CMA 1289 3-4

Evaluation of Internal Control

Oakdale, Inc. is a subsidiary of Solomon Publishing and specializes in the publication and distribution of reference books. Oakdale’s sales for the past year exceeded $18 million, and the company employed an average of 65 employees. Solomon periodically sends a member of the internal audit department to audit the operations of each of its subsidiaries, and Katherine Ford, Oakdale’s treasurer, is currently working with Ralph Johnson of Solomon’s internal audit staff. Johnson has just completed a review of Oakdale’s investment cycle and prepared the following report.

General

Throughout the year, Oakdale has made both shortterm and long-term investments in securities; all securities are registered in the company’s name. According to Oakdale’s bylaws, long-term investment activity must be approved by its board of directors, while short-term investment activity may be approved by either the president or the treasurer.

Transactions

All purchases and sales of short-term securities were made by the treasurer. The long-term security purchases were approved by the board, while the long-term security sales were approved by the president. Because the treasurer is listed with the broker as the company’s contact, all revenue from these investments (dividends and interest) is received by this individual, who then forwards the checks to accounting for processing.

Documentation

Purchase and sale authorizations, along with the broker’s advices, are maintained in a file by the treasurer. The certificates for all long-term investments are kept in a safe deposit box at the local bank; only the president of Oakdale has access to this box. An inventory of this box was made, and all certificates were accounted for. Certificates for short-term investments are kept in a locked metal box in the accounting office. Other documents, such as long-term contracts and legal agreements, are also kept in this box. There are three keys to the box held by the president, the treasurer, and the accounting manager. The accounting manager’s key is available to all accounting personnel should they require documents kept in this box. Documentation for two of the current short-term investments could not be located in this box; the accounting manager explained that some of the investments are for such short periods of time that formal documentation is not always provided by the broker.

Accounting Records

The accounting department records deposits of checks for interest and dividends earned on investments, but these checks could not be traced to the cash receipts journal, which is maintained by the individual who normally opens, stamps, and logs incoming checks. These amounts are journalized monthly in an account for investment revenue. The treasurer authorizes checks drawn for investment purchases. Both the treasurer and the president must sign checks in excess of $15,000. When securities are sold, the broker deposits the proceeds directly in Oakdale’s bank account by an electronic funds transfer.
Each month, the accounting manager and the treasurer prepare the journal entries required to adjust the short-term investment account. There was insufficient backup documentation attached to the journal entries reviewed to trace all transactions; however, the balance in the account at the end of last month closely approximates the amount shown on the statement received from the broker. The amount in the long-term investment account is correct, and the transactions can be clearly traced through the documentation attached to the journal entries. There are no attempts made to adjust either account to the lower of aggregate cost or market.

Required:

To achieve Solomon Publishing’s objective of sound internal control, the company believes the following four controls are basic for an effective system of accounting control:

• Authorization of transactions

• Complete and accurate record keeping

• Access control

• Internal verification

a. For each of the four controls listed above, describe its purpose.

b. Identify an area in Oakdale’s investment procedures that violates each of the four controls.

c. For each of the violations identified, describe how Oakdale can correct each weakness.