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ISSUES IN ACCOUNTING EDUCATION American Accounting Association Vol. 25, No. 4 DOI: 10.2308/iace.2010.25.4.709 2010 pp. 709–720

Sunshine Center: An Instructional Case Evaluating Internal Controls in a Small

Organization

Sandra K. Fleak, Keith E. Harrison, and Laurie A. Turner

ABSTRACT: Management and auditors face increased responsibilities to evaluate in- ternal control and assess the risk of fraud. This case provides the opportunity to evalu- ate internal controls and the possibility of fraud in a very small not-for-profit child care center, a setting that is easy to understand. The first goal of the case is to identify internal control weaknesses by applying the COSO internal control framework in an environment that lacks many aspects of internal control. Interactions among the five components of the COSO framework provide the basis for analyzing internal control. The case requires students to consider possible misappropriation of funds using the fraud triangle. A secondary goal of the case is to introduce financial reporting for a not-for-profit organization as a means of accountability.

Keywords: internal control; COSO framework; fraud; not-for-profit organization; finan- cial reporting.

CASE Crisis de jour! Our director is not cooperating. And, where is the money going? I would like to be able to act rather than react. We must keep the place open!

arah, chair of the Sunshine Center Committee, and the Committee’s secretary, Olivia, talked almost daily about the operations of the Sunshine Center. “At least the children seem happy and well cared for,” Sarah reminded Olivia. “Yes,” Olivia agreed, “but if we cannot pay the

ills and keep our help, we will not be open long to serve them. Rev. Andrew thinks everything ill work out, but I am not so sure.”

ackground The Sunshine Center �Center� opened several years earlier when the church allowed a mem-

er to provide child care services and pay rent to use the church facilities. The church’s admin- strative board reluctantly approved this arrangement, but the board specifically stated the church ould provide no oversight of the child care program or financial subsidy. Board members wanted

o be clear that the church had no implied oversight or liability should something go wrong at the enter.

andra K. Fleak and Keith E. Harrison are both Professors, and Laurie A. Turner is an Assistant Professor, ll at Truman State University.

he authors thank two anonymous reviewers and Kent St. Pierre �editor� for insightful and helpful comments.

Published Online: November 2010

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Although the Sunshine Center established a satisfied clientele, two years ago the Center’s ounder decided to cease child care operations for personal reasons. The Center met a community eed for child care, and Rev. Andrew, the pastor of the church, was convinced that the church hould keep the Sunshine Center open as an outreach ministry. Some administrative board mem- ers were concerned about taking on the financial responsibility for the child care facility when the hurch budget was already stretched. Others were concerned that closing the Center would cause ll will for the church in the community. Rev. Andrew strongly asserted that the child care facility ould be financially self-supporting, even though he had no data to support his claim. Swayed by ev. Andrew’s position, the administrative board reluctantly agreed to integrate the Sunshine enter into church activities with the stipulation that child care finances be kept completely

eparate from the church budget. The board expected the Center to pay rent to the church for the se of facilities and utilities.

The administrative board formed a committee composed of four church members that met eriodically to monitor Sunshine Center activities. The first Sunshine Center Committee �Com- ittee� included four church members with Rev. Andrew as an ex officio member, none of whom

ad child care management experience. The Committee hired Barb, a mother of four children, as he director of the Sunshine Center, even though she had no previous employment experience as teacher, child care provider, or manager.

ecent Operations

Presently, the Sunshine Center facility accommodates a maximum of 20 children at one time, lthough more children enroll and attend part-time. Sometimes, especially during school vaca- ions, daily attendance is less than 20. Hours are from 7:00 a.m. until 6:00 p.m. each weekday, ith lunch and snacks provided for the children. The fee is $85 per week per child, with payment ue at the beginning of each week. However, fee payments often trickle in during the week as the ervices are provided. Each day, three employees operate the Sunshine Center—the salaried di- ector, one full-time employee, and one part-time employee.

he Sunshine Center Committee

In the past, the Sunshine Center Committee met once each month. At each meeting, Barb gave brief description of monthly activities, including the theme of decorations, games, and activities, ut she never presented a financial report. Whenever Committee members questioned the lack of budget and financial information, Rev. Andrew always replied, “This is a ministry, not a busi-

ess.” Asserting that there were no financial problems, Rev. Andrew frequently pointed out, “The unshine Center fulfills a real community need.” Further, he emphasized that as a church member, arb could be trusted. In response, Committee members dropped their request for financial infor- ation. As busy people with their own careers and families, they accepted the reports about the

hild care ministry but became increasingly frustrated with the limited information that did not llow them to exercise oversight.

