevalent method used in the
industry would allow JCB’s financial statements to be more easily compared with
competitors; however, it would reduce the ability to analyze JCB’s previous financial
statements because the inventory method would not be consistently applied over time.
3. Timeliness versus Verifiability. Because the bank has asked that Hobson, Inc. provide
financial statements as quickly as possible after year-end, the qualitative characteristic
of timeliness dictates that financial information be collected and summarized as
quickly as possible. However, because some suppliers are slow in submitting invoices,
estimating liabilities will make the financial statements less verifiable.
4. Neutrality versus Relevance. The officers of Starship, Inc. believe that disclosing the
potential liability will unnecessarily bias the financial statements in a negative fashion.
On the other hand, the auditors believe that given the potential liability associated with
the malfunctions, external users would find knowledge of this risk very relevant.

1–6. 1. Comprehensive income

2. Owners’ equity
3. Liabilities
4. Revenues
5. Gains
6. Investments by owners
7. Losses
8. Distributions to owners
9. Expenses
10. Assets
1–7. 1. Arm’s-length transactions. By selling inventory to the parent company at a price other
than the market price, the transaction between the parent and its subsidiary violated
the arm’s-length assumption.
2. Economic entity. The assets of owners of a company are not to be included when
disclosing the assets of the company itself.
3. Going concern. An assumption made when preparing financial statements is that the
company will continue into the foreseeable future. In this example, the continued
existence of the savings and loan is in doubt.
4. Accounting period. To enhance comparability and consistency as well as to provide
periodic financial statement information, the economic life of a company is partitioned
into specific accounting periods. By producing financial statements at two-year
intervals, instead of annually, this assumption is violated.
5. Stable monetary unit. Financial statements assume that the value of the dollar remains
the same over time. That is, a dollar can buy just as much today as it can in one year.
This assumption ignores the effects of inflation. It is, however, consistent with the
historical cost measurement attribute.

1–8. When a company cannot justify applying the going concern assumption, different
measurement attributes may be required. The identified situations would most likely
require the use of the following attributes:
1. Plant and equipment would be valued on a liquidation basis. Thus, an exit market value
under distressed conditions would be the proper valuation.
2. The discounted value of expected future principal and interest payments would be the
proper valuation for these bonds.
3. Accounts receivable should be valued at their net realizable value, regardless of the
going concern assumption. A company in financial difficulty may have to sell its
receivables to a third party rather than wait for the orderly collection process to occur.
The expected sales price would be the proper valuation.
4. Inventory should be valued at expected liquidation value under forced sale. LIFO
inventory values are lower than current market prices in a normal inflationary market.
The revaluation of inventory in this case may result in an increase in inventory values
rather than a decrease. Although such an increase would normally not be recorded
before a sale validated the market value, the increase could be recorded earlier if
evidence of a higher market value was strong.
5. Investments in other companies would be valued at fair value if fair value can be
determined.
1–9. The answers to the sample CPA Exam questions are as follows:
1. The correct answer is c. Comprehensive income includes all changes to equity except
those resulting from investments by owners or distributions to owners, including
dividends to stockholders. A loss on discontinued operations is included in both net
income and comprehensive income. Unrealized loss from foreign currency translation
and unrealized losses on investments in noncurrent marketable equity securities are
both reported as adjustments to stockholders' equity, but they are also part of
comprehensive income.
2. The correct answer is d. One of the objectives of financial reporting is to provide
information that is useful to users in their decision making. Response a is incorrect
because GAAP is derived from the objectives. Response b is incorrect because financial
statements report on the business entity, not the management. Management's
stewardship may only be indirectly inferred from the financial statements. Response c is
incorrect because conservatism is not explicitly included in the conceptual framework.
3. The correct answer is c. Statements of Financial Accounting Concepts (SFACs)
establish a conceptual framework for accounting, which includes the objectives and
concepts used in developing standards of financial accounting and reporting.
Generally accepted accounting principles (GAAP) are based upon the conceptual
framework and must be
followed in order for financial statements to be presented fairly in accordance with
GAAP. When two or more principles apply to a given situation, the hierarchy of GAAP
sources provides guidance as to which principle or principles should be given priority.
4. The correct answer is b. Neutrality, along with complete and free from error, are the
ingredients of faithful representation, one of the fundamental qualitative
characteristics.
5. The correct answer is b. Realization occurs when noncash resources and rights are
converted into money or claims to money. This would be the case when equipment is
sold for a note receivable. Assigning of costs is a form of allocation. Realization
occurs at the time that sales of merchandise are made in exchange for accounts
receivable, not when the receivables are collected.

Hall Chap 1

MULTIPLE CHOICE
1. C

2. B

3. A

4. D

5. D

6. C

7. C

8. A

9. D
10. D

11. E

12. A

13. B

14. C
 PROBLEMS

1. USERS OF INFORMATION

a. S

b. I

c. S

d. T

e. S

f. S

g. S

h. I

i. T

j. S
2. GENERAL MODEL FOR AIS

Redraw the diagram presented for Problem 2. Label each element in the diagram and briefly

describe its role and key features.

ANS:

End users are both external and internal. External users include creditors, stockholders, potential

investors, regulatory agencies, tax authorities, suppliers, and trading partners (customers and

suppliers). Internal users include management at every level of the organization, as well as

operations personnel.

Data sources are financial transactions that enter the information system from either internal or

external sources. External financial transactions are economic exchanges with other business

entities and individuals outside the firm. Examples include the sale of goods and services, the

purchase of inventory, the receipt of cash, and the disbursement of cash (including payroll).

Internal financial transactions involve the exchange or movement of resources within the

organization. Examples include the movement of raw materials into work-in-process (WIP), the

application of labor and overhead to WIP, the transfer of WIP into finished goods inventory, and

the depreciation of plant and equipment.

Data collection is the first operational stage in the information system. The objective is to ensure that
 event data entering the system are valid, complete, and free from material errors. Should

transaction errors pass through data collection undetected, the system may process the errors

and generate erroneous and unreliable output resulting in incorrect actions and poor decisions

by the users.

Data processing involves converting data into information. Examples of data processing tasks

include mathematical algorithms (such as linear programming models) used for production

scheduling applications, statistical techniques for sales forecasting, and posting and

summarizing procedures used for accounting applications.

Database management is responsible for administering the organization’s data repository, which

involves three fundamental tasks: storage, retrieval, and deletion. The physical form of a

corporate database will vary depending upon the technology in place. For accounting/business

purposes data are organized into a logical hierarchy that consists of attributes, records, and

files.

Information generation is the process of compiling, arranging, formatting, and presenting informa-

tion to users. Information may take the form of an operational document such as a sales order, a

structured report, or a message on a computer screen. Regardless of physical form, useful

information has the following characteristics: relevance, timeliness, accuracy, completeness,

and summarization.

Feedback is a form of output that is sent back to the system as a source of data and is used to

initiate or alter a process. For example, an inventory status report signals the inventory control

clerk that items of inventory have fallen to, or below, their minimum allowable levels. Internal

feedback from this information will initiate the inventory ordering process to replenish the

inventories. Similarly, external feedback about the level of uncollected customer accounts may

be used to adjust the organization’s credit-granting policies.

3. INFORMATION SYSTEM ACQUISITION

Commercial.

This company has non-unique information needs that can be satisfied with a commercial system

that is completely finished, tested, and ready for implementation. Typically, commercial systems

are general-purpose or customized to a specific industry. The end user will have standard

business practices that permit the use of “canned” or “off-the-shelf” systems that can be

employed with little or no modification.

Custom.

Larger organizations such as this one with unique information needs often develop systems in in-

house. That would be the solution in this case, assuming that no commercial package is available to

this company.

ERP.

This large organization’s needs are diverse and complex, but not unique. Large scale enterprise

resource planning (ERP) systems are comprised of thousands of small standardized program

modules. From this vast array of options the IT team can configure the system by selecting those

modules that support the organization’s specific information and data processing needs.

4. INFORMATION SYSTEM CATEGORIZATION

a. FRS

b. TPS

c. MRS

d. MRS

e. TPS

f. MRS

g. MRS
 h. TPS

i. FRS

j. TPS

k. MRS

5. Organization Functions
6. ORGANIZATION FUNCTIONS

7. FUNCTIONAL SEGMENTATION

a. The production department’s vice president or manager should not supervise the

inventory management tasks. The production department uses the raw materials and therefore
should not have any custodial tasks over the storage of the inventory items. A separate

materials management department should handle the purchasing of inventory items and the

warehousing of raw materials. The production department may not take the time (and should not

be wasting its time trying) to investigate the best possible prices for a given quality and quantity

of goods. Further, the production department may be able to pilfer goods from the production

line if a separate department is not controlling the release of raw materials for specific job lots.

The production department should not be in charge of cost accounting. The cost accounting

department should be separate since this department tracks the costs of the production

process. If the cost accountants report to the production manager, they may be influenced to

overlook some cost items or alter the amounts to make the cost center look better. Also, the

production manager should not be in charge of payroll, he or she may have paychecks written

for fictitious employees. The sales department should not be in charge of credit approvals.

Salespeople’s compensation is typically tied to their sales figures, and thus salespeople have an

incentive to write as many sales as possible without regard to the financial stability of the

customer. Poor credit decisions may be made if the credit department reports to the sales

manager. Further, the billing department should not report to the sales manager either because

the salespeople may be tempted to issue unwarranted and unauthorized discounts to their most

valuable customers. The finance department collects and distributes cash; therefore, it should

not have custody over the accounts receivable and accounts payable. A separate accounting

function should provide a check and balance on the cash collections and disbursements.

b. A reorganization is presented in the following diagram. Two new positions have been

created: VP-Materials Management and VP-Accounting (or Controller). The VP-Finance is

a “promotion” given to the financial manager.

 8. COMMUNICATIONS

Because businesspeople were not able to adequately express their needs and much of what

they did express was not fully understood by the systems analysts, many new systems projects

produced ineffective systems. Most business students now study the development process of

information systems so they will be better able to communicate their information needs to

system personnel and have an appreciation that clear expression of the problem by the user

and better understanding of the business situation/problem environment by the system

developer will enhance a projects deployment. Either avoiding jargon or fully explaining the

terms will also help to close the communication gap.

9. CHARACTERISTICS OF USEFUL INFORMATION

Record Type Primary Key

Accounts Receivable Customer Number

Accounts Payable Vendor Number

Inventory Part Number

Customer Sales Order Sales Order Number

Purchase Orders to vendors Purchase Order Number

Cash Receipts from customers Receipt Number

Cash Disbursements to vendors Check Number

Employee Payroll Earnings records Employee Number

10. DATA ATTRIBUTES:

Accounts payable Record:

Invoice number (PK)

vendor number

amount
date due

date paid

discounts

Inventory:

part number (PK)

Description

amount on hand

unit price cost

Sales Price

economic order quantity

reorder point

Customer Sales Orders Record:

sales order number (PK)

customer number

item number

unit price

quantity

discount

date billed

date due

ship date

total (not required since it is a calculated amount)

Purchase Orders to Vendors:

purchase order number (PK)

vendor number
vendor’s part number

part number (our’s)

quantity

date ordered

date required

expected dollar amount

Cash Receipts from Customers:

cash receipt number (sequentially assigned) (PK)

customer number

invoice number

customer’s check number

amount received

date

Employee Payroll Earnings records

employee identification number (PK)

Hours worked-regular time

Hours worked-overtime

Current Gross Pay

Current federal income tax withheld

Current state income tax withheld

Current FICA tax withheld

Year to date hours-regular

Year to date hours-overtime

Year to date gross pay

Year to date federal income tax withheld

 Year to date state income tax withheld

Year to date FICA tax withheld

11. ROLE OF INTERNAL AUDIT FUNCTION

Role of Management

SOX requires management of public companies to implement an adequate system of internal controls over their

financial reporting process including transaction processing systems.

SOX requires the management to assess and annually report on effectiveness of internal controls. This

addressing the following points:

1. Understand the flow of transactions, including IT aspects, in sufficient detail to identify points at which a

misstatement could arise.

2. Using a risk-based approach, assess the design and operating effectiveness of selected internal controls related

to material accounts.

3. Assess the potential for fraud and evaluate the controls designed to prevent or detect fraud.

4. Evaluate and conclude on the adequacy of controls over the financial statement reporting process.

5. Evaluate entity-wide (general) controls that correspond to the components of the COSO framework.

Role of External Auditor:

The external auditor reviews the organization’s control structure per the COSO internal control model.

This includes the control environment, risk assessment, information and communications, monitoring, and control

procedures.

The auditor issues an opinion on control adequacy and identifies any material weaknesses in internal controls.

Role of Internal Auditor

The IA performs a wide range of activities on behalf of the organization:

including conducting financial audits

examining an operation’s compliance with organizational policies

reviewing the organization’s compliance with legal obligations

evaluating operational efficiency

detecting and pursuing fraud within the firm.

For cost reduction and efficiency purposes internal auditors often cooperate with and assist external auditors in

performing aspects of financial audits including tests of controls.

For example, a team of internal auditors can perform tests of computer controls under the supervision of a single

external auditor.

To Whom Should IA Report

The Director of Internal Audits should report to the Board of Directors Audit Committee.

When an internal audit department reports directly to a department, the internal auditor’s independence is

compromised and external auditor may not rely on evidence provided by the internal auditors.

