An example of a lack of internal controls with a disastrous result was the bond trading loss in the New York Office of Daiwa Bank in 1995. Over 11 years 30,000 unauthorized trades were made resulting in a $1.1 billion loss (an average of $400,000 in losses for every trading day). Daiwa allowed Toshihide Iguchi, a bond trader, to authorize sales, have custody of the bond assets, and record these transactions.

As a novice trader, Iguchi misjudged the bond market, racking up a $200,000 loss. To raise cash to pay Daiwa's brokers, Iguchi would order Bankers Trust New York to sell bonds held in Daiwa's account. The statements from Banker's Trust came to Iguchi who forged duplicates, complete with bond numbers and maturity dates, to make it look as if Banker's Trust still held the bonds he had sold. When he confessed to his misdeeds, the Daiwa thought their bond account was $4.6 billion when in fact only $3.5 billion was left.

Inadequate review of internal controls was also to blame. Daiwa's internal auditors had reviewed the New York branch several times since the fraud began, but Banker's Trust was never contacted for confirmation of Daiwa's bank statements. If they had, Iguchi's fraud would have been exposed. Daiwa's external auditor never audited the New York branch.

Required:

A. Define the components of internal control and explain how do the components of internal control affect each other?

B. What type of control procedures were ignored at Daiwa? For each internal control procedure missing, what damage was caused?

C. What kind of controls could have been instituted that would have prevented the problems at Daiwa?

D. What impact did the noted weaknesses in the internal control had on Daiwa, its internal and external auditors, its management, its audit committee and its shareholders?

E. What audit procedures could have been performed by the auditor to reduce the risk of misstatement?