Case Study - Drotos Theaters (Auditing) - Essay Example

Drotos Theater Audit From an auditing point of view, Drotos Theater has many loose ends it must tie up before a properly functioning company with the security of strict internal controls is established. The purpose of this paper is to discuss eight important areas which will point out the strengths and weaknesses of the present control system that exists within the theater. They include: an evaluation of the manual and computerized control activities, internal control existing and lacking in the present system, internal control limitations and risks, concerns as to why the previous auditing firm resigned, a recommendation of controls to prevent and detect financial misstatements, a recommendation of controls to assure the separation of duties, recommendations for detecting employee fraud concerning cash and an explanation of how to prevent employee theft and controls which can be implemented to prevent this from occurring. An evaluation of the manual and computerized control activities found that the computerized accounting system is accessed only when the controller posts the journal entries into the financial accounting system. Since the computerized system does not aid in the detection of miscalculations or frauds before the entries are made an incorrect number can easily go undetected and cause a serious accounting problem. The controller is responsible for manually depositing cash and recording transactions. Delegating these two important duties to the same person leaves the company with no system of internal control. The cashiers collect cash at the box office and issue tickets to customers. The company does not specify how the cashiers are accountable for the cash they collect and the tickets that they issue. The cashiers are the first point of contact between the customers and company’s cash transaction and therefore it is crucial to ensure that this transaction has a fool-proof control system. Since the ticket taker manually collects tickets it is not guaranteed that they will not allow unauthorized persons into the theater. There are many internal controls which are not present in the existing system. The controller cannot be responsible for recording the transactions and depositing money into the bank account. The controller can easily adjust the deposited amount and recorded amount according to how they see fit causing a serious lack of internal control. The theater does not have a control system which ensures that tickets issued and collected are corresponding and no system which matches issued tickets to the cash that is collected. The cashiers are allowed to freely collect cash and are not accountable for the amount which is deposited with the controller. An assessment of internal control limitations and risks found that if the controller is free to receive cash from the cashiers, there is no control that he deposits the same amount into the bank. The company is taking a big risk trusting the controller not to deposit a lower amount into the bank and fixing the journal entries. Since there is no evident system which holds the cashier responsible for the amount of cash collected this could led to internal employee trouble if a situation occurs in which it is one employees word against another’s. In a case such as this management will be accused of favoring one employee over another thus leading to bad word of mouth for the company. The cashier can easily deposit a lower amount with the controller and say that he deposited a higher amount. The cashier at the ticket counter issues a certain number of tickets according to availability but they would not be aware if a larger amount of people entered the theater. The ticket taker holds the real power which enables him to allow anybody in and out of the theater. He can easily allow unauthorized people into the theater leading to many risks such as loss of ticket profit, discomfort to paying customers and fire hazards as a result of too many people in the building. The previous audit firm resigned from the engagement with good reason. The main concern was a lack of accounting personnel which is a serious problem. More accounting personnel must be hired to ensure a separation of duties. A separation of duties is very important because it will lead to an immediate decrease in existing account imbalances and will put a stop to employee fraud. The existing system has the same person collecting cash from the cashiers, recording transactions and depositing cash into the bank. There must be a different person to receive the cash from the cashiers, another to record the transaction and a third to deposit the amount into the bank. At first, the theater might see hiring two extra people as a waste of salary but in the long run they will come to see this as an asset instead of a liability, “When comparing cost versus benefits of separating responsibilities, management should consider that benefits often include operating efficiencies in addition to improved internal control” (Boston College, 2007). An employee is needed to tally tickets issued to cash received. If each sold ticket is matched to a corresponding cash transaction it will lead to a decrease in the cashier’s power to pocket ticket money. There should be an assistant to match the ticket stubs in the box to the number of people who actually entered the theater and number of tickets actually issued. This will decrease risks related to the ticket taker allowing extra people into the theater. Controls which prevent and detect financial misstatements can be implemented by taking a few steps. The tickets should be stored in a cash box which records the exact number of tickets issued and the corresponding cash transaction which results from a ticket sale should be stored in the same box after the sale of a ticket. The cash collected should be deposited with the controller who would record the figure in the cash book and issue a receipt to the depositing cashier. The cashier would keep all receipts in an employee file which could be investigated if there are any financial misstatements. After the controller records the cash transaction into the cash book another accounting personnel would receive the cash at the end of the day and sign a voucher for the amount and deposit the amount into the bank. The controller would keep this voucher on file in case there are any financial misstatements and the accountant responsible for the deposit would receive a receipt from the bank which is also to be kept on file. An assistant who regulates the issuing of tickets and the number of people in the theater should be hired. His responsibilities would include: examining the ticket stubs from the box of the ticket taker, making checks once a week to count the number of seats empty in the theater and matching them with the number of unsold tickets. The most important internal control that the company must adopt is the separation