External auditors can rely in part on evidence gathered by internal audit departments that are organizationally

independent and report to the board of directors’ audit committee.

Structure of Audit Committee

The audit committee needs to be reconstituted to be in compliance with SOX.

The audit committee serves as an independent “check and balance” for the internal audit function and liaison with

external auditors.

To be effective:

The audit committee should consist of people who are outsiders (not associated with the families of executive
management nor former officers, etc.).

With the advent of the Sarbanes-Oxley Act, at least one member of the audit committee must be a “financial
 expert.”

12. INTERNAL AUDITOR INDEPENDENCE

Response:

a. Internal auditor independence implies no subordination of judgment to another and arises from an independent mental attitude

that views events on a factual basis without influence from organizational units to which IA is subordinate.

b. i. The internal auditor’s independence is not impaired by the preparation of policy statements on internal control. The

preparation of policy statements to guide others in the development and implementation of internal controls is a responsibility

of the internal audit staff.

ii. Auditor independence is impaired to the extent that the internal auditor is involved in the design and installation of

computerized internal accounting controls being tested. Little confidence can be placed in audit findings issued by the

individual who designed and installed the system being audited.

iii. The internal auditor’s independence is impaired by reconciling bank statements. To maintain independence, the auditor

should not perform operational assignments that are included as part of the independent evaluation and verification of a proper

system of internal control. Separation of duties must be maintained.

iv. Objectivity is not impaired in the review of the budget for relevance and reasonableness if the internal auditor has no

responsibility for establishing or implementing the budget. However, the review of variances and explanations would impair

objectivity as this is an area that would normally be reviewed during an operational audit.

v. The preparation of complex accounting transactions will materially impair the internal auditor’s objectivity by involving the

auditor in day-to-day operations.

c. The Director of Internal Audits should report to the Board of Directors Audit Committee.
The independence and competence of the internal audit staff determine the extent to which external auditors may cooperate

with and rely on work performed by internal auditors. When the internal audit department reports directly to a department, such

as the controller, the internal auditor’s independence is compromised, and the external auditor is prohibited by professional

standards from relying on evidence provided by the internal auditors. In contrast, external auditors may rely in part on evidence

gathered by internal audit departments that are organizationally independent and report to the board of directors’ audit

committee.

Hall Chap 2

MULTIPLE CHOICE
1. B
2. A
3. A
4. D
5. D
6. B
7. B
8. E
9. C
10. D
11. A
12. B
13. E
14. A
15. D
16. B
17. B
18. C
19. A
20. C
21. A
22. C
PROBLEMS
1. TRANSACTION CYCLE IDENTIFICATION

a. Expenditure cycle-payroll subsystem.

b. Conversion cycle-production system subsystem.

c. Revenue cycle-cash receipts subsystem..

d. Revenue cycle-sales order processing

subsystem.

e. Expenditure cycle-purchases subsystem.

f. Conversion cycle-production subsystem.

2. TYPES OF FILES

a. master file

b. transaction file

c. reference file

d. archive file

e. master file

f. transaction file

g. reference file

h. archive file
3. SYSTEM FLOWCHART

4. SYSTEM FLOWCHART
1) System reads the Receiving Report record and matches it to the PO record using the PO

Number.

2) System verifies that quantities received were constant with what was ordered.

3) Match the Receiving Report to the Inventory Master record

4) Update the Quantity on Hand in Inventory using the Quantity Received

5) Match the Receiving report record (or the PO) to Vendor AP file record using Vendor

Number.

6) Update the AP Balance using the Total cost field in the PO Record.

6. RECORD STRUCTURES
Explanation:

1) System reads the Cash Receipts record and matches it to the AR Sub record using the

Customer Number.

2) System updates the Current Balance in the in the AR Sub record using the Remittance Date

in the Cash Receipts record.

3) System updates the Last Payment Date in the in the AR Sub record using the Remittance

Date in the Cash Receipts record.

4) System automatically accesses the Cash record in the GL File and updates Total Debits

from the Remittance Amount in the Cash Receipts record.

5) System automatically accesses the AR Control record in the GL File and updates Total

Credits from the Remittance Amount in the Cash Receipts record.

Note: Steps 4 and 5 may be accomplished in real Time or batch mode.

7. SYSTEM FLOWCHART

a. Symbol 1 is a terminal showing the source or destination of a document or report;

symbol 2 is source document.

b. Symbols 3 and 4 depict the entry of data in real time into a system from a computer

terminal.

c. Symbols 4 and 5 depict the storage/retrieval of data to/from a computer disk.

d. Symbols 6, 8, and 9 depict the processing of a source document and its placement into a

file.
8. System Flowchart

Time sheets are collected in a batch, and the relevant data are manually keyed into the

system. The payroll data are then stored on a magnetic disk. An edit program then

verifies whether the employee number is valid by checking it against an employee master

file. The validity of the cost center assigned is also verified against a master file. Logical

and clerical errors are also tested, such as an employee working an unreasonable

number of hours in a day/week. The good records, those that pass all the edit tests, are

stored in the Edited Transactions file. Records that are found to be in error are sent to an

error file. These errors are investigated, corrected, and reentered into the system. The

Update program reads the edited transaction records, one at a time, and updates any

corresponding fields in the master files. Finally, a report program generates paychecks

and management reports.

9. SYSTEM FLOWCHARTS AND PROGRAM FLOWCHARTS

Any of the following types of errors may cause a payroll record to be placed in the error file:

a. invalid employee number

b. invalid cost center

c. incorrect batch/control total that does not equal

the totals computed by the program

A program flowchart is presented below.

 10. TRANSACTION CYCLE RELATIONSHIP

11. SYSTEM FLOWCHART MANUAL SALES PROCEDURES

Solution to Problem 2-11

 Sales Department Credit Department Warehouse Shipping Department Billing Department

Customer Sales Sales Sales Shipping

Sales
Order Order Order Notice
Order
Sales Sales
Order Order

Customer Order

Ship
Bill
Customer Goods
Check Pick Customer
Credit Prepare AR
Credit Goods Update
Records Ship
AR
Notice
Prepare
Sales
Order

Sales
Sales Order Sales Shipping Shipping
Sales
Order Order Notice Notice
Order
Sales Sales
Sales
Order Order
Order
Sales
Order
Sales
Order Customer

Sales
Order

Review
and File

Sales
Order

12. SYSTEM DOCUMENTATION – EXPENDITURE CYCLE

See the drawings on this and the following page.

13. SYSTEM DOCUMENTATION – CASH RECEIPTS

14. SYSTEM DOCUMENTATION PAYROLL

See drawings on the following pages.

15. SYSTEMS DOCUMENTATION – PAYROLL

See the data flow diagram, ER diagram, and flowchart on the following pages.
16. SYSTEM DOCUMENTATION – REVENUE CYCLE

Sales Department Shipping Department Billing Department

Customer SO SO A

SO
Customer SO
SO SO
Order SO

Prepare Pick T
Sales Goods
Order and Ship
Add
Prices
and
SO
SO Taxes

SO SO

SO SO SO
SO Record Sale
SO
SO

SO Sales
Journal
SO
SO
SO
SO
Customer

A
B C
Problem 2-16 Flowchart Page 1
rtment Inventory Control Department Mail Room Cash Receipts

D C Customer Check

Remit SO
Check Record
Advice
Cash
Remit Receipt
Advice
Cash
Receipt
Journal
Update
Inventory Open
Mail and
Inventor distribut
AR Sub ed Dep
SO Slip
Dep
emit Slip
dvice Check Check

Remit
Advice

Bank

Problem 2-16 Flowchart Page 2

17. SYSTEM DOCUMENTATION EXPENDITURE CYCLE

Purchasing Department Data Processing Center Receiving Department

A
PO
Inspect Good
PO and Review PO

Inventory
Purchasing
System
Review Rec Rept
and Sign PO File
PO Rec Rept
PO
Rec Rept
PO
SO Stores

SO Purchases
Check Journal

Check
Supplier AP Sub

B
CD Journal

Problem 2-17 Flowchart Page 1

Accounts Payable Cash Disbursements Dept

B
Supplier

Check
Invoice
Check
A

Review and Review

Reconcile and Sign
Checks

Check
Check
Copy

Supplier

Problem 2-17 Flowchart Page 2

 PO 1
File

Review PO 1, 2
Review and sigh PO2
Inventory and
PO Supplier
prepare PO

Stores
Inventory
Check
Rec Rept File
PO File Receive and
inspect Goods Rec Rept
CD
File
Update Journal
Inventory

Review AP for
Post to AP and Item Due and Review, Sign,
Rec Rept
record in Purch prepare Check Distribute Check
Record Check 1,2
Journal

Invoice AP
Ledger
Purch
Journal

Supplier
Problem 2-17 DFD

18.
Solution to Problem 2-18 – Cash Receipts Centralized DP System
 Cash Receipts System Flowchart

Mail Room Cash Receipts Accounts Receivable Data Processing Controller Office
Department Department
Customer B
Remittance C Bank
Check
Advice
Remittance
Remittance Cash
List
List Receipt
System
Check A Remittance Deposit
List
Remittance
Advice Cash Receipt
Prepare Check and B Update AR
Journal
Record in Journal Balance

Perform
AR Sub
Open Envelop and Remittance Reconciliation
Check Remittance Ledger
Reconcile Check List
and Remittance Advice
Deposit
Remittance
List
Deposit Remittance
C
List
Deposit
Deposit
Check

Remittance
List File
Remittance
Advice Bank
File
Remittance
List Copy

File

19.

Solution to Problem 2-19 Purchases System Centralized Data Processing

 Data Center Receiving Department AP Department

Vendor Vendor

Inventory A

Packing Slip Invoice

Purchases
System
Inspect and Review and
A
Record Record AP

Purchase
Purchase
Order
Order
Packing Slip Invoice

Receiving
Report Vendor

Vendor
Invoice

Accounts
Payable

20. SYSTEM DOCUMENTATION CASH DISBURSEMENT

 Solution to Problem 2-20, Cash disbursement Procedures (Centralized DP)

Data Center AP Department Cash Disbursement Department

Accounts
Payable A Vendor

Invoice
Purchases
System

Review and A
Review Items Due
Purchase Record AP
Order

Cash
Check Invoice Disbursement
Receiving Summary
Report

Vendor Vendor
Invoice

Cash
Disbursement
Journal

21. CODING SCHEME

101.0 Cash

102.0 Accounts Receivable

103.0 Office Supplies Inventory

104.0 Prepaid Insurance

105.0 Inventory

121.0 Investments in Marketable Securities

131.0 Delivery Truck

131.5 Accumulated Depreciation – Delivery Truck

132.0 Equipment

132.5 Accumulated Depreciation – Equipment

133.0 Furniture and Fixtures

133.5 Accumulated Depreciation – Furniture and Fixtures

134.0 Building

134.5 Accumulated Depreciation – Building

135.0 Land

201.0 Accounts Payable

202.0 Wages Payable

203.0 Taxes Payable

221.0 Notes Payable (Long-term)

222.0 Bonds Payable

301.0 Common Stock

302.0 Paid in Capital in Excess of Par

311.0 Treasury Stock

390.0 Retained Earnings

401.0 Sales

401.5 Sales Returns and Allowances

420.0 Dividend Income

501.0 Cost of Goods Sold

501.0 Wages Expense

521.0 Utility Expense

522.0 Office Supplies Expense

531.0 Insurance Expense

541.0 Depreciation Expense

551.0 Advertising Expense

561.0 Fuel Expense

571.0 Interest Expense

22. CODING SCHEME

The following scheme uses group codes with alphabetic and numeric data since they can be used to

categorize information in a hierarchical form.

Left or right

Warehouse Aisle Side of Aisle Shelf Bin

1 C L 5 08

Thus, code 1CL08 represents the above. 2AR415 represents inventory in warehouse #2, aisle A,

right side of aisle, shelf 4, bin #15.

23. FLAT FILE VS DATABASE MODEL

The problems with flat files that are resolved by Database technology include:

Data Storage --- Flat files result in considerable data redundancy and storage problems
Data Updating -- When users keep separate files, all changes must be made separately for

each user. This adds significantly to the task and the cost of data management.

Currency of Information -- If update information is not properly disseminated, the change will

not be reflected in some users’ data, resulting in decisions based on outdated

information.

Task-Data Dependency -- The user’s information set is constrained by the data that he or she

possesses and controls

Flat Files Limit Data Integration -- The flat-file approach is a single-view model. Files are

structured, formatted, and arranged to suit the specific needs of the owner or primary

user of the data.

24. ACCESS METHODS

a. indexed sequential or indexed random; least optimal: sequential

b. indexed random or hashing; least optimal: sequential

c. sequential; least optimal: indexed random

d. sequential or pointer; least optimal; indexed random

e. indexed random or hashing; least optimal: sequential

f. indexed random or hashing; least optimal: sequential

g. indexed random; least optimal: hashing

25. FILE ORGANIZATION

a. A sequential file could be used, but with only eight updates per month, in charge of
 utilities.

b. Random access for customer balances and payment information is crucial. A network or

relational database is necessary since this is a many-to-many relationship: many

purchases per customer, many merchants per customer, many customers per merchants.

c. Random access will be necessary for flight inquiries and updates throughout the day. A

navigational database would be appropriate. Only one direction needs to be investigated.

