The following questions and cases deal with the subject of cost-benefit analysis of internal control. Some important concepts in cost-benefit analysis are as follows:

1. Measurable benefit. Benefits or cost savings may be measured directly or may be based on estimates of expected value. An expected loss is an estimate of the amount of a probable loss multiplied by the frequency or probability of the loss-causing event.

A measurable benefit can arise from the reduction of an expected loss.

2. Qualitative benefit. Some gains or cost savings may not be measurable, such as company public image, reputation for regulatory compliance, customer satisfaction, and employee morale.

3. Measurable costs. Controls may have direct costs such as wages and equipment expenses.

4. Qualitative cost factors. Some costs may be indirect, such as lower employee morale created by over-controlled work restrictions.

5. Marginal analysis. Each successive control feature may have marginal cost and benefit effects on the control problem.

Case A

Porterhouse Company has numerous bank accounts. Why might management hesitate to spend $20,000 (half of a clerical salary) to assign someone the responsibility of reconciling each account every month for the purpose of catching the banks’ accounting errors? Do other good reasons exist to justify spending $20,000 each year to reconcile bank accounts monthly?

Case B

Harper Hoe Company keeps a large inventory of hardware products in a warehouse. Last year, $500,000 was lost to thieves who broke in through windows and doors. Josh Harper figures that installing steel doors with special locks and burglar bars on the windows at a cost of $25,000 would eliminate 90% of the loss. Hiring armed guards to patrol the building 16 hours a day at a current annual cost of $75,000 would eliminate all the loss, according to officials of the Holmes Security Agency. Should Josh arrange for one, both, or neither of the control measures?

Case C

The Merry Mound Cafeteria formerly collected from each customer as he or she reached the end of the food line. A cashier, seated at a cash register, rang up the amount (displayed on a digital screen) and collected money. Management changed the system, and now a clerk at the end of the line operates a calculator/printer machine and gives each customer a paper tape. The machine accumulates a running total internally. The customer presents the tape at the cash register on the way out and pays.

The cafeteria manager justified the direct cost of $30,000 annually for the additional salary and $500 for the new machine by pointing out that he could serve four more people each weekday (Monday through Friday) and 10 more people on Saturday and Sunday. The food line now moves faster and customers are more satisfied. (The average meal tab is $12, and total costs of food and service are considered fixed.) “Besides,” he said, “my internal control is better.” Evaluate the manager’s assertions.

Case D

Assume, in the Merry Mound situation cited above, that the better control of separating cash custody from the end-of-food-line recording function was not cost beneficial, even after taking all measurable benefits into consideration. As an auditor, you believe the cash collection system deficiency is a significant deficiency in internal control, and you have written it as such in your letter concerning reportable conditions, which you delivered to Merry Mound’s central administration. The local manager insists on inserting his own opinion on the cost-benefit analysis in the preface to the document that contains your report. Should you, in your report, express any opinion or evaluation on the manager’s statement?