Walker Books, Inc. (Manual System with Minimal PC Support)

(Prepared by Matt Wisser, Lehigh University)

Company Background

Walker Books, Inc., is one of the fastest-growing book distributor in the United States. Established in 1981 in Palo Alto, California, Walker Books was originally a side project of founder and current president Curtis Walker, who at the time was employed by a local law firm. Because reading was much more than just a hobby of his, he decided to use some of his savings to buy an abandoned restaurant and convert it into a neighborhood bookstore, mainly selling used books that were donated and obtained from flea markets. When the doors first opened, Walker’s wife, Lauren, was the only employee during the week and Curtis worked weekends. At the end of the first fiscal year, Walker Books had grossed $20,000 in sales.
As the years passed, Curtis Walker quit the law firm and began concentrating fully on his bookstore. He hired more employees, more books were traded in, and sales increased annually. During the mid-1990s, however, Walker was faced with two problems: many large, upscale bookstores were being built in the area, and the use of the Internet for finding and ordering books was becoming cheaper and more popular for current customers. In 1995, Walker’s sales started to decline. Deciding to take a risk because of the newfound competition, he closed his doors to the neighborhood, invested more money to expand the current property, and transformed his company from simply selling used books to being a distributor of new books. His business model was to obtain books from publishers at a discount, store them in his warehouse, and resell them to large bookstore chains.
Under his current business model, all of Walker’s customers are large-chain bookstores who themselves net many millions of dollars in revenue per year. Some of these customers, however, are now experiencing problems with Walker Books that threaten their business relationship: books are ordered but not sent, Walker’s poor inventory management causes stockouts, and Walker is commonly unable to provide legitimate documentation of transactions.
One potential source of these problems rests with Walker’s antiquated accounting system, which is a combination of manual procedures supported by standalone PC work stations. These computers are not networked and cannot share data between departments. All interdepartmental communication takes place through hard-copy documents.
You have been hired as an independent expert to express an opinion on the appropriateness of Walker Books’ business processes and internal controls. The expenditure cycle is described below:

Expenditure Cycle

Purchases System

The purchases process begins with the purchasing agent, who monitors the levels of books available via a computer terminal that lists current inventory. Upon noticing deficiencies in inventory levels, the agent manually generates four hard copies of a purchase order: one is sent to AP, one is sent to the vendor, one is sent to the receiving department, and the last is filed within the department.
Vendors will generally ship the products within five business days of the order. When goods arrive in the receiving department, the corresponding packing slip always accompanies them. The receiving department clerk unloads the goods and then reconciles the packing slip with the purchase order. After unloading the goods, the clerk manually prepares three hard copies of the receiving report. One copy goes with the goods to the warehouse, another is sent to the purchasing department, and the final copy is filed in the receiving department. In the warehouse, the copy is simply filed once the goods are stored on the shelves. In the purchasing department, the clerk receives this copy of the receiving report and files it with the purchase order.
When the AP department receives the purchase order, it is temporarily filed until the respective invoice arrives from the vendor. Upon receipt of the invoice, the AP clerk removes the purchase order from the temporary file and reconciles the two documents. The clerk then manually records the liability in the hard copy AP subsidiary ledger. Finally, the clerk files the purchase order and invoice in the open AP file in the department. At the end of the day, the clerk prepares a hard-copy journal voucher and sends it to the general ledger department.
Once the general ledger department receives the journal voucher, the clerk examines it for any obvious errors and then enters the relevant data into the department PC to update the appropriate digital general ledger accounts.

Cash Disbursements System

The AP clerk periodically reviews the open AP file for liabilities that are due. To maximize returns on invested cash, yet still take advantage of vendor discounts, the clerk will pull the invoice two days before its applicable due date. Upon finding an open accounts payable file in need of payment, the clerk manually prepares a check for the amount due as per the invoice. The hard copy AP ledger is also updated by the AP clerk. The check number, dollar amount, and other pertinent data are manually recorded in the hard-copy check register. The check is then sent to the cash disbursements department. Finally, the invoice is discarded, as it no longer has any relevant information that hasn’t already been recorded elsewhere.
When the cash disbursements clerk receives the unsigned check, she examines it to ensure that no one has tampered with any of the information and that no errors have been made. Because she is familiar with all of the vendors with whom Walker deals, she can identify any false vendors or any payment amounts that seem excessive. Assuming everything appears in order, she signs the check using a signature block that displays the name of the assistant treasurer, Tyler Matthews. Only Matthews’ signature can validate a vendor check. The cash disbursements clerk then photocopies the check for audit trail purposes.
Once the check is signed, it is sent directly to the supplier. The photocopy of the check is marked as paid and then filed in the cash disbursements department. The clerk then creates a journal voucher, which is sent to the general ledger department. Once the general ledger department receives the journal voucher, the clerk examines it for any obvious errors and then enters the relevant data into the department PC to update the appropriate digital general ledger accounts.

Required:

a. Create a data flow diagram of the current system.

b. Create a system flowchart of the existing system.

c. Analyze the internal control weaknesses in the system. Model your response according to the six categories of physical control activities specified in the COSO internal control framework.

d. Prepare a system flowchart of a redesigned computer based system that resolves the control weaknesses you identified.