Most customers start with a departure city and then flights to the destination city can be

investigated. Many different destinations will exist for a given departure city. Rarely will a

customer wish to book a flight based on a destination where they do not know from which

city they will depart.

d. A random access storage device is necessary to access the students’ records quickly

when they check out books. A network or relational database will be necessary since the

data should be bidirectional. An investigation may need to be conducted to determine what

books a student has checked out or an investigation may need to be conducted regarding

who has a certain book checked out that has been recalled.

Hall Chap 3

MULTIPLE CHOICE
1. D

2. C

3. A

4. B

5. B

6. C

7. C

8. A

9. D
10. B

11. A

12. B

13. C

14. B

15. D

16. C

17. C

18. C

19. B
PROBLEMS
1. FRAUD SCHEME: City Health Inspector

This is an example of economic extortion.

Frauds of this sort are difficult to detect because of the absence of records. Management and
auditors need to take a proactive approach to uncover such activity. The following techniques
may be used:
a. The Health Department should have a publicized policy against such abuses that are signed

by the inspectors.

b. An independent audit function should be in place that formally investigates any accusations

of extortion.

c. If auditors suspect that economic extortion may exist, hard evidence can be obtained through

“sting” operations.

2. FRAUD SCHEME: purchasing agent

This is an example of conflict of interest.

Controls used to prevent or detect this fraud include:

a. The Hardware Company should establish a formal policy stating its position on business

transactions that are not “arms-length” transactions. If such transactions are to be permitted,

they should be formally and explicitly declared by the employees and approved by management

prior to any transactions.

b. The organization should establish a valid vendor file, which is a list of approved suppliers.

No transactions (particularly disbursements of cash) are to be permitted with suppliers that are

not on the list without formal management approval.

c. Independent verification of transactions through management reports could be used to

identify unusual business patterns and material changes in accounts. For example, a report
 could summarize transaction volumes to vendors and analyze relevant financial ratios such as

cost-of-sales to sales across periods.

3. MAIL ROOM FRAUD AND INTERNAL CONTROL

a. After a month the customers whose accounts were not updated will be complaining

when they receive their bills.

b.

1. Supervision—cut down on the span of control of the supervisor.

2. Set up a separate, smaller mail room responsible only for collecting cash.

3. Perform background checks on all employees.

4. SEGREGATION OF DUTIES

a. These two tasks need to be separated. Having the responsibility for writing off bad debts (asset-

accounts receivable) and reconciling accounts receivable with the general ledger control

account assets creates the potential for fraudulent behavior.

b. These two need to be separated since the individual having authority for creates the

potential for fraudulent behavior.

c. In neither case does the employee have access to the assets; therefore no danger

exists.

d. These two tasks do not need to be separated since the two tasks are independent of one

another.

e. These tasks should be separated. The employee records the transactions and has

access to assets. To allow the employee to verify the accuracy of the records would

allow him or her to cover up any money embezzled by doctoring the bank reconciliation.

5. EXPENSE ACCOUNT FRAUD

a. Control Procedures:

All checks should require the treasurer’s signature (transaction authorization).

An individual who is dispersing cash should not also be reconciling the cash account

(segregation of duties).

A bonding agency can be used to verify employee integrity through background checks

(supervision).

The internal auditors should perform a periodic review of expense accounts, which are

frequently used to offset fraudulent transactions (accounting records).

b. Ethical Issues:
 Apart from the obvious lack of ethical standards by Mary Boghas, the ethical behavior of

Swindle, Fox, and Kreip also comes into question. They had received numerous checks

drawn upon the bank account of the Petty Corporation in payment of Mary Boghas’s legal

fees.

6. Segregation of Functions
a. Sales manager has the power to authorization as well as record keeping.
Risk -- manager may approve credit to a friend’s or relative’s business and then write off the
account as bad.
b. Warehouse clerk has custodial responsibility as well as record keeping responsibility.
Risk -- clerk may steal inventory and use his record keeping authority to adjust the inventory
records to hide the theft.

c. No risks due to combining these tasks.

Billing clerk is responsible for recording sales in the sales journal after they have been shipped

to the customer

d. Foreman has authority to authorize time cards and also has asset custody (the employee pay

check).

Risk -- supervisor may submit a false time card for a terminated or non-existent employee and

then keep the paycheck that results.

e. Accounting clerk both records transactions and verifies the accuracy of the recording.

The Risk -- the accounting clerk may conceal errors or cover up balances that do not equal

because of embezzlement of funds.

7. FRAUD MOTIVATING FACTORS

a. Examples of situational pressures in a public company that would increase the likelihood of fraud

include:

Competitive pressures.

Excessive expectations for financial targets.

Penalties for not meeting budget targets.

Sudden decreases in revenue or market share.

Payment with stock options or other bonus programs that depend on short-term economic

performance

b. Opportunity situations that would increase the likelihood of fraud include:

Weak or nonexistent internal accounting controls.

Accounting estimates requiring significant judgment by company management.

Poor segregation of duties.

Absence of policies that limit collusion, such as nepotism rules.

8. FINANCIAL AID FRAUD Segregation of Functions Control:

The tasks in the financial aid process are performed entirely by Mr. Jones. As a minimum, the
following tasks should be performed by separate individuals:
 Receipt of applications

 Approval of applications

 Check processing

 Distribution of check to recipient (by mail or direct deposit)

Independent Verification Control:

 Financial information presented in financial aid applications should be verified through credit

agencies.

 Prior to awarding any grants, the financial aid department should verify that the student is still
 enrolled and in good standing.

 The internal auditor should periodically confirm the receipt of cash awards with the financial aid

recipients.

9. KICKBACK FRAUD

Preventive Controls

 Implement an organization policy prohibiting kickbacks.

 Establish a code of ethics within the organization that outlines the boundaries of unethical

behavior. Require all employees to sign the code.

 Establish a list of valid vendors from whom the agent must place orders for merchandise.

Orders from vendors not on the list must be formally approved by the agent’s supervisor.

Detective Controls

 Prior to making payment to the vendor, the amount to be paid should be compared to the

amount expected (based on historic data) to determine its reasonableness.

 Prior to making payment, the authenticity of the vendor should be verified against the valid

vendor file.

Corrective Controls
 Discrepancies detected above should be evaluated by an independent manager before

payment to the vendor is authorized.

 If it is found that the purchasing agent violated the code of ethics or company policy,

appropriate disciplinary action should follow. This may include, censure, suspension,

dismissal, or even possible criminal charges.

10. Assessing Internal Control: cash receipts procedures

1.

a) Weakness: Mailroom clerks have access to checks and remittance advices.

b) Risk: The mailroom clerks could steal the check and destroy the remittance advice -- no
 record of transaction

c) Control: Require the cash receipts to be sent to a separate PO box a separate room. This

smaller amount of similar mail can be better controlled though supervision.

2.

a) Weakness: The AR clerk receives checks and remittance advices from the mailroom

supervisor.

b) Risk: The AR clerk has access to both asset and records. The clerk could steal the check

and destroy the remittance advice to eliminate any record of the cash receipt.

c) Control: Prepare remittance list in the mailroom. Any loss or theft of checks after they

are recorded on the remittance list would result in a discrepancy between the remittance

list and the checks that are deposited in the bank.

3.

a) Weakness: The AR clerk has responsibility for recording cash and updating the customer

accounts from the checks (asset).

b) Risk: The clerk could engage in a lapping fraud.

c) Control: Segregation of duties is needed to separate the tasks of recording accounts

receivable and receiving cash receipts.

11. Assessing Internal Control: cash disbursement procedures

1.

a) Weakness: Clerk sets up a liability based solely on the vendors invoice.

b) Risk: The company may be paying for things it did not order, did not receive, or is paying too

high a price.

c) Control: The clerk should perform a three-way-match of the purchase order, receiving
 report, and invoice to verify that the liability is legitimate and correctly stated.

2.

a) Weakness: AP clerk authorizes the liability and writes the check to pay it.

b) Risk: The clerk could create a false vendor, set up a liability and disburse funds (see

payments to fictitious vendors, chapter 12),

c) Control: Segregation of duties between the tasks of authorizing a liability and check writing.

a) Weakness: AP clerk has access to both the AP subsidiary ledger and the general ledger.

b) Risk: Balancing general ledger control accounts with corresponding subsidiary ledgers, can

help detect certain types of errors and irregularities.

This control is lost when the same individual is responsible for updating both accounts.

c) Control: Segregation of duties between the general ledger function and other accounting

functions.
12. Evaluation of Internal Controls: The Never Sink Canoe (NSC) Company

Segregations of Duties Issues

Control Weakness 1: Transaction authorization should be separated from transaction
processing. The sales person both authorizes the sale by approving the credit worthiness of the
customer and processes it.
Fraud Potential: Sales person can approve sales to customers with poor credit to increase
his/her commission.
Recommendation: NSC should implement a formal credit approval process that is
independent of the sales person.

Control Weakness 2: Asset custody should be separate from record keeping responsibility.
The accounting clerk has cash receipts and check writing responsibility and also sets up AP and
AR accounts and updates those accounts.
Fraud Potential:
1) The clerk could create a false (or overstated) AP account for a sales person or for the clerk
and then write the check.
2) The clerk could establish a lapping fraud with accounts receivable payments.
Recommendation: NSC should separate the cash receipts and disbursements from the
recording of AR and AP functions.

Control Weakness 3: Asset custody should be separate from record keeping responsibility.
The warehouse clerk has custody of inventory and record keeping responsibility for the
inventory subsidiary ledger.
Fraud Potential: The clerk could remove inventory from the warehouse, sell it, and cover the
theft by adjusting the inventory records.
Recommendation: NSC should separate the task of updating the inventory records from the
warehouse function.

Accounting Records Issues

Control Weakness: Adequate source documents, journals, and ledgers need to be in place to
form an audit trail. Sales staff should submit receipts for travel expense reimbursements.
Fraud Potential: Sales staff need only submit a form to claim reimbursement but no proof of
the actual expense. They can thus “pad” their expenses. Recommendation: NSC should
require the submission of receipts for all expenses above a pre-specified dollar amount. (e.g.
$25.00)

Independent Verification Issues

Control Weakness: Verification procedures are checks on the accounting system to identify
errors and misrepresentations. No verification procedures exist at NSC to review sales
commissions or expense reimbursements.
Fraud Potential: The fraud potential has been previously discussed regarding commissions
and expense padding. Knowing that these activities are not reviewed my management would
only embolden someone with the intent to commit fraud.
Recommendation: NSC should implement procedures to review commissions and expenses
transaction for reasonableness.
13. Documenting System and Evaluating Controls

a. Flowchart of Process
 b. The following segregation of functions problems exist:

1. The warehouse clerk has (asset custody) and is responsible for updating the inventory

subsidiary ledger (record keeping).

2. The clerk determines what should be ordered (authorization) and the places the order

(transaction processing).

c. The following frauds could result from these control weaknesses:

1. Kickback fraud— The clerk selects the supplier and also places the order. He is thus in position

to order inventory that is not needed or that is above market price from a supplier with whom he

has a personal fraudulent arrangement. In exchange, the supplier pays a kickback to the

warehouse clerk.

2. Vendor fraud—the clerk authorizes, orders, and receives the goods; he could establish himself

as a vendor and process fraudulent transactions.

3. Theft of inventory—the clerk can remove inventory from the warehouse, sell it, and adjust the

inventory records. A reconciliation between the physical inventory on hand and the records

would indicate no discrepancies.

14. Analysis of Flowchart, Internal controls

a)

 Segregation of Duties: The clerk is responsible for cash receipts and recording accounts

receivable.

 Segregation of Duties / Accounting Records: The clerk has access to both the subsidiary

ledger and the general ledger.

 Independent Verification. The clerk deposits funds in the bank and also preforms the bank

reconciliation function.

b) The following possible fraud could be committed:

Skimming: The clerk steal the check and destroy the deposit slip to remove any trace of the

transaction.

Cash Larceny: The clerk can implement a lapping scheme because she has access to both

cash receipts and AR records.

Cash Larceny: Clerk can write off customer account receivable as a bad debt and keep the

customer checks.
15. Evaluating Internal Controls: Warehouse manager

a) Flowchart
 b. The following segregation of functions problems exist:

1. Mirchandaniis is the warehouse manager (asset custody) and is responsible for updating the

inventory subsidiary ledger (record keeping).

2. Mirchandaniis determines what should be ordered (authorization) and the places the order

(transaction processing).

c. The following frauds could result from these control weaknesses:

1. Kickback fraud—Since Mirchandaniis selects the supplier and also places the order, he could

order inventory that is not needed or that is above market price from a supplier with whom he

has a personal fraudulent arrangement. In exchange, the supplier pays a kickback to the

warehouse manager.

2. Vendor fraud—Mirchandaniis authorizes, orders, and receives the goods; he could establish

himself as a vendor and process fraudulent transactions.

3. Theft of inventory—Mirchandaniis can simply remove the assets from the warehouse, sell them,

and adjust the inventory records. A reconciliation between the physical inventory on hand and

the records would indicate no discrepancies.