of duties. By separating tasks that are currently preformed by one staff member management can cut down on fraud and error. “If two elements of a transaction are processed by different individuals, each person provides a check over the other. Separation of duties also acts as a deterrent to fraud or concealment because collusion with another individual is required to complete the fraudulent act. Separating responsibility for physical security of assets from related record keeping is a critical control” (Boston College, 2007). Controls that would assure the separation of duties for back accounting staff must be implemented. The person responsible for checking the stub box for the number of stubs, checking empty seats and matching them with sold tickets would not be able to sell tickets, take tickets or handle cash. The person responsible for depositing cash in the bank would not be able to collect the cash from the cashiers or make any journal entries. The accountant responsible for collecting cash from the cashiers would not be able to sell tickets or deposit the cash into the bank. The number of tickets issued to the cashiers should be tallied with the tickets left unsold and the cash received. This task would not be done by the box office cashiers or the ticket takers but by a separate accountant. Procedures for detecting employee fraud concerning cash should be strictly followed. These procedures include having an accountant subtract the number of unsold tickets from the tickets issued and matching them with the cash collected on a daily basis. The number of tickets in the ticket collectors box should be tallied with the number of people physically in the theater once or twice a week. Cash received from the cashier by the accountant should be separated in a locked cash box and given to another accountant responsible for depositing the money after the receipt of a signed voucher. On a daily basis the bank receipts should be tallied with the total collections from all box office cashiers. The above stated procedures follow a common formula used by many reputable establishments in order to detect fraud such as Boston College, “The major tenets of an internal control system include: (1) separation of duties; (2) physical safeguards over assets; (3) proper documentation; (4) proper approvals; (5) adequate supervision; (6) physical inventories; and (7) independent validation of transaction accuracy” (2007). The cashier and ticket-takers have easy access to incoming cash so it is important that controls which prevent theft must be implemented. One of the most important methods in which to prevent employee fraud is to establish a code of ethics. It is not evident that the theater has a code of ethics or any employee incentives; every company needs a written code of conduct that reflects their ethics and values. But it can't just be on paper. “Management must take that code to heart and demonstrate their commitment through their actions. Like any aspect of corporate culture, expectations regarding ethical behavior need to be communicated, understood, and supported from the top down” (Ethics Line, 2006). Next to a code of ethics internal controls which physically prevent fraud must be established. The ticket taker has the authority to admit customers into the theater and might accept cash instead of tickets. A control which would require an accountant to count the number of stubs in the ticket takers box and compare them with the total number of customers in the theater by performing a head count. This would be done twice a week after the gates are closed. The cashier might enter a lower number of tickets sold and pocket the cash for the extra tickets sold. This problem can be eliminated if the number of stubs found in the ticket takers box is matched with the total number of tickets sold. It is very important that imbalances be properly investigated and not written off as a mistake, “If you do not believe fraud is possible, you will not identify it even if it is clearly evident.  Very often fraud symptoms are viewed as administrative errors because individuals cannot conceive of the existence of fraud particularly in organizations where there is a longtime affiliation with co-workers” (Boston College, 2007). The company should hire an employee whose sole responsibility is to investigate employee fraud. This employee does not have to be a full time employee; instead they could be a contracted worker who is called when there is obvious evidence of fraud. Also, the company should keep track of all the assets that can be abused by staff members aside from cash such as: food, equipment, tickets and office supplies. It is important that the company is aware of the loss it can suffer if assets re abused on a continual basis by staff members. “Identify the risks associated with safeguarding these assets. Ask yourself: (1) How could these assets be misused or improperly used? (2) If these assets were misused or misappropriated, how would I know? (3) What controls exist to prevent or detect inappropriate use or loss of assets? (4) What additional controls are necessary to ensure that assets are adequately protected from loss? and (5) Is the cost of additional controls reasonable in relation to the risk involved” (Boston College, 2007). The prevention of fraud can be cleverly hidden by implementing a rewards program for staff. For example, the cashier with the most accurate ticket sales to cash ratio could win a monthly movie pass. Every month a new movie pass will be given to the cashier with the best track record. This program can include the accounting staff as well in the form of a bonus if they catch a misstatement made by another accounting staff member. The company must reinforce that this not in order to turn staff against one another but to increase morale and employee motivation. Drotos Theater has a strong tradition of being profitable in both good times and bad times. If they would like to continue this tradition in the face of expansion they must consider implementing the recommended actions. The management must make responsible decisions that will encourage a strong system of internal control and must remember that a even a strong system can be faulty, “Human judgment in decision-making can be faulty, persons responsible for establishing controls need to consider their relative costs and benefits, and breakdowns can occur because of human failures such as simple error or mistake” (Boston College, 2007). Internal control is a strong asset that will aid in the detection and prevention of miscalculations which will ultimately lead to a more profitable theater. Reference List Boston College. (January 4, 2007). Separation of Duties. Retrieved June 12, 2007, from http://www.bc.edu/offices/audit/controls/sepduties.html Ethics Line. (2006). Ten Tips for Preventing Corporate Fraud. Retrieved June 12, 2007, from http://www.ethicsline.com/news/TNW_10TIPS_CM_EL.asp Read More