7.5. During a Recent Review, ABC Corporation Discovered That It Has a Serious Internal

PROBLEMS

7.5.  During a recent review, ABC Corporation discovered that it has a serious internal control problem. It is estimated that the exposure associated with this problem is $1 million and that the risk is presently 5 percent. Two internal control procedures have been proposed to deal with this problem. Procedure A would cost $25,000 and reduce risk to 2 percent. Procedure B would cost $30,000 and reduce risk to 1 percent. If both procedures were implemented, risk would be reduced to one-tenth of 1 percent.

Required

a.  What is the estimated expected loss associated with ABC Corporation’s internal control problem before any new internal control procedures are implemented?

b.  Compute the revised estimate of expected loss if procedure A were implemented, if procedure B were implemented, and if both procedures were implemented.

c.  Compare the estimated costs and benefits of procedure A, procedure B, and both procedures combined.

d.  Considering only the estimates of cost and benefit, which procedure(s) should be implemented? What other factors might be relevant to the decision?

The first column in the table below lists transaction amounts that have been summed to obtain a batch total. Assume the amounts and the batch totals are correct. Columns a through d contain batch totals computed from the same amounts after these transaction amounts were processed in a subsequent processing step. One processing error occurred during each of the four cases.

Required

For each case, you are to do the following:

a.  Compute the difference between the batch total obtained after processing and the correct batch total shown on the left.

b.  Explain specifically how this difference is helpful in discovering the processing error.

c.  Identify the processing error.

Transaction Amounts from Source Documents and Batch Totals

Transaction amounts / a / b / c / d
$3,630.62 / $3,630.62 / $3,630.62 / $3,630.62 / $3,630.62
1,484.86 / 1,484.86 / 1,484.86 / 1,484.86 / 1,484.86
2,164.67 / 2,164.67 / 2,164.67 / 2,164.67 / 2,164.67
946.43 / 946.43 / 946.43 / 946.43 / 946.43
2,626.28 / -2,626.28 / 2,626.28 / 2,626.28 / 2,626.28
969.97 / 969.97 / 969.97 / 969.97 / 969.97
2,772.42 / 2,772.42 / 2,772.42 / 3,772.42 / 2,772.42
934.25 / 934.25 / 934.25 / 934.25 / 934.25
1,620.94 / 1,620.94 / 1,620.94 / 1,620.94 / 1,620.94
4,566.86 / 4,566.86 / 4,656.86 / 4,566.86 / 4,566.86
1,249.32 / 1,249.32 / 1,249.32 / 1,249.32 / 1,249.32
1,070.27 / 1,070.27 / 1,070.27 / 1,070.27 / 1,070.27
2,668.51 / 2,668.51 / 2,668.51 / 2,668.51 / 2,668.51
1,762.62 / 1,762.62 / 1,762.62 / 1,762.62 / 873.26
873.26 / 873.26 / 873.26 / 873.26 / $27,578.66
$29,341.28 / $24,088.72 / $29,431.28 / $30,341.28