16. EVALUATION OF PAYROLL CONTROLS

a. flowchart 3–16.
b. The following segregation of functions problem exists:

Foreman authorizes the transaction (signs and submits timecards) and has asset custody

(he distributes the checks to employees).

c. The following frauds could result from these control weaknesses:

i. Kickback fraud—the forman permits employees to inflate the hours worked and approves

payment. The employee then splits the excess pay with the supervisor as a kickback.

ii. Nonexistent employee fraud—After an employee leaves the company, the formeman

continues to submit timecards for him. When the paychecks are distributed by the forman, he

keeps the ones for the terminated employees and cashes them by forging their name.

17. EVALUATION OF CONTROLS

a) Mary Jane’s dedication to her job from which she has not taken a vacation in many years is

a red flag that she may be engaged in something illegal. This concern is reinforced by her

job description, which combines several incompatible tasks:

 Segregation of Duties: Mary Jane is responsible for recording both accounts receivable and

cash receipts.

 Segregation of Duties / Accounting Records: Mary Jane has access to both the AR subsidiary

ledger and the general ledger accounts.

b) The following possible fraud could be committed:

Skimming: Mary Jane could steal check and write off customer account receivable as a bad

debt.

Cash Larceny: Mary Jane could implement a lapping scheme because she has access to both

cash receipts and AR records. The complex accounting procedures needed to manage

such a scheme would require her to not take a vacation for fear that a replacement clerk

would uncover the fraud.

c) Controls need to reduce the risk of fraud are:

Implement a policy that all employees must take a vaction each year.
Separate the task of AR record keeping and cash receipts processing

Separtate the tasks of posting to the general ledger from the tasks of updating subsidiary ledgers,

18. Input Validation

a Alphabetic check—validates that letters are entered where only letters are required to

be entered e.g., employee name.

b Validity checks—validates that only authorized values are entered, e.g., employee or

social security numbers.

c. Numeric check—validates that only numbers are entered where only numbers are

required, e.g., social security number.

d Range Check

e Validity —only acceptable values are “S”, “M”, or “D”. or other values will be detected.

f. Reasonableness checks—validates that only data within a pre-specified range is

entered, e.g., number of dependents does not exceed normal range

g Validity check

h. Limit check

i. Limit check
19. APPLICATION CONTROLS

Application controls are classified as (1) input controls, (2) processing controls, and (3) output controls.

Control Category Specific Controls Contribution to Data Reliability

Input controls Check Digit Ensures that account numbers are

correct

Identifies missing data required for

Missing Data Check
processing.

Identifies field values that are

Limit Check
outside the acceptable limit.

Processing controls Batch controls The objective of batch control is to

reconcile system output with the

input originally entered into the

system to ensure nothing is lost or

corrupted during processing.

Run-to-run controls Run-to-run controls use the values

in the batch control record to

monitor the batch as it moves from

one programmed procedure (run)

to another.

Output controls Report distribution Ensures the reports reach the

intended user only.

Controls over aborted reports and

Waste control
other output that may contain

sensitive data.
20. INPUT CONTROLS SALES ORDER SYSTEM

Phone Orders:

New Customers – assign a customer number and add to the customer master file

Existing customers

Validity check to verify Customer Number in the customer file

Miissing data check to verify that all required fields such as name, address, and zip code have

been entered.

Numeric check to verify the credit card data are entered correctly. Once the order is totaled,

authorization with the credit card company will be provided on-line. The creditcard company will

perform a check-digit test to verify the account number of the customer.

Validity check to verify correctness of the inem number(s) of the item(s) ordered anaginst the

inventory inventory master file.

E-Mail Orders
Calculate batch control numbers including:
Control number for the total dollar value of the batch
Hash total of a nonfinancial field such as order number
Record count
Date
Once the batch has been entered for processing the input controls described for phone orders
would apply for these records also.

Hall Chap 4

MULTIPLE CHOICE

1. C

2. A

3. A

4. C

5. B
6. D

7. C

8. E

9. A

10. D
PROBLEMS

1. System Description and Internal Controls

a. Prepare a flowchart of the cash receipts procedures described

b. Describe the risks, if any,that are inherent in the current system configuration.
1) Risk of Cash misappropriation in mailroom fraud (skimming)

2) Risk of cash misappropriation by skimming, lapping, or other forms of larceny in the AR

department

3) Risk of incorrect record keeping in the AR Department

c. Describe the controls, if any, that are needed to reduce or eliminate the risks identified in (b)

above.

1) Supervision in the Mailroom is inadequate with one supervisor overseeing 40 clerks. This span of

control can be reduced by having customers submit their payment to a separate POX address.

The US mail service will then pre-sort and separate cash receipts from the general mail. The

smaller number of cash receipts can then be processed in a smaller mailroom area where fewer

clerks who work exclusively with cash receipts can be more effectively supervised.

2) A remittance list should be prepared under supervision in the mailroom.

Remittance Checks should be separated from remittance advices in the mailroom and not go to the

AR department.

3) The AR department should not have access to general ledger accounts.

2. INTERNAL CONTROLS AND FLOWCHART ANALYSIS

 No credit check is performed.

Billing clerk should not record sales in the Sales Journal before the economic event

(shipping the goods) has occurred.

 Billing department bills customer before the goods are shipped and without
 confirmation of shipment and quantity shipped. A shipping notice should trigger the

billing process.

 Warehouse clerk, who controls the physical inventory, should not also maintain the

inventory subsidiary records.

 Warehouse clerk updates the Inventory subsidiary ledger and the GL Inventory

Control.

 Accounting clerk updates AR subsidiary, and various GL accounts.

IT Controls for a centralized integrated system should include:

3. FLOWCHART ANALYSIS

a. Cash prelist or remittance list

b. Cash Receipts department

c. Post to Cash Receipts Journal and deposit checks

d. Bank
e. Cash Receipts Journal

f. Accounts Receivable Department

g. Update AR

h. Accounts Receivable file

4. SEGREGATION OF FUNCTIONS

All are proper segregation of functions except b. The sales department should not be allowed to

approve credit memos since it could potentially overstate sales in one period to meet quotas

and boost bonuses and reverse them in a subsequent period. The receiving report indicating

that goods have been received by the receiving department should be the source document for

credit memos and it should be authorized by someone independent of the sales department.

5. RISKS AND INTERNAL CONTROLS

Risks Control Weaknesses

Sales to un-creditworthy customers Sales clerk approves credit

Inaccurately recording the sales transactions in Sale is recorded when the sales clerk takes

journals the order rather than after it is shipped.

Misappropriation of cash Accounting department clerk has access to

the cash, the remittance advice, the AR sub

– ledger, and the General ledger.

Opportunity for embezzlement such as

lapping

Mailroom span of control is wide (32

employees) for a single supervisor. This

inhibits close supervision. The mailroom

clerks, with access to the cash and

remittance advices, have an opportunity to

commit mailroom fraud.

Warehouse / shipping are combined allowing

Shipping customers the wrong items for no reconciliation between what is picked

and what is ordered and shipped.

Warehouse clerk has custody of inventory

and the inventory sub - Ledger

Misappropriation of inventory
6. INTERNAL CONTROL EVALUATION

A)   Sales clerk should not record sales in the Sales Journal before the

economic event (shipping the goods) has occurred. Billing should perform this

role.

 No credit check is performed.

 Billing department bills customer before the goods are shipped and without

confirmation of shipment and quantity shipped. A shipping notice should trigger the

billing process.

 Accounts Receivable should not process cash receipts and maintain the AR

subsidiary records.

 Warehouse clerk, who controls the physical inventory, should not also maintain the

inventory subsidiary records.

 The general ledger department should receive journal vouchers and account

summaries from AR, Cash Receipts, Billing, and Inventory control. Instead they

inappropriately use source documents to update GL accounts.

B)

The IT controls in a basic technology system such as this include the following:
7. STEWARDSHIP

a. Customer open order file Sales

b. Sales journal Billing

c. Journal voucher file General Ledger

d. Cash receipts journal Cash Receipts

e. Inventory subsidiary ledger Inventory Control

f. Acct Rec subsidiary ledger Accounts Receivable

g. Sales history file Sales

h. Shipping report file Shipping

i. Credit memo file Sales

j. Sales order file Sales

k. Closed sales order file Sales

8. CONTROL WEAKNESSES

a. Elaine performs many incompatible tasks. She opens the mail, deposits all cash and

check receipts, and keeps the accounts receivable records. She could easily keep

checks and alter the accounts receivable to cover her theft. Furthermore, she records

the bills, so she could potentially bill a customer, not record it in the books and keep

the money when the check is received. Even more troublesome is the fact that she

handles the point of sale receipts and prepares the daily deposits, which are a

substantial amount of sales (30%). Elaine never takes enough vacation time where

anyone else can perform her duties long enough to check the books. The employee

who handles the inventory and accounts payable function also has incompatible

tasks. This employee could be making payments to a family or friend for inventory

not received. The employee who handles all receipts, stocking, and shipping of

inventory is also performing incompatible tasks and could be pilfering some

inventory as it comes in and shipping it to him or herself.

b. Close supervision is needed for the employee working in the receiving, stocking, and

shipping department. This employee needs to be kept from stealing inventory. Close

supervision should help this aspect. Prenumbered shipping forms which must be

accounted for may deter this employee from shipping any goods to him or

herself or friends. The accounting function should be redistributed

among the remaining two employees and close supervision should be

exercised at one time. One possible reallocation of tasks would be:

 Employee 1 Employee 2

record point of sale receipts prepare the daily cash deposits and

reconcile to daily cash sales

update the accounts receivable account open the mail and make a list of all

records incoming checks; prepare deposit

prepare the bills for accounts receivable accounts payable

inventory general ledger

purchasing

payroll

This system is not perfect and close supervision is important.

9. INTERNAL CONTROL

Iris needs to consider whether she wishes to purchase one microcomputer system or three.

Assuming that she only wishes to purchase one microcomputer for the central shop, she should

definitely consider an accounting software package that has an accounts payable and general

ledger module. The purchase of a payroll module will depend upon the number of employees

paid each period. Iris will need to determine if the time saved is worth the cost. The payroll

module may also help with year-end forms such as W-2s and 1099s. Iris may also wish to

consider centralizing the purchasing function in order to obtain quantity discounts by placing

larger orders. If she wishes to do this, an inventory control module may be appropriate. As the
system is currently designed, Iris has no good way to determine whether the managers are

purchasing the right mix of inventory items, nor whether they are being used efficiently. Floral

shops, because of the perishability of inventory and need to respond to unexpected orders

suddenly, may not lend themselves to centralized purchasing and/or centralized inventory

control.

If Iris wishes to purchase a computer for each store then, in addition to the modules discussed
above, she should consider purchasing software that can process point of sale transactions and
balance the cash receipts at the end of the day. Inventory control software, which helps to track
the profitability and spoilage of certain items as well as to aid the managers in their purchasing
decisions, might be considered. The system could then provide summary reports for Iris so that
she may examine the inventory purchasing and usage decisions of the managers. The cash
receipts should provide better management over cash receipts due to errors than a manual
system, and if the correct controls are included, then control may increase. For example, a
notice might be placed over the cash register that states “If you do not get a receipt from the
computer, your order is free.” The information system then will cut down on the possibility that a
customer may pay cash and the employee or manager keeps the money and never rings up the
sale.
Iris may be able to find software specifically designed for florists. She should examine them to
see if they will suit her partially decentralized management. With the correct system, Iris should
see increased control over cash receipts and maybe even over inventory purchases and usage.
A disadvantage is that the managers may feel that they are being watched more closely and this
may cause some resentment.

10. INTERNAL CONTROL

a) Prepare a POS system flowchart for a restaurant (see following page)
b) Describe the risks inherent in the system and the physical and computer controls needed to
mitigate the risks.
Risk: Data input errors
Control: Input control edits to detect clerical errors and invalid entries

Risk: Theft of Cash through Coupon fraud. An employee should not be able to ring up a sale at
the coupon price for a customer without a coupon, then charge the customer full-price and keep
the difference.
Control: The manager should reconcile physical coupons with the number of coupons entered
into the system.

Risk: Theft of Cash through access to cash register

Control:
Supervision over the cash drawer by the manager.
If possible each cash register should be assigned to only one cashier during a shift.
The internal tape should be reconciled with the cash drawer at the end of the shift. The
flowchart provided shows the procedures for reducing employee theft of cash received.

Risk: Direct theft of food by employees and employees theft by giving away free food to friends
and relatives.
Control: The system should track all food items recorded as sold and the related waste and
compare with the materials used.
11. CONTROL WEAKNESSES AND RELATED RISKS

Refer to the system flowchart in the figure labeled Problem 11 in the text.

a. Discuss the uncontrolled risks associated with the system as currently configured.

1) Risk of Cash misappropriation in mailroom (skimming) by clerk1 and clerk2 before

the remittance list is prepared.

2) Risk of cash misappropriation by lapping or other forms of larceny in the AR

department.

3) Risk of incorrect record keeping in the AR Department

b. Describe the controls that need to be implemented into the system to mitigate the

risks in (a) above.

1) Supervision over opening checks in the mailroom.

2) Remittance list should be prepared as soon as possible after the envelopes are

opened.

3) Checks should be separated from remittance advices in the mailroom and not go

to the AR department.

4) Segregation of duties. The AR clerk should not be responsible for receiving

checks and depositing them into the bank.

5) AR clerk should not have access to the general ledger accounts.

12. CONTROL WEAKNESSES AND RELATED RISKS

Refer to the system flowchart in the figure labeled Problem 12 in the text.

