Howard Street Jewelry Accounting Case Study on Internal Controls1. The main internal control concept the Levis ignored was segregation of duties. No one person should be responsible for all transactions from the beginning to the end. Betty had too many responsibilities that were interwoven and should have been performed by more than one person. She handled the cash that came in, maintained the cash receipts and the sales records. Another concept that this relates to is that no one individual should perform more than one of the following; recording transactions, authorizing transactions and maintaining custody over the assets. Betty was able to do all three; selling jewelry, putting items in layaway, recording sales, maintain cash receipts and accepted the cash. Betty was allowed to have incompatible duties which allowed her to commit fraud of $350,000.

2. The case states that the CPA served as their accountant for almost 40 years providing a wide range of accounting and business issues. The responsibility that the CPA has to pursue this matter is dependent on the time of this fraud relating to what services were provided by the CPA. It is also dependent on what services the CPA is providing now. Assuming the CPA was only providing tax return services, as he is doing now, than the CPA does not have responsibility to pursue this matter.

The answer is not the same if the CPA is performing an audit, review or compilation. The CPA is liable in these circumstances. There are two types of liabilities that the CPA can have; common law liability and statutory law liability. The liability that the CPA has in this case is common law liability. Since it is a privately owned company, the CPA will not have statutory liability.

The CPA must exercise due professional care, and if the CPA was performing one of the three tasks mentioned, then he probably was not exercising due professional care since this is a small company and over $350,000 in fraud was committed. It was also mentioned that the CPA mentioned that there were occasional shortages in the cash receipts records that seemed larger than normal for a small retail business.

$350,000 is a material amount for this business and would change the users of financial statements viewed the financial statements. It was so material, that it almost forced the store to close.

3. I do not agree with dropping what I am working on to try to sell a new client on my services. So the answer to this question is dependent on how desperate I am for a new client. If I did not have a chance to prepare for the meeting and they did not have an appointment, I would ask the potential client to come back shortly.

There are three major reasons for sending the client away; the first is I will not drop what I am doing for somebody who does not have an appointment. A CPA firm is not something that you window shop, and the potential client could have picked up the phone to make an appointment instead of just walking in. This client already seems too needy and not responsive to other peoples’ schedules. This deal could be lucrative, and I would not want to lose them to my competition, but as I mentioned, I am not worried about somebody window shopping for a CPA firm.

The second reason I would send them away is because I did not have time to prepare and I would want to be sure that I knew enough about the industry and other factors so I would be able to not lose the client by sounding uneducated on the subject.

The third reason I would not see the client right away is because the services this person needs can wait a few hours or even days. This is not something he needs me right away for. Therefore, when I make them come back later, it would not be a major inconvenience for them.

Once I did meet with them, there would be five internal control issues I would discuss with them. They are organizational structure, physical controls, accounting information systems, assignment of authority / responsibility and performance reviews.

Even though this is a very small family owned business, an organizational structure is still necessary. This will provide a basis for planning, directing, and controlling operations of the jewelry store. This organizational structure will need to separate some responsibilities such as authorization of transactions, record keeping for transactions and custody of assets. The organizational structure, if successfully implemented, should lead to segregation of duties.

Physical controls include controls that provide physical security over both records and other assets. In the case of a small jewelry store, an example would be numbered invoice sheets (sales receipts) so any skip in numbers would indicate that an employee may have pocketed the cash from the sale. The number on the receipt can trace it back to who the salesperson was and it would be very difficult to steal cash transactions. Physical security would be a safe

for the layaway items, or locks on the cabinets with only selected employees having access to the keys.

The accounting information system would provide inventory controls, records of transactions and the database for the financial / accounting data. The AIS can provide daily cycle counts so an entire storewide inventory is not needed as often. If the cycle counts are above a certain percentage, then the physical inventory can be delayed.

The assignment of authority and responsibility ties into the organizational structure / segregation of duties. The employees need to have an understanding of what their functions are to include, doing more may jeopardize the internal controls by unsegregating the duties.

Performance reviews compare where the company is standing compared to past years and to forecasted budgets. Any deviation can imply that something may be wrong with the internal controls and it should be investigated further by the CPA.

Howard Street Jewelers, Inc.1.)The Levis overlooked both Administrative control and Accounting control objectives. By allowing Betty to execute transactions without Management’s approval they did not satisfy Administrative controls. It is also unclear whether there was any formal official procedure established which Betty was required to follow. Concerning Accounting control, the Levis first and foremost did not ensure that transactions were recorded as necessary. Betty was apparently given access to assets (cash and merchandise) without Management approval, allowing her to commit prolonged acts of fraud.

QUESTIONS1. Identify the internal control concepts that the Levis overlooked or ignored.One of the most blatant oversights in internal controls was the lack of segregation of duties. A cashier should never be in a position that also handles all cash and sales records. 

2. When Mrs. Levi informed the CPA of her suspicions regarding Betty, what responsibilities, if any, did the CPA have to pursue this matter? Because the CPA was just doing their taxes, he doesn't have any real responsibilities to pursue the matter any further. However, if he suspected something was amiss he should have discussed it with the Levi's to let them know there may be a problem. In addition to preparing tax returns for Howard Street Jewelers, alternately assume that the CPA (a) audited the business's annual financial statements. If the CPA were their auditor, he would have a responsibility to bring any hint of fraud to the attention of the audit committee. (b) reviewed the annual financial statements. If the CPA were hired to review the annual financial statements, he would be responsible to inform the Levi's of any discrepancies he may find. (c) Compiled the annual financial statements. He would be responsible to inform the Levi's of any discrepancies found.

1. The internal control concepts that the Levis ignored werea. Segregation of duties - No one person should be responsible for all transactions from the beginning to the end. Betty had too many responsibilities that were interwoven and should have been performed by more than one person. She handled the cash that came in, maintained the cash receipts and the sales records. Another concept that this relates to is that no one individual should perform more than one of the following; recording transactions, authorizing transactions and maintaining custody over the assets. Betty was able to do all three; selling jewelry, putting items in layaway, recording sales, maintain cash receipts and accepted the cash. Betty was allowed to have incompatible duties, which allowed her to commit fraud of $350,000.b. Physical safeguarding of assets – She physically handled all the cash that came in and had ample opportunity to skim the cash even before any transactions were recorded.c. Proper Authorizations – Betty had authority to record and authorize

the transactions which should not have been the case. She should not have the authority to record sales returns, or having access to layaway or jewelry items. This authority should be given to a manager above her.d. Independent checks – the activity performed by Betty was never checked as there was trust placed in her.e. Proper documentation – there were problems with maintaining proper trail documentation or with missing documentation which should have been monitored and entered into system to keep an easy track of instead of depending on filing papers.