Working through sox: how to help corporations improve their accounting departments' policies.

Author:Febres, George E.

    1.1 Purpose of the Investigation

    The purpose of the investigation has been to detect problems in the accounting department of a large non-profit organization located in South Florida. Serious problems have been found in the areas of financial accounting, accounting software, and forensic accounting.

    A preliminary investigation has been conducted in the accounting department of this company. The inquiry involved a review of the asset, liability, equity, revenue, and expense accounts of the non-profit entity. Although this is a non-profit business, it operates three warehouses. The agency buys low price merchandise and resells it to retailers and to the ultimate consumers. In addition, a search for the accounting policies and procedures was undertaken. Furthermore, the accounting software used by the company has been evaluated. This preliminary review has identified three areas that need intervention: financial accounting concerns, accounting software concerns, and forensic accounting concerns.

    1.2 The Company

    The company incorporated as a non-profit organization in Florida in 1981. In addition to its charity operations, the company operates three warehouses. Merchandise is purchased for resale to retailers and to the general public. The company also receives substantial cash donations from organizations and individual donors, and holds several fund-raising events every year. An executive director is responsible for all the operations of the agency. The executive director reports to a nineteen-member board of directors. The accounting department is staffed by a director of finance and one accounting clerk. The fiscal year for the agency runs from Jul1 to June 30 of the following year.

    1.3 The Problem

    The initial review of the affairs of the accounting department of this non-profit organization supports the fact that the agency has been experiencing serious problems in its accounting department for the last few years. The former director of finance ran the department without any oversight by the former executive director for a period of five years. Internal controls have been non-existent. The former director had the responsibilities of both the custody of assets and all accounting functions, including receiving cash and check donations, recording the transactions in the accounting records, and making the bank deposits. Furthermore, the former director of finance was entrusted with an American Express company credit card and was allowed to purchase assets without any approval or oversight by his superior.

    Four months ago, a new executive director was hired. During the first month of his tenure, he realized that the former director of finance had probably engaged in fraudulent activity and dismissed him. The recently hired executive director also became aware that his accounting department was in total disorder and proceeded to employ a young certified public accountant (CPA) as director of finance, charging this individual with the task of fixing the accounting records. The CPA found a large discrepancy between the cash account balance per books and the cash in the bank and attempted to solve this situation by making a journal entry debiting a newly created clearance account named "cash balance discrepancies" and crediting the cash account. In addition, she made other journal entries in the hope of fixing other account balances. By doing this, she made the problem worse. The executive director fired her after only three weeks of her hiring date and employed another director of finance.

    The problem is very important as a social concern because this agency is a non-for-profit organization that often receives sizable cash donations from businesses and from individual donors. If fraud has been perpetrated as the initial observations indicate, the trust of the donors has been violated and the intended use of the donated funds has not been realized. Apparently, previous audits have not uncovered fraud for reasons that need to be explained. According to Reffett (2010), "Counterfactual reasoning theory indicates that investigating fraud risks likely can increase auditors' liability in the event of an audit failure due to undetected fraud" (p. 2146). Furthermore, Kahan argues that research continuously confirms that preventing fraud and uncovering deceptive accounting practices are in strong demand as companies respond to closer scrutiny of their financial activities by shareholders and government agencies (as cited in Digabriele, 2008, p. 331). The problem also has a high degree of theoretical interest as financial accounting theories, fraud theories, and forensic accounting theories must be applied in order to solve it.


    2.1 Financial Accounting Issues

    The accounting records are in complete disarray. In addition, many source documents (about 30%) that were supposedly used as the basis for recording transactions in the accounting records are missing. The checking account has not been reconciled for the past sixteen months and the balances of most of the ledger accounts are not accurate.

    2.1.1 Possible Solutions

    Solution 1. Using the original source documents, enter all current fiscal year (July 1, 2010 to present) business transactions into Quick Books in an attempt to reconstruct the accounting records to date. At the same time, record current and future transactions in both the company's accounting software and Quick Books. In addition to the above, purchase new accounting software and write a comprehensive accounting policies and procedures manual.

    Analysis 1. This possible solution is laudable...

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