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Chapter 7: Q1FC (page 430)

Levon Helm was a kind of one-person mortgage broker. He would drive around Tennessee looking for homes that had second mortgages, and if the criteria were favorable, he would offer to buy the second mortgage for “cash on the barrelhead.” Helm bought low and sold high, making sizable profits. Being a small operation, he employed one person, Cindy Patterson, who did all his bookkeeping. Patterson was an old family friend, and he trusted her so implicitly that he never checked up on the ledgers or the bank reconciliations. At some point, Patterson started “borrowing” from the business and concealing her transactions by booking phony expenses. She intended to pay it back someday, but she got used to the extra cash and couldn’t stop. By the time the scam was discovered, she had drained the company of funds that it owed to many of its creditors. The company went bankrupt, Patterson did some jail time, and Helm lost everything

Requirements

  1. What was the key control weakness in this case?
  2. Many small businesses cannot afford to hire enough people for adequate separation of duties. What can they do to compensate for this?

Short Answer

Expert verified
  1. There was no separation of duties between cash disbursements and recording transactions.
  2. Small businesses must be aware of the risks and vulnerabilities of their business.

Step by step solution

01

Meaning of Mortgage

A mortgage loan can be a type of advance used to purchase real estate, such as a domestic or commercial building. The bank registers a contract with the province where the property is found as part of the loan application process. If the borrower does not make the specified installment, the contract pays the bank a security interest within the home.

02

(1) Meaning of crucial control in the case

Cindy was able to keep her activities under wraps since there was no distinction between the tasks of allocating funds and noting transactions in the notebook. Additionally, the owner was not reviewing the payments or the bank reconciliations. He probably would have discovered the deception right away if he had looked at those documents.

03

(2) Explaining how small businesses can compensate

Small firms must first be conscious of their weaknesses and hazards. Owners must then personally evaluate and authorize all cash-related transactions. Reviewing bank reconciliations is a crucial step in keeping cash under control.

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Most popular questions from this chapter

Question: How does the Sarbanes-Oxley Act relate to internal controls?

Accounting for petty cash transactions

Suppose that on June 1, Rockin’ Gyrations, a disc jockey service, creates a petty cash

fund with an imprest balance of \(300. During June, Michael Martell, fund custodian,

signs the following petty cash tickets:

Petty Cash

Ticket Number Item Amount

1 Postage for package received \) 30

2 Office party 25

3 Two boxes of stationery 20

4 Printer cartridges 15

5 Business dinner 65

On June 30, prior to replenishment, the fund contains these tickets plus cash of \(140.

The accounts affected by petty cash payments are Office Supplies, Entertainment

Expense, and Postage Expense.

Requirements

1. On June 30, how much cash should this petty cash fund hold before it is replenished?

2. Journalize all required entries to (a) create the fund and (b) replenish it. Includeexplanations.

3. Make the entry on July 1 to increase the fund balance to \)325. Include an explanation

What are some common controls used with a bank account?

Match the accounting terminology to the definitions.

1. Sarbanes-Oxley Act

2. Internal control

3. Encryption

4. Separation of duties

5. Internal auditors

a. Organizational plan and all the related measures adopted by an entity to safeguard assets,

encourage employees to follow company policies, promote operational efficiency, and ensure

accurate and reliable accounting records.

b. Employees of the business who ensure that the company’s employees are following company

policies and meeting legal requirements and that operations are running efficiently.

c. Rearranging plain-text messages by a mathematical process—the primary method of

achieving security in e-commerce.

d. Requires companies to review internal control and take responsibility for the accuracy and

completeness of their financial reports.

e. Dividing responsibilities between two or more people.

Applying internal control over cash receipts by mail. Review the internal controls over cash receipts by mail presented in the chapter. Exactly what is accomplished by the final step in the process, performed by the controller?
See all solutions

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