Case Study

1. The management at Covington, Inc recognizes that a well designed internal control system
provide many benefits. Among the benefit are reliable financial records that facilitated decision
making and a greater possibility of preventing or detecting errors and fraud. The Company
internal auditing department periodically review the company’s accounting records to determine
the effectiveness of internal control, In its latest review, the internal audit staff found the
following eight condition :
1. Daily bank deposit do not always correspond with cash receipts
2. Bad debt write off are prepared and approved by the same employee
3. There are occasional discrepancies between physical inventory counts and perpetual
inventory records
4. Alteration have been made to physical inventory counts and perpetual inventory records
5. There are many customer refunds and credits
6. Many original document are missing or lost, However, there are substitute copies of all
missing original
7. An unexplained decrease in the gross profit percentage has occurred
8. Many documents are not approved

Required :

For each of the eight condition detected by the Covington Internal audit staff :

a. Describe a possible cause of condition

b. Recommend action to be taken and/ or control to be implemented that would correct the
condition.

2. During recent review, ABC Corporation discovered that it has a serious internal control problem,
It is estimated that the impact associated with this problem is $1 million and that the likelihood
is currently 5%. Two internal control procedures have been proposed to deal with this problem,
Procedure A would cost $25,000 and reduce likelihood 2%. Procedure B would cost $30,000 and
reduce likelihood to 1%. If both procedures were implemented, likelihood would be reduced to
0.1%.
Required :
A. What is the estimated expected loss associated with ABC Corporations internal control
problem before any new internal control procedure are implemented?
B. Compute the revised estimate of expected loss If procedure A were implemented, if
procedure B were implemented, and if both of procedure were implemented?
C. Compare estimated costs and benefits of procedure A, procedure B and both procedure
combined. If you consider only the estimates of cost and benefit, which procedures should
be implemented?

Note :
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