Required;
a. Describe the control weaknesses depicted in the system flowchart.

1. Sales clerk approves credit and processes the sales order

2. AR Clerk has Access to both the AR –Sub Ledger and the AR-Control account in

the general ledger.

3. Billing Clerk is billing the customer and recording the sale based on the sales

order without evidence that the goods were shipped.

4. The warehouse clerk has access to the inventory and the inventory sub-ledger.

5. Shipping clerk does not prepare a shipping notice to notify the billing function the

goods were shipped

b. Discuss the risks associated with the control weaknesses in identified (a) above.

1. Risk of selling to un-creditworthy customers is increased when the sales clerk

also approves credit.

2. Independent verification between the AR sub ledger and the AR Control is lost

when the AR clerk also updates the GL. This increases the risk that transactions will

be incorrectly recorded.

3. The billing clerk runs the risk that sales transactions will be recorded in the

wrong period because he or she does not know when the products are shipped to

the customer. Transactions that occur towards the end of the period are at risk

since the order may occur in one period and the actual shipment takes place in the

subsequent period.

Also, since no shipping document is produced, the billing clerk does not know the

actual quantity shipped and may bill the customer for items on back order. This

situation increases the risk that customers will be incorrectly billed.

 4. The risk of inventory misappropriation is increased by allowing the warehouse

clerk to also maintain the inventory subsidiary ledger.

5. Failure to prepare a shipping notice increases the risk of transaction recording

errors. See 3 above for details.

INTERNAL CONTROL CASES

1. Solution Smith’s Market

a), b) See diagrams on the following pages.

c) Internal Control Weaknesses

1) Access to the cash drawers by sales clerks requires more accountability. Each drawer is
accessed by various clerks throughout the day and cash may be withdrawn by any of them.

2) The internal cash register tape should be used as a control to determine how much cash
(including checks, and credit card vouchers) should be in the register drawer.

3) The shift supervisor does not sign for the specific amount of cash received or returned at
the end of the day. He simply logs the drawers in and out.

4) The treasury clerk is unsupervised in the counting of cash.

5) The treasury clerk has asset custody and responsibility for recording sales and cash in the
journal and General Ledger.
d)
 Credit Card Check
Customer Credit

Sales
Approval

Cash or Check Process

Sale Cash, Check,
Credit Card
Receipt
Sales
Cash Receipt, Credit Card Receipt Journal
Signature Log, Count,
Record and
Total Sales
Cash Deposit
Amount
In/Out Log
General
Ledger

Deposit
Bank Slip
Cash, Check,
Credit Card File
Receipt and
Deposit Slip
Smith’s Market Sales Order DFD
 Customer Sales and Check Out Treasury Cle

Sh
Bank Card
Cash / Super
Company
Check 3
Credit
Signs
Card Process 1
Cash In
Sale and Out

Cash / Cash
Credit Check In/Out
Card Credit Log
Card
Receipt Count,
Record, and
Deposit cash
2

Deposit
Shift Slip
Supervisor 5

Cash /
Check
Credit
Card
Depo
Smith’s Market Sales System Slip
Flowchart
2. Solution to Tight Lines Fishing and Camping

a, b, and d, see pages that follow

c) Internal Control Weaknesses. The following tie to the numbered circles on the flowchart.

1) The sales clerk performs the credit check this is a segregation of duties and transaction authorization
problem.

Risk: Clerk may grant credit to non-creditworthy customers

2) Warehouse should not update the inventory subsidiary and General ledger control accounts. Multilevel
security controls are needed to provide a separation of duties.

Risk: Clerk could steal inventory, adjust the subsidiary ledger, and adjust the GL control account to cover the
theft.

3) and 7) AR Clerk should not update the general ledger.

Risk: The ability to reconciliation the AR Sub Ledger and the AR Control account is diminished when both are
updated by the same person.

4) Billing and AR are combined.

Risk: This structure will mask discrepancies between what was billed and what was recorded as a sale.

5) Supervision is needed in the mailroom.

Risk: Employees who open the mail have access to both cash and the remittance advice. This increases the
risk of mailroom fraud through skimming.

6) The cash receipts clerk has access to the assets (cash) and is responsible for updating the general
ledger.

Risk: The clerk could steal cash and adjust the cash account to cover the theft.
Customer 20
Update A/R Subsidiary
A/R Ledger
Subsidiary
Remittance Advice 19 Remittance Ledger
& Remittance List Reconcile Advice
Check &
14 Docu-
Remittance
Prepare ments 21
Advice
Remitt- Update
ance General General Ledger
Lists Ledger

Checks &
Remittance
List

15 Signed Checks & 16 Signed Checks &

Reconcile Remittance List Prepare Deposit Slips
Bank
Docu- Deposit
ments Slip

Cash Receipts
Information

17
18
Update
Update
Cash
General
 Computer
Sales Operations Warehouse Shipping

Customer Inventory Printer

Records Credit A
History Stock
Release

Customer Stock
Credit & Release
Order
Inventory Printer
Check

Reconcile
Terminal Goods & Packing
Docs. Slip
Approved Pick Raw
Sales Orders
Mats. &
A Make Stock
Goods Release
Packing
Slip

Update
Records Stock
Release Bill of
File Lading 2
Bill of
A/R Subsidiary Lading 1
Inv. Subsidiary Ledger
Ledger

Sales
Journal
General Ledger

Carrier

Customer Manage.
Invoice Reports

Customer Management

Bait
Tight’n Reel Superstore
Lines RevisedRevised Sales Order
Sales System
System Flowchart
Flowchart
Mailroom Computer Operations Cash Receipts

Read & Printer

Customer Reconcile

Deposit
Check
Slip
Remit. Cash Receipts A/R Subsidiary
File Ledger Check
Advice

Machine General Ledger

Manage-
ment
Reports
Bank

Management

Tight Lines
Bait ’n Reel Revised Cash
Superstore Receipts
Revised System
Cash Receipts
System
Flowchart Flowchart
3. Solution to TVR Classics. a) and b) See diagrams on the following pages.

c) Internal Control Weaknesses

1) No credit check is performed before placing the order

2) The Sales Journal is updated before the goods are shipped. This can result in sales being incorrectly
matched to the period.

3) The warehouse clerk has access to inventory and also updates the inventory ledger. The clerk may be
capable of stealing inventory and covering up the theft by adjusting the inventory records.

4) Mailroom clerk has access to both the remittance advice and the checks, no remittance list is prepared.
This weakness can result in mailroom fraud through skimming cash and destroying the remittance
advice.

5) AR clerk has access to both the checks and the remittance advices. This can result in theft of cash
through skimming or lapping.
 Stock rel

Prepare SO Prepare Pick good Prepare

Stock rel
Sales Order Invoice and Update BOL and
Cust Ledger ship
Customer Order
Order
File Journal
Inventory Pa
Voucher
BO
Invoice Sales Journal
Journal Voucher

Summary
Update AR
Update GL GL

AR Ledger
Journal
Check, Voucher
Remit Advice
Check
Update CR Check Deposit
Journal Check
Check, Remit Chec
Advice Slip
Open Mail
TVR Sales Order System
Customer CR Journal
TVR Revenue Cycle DFD
AV Safety Revenue Cycle DFD

Sales Department Billing Department Warehouse Shipping

Stock A
Sales Rep Sales Release
Order
2
Packing
Customer Slip
Order Pick Stock
Prepare Sales Goods Release
Invoice Journal

Prepare
Sales Stock Review /
Order Sales Journal Release Prepare
1 Invoice
Order Voucher BOL
3
Sales
Order Update
Stock
Packing Ledger
B Customer C Release
Slip
Stock
Inv Sub
Release
Ledger
A Customer
Order Stock
Release Packing
Slip
Inventory BOL
Summary

AV Safety Sales Order System Flow Chart Page 1

C Carrier
 Account Receivable General Ledger

B C
E

Sales
Journal
Order
D Voucher
Inventory Journal
Summary Voucher
AR Sub
Update AR Ledger AR
Summary

Sales AR
Order Summary General
Update GL Ledger

Journal
Voucher
Inventory
Summary
Journal
Voucher
AR
Summary

TVR
AV Sales
Safety Order
Sales Order System Continued
System Flow Chart Page 2
Mail Room Accounts Receivable Cash Receipts

Customer Check
Check
Remit
Advice
Check
Remit
Advice AR Sub
5
Ledger
Update CR
Update AR Journal CR Journ
Open
Mail
4

Journal
Remit AR Voucher
Check Advice Summary
Remit
Advice

D
E
Checks

Checks
Prepare
Deposit
Slip
AV Cash Receipts System Flow Chart
TVR Cash Receipts Flowchart
Bank
d) Student responses will vary for this part of the assignment, but should address the internal control issues
identified above.
4. SOLUTION TO DISCOUNT TOOLS

a), b), d) See diagrams on the following pages.

c) Internal Control Weaknesses

1) Transaction is recorded in Sales Journal before goods are shipped.

2) Warehouse and Shipping functions are combined. This removes control over picking and shipping the

wrong products.

3) Mail room clerk should prepare a remittance list to control remittance advices and checks

d) IT Controls
 Invoice
File

Sales Order
Sales
Journal

Pick Goods
Approval
Receive Sales Order Sales
/Rejection
Customer Order
Check Credit Prepare Sales
Order
Order

Ship Notice
Sales Order
Customer Order

File
Batch Totals
Sales Order
Approval/ Reconcile and
Rejection Bill Customer
Customer
Sales Order

Batch Totals File

Update
Check
Post to Cash General Ledger
Rec Journal
Check
Remit Advice
Batch Totals

Receive Bank
Customer Check
Payment
Invoice Copy

Remit Advice
Update Accts
Receivable

Premier Sports Revenue Cycle DFD

Discount Tool DFD
 Sales Department Central Computer Server Warehouse Billing Department

On Line Sales
Customer Orders On Line A
Sales Order
Order Credit Check Order
2

Sales Pick Reconcile B

Enter Sales System Goods
Order and
Prepare
Docs Sales
Prepares Order
B
Rejectio Sales Invoice
Sales Journal Sales
n or Order Ship Notice Order
Sales Invoice
AR Sub
Order BOL
CR Journal
1 Gen Ledger Packing
Enter Sales Slip
Order C
Order Customer
Rejection
Sales
Order Carrier

Customer
Prepare
Ship Notice
Sales
Order
Sales
Order B
Sales
Order

Premier Sports Revenue Cycle System Flowchart

A Discount
Page 1
Tools Sales Process Flowchart
 Mail Room AR Department Cash Receipts Department

C
Check

Remit Remit Check

Invoice
Advice Advice

B Post to CR
B Update AR Journal
Open
and
Separate
Check
Invoice
Deposit
3 Remit
Remit Slip
Advice
Advice

Bank

Check

Discount
PremierTools
Sports Cash
RevenueReceipts
Cycle SystemProcess
Flowchart Flowchart
Page 2
e) Student solutions to this part of the case will vary. The solution should address the control issues identified

in part C.
5. SOLUTION TO ABE PLUMBING

a), b) See diagrams on the following pages.

c) Internal Control Weaknesses

1) No Credit check is performed.

2) The sales clerk closes the open sales order causing the sale to be recorded before the goods are
actually shipped.

3) The warehouse clerk has asset custody and should not also update the inventory records.

4) The shipping clerk does not reconcile the stock release with the original order. This allows for the wrong
items and or quantities to be shipped.

5) Customer is billed before the goods are shipped. Billing should be triggered by shipping notice. Instead,
the customer invoice is printed from the closed sales order, which was prepared before the goods were
shipped.
 Invoice 1

Charges AR Su
Customer Closed Order Bill File
File Customer
Customer
Customer Data
Invoic
Invoice 2
Item, File
quantity,
Custome
Sales Order Prepare r Open/Closed
Order Order
Update
GL
Open Order
Accounts
Item
Picked

GL
Pick Stock Release 1

Item and Goods Close SO

Quantity

Inventory
Sub File BOL,
Stock Release 2 Ship Stock
Release
Goods Dept File

BOL

ABE Plumbing DFD Carrier

 ABE Plumbing Revenue Cycle (Original System)

Sales Dept Warehouse Data Processing Shipping Dept

B
Customer
Prints Hard A D
Copy
Stock
Customer Releas
Order Stock
Releas Sales Order
4
Stock System
1 Releas Prepare BOL
and Ship
Prepare
Sales Order

Pick Items Customer

from
Shelves
BOL
A Stock
BOL
Open/Closed Releas
B
SO BOL
Stock
Releas
Stock Inventory Carrier
2 Close Releas
Sales Order
Accounts Rec

Updates
Inventory
Stock GL
Releas

3 Customer

d) Flowchart of revised system

Student responses will vary for this part of the assignment. The following issues, however, need to be

addressed.

 The internal control problems already covered that need to be corrected in the new system.
6. SOLUTION TO GREEN PRODUCTS GARDEN SUPPLY

a), b), See diagrams on the following pages.

c) Internal Control Weaknesses

1) No credit check

2) Inventory control function is performed by warehouse clerk.

3) Accounting department bills customer, updates the AR account, and records sales in the Sales Journal
thus reducing the opportunity to detect discrepancies between total sales and AR postings.

4) Customer is billed before order is actually shipped

5) Remittance List should be prepared in the mailroom

6) No journal voucher prepared by cash receipts clerk.

