Case Study:
Your CPA firm has just been engaged as the independent auditors for Drotos Theaters. The theater chain is opening a new theater in one month. Because of recent attention on the Sarbanes-Oxley Act, the main investment banking firm for Drotos’ corporate operations has expressed concerns about internal control. Due to this concern, your firm has been asked to immediately review the internal policies and procedures that are to be established at the new theater.
Drotos Theaters has been in business over 75 years. It was a family-run business until the late 1980s, when it was sold to another chain. There are no family members still involved in the daily operations. The entertainment industry historically has been profitable throughout economic fluctuations. The new theater is located in a booming part of the Southwest, where the labor pool is highly skilled and the unemployment rate is low. The monthly lease was negotiated for a 20-year period at a favorable rate, and the lease payment is not dependent on monthly revenues. A major bookstore chain has signed a lease for space next to the theater.
Each Drotos Theater operates as a separate organization cost center under the Drotos corporate umbrella. The Drotos home office requires that procedures be established before the opening of a new theater. A Controller from another Drotos theater operation has been transferred to this new theater, and is planning on following the same procedures that were previously used. Under these procedures, the Controller is responsible for both depositing cash and recording transactions by posting journal entries into the computerized financial accounting system. Due to the prime location of the new theater, first year revenues are expected to hit $100 million, with more than 50% of revenues collected in cash.
The cashiers at the front box office are to receive payments from theater customers and provide customers with a serially numbered, perforated ticket. To gain admittance to the theater, customers must present the ticket to the ticket taker located 100 feet from the box office and front lobby entrance. The ticket taker rips the ticket at the perforation, deposits one half in a box, and hands the ticket stub to the customer. The box office and lobby areas have been designed with state-of-the art equipment, including upscale furniture and fixtures. The theater has signed a 5-year contract with the ticketing system vendor.
The theater’s auditing firm prior to your firm resigned due to heated discussions between the previous auditors and Drotos’ management regarding the number of accounting personnel needed to adequately staff theater operations. The investment banking firm wants your review to look specifically at the new theater’s controls for safeguarding cash revenues, and also requests that you assess the staffing requirements for the accounting function.
Please assist with the given:
o Evaluate the manual and computerized control activities.
o Discuss internal controls that are and are not present in the above scenario.
o Assess internal control limitations and risks.
o Discuss your concerns given your knowledge that the previous audit firm resigned from the engagement.
o Recommend controls to prevent and detect financial misstatements.
o Discuss which controls you would put into place to assure the separation of duties for back office accounting staff.
o Recommend procedures for detecting employee fraud concerning cash.
o Explain how the cashier and ticket taker might steal cash and describe the controls you would put into place to keep this from occurring.