At the beginning of the second year of operations under church control, all four members of he Committee indicated they would not continue on the Sunshine Center Committee. The church dministrative board appointed two new members—Sarah and Olivia. Sarah, a stay-at-home other, was new in the community and cheerfully willing to help with church activities. Olivia, a

ecently retired elementary school teacher, had time for volunteer activities. Sarah agreed to chair he Sunshine Center Committee and Olivia agreed to be secretary. Rev. Andrew continued as an ex fficio member. The board sought, but did not find, additional church members willing to serve on he Committee.

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he Sunshine Crisis

Soon after Sarah and Olivia became involved, the Sunshine Center stopped paying rent and tilities to the church. Barb began complaining to the Committee that she was barely able to meet ayroll and purchase supplies or food for the children’s lunches and snacks. She told the Com- ittee that many parents were behind in paying their obligations to the Center.

Sensing that a crisis was looming, Sarah and Olivia decided they must become more active in heir oversight of the Center to make the Center viable. They were confident that financially sound perations would allow the Center to meet a growing community need for child care. Further, if hey could demonstrate to fellow church members and the administrative board that the Center as a success, they believed others would be willing to support the Center and participate on the versight committee.

Sarah and Olivia decided to learn more about Sunshine Center operations and activities. They nterviewed parents and were pleased to find that parents were happy with the child care program. hrough interviews and observations, they found all employees did an excellent job supervising hildren’s activities. They discovered that Barb was involved in every facet of operations. In ddition to working directly with the children, Barb collected the fees paid by parents, supervised he activities of the Center, purchased supplies and food using charge accounts at local stores, paid ll the Center’s bills, prepared snacks and meals for the children, and kept all records.

Sarah and Olivia quickly determined that Barb’s immersion in the Center was cause for oncern. Barb’s salary as director was slightly over minimum wage with no fringe benefits, and er days were long and frustrating. It was clear to Sarah and Olivia that Barb found the work tressful. The Center’s cash flow problems added to the stress. Sarah and Olivia were particularly roubled by Barb’s lack of previous experience in a comparable job, with no knowledge about usiness processes and controls.

To understand the cash flow problems, Sarah and Olivia decided they should review a finan- ial summary of past activities along with the Center’s budget. Ready to accomplish that goal, the wo Committee members arranged to meet Barb at the Center. Although they were astounded hen Barb indicated that the Center had no financial reports or budget, Olivia suggested that they

ould construct financial statements from canceled checks and bank statements. Barb told Sarah nd Olivia that the checks and bank records were at her home and she would make them available he next day. However, Barb did not provide the bank records or checks as she promised. After epeated attempts to get the bank records, with no success, Sarah and Olivia became suspicious. fter a particularly tense confrontation, Barb tearfully admitted to Sarah and Olivia that she no

onger had the information because she had destroyed the bank records, unaware that such infor- ation should be kept. Sarah and Olivia then asked to see the check register, which Barb promised

o provide. A few days later, Sarah and Olivia examined the check register that Barb finally gave them

nd found a record of checks and deposits for only the previous 12 weeks. Barb had calculated no ash balances. When asked how she knew the cash balance, Barb replied that she called the bank eekly to find the account balance.

Sarah and Olivia were stunned and immediately set up a meeting with Rev. Andrew. They told im about the lack of financial records. Both women forcefully asserted that Barb should be erminated. Rev. Andrew reacted more calmly and defended Barb’s behavior, emphasizing Barb’s ood qualities in dealing with the children and parents. Since Barb was talented in supervising the hildren, and the parents liked her, he thought those strengths overcame her weakness at record eeping. He suggested that Barb could be taught the business skills necessary to run the Center. hough unconvinced, Sarah and Olivia chose to avoid a disagreement with Rev. Andrew and a

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urther confrontation with Barb. They reluctantly agreed to retain Barb as director of the Sunshine enter, but they were resolute that she must run a financially viable operation.

Certain that she would receive no additional historical financial information from Barb, Olivia orked to reconstruct Sunshine Center finances from the sketchy information in the check register. he soon discovered the check register showed no checks recording Barb’s salary.