G Supply Sales Process DFD
PG Cash Receipts System DFD
ales Order Process Flowchart
GPG Sales Order System Flowchart Continued
 Check
Dep
Slip

G Cash Receipts System Flowchart

d) Flowchart of revised system

Student responses will vary for this part of the assignment. The following issues, however, need to be

addressed.

 Upgrade stand-alone computers to a networked environment

 The internal control problems already covered that need to be corrected in the new system.
7. SOLUTION TO CUSTOM FABRICATIONS

a), b) and e) See diagrams on the following pages.

c) Internal Control Weaknesses

1. The customer should not be billed until the goods are shipped. The billing process, however,
is triggered in this system by the sales order, rather than the shipping notice.

Risk: Billing before shipment occurs leads inaccurate record keeping and the possibility of
recording sales in the wrong period.
This activity can also damage customer relationships.

2. The billing process includes updating accounts receivable.

Risk: This prevents a meaningful independent verification between sales and AR by the
general ledger because both numbers are created in the same function.

3. Asset custody should be kept separate from record keeping. In this system, however, the
warehouse clerk has custody of inventory and also updates the inventory records.

Risk: The Warehouse clerk could steal inventory and cover the theft by adjusting the inventory
records.

4. The shipping department fails to reconcile the stock release with a sales order copy or the
packing slip.
 Risk: The wrong product or quantities could be shipped to the customer. The shipping function
serves as an important independent verification checkpoint and is the last control point to
determine if the order is correct before the goods change hands.

5. The General ledger function updates the cash account and AR control account from a
remittance list. It should receive a journal voucher from the cash receipts function and a
summary of the AR subsidiary. The journal voucher plays an important audit trail role.

Risk: The GL accounts may be corrupted with unauthorized transactions.

 Customer Invoice Sales Details Sales Journal

Customer Order Copy

Customer Order
Update Accounts
Sales Order Copy 1 Bill Customer Invoice Copy Amount, Date AR Subsidiary
Receivable

Receive Order Sales Order Copy 3

Update Accounts
Summary of Sales Journal and AR Subsidiary
Receivable

Sales Order Copy 2

Schedule Production Order 2 Open
Production Order 1
Production Materials Requisition Production File

Open Sales
Order File Voucher

Production Order 2
Materials Requisition

Produce Goods Materials Used Update Inventory

Revenue Cycle DFD Production Order 2 Store Goods

Item, Quantity

CUSTOM FABRICATIONS
Inventory
Subsidiary
Stock Release

Bill of Lading Copy 3 Ship Goods Shipping Details Shipping Log

Carrier Bill of Ladings 1 & 2, Packing Slip

Cash Amount

Open Mail, Prepare Update General

Customer Check, Remittance Advice Remittance List 3 Posting Details General Ledger
Remittance Advice Ledger

Check, Remittance List 1

Remittance List 2
Record and Deposit Remit Advice
Checks

Reconcile and
Payment Amount General Ledger
Update AR

Check, Deposit Slips 1 & 2

Bank

Cash Receipts DFD

CUSTOM FABRICATIONS
Cash Receipts System Flowchart

Mail Room Cash Receipts Billing General Ledger

Customer Remit List 1 B A

Check

Check Remit List 3

Remit List 2
Remit Advice Update AR Remit Advice
Subsidiary

Prepare Update AR Update General

Remittanc Cash Subsidiary Subsidiary Ledger
e List

Deposit Slip

Remit List 1 Deposit Slip AR Subsidiary General Ledger

Check Check

Remit List 2

Remit Advice

Remit List 3 Bank

B A
Will Richens
Revised Cash Receipts System Flowchart

Mail Room Cash Receipts Accounts Receivable Data Processing

Customer Remit List 1 A B

Check

Check
Remit List 2
Sales Order System
Remit Advice
Remit Advice
Update AR
Subsidiary, Prepare
Deposit Slips

Prepare Cash Subsidiary

Remittance
List
B Update AR
Subsidiary

General Ledger

Remit List 1
Deposit Slip
Check
Deposit Slip B AR Subsidiary
Remit List 2 Check

Remit Advice

Remit List 3

Bank

Temporary
Production
File
Will Richens
8. SOLUTION TO PERFORMANCE WATER PUMPS

a), b) See diagrams on the following pages.

c) Internal Control Weaknesses

1) The sales clerk who processes the orders also performed the credit check. This creates internal control problems
as sales staff pay is sometimes linked to sales levels.

2) The shipping function does not notify the billing function that goods are shipped. Without this necessary
transaction authorization, customers could be billed before items are shipped which leads to inaccurate record
keeping.

3) The billing department records the accounts receivable and also prepares and sends the AR summary to the
general ledger function. The problem here is that the billing department also prepares and sends to the general
ledger function the sales journal voucher. This approach eliminates the GL reconciliation function.

4) The inventory warehouse clerk updates the inventory records. This can lead to inventory theft and concealment
by adjusting the inventory records.

d)
PWP Sales System DFD
PWP Cash Receipts DFD
 2

4
1

PWP Sales System Flowchart

 Mail Room Cash Receipts Department Billing Dept Computer Center

Remittance A B
Check List
Remittance
Check
Advice Remittance Accounting
List D
System
Remittance
Advice
Review Verifies
and and Signs
Prepare Cash receipts
Remi List Journal

Update AR

AR Sub Ledger
Remittance Check
List
Deposit B AR Journal Voucher
Check Slip Summary File

Remittance
List General Ledger
Update Cash
Remittance Rec C
Advice
Bank General Ledger Department
Journal
voucher
A
C

C
AR Summary
Journal Review and D
Update GL
PWP Cash
Steeles Receipts
Cash Flowchart
Receipts Process Voucher
 Hall Chap 5

MULTIPLE CHOICE

1. C
2. C
3. D
4. A
5. B
6. E
7. B
8. C
9. A
10. D

PROBLEMS
1. UNRECORDED LIABILITIES

Term FOB shipping point:

a. Yes

b. The best evidence is provided by the Purchase Order and Bill of Lading

Purchase Order—is evidence that the item was ordered, but does not indicate when it was

shipped.

Bill of Lading—reviewed post-period; will indicate when the goods were shipped

Receiving Report—prepared post-period; establishes possession but may not indicate when

goods were shipped

c. June 15

d. July 10

Term FOB destination:

e. No

f. N/A

g. July 5

h. July 15
2. INVENTORY ORDERING ALTERNATIVES

a. A purchase requisition is created when an item of inventory is needed (e.g., fallen

below the reorder point) and authorizes its purchase. A purchase order is created

from requisitions to the same vendor. Thus, one purchase order may contain many

purchase requisitions.

b. The system shown in alternative two expedites the ordering process by distributing the

purchase orders directly to the vendors and internal users, thus bypassing the purchasing

department completely. This shortens the time between recognizing the need for inventory

and mailing the PO to the vendor. Consequently, inventory safety stock levels can be

reduced, thus reducing inventory carrying costs.

c. Alternative one provides additional control over the ordering process. For example, the

purchasing agent could manually detect unusual order quantities or frequency caused by a

computer error. Managers whose systems lack reliable computer controls, and who wish to

compensate with human independent verification, may prefer this alternative. The price of

this added control is excessive inventory carrying costs.

3. SYSTEM FLOWCHART ANALYSIS

a) Department X is Cash Disbursements, Department Y is General Ledger

b) Doc A = Purchase Order

Doc D = Journal Voucher

Doc H = Vendor Check

Doc K= Check Copy

Doc G = Journal Voucher

c) Process B = Set Up Liability (Post to AP)

Process E = Disburse cash (discharge liability)

Process I = Post to GL

d) File C = AP Sub ledger (vendor Invoice file)

File F = Check register (Cash Disbursements Journal)

File J = General Ledger

e) Terminal Z = Vendor (Supplier)

4. SYSTEM FLOWCHART ANALYSIS.

Part a. and b. below:

1) Risk: Unnecessary purchases of inventory may occur and the potential for kick-back fraud exists

under the current system. Control: A purchase requisition should originate from the inventory

control function to authorize the creation of a purchase order. 2) Risk: The organization

may receive and accept incorrect item types and /or quantities of items. Control: Use of a

blind copy of the PO will force the receiving clerk to count and inspect receipts. The clerk

should not have access to the packing slip, which contains details. 3) Risk: The organization

may pay for items that it did not order. The liability is set up based only on the Invoice and the

Rec Rept. Control: Perform a three-way-match (PO, Rec Report, Invoice). 4) Risk: The

potential for vendor fraud exists because the AP department sets up the liability and also pays it.

Control: AP should authorize Cash Disbursements to may payment on the due date.
5. RISK ANALYSIS AND INTERNAL CONTROL SOLUTION,

Part a. (see following page) Part b., c. and d below:

1) Risk: Purchase items not needed, stock outs, purchase from unapproved vendors

Control:

Transaction Authorization: An automated Inventory Control function should identify inventory

needs, which incorporates a valid vendor file.

Accounting Records: The company should not destroy the requisition, which is part of the audit

trail. If transactions cannot be traced to a formal authorization then purchases without

authorization could be processed.

2) Risk: Receive incorrect quantities of items ordered or defective items.

Control:

Independent verification. Receiving clerk should use blind copy of PO to count and inspect, not

the packing slip. This allows the clerk to simply transfer quantities from the packing slip to the

receiving report.

3) Risk: Misappropriation of cash through vendor fraud.

Control:

Segregation of duties. Purchasing agent’s assigned tasks need to be limited. Currently the

agent creates the PO and the receiving report records. In addition, he destroys the source

documents. With this access he could create false purchase transaction, submit a false

invoice, and receive an automatic payment.

Part d

IT Controls for this system should include:

6. RISK ANALYSIS AND INTERNAL CONTROL,

Part a. (see following page) Part b. and c. below:

1) Risk: Purchase items not needed, stock outs, purchase from unapproved vendors

Control: Transaction Authorization: Inventory Control function should identify inventory needs

and should incorporate a valid vendor file.

2) Risk: Receive items not ordered or incorrect quantities.

Control: Independent verification. Receiving clerk should use blind copy of PO to count and

inspect, not the packing slip

3) Risk: Pay for items not received.

Control: Independent verification. AP Clerk should perform a 3-way match. The clerk is

reconciling only the PO and the Invoice. No evidence that the items were actually received.

4) Risk: Misappropriation of inventory

Control: Segregation of duties. Inventory warehouse clerk should not also have responsibility

for updating inventory sub ledger.

7. IT APPLICATION CONTROLS:

a. Automated Purchase Approval. Computer logic, not a human being, decides when to

purchase, what to purchase, and from which vendor. The key attributes needed to

execute this logic come from the purchase requisition file and the valid vendor file.

The objective is to prevent unauthorized purchases from unapproved vendors.

b. Automated Three-Way Match and Payment Approval. When the AP clerk receives the

supplier’s invoice, the clerk accesses the system and adds a record to the vendor

invoice file. This act prompts the system to automatically create a virtual AP

packet by linking the vendor invoice to the associated purchase order and

receiving report records, using the PO number as a common attribute. The

application then reconciles the supporting documents, using programmed criteria

for assessing discrepancies. Discrepancies in excess of the threshold are

submitted to management for review and manual approval.

c. Multilevel Security. Multilevel security is a means of achieving segregation of duties

in an integrated data processing environment where multiple users simultaneously

access a common central application. Two methods for achieving multilevel

security are the access control list (ACL) and role-based access control (RBAC).

Through these techniques, purchasing, receiving, accounts payable, cash

disbursements, and general ledger personnel are limited in their access based on

the privileges assigned to them.

d. Automated Posting to Subsidiary and GL Accounts. All of the record keeping functions

are automated in the advanced technology system. In the advanced technology

system, a computer application, which is not subject to human failings such as

yielding to situational pressures and/or lacking ethical standards, decides which

accounts to update and by how much. By eliminating the human element from
 accounting activities, the potential for errors and opportunities for fraud are

significantly reduced. Also, since these are labor intensive activities, automating

them greatly improves efficiency of operations.

8. PHYSICAL CONTROLS

Transaction Authorization. Purchases are not authorized by inventory control.

Accounting Records. Inventory records are updated based on the purchase order rather than
the Receiving Report or Invoice.
Accounting Records. The Accounts Payable Subsidiary ledger is updated based only on the
Invoice. There is no reconciliation with supporting documents (purchase order and receiving
report).
Accounting Records. There is no Cash Disbursements Journal or Check Register in use.
Accounting Records/Segregation of Functions. The receiving department prepares the
Receiving Report directly from the Packing Slip. A blind copy of the Purchase Order should go
to the receiving clerk to control this activity. A supervisor should take possession of the packing
slip that contains relevant data and oversee the inspection process.
Accounting Records/Independent Verification. The General Ledger department should
receive Journal vouchers or batch totals from Inventory Control, Cash Disbursements, and
Accounts Payable. These are used to keep the General Ledger Control accounts current and to
verify the overall accounting accuracy of the process.

9. IT APPLICATION CONTROLS THAT APPLY.

a. Automated Purchase Approval. Computer logic, not a human being, decides when to

purchase, what to purchase, and from which vendor. The key attributes needed to

execute this logic come from the purchase requisition file and the valid vendor file.

