During a recent review, ABC Corporation discovered that it has a serious internal control problem. It is estimated that the impact associated with this problem is $1 million and that the likelihood is currently 5%. Two internal control procedures have been proposed to deal with this problem. Procedure A would cost $25,000 and reduce likelihood to 2%; procedure B would cost $30,000 and reduce likelihood to 1%. If both procedures were implemented, likelihood would be reduced to 0.1%.
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. If you consider only the estimates of cost and benefit, which procedure(s) should be implemented?
d. What other factors might be relevant to the decision.
e. Use the Goal Seek function in Microsoft Excel to determine the likelihood of occurrence without the control and the reduction in expected loss if the net benefit/cost is 0. Do this for procedure A, procedure B, and both procedures together.