You were engaged to audit the financial statements of Blank City Newspapers, Inc., for the year ended December 31. The company publishes a newspaper with a daily circulation of approximately 65,000 .

During your examination of accounts receivable, certain unusual transactions were noted and discussed with company executives. When questioned about the transactions, the cashier admitted to a defalcation and gave company executives 298 remittance advices consisting of either the top half of the newspaper's monthly statement, the voucher portion of the customers' checks, or the cashier's memo of payment. The cashier said these remittance advices (amounting to \(\$ 74,437.38\) ) were the record of payments made by customers for which the checks had been deposited in the bank but no credit had been given in the customers' accounts. She had diverted some previous checks received by mail to an unauthorized bank account that she established in the company's name using a forged corporate resolution. Funds could be withdrawn upon her signature.

The company was shocked because the cashier was an old and faithful employee who was never sick and so interested in her work that she never took a vacation.

To conceal the irregularity, the cashier was lapping accounts receivable by withholding cash receipts from some customers and posting later cash receipts to these earlier customers' accounts. As the total misappropriated grew to a sizable amount, the process became so involved that most customers were receiving credit up to two weeks late.

A review of the company's internal control for cash receipts disclosed the following:

The cashier reported directly to the controller.

Mail was opened by another employee of the company. This employee did not prepare a record of the money and checks received before he distributed them.

All mail and over-the-counter receipts (cash sales and payments on account) were given to the cashier. Receipts included approximately \(\$ 100\) to \(\$ 200\) daily in currency.

The cashier prepared a daily report showing customer and amount of payment. She gave this report, together with remittance advices, to the accounts receivable department for posting to the customers' accounts receivable ledger cards.

The cashier prepared the bank deposit and took the deposit to the bank. She obtained an authenticated deposit slip from the bank.

The cashier gave the authenticated deposit slip to the controller, who compared the total shown thereon with the total shown on the daily cash receipts report. These totals were always in agreement.

Required:

a. Write a letter to the audit committee listing the reportable conditions noted in the company's accounting procedures for cash receipts and recommendations for improvement.

b. List the tests of controls that might have disclosed the fraud by the cashier.

c. What should you do when you discover unusual items that might indicate a fraud by one of the company's employees?

Source: Adapted and used with permission of Ernst \(\mathcal{E}\) Young.