The objective is to prevent unauthorized purchases from unapproved vendors.

b. Automated Three-Way Match and Payment Approval. When the AP clerk receives the

supplier’s invoice, the clerk accesses the system and adds a record to the vendor

invoice file. This act prompts the system to automatically create a virtual AP

packet by linking the vendor invoice to the associated purchase order and

receiving report records, using the PO number as a common attribute. The

application then reconciles the supporting documents, using programmed criteria

 for assessing discrepancies. Discrepancies in excess of the threshold are

submitted to management for review and manual approval.

c. Automated Posting to Subsidiary and GL Accounts. All of the record keeping functions

are automated in the advanced technology system. In the advanced technology

system, a computer application, which is not subject to human failings such as

yielding to situational pressures and/or lacking ethical standards, decides which

accounts to update and by how much. By eliminating the human element from

accounting activities, the potential for errors and opportunities for fraud are

significantly reduced. Also, since these are labor intensive activities, automating

them greatly improves efficiency of operations.

10. INTERNAL CONTROLS

Solution to Part a:

Inventory Control Receiving Account Payable

Reviews and Vendor

Updates Inventory Prints PO
Inventory
Vendor
Invoice
Accounting
System
Purchase
Purchase Packing
Order Order Slip

Purchase Reconcile
Orders And Post
Vendor
Reconcile
Receiving Create Rec Rp
Report Voucher
Invoice
AP Sub
Ledger
Open
Purchases AP
Journal
Reviews
and
Cash Prepares
Checks
Vendor

Check

Solution to Part b:
 Transaction Authorization

Inventory Control clerk approves PO and make purchase

Supervision

There is no supervision in the receiving area.

Accounting Records

Receiving clerk prepares receiving report from packing slip

No blind copy of purchase order goes to Receiving Department

Segregation of Duties

Accounts payable clerk approves AP and writes the check

Access Control

All users of the networked system have full access to all database records. This might result in

transaction corruption, document destruction and various forms of fraud including vendor fraud.

11. ACCOUNTING DOCUMENTS

a. the inventory control department

b. purchase requisition

c. accounts payable, receiving, and inventory control departments

d. vendor’s invoice, purchase order, and receiving report

e. a bill of lading
INTERNAL CONTROL CASES

1. Solution Smith’s Market

a), b) See diagrams on the following pages.

c) Internal Control Weaknesses

6) Warehouse clerk has transaction authorization and purchasing responsibility.

7) Warehouse clerk has asset custody and recordkeeping responsibility. Blind PO is

not used to verify received inventory.

8) Accounting clerk approves invoice for payment without the benefit of a receiving

report or a purchase order. No three way match control.

9) Accounting clerk has account payable and cash disbursement responsibility.

d)
 Smith’s Market Exp Cycle D
Invoice

Vendor

Review Review and F

stock File
Prepare PO

Invoice
Journal
Stock
File Voucher Up
Records
Packing Acc
Slip
Invoice

Check
Pay Vendor

Invoice
Inspect and
Update
Check
Packing Stock File
Register
Slip Records
Summary

File
 Ware house Accounting Clerk Treasu

Vendor
Observe
inventory Stock
On Hand Records Purchas
Summar
Invoice Jou
Vou

Review Stock
Prepare PO Review
3 and File Update
1 Accounts

PO Invoice
Account
Packing
Summary
Jour
Slip
Vouc
Vendor
4

Inspect and Pay Vendor

2 Update Stock and Record in
Records Journ
Accounts Vouch

Invoice
Packing Purchases
Slip Summary Check
Check
Registe

Smith’s Market Exp Cycle Vendor

FC A
2. SOLUTION TO TIGHT LINES FISHING AND CAMPING SUPPLIES

a), b), See diagrams on the following pages.

c) Internal Control Weaknesses and Risks

1) Purchasing clerk should not authorize purchases; this is an inventory control function.

Risk. Purchasing clerk could purchase items not needed. This could result in inefficient

inventory management. It could also allow fraud such as a kick-back from vendors who are

unloading items.

2) The receiving department clerk should receive a ‘blind copy’ of the purchase order and should

not have access to the packing slip.

Risk: This situation would allow the receiving clerk to complete a receiving report without

actually counting and inspecting the items.

3) Inventory clerk updates the inventory subsidiary ledger.

Risk: This is a segregation of duties issue – asset custody and recordkeeping. Clerk could steal

inventory and adjust inventory records to conceal the theft.

4) The AP Clerk should not update the general ledger AP Control account.

Risk: With access to both the sub ledger and control account, discrepancies caused by errors

and fraud can be concealed.

5) Cash Disbursement clerk should not update the AP subsidiary ledger or the AP Control account

in the GL.

Risk: Clerk prepares check and updates the AP subsidiary and GL accounts. The clerk could

set up a fraudulent AP and pay it (vendor fraud).

d.) Revised system

Student responses will vary for this part of the assignment. Since the case is based on a centralized system,

the redesigned system flowchart may not look very different from the original. Student solutions should correct

the internal controls issues identified above through implementation of IT controls including multilevel security,

password controls, and automated processes such as three way match and GL updates.
3. SOLUTION TO TVR CLASSICS

a), b), See diagrams on the following pages.

c) Internal Control Weaknesses

Purchases Procedures

1) The inventory clerk in the warehouse department has asset custody and transaction

authorization to order inventory.

2) The receiving clerk prepares the receiving report from the packing slip information. The

receiving department clerk should receive a ‘blind copy’ of the purchase order to force the

receiving clerk to count and inspect the items before preparing the receiving report.

3) The inventory clerk in the warehouse department has asset custody and record keeping

responsibility.

4) Accounts Payable does not verify that the good have been received via a formal receiving

report. Payment approval is based on a PO and invoice only.

Cash Disbursements Procedures

5) The company may be paying for items not received. The cash disbursement voucher is

based on a flawed process to set up the AP. A proper 3-way match needs to be performed

prior to establishing the liability.

6) No valid vendor file is used to approve payment.

7) No formal Journal vouchers are used to update the General Ledger.

d.

Revised System

Student responses will vary for this part of the assignment. Their solutions should resolve the internal

control issues above and employ advances technologies that reduce reliance on paper documents and manual

data entry.
4. SOLUTION TO DISCOUNT TOOLS INC.

a), b) see the following pages

c) Internal Control Weaknesses

1) Purchasing clerk should not authorize inventory purchases.

2) Receiving clerk should receive a blind copy of the PO and not have access to the packing

slip

3) Warehouse clerk should not update inventory sub ledger.

4) AP Clerk does not perform a three way match. The clerk sets up a liability based only on a

PO and the vendor’s invoice, but no receiving report.

d) Relevant IT Controls are below:

e) Revised System

Student responses will vary for this part of the assignment. Their solutions should resolve the

internal control issues above and employ advances technologies that reduce reliance on paper

documents and manual data entry.

5. SOLUTION TO ABE PLUMBING, INC

a), b) see the following pages

c) Internal Control Weaknesses

1) Purchasing agent authorizes and executes the purchase transaction.

2) Receiving clerk prepares receiving report from the packing slip. He should receive a “blind”

copy of the PO.

3) Warehouse clerk should not be updating the inventory subsidiary ledger. The clerk has asset

custody and record keeping responsibility.

4) Accounts Payable clerk should not be writing checks. The clerk has asset custody and record

keeping responsibility.
 ABE Plumbing, Inc. DFD Expenditure
Cycle
Purchase Order
Inventory
Vendor
Requirements
Review Inventory
Inventory
Records
Packing Slip
Order Data PO

PO File Payment Data

Update AP
Receive Check
Inventory Receiving Number
Data RR CD Voucher

Quantity and
Hard Due Date
Condition Receiving
Copy Post
Report
RR
Update AP
Post Check
General Amount
Update ledger
Inventory

Post Check
Inventory Register
Quantity
Check
 Vendor Purchasing Department Data Processing Receiving Department Warehouse

A
1 2
PO
B
Monitor / Packing
PO
Prepare PO Slip
Rec
Report
Purchases /
Prepare
AP System
Packing Rec Report 3
Slip
Accounts Pay
Update
Inventory
A Rec
Invoice PO File Report
Rec
Report
Invoice Inventory
Reconcile Sub Ledger
and Post
Rec Report
B File
4

Review and GL
Check
Write
Checks Open/Closed
Cash Disb

Check Reg ABE Plumbing Purchases / Cash

Disbursements System

d) Flowchart of revised system

Student responses will vary for this part of the assignment. The solution should address the control issues

identified in part C of the case.

6. SOLUTION TO GREEN PRODUCTS GARDEN SUPPLY

a), b) see the following pages

c) Internal Control Weaknesses

1) Purchasing approves and executes purchases. The company needs an inventory control

function.

2) Purchasing updates inventory records for transactions that it previously approved and

executed.

3) Receiving clerk prepares receiving report from the packing slip. Should have a Blind Copy of

the PO.

4) Accounts Payable approves vendor payments based only on a PO and Invoice. They have

no evidence of inventory receipts and inspection. They need a receiving report as well.

5) AP approves liability and also writes the check.

6) AP clerk updates AP subsidiary, writes checks, and has access to the AP control account

and the cash account in the general.

d) Flowchart of revised system

Student responses will vary for this part of the assignment. The following issues, however, need to be

addressed.

 Upgrade stand-alone computers to a networked environment

 The internal control problems already covered need to be corrected in the new system.
7. SOLUTION TO CUSTOM FABRICATIONS

a), b), see the diagrams on the following pages.

C and d) Internal Control Weaknesses and Risks:

1) Purchasing clerk should not authorize purchases; this is an inventory control function.

Risk. Purchasing clerk could purchase items not needed. This could result in inefficient inventory

management. It could also allow fraud such as a kick-back from vendors who are unloading items.

2) The accounts payable department creates a liability in their records with only the receiving report and

vendor’s invoice. No three way match.

Risk: Company may be paying for items that were never officially ordered.

3) The warehouse receives the goods and prepares the receiving report. No formal and separate

receiving function.

Risk: This is a poor organization structure. By separating warehousing from receiving, errors in the

receiving function may be detected by the warehousing function. This independent review is lost

when the functions are combined.

4) The receiving report is prepared based on packing slip. No blind Copy of the PO.

Risk: This situation allows the receiving clerk to complete a receiving report without actually

counting and inspecting the items.

5) The general ledger updates the inventory control account from the receiving report. No journal

voucher.

Risk: Erroneous data may be entered into GL accounts. To reduce this risk, journal vouchers are

used to formally post to the GL.

 Purchase Inventory
Supplier Order File Subsidiary

Purchase Order Copy 2 Inventory Levels

Update Inventory
Records Purchase Order Copy 1

Packing Slip
Prepare Purchase Monitor Inventory
Purchase Requisition
Order Levels

Receiving
Report
Quantity
Copy 2
Purchase Order Copy 3

Inventory Receive Goods Receiving Report 3

Post to General
Ledger
Posting Details General Ledger Expenditure Cycle DFD
Subsidiary

Voucher
CUSTOM FABRICATIONS

Summary
Receiving Report Copy 1

Update Accounts Prepare Cash

Check Copy Check Supplier
Payable Disbursements
Set Up Accounts
Payable

Check Details Voucher

Amount, Date

Review Accounts
AP Subsidiary Amount, Due Date
Due
8. SOLUTION TO PERFOMANCE WATER PUMPS

a), b), see the diagrams on the following pages.

c) Internal Control Weaknesses:

1. The receiving clerk uses the purchase order to reconcile with the goods received. Does not use the blind

copy of the purchase order to verify the goods received.

2. The clerk in the warehouse updates the inventory subsidiary ledger. This violates the segregation of

duties, because the clerk both keeps the record of the inventory and takes the custody of the inventory.

3. The accounts payable account is updated when the supplier invoice arrives. Not clear if the system

automatically performs a three-way match.

d) IT Controls
Hall Chap 11

MULTIPLE CHOICE
1. B

2. E

3. D

4. E

5. E

6. C
7. C

8. D

9. C

10. B
PROBLEMS
1. DATA WAREHOUSE ACCESS CONTROL

Merit: The primary reason for a data warehousing is to optimize the business. Many

organizations’ management personnel feel that more strategic benefit can be gained by sharing

data externally. By providing customers and suppliers with the information they need when they

need it, the company can improve its relationships and provide better service. The potential gain

to the giving organization is seen in a more responsive and efficient supply chain. Using Internet

technologies and OLAP applications, an organization can share its data warehouse with its

trading partners and, in effect, treat them like divisions of the firm.

Control: Access control is a vital feature of a data warehouse that is shared with customers and suppliers.

The following control issues need to be considered:

 The organization should establish procedures to oversee the authorization of individuals

at customer and supplier sites which will be granted access to their data warehouses.

 Access privileges should be specified for each outside user and controlled by the use of

passwords.

 User views need to be created that will limit outsider access to only approved data.

 Internet sessions should be managed by means of a firewall and use encryption and digital

signatures to maintain confidentiality.

 Firewalls, which are a combination of hardware and software that protect resources of a

private network, help to secure data from unauthorized internal and external users.

 Auditing tools for intrusion detection are available to assist in mitigating security risks.

 Periodic audits should include a risk assessment and review of access levels granted to

both internal and external users, based on their job descriptions.

