Heirloom Photos sells a $900 photography plan to rural customers using a commissioned sales force

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Case 5.2 (page 152) – Heirloom Photo Plans: In two- to three-pages, answer the four questions at the end of the case.
Case 5-2 Heirloom Photo Plans
Heirloom Photos sells a $900 photography plan to rural customers using a commissioned sales force. Rather than pay the price up front, most customers pay $250 down and make 36 monthly payments of $25 each. The $900 plan includes the following:
A coupon book good for one free sitting every six months for the next five years (10 sittings) at any Heirloom-approved photo studio. The customer receives one free 11-by-14-inch black-and-white print. Additional photos or color upgrades can be purchased at the photographer’s retail prices.
To preserve the 11-by-14-inch photos, the family name is embossed in 24-carat gold on a leather-bound photo album.
The embossed leather album, with a retail value of $300, costs Heirloom $75. Each sitting and free 11-by-14-inch print, with a retail value of $150, costs Heirloom only $50 because photographers are given exclusive rights to all Heirloom customers in a geographic region and have the opportunity to offer customers upgrades to color and/or more pictures.
The commissioned sales staff is paid on the 10th of each month, based upon the prior month’s sales. The commission rates are as follows:
5.7-8 Full Alternative Text
Over 70% of all agents sell at least 101 plans per year; 40% sell over 200. There is a strong sales surge before year-end as customers purchase plans to give as holiday gifts. About 67% of all agents reach their highest incentive level in late November or December. Heirloom treats the sales staff and the photographers as independent contractors and does not withhold any income or payroll taxes on amounts paid to them.
Salespeople send Heirloom’s accounting department the order form, the total payment or the down payment, and the signed note for $650 if the customer finances the transaction. Often, the payment is a hand-written money order. Because many customers live in rural areas, the return address is often a Post Office box, and some customers do not have phones. Heirloom does not perform any credit checks of customers.
Heirloom makes the following entries at the time a new contract is recorded:
5.7-9 Full Alternative Text
Because the entire cost of the photographer is accrued, the company points to the last entry to show how conservative its accounting is.
After waiting 10 days for the check or money order to clear, Heirloom embosses and ships the album, the photo coupon book, and a payment coupon book with 36 payments of $25. Customers mail a payment coupon and a check or money order to a three-person Receivables Department at headquarters. The Receivables employees open the envelopes, post the payments to the receivables records, and prepare the bank deposit.
The photo coupon book has 10 coupons for photographer sessions, each good for a specific six-month period. If not used within the six-month period, the coupon expires.
Each month, the credit manager sends letters and makes phone calls to collect on delinquent accounts. Between 35% and 40% of all customers eventually stop paying on their notes, usually either early in the contract (months 4 to 8) or at the two-year point (months 22 to 26).
Notes are written off when they are 180 days delinquent. Heirloom’s CFO and credit manager use their judgment to adjust the Allowance for Bad Debts monthly. They are confident they can accurately predict the Allowance balance needed at any time, which historically has been about 5% of outstanding receivables.
Agricultural product prices in the area where Heirloom sells its plans have been severely depressed for the second straight year.
Heirloom has been growing quickly and finds that it is continually running short of cash, partly because of the large salaries paid to the two equal owners and their wives. (The wives each receive $100,000 to serve as the treasurer and the secretary; very little, if any, time is required in these duties.) In addition, Heirloom spent large amounts of cash to buy its headquarters, equipment and furnishings, and expensive automobiles for the two owners, their wives, and the four vice presidents.
Figure 5-3 Internal and External Relationships at Heirloom Photos
Heirloom needs to borrow from a local bank for corporate short-term operating purposes. It is willing to pledge unpaid contracts as collateral for a loan. A local bank president is willing to lend Heirloom up to 70% of the value of notes receivable that are not more than 60 days overdue. Heirloom must also provide, by the fifth day of each month, a note receivable aging list for the preceding month and a calculation showing the maximum amount Heirloom may borrow under the agreement.
Figure 5-3 shows the employees and external parties that deal with Heirloom. Explain how Heirloom could defraud the bank and how each internal and external party, except the bank, could defraud Heirloom.
What risk factor, unusual item, or abnormality would alert you to each fraud?
What control weaknesses make each fraud possible?
Recommend one or more controls to prevent or detect each means of committing fraud.
Problem 7.1 (page 224) – Go-Go Corporation: In one- to two-pages, identify and explain the internal environment problems.
7.1 You are an audit supervisor assigned to a new client, Go-Go Corporation, which is listed on the New York Stock Exchange. You visited Go-Go’s corporate headquarters to become acquainted with key personnel and to conduct a preliminary review of the company’s accounting policies, controls, and systems. During this visit, the following events occurred:
You met with Go-Go’s audit committee, which consists of the corporate controller, treasurer, financial vice president, and budget director.
You recognized the treasurer as a former aide to Ernie Eggers, who was convicted of fraud several years ago.
Management explained its plans to change accounting methods for depreciation from the accelerated to the straight-line method. Management implied that if your firm does not concur with this change, Go-Go will employ other auditors.
You learned that the financial vice president manages a staff of five internal auditors.
You noted that all management authority seems to reside with three brothers, who serve as chief executive officer, president, and financial vice president.
You were told that the performance of division and department managers is evaluated on a subjective basis, because Go-Go’s management believes that formal performance evaluation procedures are counterproductive.
You learned that the company has reported increases in earnings per share for each of the past 25 quarters; however, earnings during the current quarter have leveled off and may decline.
You reviewed the company’s policy and procedures manual, which listed policies for dealing with customers, vendors, and employees.
Your preliminary assessment is that the accounting systems are well designed and that they employ effective internal control procedures.
Some employees complained that some managers occasionally contradict the instructions of other managers regarding proper data security procedures.
After a careful review of the budget for data security enhancement projects, you feel the budget appears to be adequate.
The enhanced network firewall project appeared to be on a very aggressive implementation schedule. The IT manager mentioned that even if he put all of his personnel on the project for the next five weeks, he still would not complete the project in time. The manager has mentioned this to company management, which seems unwilling to modify the schedule.
Several new employees have had trouble completing some of their duties, and they do not appear to know who to ask for help.
Go-Go’s strategy is to achieve consistent growth for its shareholders. However, its policy is not to invest in any project unless its payback period is no more than 48 months and yields an internal rate of return that exceeds its cost of capital by 3%.
You observe that company purchasing agents wear clothing and exhibit other paraphernalia from major vendors. The purchasing department manager proudly displays a picture of himself holding a big fish on the deck of a luxury fishing boat that has the logo of a major Go-Go vendor painted on its wheelhouse.
The information you have obtained suggests potential problems relating to Go-Go’s internal environment. Identify the problems, and explain them in relation to the internal environment concepts discussed in this chapter.

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