Case Study 2: Internal Control Due By Saturday Of Week 5

Case Study 2—Internal Control Due by Saturday of Week 5, 11:59 p.m., Mountain time

Evaluate the internal control system of LJB Company, a local distributor planning to go public. Identify new regulatory requirements if they go public, assess what they are doing well, and recommend improvements, including whether to purchase an indelible ink machine. Provide a detailed, formal report addressing these points with appropriate references.

Paper For Above instruction

Introduction

Ensuring robust internal control systems is fundamental for any company aspiring to go public. Public companies are subject to rigorous regulations designed to protect investors and ensure transparency. This paper evaluates the current internal control environment of LJB Company, a regional distributor preparing to become a publicly traded entity. The assessment covers the specific regulatory requirements that will impact the company upon going public, recognizes existing strengths, offers recommendations for improvement—particularly concerning the potential purchase of an indelible ink machine—and highlights critical areas needing enhancement based on internal control principles.

Regulatory Requirements for Going Public

Transitioning from a private to a public company introduces a host of regulatory obligations, primarily governed by the Sarbanes-Oxley Act of 2002 (SOX). This legislation mandates comprehensive internal control procedures to ensure the accuracy and reliability of financial reporting. Section 404 of SOX obligates management to establish and maintain an adequate internal control framework and requires an annual independent auditor’s assessment of these controls (Coates, 2007). Companies must implement controls over financial reporting processes, safeguard assets, and prevent fraud. Furthermore, the public company accounting oversight board (PCAOB) has established standards for auditing internal controls, emphasizing documentation, testing, and remediation efforts (PCAOB, 2020). LJB will need to formalize policies, segregate duties, enhance documentation, and strengthen cybersecurity measures, including assigning unique passwords to employees to prevent unauthorized access to sensitive information.

Strengths in Current Internal Controls

Despite notable weaknesses, certain practices within LJB Company demonstrate commendable internal control aspects. For example, the use of pre-numbered invoices, initiated by the accountant, helps ensure documentation completeness and reduces the risk of data manipulation, aligning with the internal control principle of documentation integrity (Arens, Elder, & Beasley, 2019). Additionally, the company's reliance on a trusted long-term employee to handle multiple roles indicates a degree of confidence in their personnel, which, if managed properly, can foster accountability. The company's effort to conduct bank reconciliations regularly is another positive control activity, aiding in early detection of discrepancies and preventing theft or fraud. Such practices are in line with the control principle of safeguarding assets and maintaining accurate records.

Recommendations on the Indelible Ink Machine

The consideration of purchasing an indelible ink machine is linked to achieving a higher level of control over check issuance. According to the internal control principle of segregation of duties and physical controls, printing checks on indelible ink enhances security by making alterations or fraud attempts more detectable and reducing the risk of unauthorized changes. While the current system of leaving checks in the accountant’s office for pickup simplifies operations, it exposes the organization to theft or unauthorized access. Therefore, investing in a check printer equipped with secure printing features is advisable. This aligns with best practices outlined in accounting standards, which recommend implementing technological controls to prevent fraud and guarantee the integrity of financial documents (COSO, 2013). Ultimately, if the company aims to strengthen internal controls and improve accountability, purchasing an indelible ink printing machine is a prudent step.

Weaknesses and Internal Control Violations

Several critical internal control deficiencies are evident in LJB's current setup. Firstly, the lack of segregation of duties—where one employee handles purchasing, cash handling, bank reconciliation, and interviewing new hires—violates the fundamental internal control principle of segregation of duties, increasing the risk of fraud and errors (Arens et al., 2019). This consolidation of responsibilities compromises the integrity of financial data and asset security. A significant concern is the handling of petty cash; all employees have access and only note withdrawals without proper authorization, verification, or reconciliations, raising the risk of misuse and misappropriation. Implementing petty cash controls such as limiting access, requiring receipts, and performing periodic reconciliations would substantially reduce these risks.

Another critical issue is the absence of individual passwords for computer access, which severely limits accountability. For example, the incident involving viewing inappropriate content highlights the vulnerabilities in security controls. Implementing unique user passwords and access controls is essential to reinforce accountability, deter misconduct, and comply with cybersecurity standards (Pike et al., 2020). Furthermore, the current bank reconciliation process, handled solely by the accountant, lacks independent review, increasing susceptibility to undetected errors or fraud. Establishing a segregation of duties in bank reconciliations, such as assigning this task to an independent person or department, is recommended.

Conclusion

In conclusion, LJB Company must address several key areas to meet the internal control standards required for a public company and to optimize their operations. They should adhere to the formal internal control frameworks mandated by regulations such as SOX, including strengthening documentation, segregation of duties, and cybersecurity measures. The purchase of an indelible ink machine aligns with these principles, enhancing the security and integrity of check issuance. The company’s strengths, such as timely bank reconciliations and use of pre-numbered invoices, should be maintained and expanded upon. Conversely, weaknesses like overlapping responsibilities, unsecured petty cash, and poor cybersecurity protocols must be remedied to prevent fraud and ensure accurate reporting. Implementing these recommendations will position LJB favorably in their pursuit of going public and establish a resilient internal control environment that safeguards assets and promotes transparency.

References

• Arens, A. A., Elder, R. J., & Beasley, M. S. (2019). Auditing and Assurance Services: An Integrated Approach. Pearson.
• Coates, J. C. (2007). The goals and promise of the Sarbanes-Oxley Act. Journal of Economic Perspectives, 21(1), 91-116.
• Committee of Sponsoring Organizations of the Treadway Commission (COSO). (2013). Internal Control—Integrated Framework. COSO.
• Pike, T., Boudria, M., & Kumar, S. (2020). Cybersecurity in financial reporting: Controls, standards, and regulations. Journal of Accounting and Public Policy, 39(6), 106731.
• Public Company Accounting Oversight Board (PCAOB). (2020). Auditing Standard No. 5: An Audit of Internal Control Over Financial Reporting That is Integrated with An Audit of Financial Statements. PCAOB.