2. PROJECT IMPLEMENTATION

While the big bang method has certain advantages, it has been associated with numerous
 system failures. Since the new ERP system means new ways of conducting business, getting

the entire organization on-board and in sync can be a problem. On day one of the

implementation, no one within the organization will have had any experience with the new

system. In a sense, everyone in the company is a trainee learning a new job. The new ERP will

initially meet with opposition, because using it involves compromise. The legacy systems, with

which everyone in the organization was familiar, had been honed over the years to meet exact

needs. In most cases, ERP systems have neither the range of functionality, nor the familiarity of

the legacy systems which they replace. Also, because a single system is now serving the entire

organization, individuals at data input points often find themselves entering considerably more

data than they did previously with the more narrowly focused legacy system. As a result, the

speed of the new system often suffers, causing disruptions to daily operations. These problems

are typically experienced whenever any new system is implemented. The magnitude of the

problem is the issue under the big-bang approach where everyone in the company is affected.

Once the initial adjustment period has passed and the new culture emerges, however, the ERP

system becomes an effective operational and strategic tool that provides competitive advantage

to the firm.

Because of the disruptions associated with the big bang, the phased-in approach has emerged as a

popular alternative. It is particularly suited to diversified organizations with units that do not share

common processes and data. In these types of companies, independent ERP systems can be

installed in each business unit over time, to accommodate the adjustment periods needed for

assimilation. Common processes and data (such as the general ledger function) can be integrated

across the organization without disrupting operations throughout the firm.

To be successful, all functional areas of the organization need to be involved in determining the

culture of the firm and in defining the new system’s requirements. The firm’s willingness and ability to

undertake a change of the magnitude of an ERP implementation is an important consideration. If the

 corporate culture is such that change is not tolerated or desired, then an ERP implementation will not

be successful.

The technological culture must also be assessed. Organizations that lack technical support staff for

the new system, or have a user base that is unfamiliar with computer technology, face a steeper

learning curve and a potentially greater barrier to acceptance of the system by its employees.

All things considered, a phased-in approach is more likely to be successful with this organization

culture.

3. OLTP VERSUS OLAP SERVERS

a. On-line transaction (OLTP) processing is appropriate because the amount of data

accessed is limited, few business elements are analyzed, the data is not aggregated,

and the time frame is finite.

b. On-line analytical processing (OLAP) is appropriate because analysis of data over several years is

required.

c. OLAP because that data being analyzed spans several regions.

d. OLAP. While this system will analyze simple transactions, the volume of activity and the analytical

procedures may require greater resources than OLTP can provide.

e.. OLAP. OLAP supports consolidation of data, drill-down analysis, and slicing and dicing.

f. OLAP. While OLTP has been sufficient to provide the information requirements to date, the company

is not meeting its goals, and an understanding of the business processes, related phenomena, and

comparisons among processes is indicated. Analyses in these areas may help the company

determine better business practices. OLAP will provide the company with the analytic tools that may

help management find better ways to operate.

4. SELECTING A CONSULTANT

Consulting firms, particularly the big four with large ERP practices, are desperately short of

human resources at times. We saw this in the mid-to-late 1990s when thousands of clients were

rushing to implement ERP systems before the new millennium, and thus avoid Y2K problems.

As demand for ERP implementations grew beyond the supply of qualified consultants, more and

more stories of botched projects materialized.

A common complaint is that consulting firms promise experienced professionals but deliver

incompetent trainees. They have been accused of employing a bait-and-switch maneuver to get

contracts. At the initial engagement interview, the consulting firm introduces their top consultants who

are sophisticated, talented, and persuasive. The client agrees to the deal, incorrectly assuming that

these individuals, or others with similar qualifications, will actually implement the system. The problem

has been equated to the airline industry’s common practice of overbooking flights.

Consulting firms, not wanting to turn away business, are perhaps guilty of overbooking their

consulting staff. However, the consequences are far graver than the inconvenience of missing a flight.

Currently a number of lawsuits have been filed against the consultants of failed ERP projects. We can

avoid these pitfalls by selecting the right consultant. Therefore, before turning the problem over to just

any outside consultant, we need to do the following:

 Interview the staff proposed for the project and draft a detailed contract specifying which

members of the consulting team will be assigned to which tasks.

 Obtain an agreement in writing as to how staff changes will be handled.

 Conduct reference checks of the proposed staff members.

 Align the consultants’ interests with those of the organization by negotiating a pay-for-

performance scheme, based on achieving certain milestones in the project. For example,
 the actual amount paid to the consultant may be between 85 to 115 percent of the contracted

fee, based on whether a successful project implementation comes in under, or over,

schedule.

 Set a firm termination date for the consultant. There is a lot of evidence that consulting

arrangements can become interminable, resulting in dependency and an endless stream of

fees.
5. AUDITING ERP DATABASES

While organization’s data warehouse is an excellent resource for performing analytical reviews, I

will need to gain an understanding of the procedures used to populate the warehouse. I am

concerned that your data cleansing procedures may be sanitizing the warehouse, which could

create a false picture of your financial position. To be useful as an OLAP tool, the data

warehouse needs to be free of contamination. Erroneous data (such as negative inventory

values, missing fields, and other clerical errors) that are a natural part of operational databases

are identified and repaired (or rejected) in the cleansing process prior to their entering the data

warehouse. Since the data warehouse exists in an artificially pristine state, it may not be a

suitable substitute for the operational database when assessing tests of process controls and

performing substantive tests. I must, therefore, perform tests of your cleansing procedures

before I can place reliance on the data warehouse as a resource for substantive testing.

6. BIG BANG VERSUS PHASED-IN APPROACH

Either approach would require transformation of data from the legacy systems to a common

data warehouse. A phased-in approach has an advantage of uncovering discrepancies among

data at a single site. Once the discrepancies are found, the resulting bugs can be corrected, so

relatively error-free systems can be placed in other sites.

Presuming the goals of a DMV are to correctly tax and license drivers and vehicles, and to do so

expediently, the fact that customers were waiting too long and that many chose not to comply with the

law requiring they become properly licensed, organizational goals were not met with the big bang

approach. Again, a phased-in approach might have uncovered these problems and found corrections

on a local rather than state-wide basis.

The employees seemed to lack adequate training and seemed not to support the new system.

Phasing-in a new system does not require as many technicians, as the instruction process can take
place over time and across geography. With an increased number of required technicians, there is a

decreased the chance that all technicians will be familiar with the system and the requirements.

Therefore, a phased-in approach might have supplied the DMV with better instruction. The big bang

approach also seemed to catch the employees off guard. It is possible that if a phased-in approach

had been used, the process might have gone more smoothly, and word-of-mouth about the system

(and its probable improvement over the legacy systems) might have lessened the resistance to

change on the part of employees anticipating their own phasing-in.

If customers were satisfied with the service they received, and if employees were adequately trained

and accepting of the new system, (probable consequences of a phase-in), the DMV could have

avoided loss of revenue resulting from customer reluctance to register vehicles and obtain licenses.

7. Who is to blame for ERP failure?

By Barry Calogero. Barry Calogero is executive vice president for Robbins-Gioia, Inc. He has had
extensive experience in program control, financial management and cost management.
Enterprise Resource Planning (ERP) tools, or enterprise-wide client/server applications for managing

accounting, manufacturing, distribution and human resources have become the de facto backbone of

business intelligence. As more and more organizations across the globe have chosen to build their

corporate knowledge-base around this class of complex infrastructure tools, the implementation

challenges have become evident.

These challenges have been well publicized in the leading business periodicals, underscoring

organizational frustrations and even total meltdowns. Whirlpool and Gore-Tex recently blasted SAP

and PeopleSoft in separate front page articles in “The Wall Street Journal” articles, highlighting

serious business consequences and blaming these leading ERP vendors and implementing

consultants for botched deployments. What’s more, the nation’s leading chocolate manufacturer,

Hershey Food Corp., recently noted that it has lost its taste for SAP, holding the vendor accountable

for order processing problems that hampered its ability to ship candy and other products to retailers

around the peak Halloween season.

In reality, however, the software giants are not to blame for these high-profile failures. The customers

are not to blame either. The real culprit is the process.

Revising implementation management strategies can put ERP solutions back on a successful path.

At the root of many ERP problems lies one overlooked but critical step: new business processes must

be established, thought through, and implemented before software tools are selected, purchased, and

rolled out.

As showcased in the recent media articles, business evolution to ERP is about more than software

tools. Herein lies the greatest challenge for end-user organizations and consultants working to

implement solutions. To an even greater degree, the success of an ERP implementation is gauged by

its ability to align IT and business management objectives, supply demanding program management

skills and provide a refined process for success.

To add to the complexity, the software world today is undergoing a significant transformation, with

many vendors adapting the popular Web-enabled Application Service Provider (ASP) model. ASPs

lease software to organizations via the Web. Although some will try to apply this model to ERP

implementations, it may well serve to add additional complexity and remove much of the critical

business process planning that can make or break the implementation. In addition, it will likely

encourage “square-pegs-in-round-holes” ERP implementations, in which organizations spend

significant dollars to buy a technology—and are then forced to squeeze their business processes to fit

the mold of the purchased technology. There may be opportunities to marry ERP with the Web

through front-end technologies, giving users access to the system through browser-based

alternatives to the traditional client-server paradigm. Whatever model they choose to roll out, an

organization’s success will depend on redesigning the process and customizing the technology to fit

that process—rather than the other way around.

A roadmap for success

 There are three basic building blocks to a successful ERP implementation: define the requirements;

develop a plan; and implement. The marriage of these three components, coupled with technology

integration and user training comprises the total effort. If an organization does not make conscious

decisions regarding what to architect and what benefits must be received, the organization cannot

hope to realize the maximum value creation from implementation.

The first step, requirements definition, is often given the most superfluous attention. There are a

number of different types of requirements, each of which should be addressed and discussed with

key stakeholders. Technical requirements will define expectations in terms of processing time,

reliability, maintainability, and technical support. Functional requirements should be derived from the

overall business process and gaps in ERP software. Functionality that must be included based on the

business requirements should be identified and catalogued. Finally, programmatic requirements take

into account all of the implementation’s end goals and the team’s actions from a value perspective.

The development and implementation plans should grow from these requirements and form a

lifecycle implementation plan for the technology. Adopting a structured approach to managing this

lifecycle implementation plan will help the team understand the decisions that are being made and,

importantly, reduce the risk of failure.

Common barriers to success

There are three process barriers that are the real culprits for ERP failure. These barriers cause an

elongated development cycle with poorly defined requirements and, as a result, poorly defined

measures of success. The implementation team often is tasked with chasing a series of floating

requirements, no optimizing process, and a false belief that technology alone will provide a silver

bullet. These teams are, without fail, disappointed with the results.

Specifically, the three most common mistakes of ERP implementations are the following:

1. Focusing on technology. The technology “silver bullet” approach is one that is sometimes sold by

vendors. However, there is no evidence anywhere in the history of IT that software alone will solve a
 business problem.

2. Ignoring the importance of requirements definition. Organizations too often ignore the need to define

an optimal process and then use the technology as an enabler for the process. In too many

instances, organizations either try to adopt a process that is inherent in the ERP solution, even if it

does not fit their business requirements, or they try to shoehorn their legacy processes into a

software package that is not designed to support their processes. In both cases, they sub-optimize

the capabilities in the technology and don’t take advantage of the opportunity to streamline their

business process—the entire point of technology implementations.

3. Jumping from the requirements definition to the development phase. Pressed to deliver systems

against pre-defined timelines that don’t take into account all of the necessary implementation steps,

organizations often rush the process, neglecting to build a solid implementation plan and neglecting to

establish solid agreement across the organization as to what it will take to develop and implement the

solution prior to implementing the technology.

ERP program remediation is required when an organization has a significant investment in an ERP

implementation that has not delivered the anticipated ROI. In some cases, these programs are

abandoned entirely, costing organizations much more than dollars. Ancillary effects include the

erosion of corporate confidence in the IT function, as well as erosion in IT staff morale. An

independent third party, skilled in program management, can preempt these negative consequences

by providing a clear and honest evaluation of the current situation. This third party, however, cannot

be a software vendor or a consulting implementer, and must have no stake in the process other than

delivering business value.

Looking at the current cost and schedule overruns associated with ERP implementations, as well as

the number of implementations that are abandoned mid-stream, it is obvious that the business world

is missing an enormous opportunity to harness technology as the business evolves and a golden

opportunity for IT to deliver business value. Failure is not a given.

A November 11 “Computerworld” article recounts the question that haunted Lockheed Martin Corp.’s

aeronautics group, involved in an ERP project similar to that of Hershey. Anxious about its future,

Lockheed Martin recently contacted SAP to investigate whether or not they needed to brace

themselves for the sticky issues that afflicted Hershey. The Response: a resounding no. Their

success was attributed to the way that they were planning and managing the project, rather than to

the software itself. This view was “seconded by several other R/3 users...in the aftermath of

Hershey’s problems and similar snafus at Whirlpool Corp.,” wrote Craig Stedman in Computerworld.

At Lockheed, business users from its three aircraft manufacturing companies have been working

since 1998 to design common ways to enter orders and process other transactions—first defining

processes, then working with SAP to use R/3 to implement its ERP solution. Similarly, Elf Autochem

North America Inc., a chemical supplier, assigned a team of 24 workers to work for four months on

business process redesign before even selecting R/3.

There is a clear and pressing requirement for improved program management for these implementations. The fact that
such planning contributes significantly to corporate competitiveness cannot be ignored and presents an enormous
opportunity for those working to architect business change.