Mel O\'Conner operates rental properties in Michigan. Each property has a manage
ID: 2454852 • Letter: M
Question
Mel O'Conner operates rental properties in Michigan. Each property has a manager who collects rent, arranges for repairs, and runs advertisements in the local newspaper. The property managers transfer cash to O'Conner monthly and prepare their own bank reconcilations. The manager in Lansing has been stealing from the company. To cover the theft, he overstates the amount of the outstanding checks on the monthly bank reconciliation. As a result, each monthly bank reconciliation appears to balance. However, the balance sheet reports more cash than O'Conner actually has in the bank. O'Conner is currently putting his entire business up for sale. In negotiating the sale of the business, O'Conner is showing the balance sheet to prospective buyers.
Explain how overstating the amount of outstanding checks on the monthly bank reconciliation works to 'cover' the theft perpetrated by the manager in Lansing.
Identify who, other than O'Conner, could be harmed by this theft. In what ways could they be harmed?
Discuss the role accounting plays in this situation.
What controls could have been put in place to prevent this type of deception?
Explanation / Answer
Part A)
Overstating the amount of outstanding checks would indicate that the amount due to be paid is yet to get cleared and debited from the bank account. The amount of outstanding checks is deducted from the balance in the bank account at the time of preparation of bank reconciliations to match with the balance available in the cash book. Since, a cash book would show a lesser balance (as it has been stolen), overstatement of outstanding checks would result in lower balance available in the bank account (as it would mean that the amount due to be paid has been adjusted for in the cash book, but not in the pass book requiring an adjustment at the time of reconciliation) thereby, covering up the theft perpetrated by the manager.
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Part B)
The other parties who will get affected by the overstatement are company's creditors/lenders and potential buyers of the business. Overstating the amount of cash may indicate a sound cash flow position for the company which actually is not the case. Wrong decisions may be made by these parties on the basis of the cash balance reported in the balance sheet. Incorrect information provided to third parties may affect the reputation of the business which may find it difficult to obtain favorable terms from lenders/creditors and may also affect the future business of the entity buying O Conner's business.
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Part C)
Proper accounting is essential to ensure that the transactions are reported as and when they occur in accordance with the generally accepted accountig principals and that the financial statements provide a true and fair picture of the company's current financial position. These financial statements are frequently used by various internal and external stakeholders to make important decisions such as investment in the company. Proper accounting can also help in detection of frauds like the one discussed in this case.
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Part D)
The most important control that can be implemented to prevent this type of deception is segregation of duties. The reconciliation should not be allowed to be performed by the manager responsible for collection. At the same time, the deposit (of amount/payments received) in bank accounts should be performed by a person other than the property manager and the person preparing the reconciiation. In simple, words, a single person should not be allowed to perform all the tasks of a particular process. Another control that could have been implemented is balance confirmation directly with customers and suppliers both. A written conformation can be obtained randomly (on a periodical basis) from certain suppliers/customers on the balance in their books of accounts and matched with balances reported in company's books.