Olivia also decided she should gather more information about the Center’s cash collection rocess. Olivia began visiting the Center daily to collect the cash receipts that she immediately eposited in the Sunshine Center bank account. She thought that Barb provided a receipt whenever parent paid the weekly fee. Initially, Olivia noted no discrepancy between the cash that Barb

urned over to her and the receipt stubs in the receipt book. But, within a few days, Olivia noticed he cash collected did not match the number of children she observed at the Center during the eek. When Olivia asked Barb if there was additional cash that had been collected, Barb reached

nto a desk drawer and handed Olivia currency that totaled $100. Barb explained that she failed to ut the cash in the normal place when the parent paid. Olivia was uncomfortable with this ituation and thought it prudent to investigate further. She scanned the weekly attendance record nd the receipt book. She noted no cash receipt for a family she personally knew, even though heir children were listed as attending that week. When contacted by Olivia, the family showed her receipt for the payment, even though none appeared in the Center’s receipt book.

Although uncomfortable about confronting Barb, Sarah and Olivia knew they needed to speak ith her about the Center’s cash collection procedures and her salary. Especially, they needed ore details concerning the $100. When questioned, Barb confessed that the Sunshine Center had past due Food Market grocery bill that she was paying with cash from daily receipts. Sarah and livia next visited the Food Market office where they learned that the Center indeed had an utstanding bill of approximately $1,000. The unpaid Sunshine Center bill had been almost $1,500 arlier in the year.

Within the same week, a letter from the IRS arrived at the church office. The letter included notification that the Sunshine Center failed to file a payroll tax return. Again, Sarah and Olivia

uestioned Barb. Upset, Barb responded that she made all the tax deposits but did not know eports needed to be filed.

Within a few days, Barb notified Rev. Andrew that she would be leaving the Sunshine Center n two weeks. She stated that her departure was due to the additional stress from dealing with arah and Olivia and the Center’s financial problems. Sarah and Olivia were neither surprised nor isappointed by Barb’s decision, but Rev. Andrew tried to convince Barb to reconsider. During the nal two weeks that Barb was director of the Sunshine Center, she told parents that she was tarting a child care service in her home. Parents related that Barb said, “The church has lots of oney but just will not support this Center adequately. That is the reason I am leaving.”

iscussion Questions

verview

1. What do you think is the primary problem at the Sunshine Center? 2. Why is accountability important to the Sunshine Center Committee? The director? Cli-

ents of the Sunshine Center? Church members?

nternal Control

3. The Committee of Sponsoring Organizations of the Treadway Commission �COSO� in- ternal control framework �COSO 1992� is an excellent tool for understanding and imple- menting internal control. How is internal control defined in the COSO framework?

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4. Internal control may need to be applied selectively in a small organization. What are the components of the COSO framework, and what components do you think should be used at the Sunshine Center?

5. One factor of the control environment component is “integrity and ethical values.” In what ways were integrity and ethical values slighted by Barb? The Sunshine Center Committee? Rev. Andrew? The church’s administrative board?

6. What constraints are encountered in designing internal control procedures for an organi- zation such as the Sunshine Center?

7. What are the weaknesses in the Center’s internal control? Make recommendations for changing the accounting and reporting system. Additionally, what constitutes a minimum set of records for a small organization like the Center?

raud

8. Identify the elements of the fraud triangle. Which elements of the fraud triangle do you see in this case?

9. What types of fraudulent activities could Barb have perpetrated? Do you think it is possible that Barb did not commit fraud? Why?

10. How would you determine if a misappropriation of funds occurred?

ooking Forward

11. What are the primary strengths of the Sunshine Center for its clients? 12. What must happen for this child care program to remain a viable ministry of the church?

inancial Reporting (Optional)

13. Determine the appropriate GAAP financial reporting for a not-for-profit child care center and identify the financial statement captions for a not-for-profit entity.

14. Suppose Rev. Andrew came to you and said, “I have found a donor who will provide enough money to pay all of the Center’s back bills. We simply must estimate the amount of money needed to bring the Center back to financial health.” What are potential sources of information for determining or estimating the Center’s current financial position?

REFERENCES

ommittee of Sponsoring Organizations of the Treadway Commission �COSO�. 1992. Internal Control—Integrated Framework. New York, NY: COSO.

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