Financial Accounting: An Integrated Statements Approach, 2nd Edition

This year, returns at Elegance by Elaine have reached an all-time high. There are a large

number of returns under $50 without receipts.

a. How can sales clerks employed at Elegance by Elaine use the store’s return policy to steal

money from the cash register?

b. What internal control weaknesses do you see in the return policy that make cash thefts

easier?

c. Would issuing a store credit in place of a cash refund for all merchandise returned with-

out a receipt reduce the possibility of theft? List some advantages and disadvantages of

issuing a store credit in place of cash refund.

d. Assume that Elegance by Elaine is committed to the current policy of issuing cash refunds

without a receipt. What changes could be made in the store’s procedures regarding cus-

tomer refunds in order to improve internal control?

First Charter Bank provides loans to businesses in the community through its Commercial

Lending Department. Small loans (less than $100,000) may be approved by an individual loan

officer, while larger loans (greater than $100,000) must be approved by a board of loan officers.

Once a loan is approved, the funds are made available to the loan applicant under agreed-

upon terms. The president of First Charter Bank has instituted a policy whereby she has the in-

dividual authority to approve loans up to $5,000,000. The president believes that this policy will

allow flexibility to approve loans to valued clients much quicker than under the previous

policy.

As an internal auditor of First Charter Bank, how would you respond to this change in

policy?

One of the largest fraud losses in history involved a securities trader for the Singapore office of

Barings Bank, a British merchant bank. The trader established an unauthorized account num-

ber that was used to hide $1.4 billion in losses. Even after Barings’ internal auditors noted that

the trader both executed trades and recorded them, management did not take action. As a re-

sult, a lone individual in a remote office bankrupted an internationally recognized firm overnight.

What general weaknesses in Barings’ internal controls contributed to the occurrence and

size of the fraud?

An employee of JHT Holdings Inc., a trucking company, was responsible for resolving road-

way accident claims under $25,000. The employee created fake accident claims and wrote set-

tlement checks of between $5,000 and $25,000 to friends or acquaintances acting as phony

“victims.” One friend recruited subordinates at his place of work to cash some of the checks.

Beyond this, the JHT employee also recruited lawyers, who he paid to represent both the truck-

ing company and the fake victims in the bogus accident settlements. When the lawyers cashed

the checks, they allegedly split the money with the corrupt JHT employee. This fraud went un-

detected for two years.

Why would it take so long to discover such a fraud?

Event Sound Co. discovered a fraud whereby one of its front office administrative employees

used company funds to purchase goods, such as computers, digital cameras, compact disk play-

ers, and other electronic items for her own use. The fraud was discovered when employees no-

ticed an increase in delivery frequency from vendors and the use of unusual vendors. After some

investigation, it was discovered that the employee would alter the description or change the

quantity on an invoice in order to explain the cost on the bill.

What general internal control weaknesses contributed to this fraud?

334 Chapter 7 Sarbanes-Oxley, Internal Control, and Cash

Exercise 7-4

Internal controls for bank

lending

Goals2, 3

Exercise 7-5

Internal controls

Goals2, 3

Exercise 7-6

Internal controls

Goals2, 3

Exercise 7-7

Internal controls

Goals2, 3