EXAMINATION OF CERTAIN FINANCIAL
PROCESSES AND INTERNAL CONTROLS OF THE
KENTUCKY CORRECTIONAL INDUSTRIES

CRIT LUALLEN
AUDITOR OF PUBLIC ACCOUNTS
www.auditor.ky.gov

105 SEA HERO ROAD, SUITE 2
FRANKFORT, KY 40601-5404
TELEPHONE (502) 573-0050
FACSIMILE (502) 573-0067

CONTENTS
Page
TRANSMITTAL LETTER

1

BACKGROUND

4

FINDINGS AND RECOMMENDATIONS

6

DEPARTMENT OF CORRECTIONS’ RESPONSE

13

List of abbreviations/acronyms used in this report
ACCPAC
CFO
Corrections
CREFNO
KCI
KSP
MARS
MOA
Treasury

Kentucky Correctional Industries Accounting Software
Chief Financial Officer
Kentucky Department of Corrections
ACCPAC Data Field – Payment Reference Made At Time Of
Payment
Kentucky Correctional Industries
Kentucky State Police
Management Administrative Reporting System
Memorandum of Agreement
Kentucky Department of the Treasury

November 15, 2004

John D. Rees, Commissioner
Department of Corrections
275 East Main Street, P.O. Box 2400
Frankfort, Kentucky 40602-2400
RE: Special Examination of Kentucky Correctional Industries
Dear Commissioner Rees:
We have completed our examination of certain financial processes and internal controls
for the period July 2000 through May 2004 at the Kentucky Correctional Industries (KCI) as
requested by your letter of May 4, 2004. Our examination revealed flawed business practices,
lack of financial controls, and gross mismanagement by the former branch manager and previous
administrators that led to the inability to conclusively account for all KCI receipts. Certain
issues were identified that we are referring to the Kentucky State Police (KSP) for further
investigation of potential criminal activity.
The scope and objectives of our examination were outlined in a Memorandum of
Agreement (MOA) between our office and the Kentucky Department of Corrections
(Corrections). The objectives of this examination were to:
•
•
•
•

Perform procedures to determine whether a reliable process exists to reconcile
payments made to KCI to customer invoices;
Determine the amount of loss, if any, that resulted from the failure to deposit
certain identified payments made to KCI;
Evaluate the design and operation of KCI processes and controls for the
receipt and deposit of payments made to KCI; and
Report control weaknesses or other issues identified during our examination
and offer recommendations to strengthen processes and controls, or address
other issues as needed.

We also designed and performed specific tests to detect exceptions in the receipt and deposit
processes followed by KCI.

Commissioner Rees
November 15, 2004
Page 2
The scope and objectives of this engagement were approved by you and other KCI
representatives. Two of the original objectives of this examination to reconcile data and
determine any specific loss for a four-year period were modified, with your consent, because
inconsistent processes followed by KCI made it impossible to properly complete all of the
original objectives.
One objective of the original MOA was to determine whether all payments made to KCI
have been properly accounted for from July 2000 through May 2004. Completion of this
objective required a reconciliation of KCI’s accounting software (ACCPAC) to the
Commonwealth’s accounting system, Management Administrative Reporting System (MARS).
Because of the high volume of transactions KCI processed during the examination
period, it was unmanageable to perform a manual reconciliation of all transactions. We designed
an approach to automate the reconciliation of individual payments entered into ACCPAC to
individual payments KCI entered into MARS. To automate the reconciliation process, a data
field unique to both accounting systems must exist. Because both ACCPAC and MARS were
capable of capturing inter-account transaction document numbers, we were able to perform an
electronic reconciliation of inter-account transactions that had a document number entered in
both ACCPAC and MARS for fiscal years 2003 and 2004. This reconciliation yielded a
$177,000 variance between ACCPAC and MARS. In addition, 84 transactions were entered into
ACCPAC with an incomplete inter-account document reference. These transactions were
inappropriately identified as paid when they had not been entered into MARS for processing.
Because KCI failed to establish policies and procedures requiring employees to follow a
uniform process for entering transaction data, non inter-account transactions were inconsistently
entered or omitted from ACCPAC and MARS. This made it impossible to perform a complete
electronic reconciliation.
We then attempted to manually reconcile all non
ACCPAC to MARS. Due to the issues noted above, we
percentage of non inter-account transactions. Because of
both systems, we attempted to reconcile ACCPAC and
transaction amounts.

inter-account transactions posted in
were only able to reconcile a small
the lack of unique data captured by
MARS transactions using only the

We were able to identify certain transaction amounts posted in MARS that also appeared
in ACCPAC. However, due to inconsistent data entry, obvious data entry errors, and multiple
transaction amounts entered in ACCPAC being accumulated into a single transaction amount
entered into MARS, we were unable to perform a complete reconciliation of data within these
systems. In attempting to reconcile transactions within these systems, we identified transaction
discrepancies totaling $202,000. It appears that these discrepancies are the result of data entry
errors and other weaknesses identified above.

Commissioner Rees
November 15, 2004
Page 3
As a result of our examination, we cite several internal control weaknesses at KCI
including:
x Inadequate segregation of duties;
x Negotiable instruments not restrictively endorsed;
x Untimely deposits;
x Remittance advices not included with sales invoices;
x Lack of management reviews and reconciliations;
x Inconsistent data entry; and
x Outdated written policies and procedures.
Accordingly, we have made recommendations to improve each of these concerns
including:
x Recommendations to improve business processes to ensure sufficient
management oversight;
x Recommendations to improve accountability by suggesting a process to
facilitate a reconciliation of transactions entered into ACCPAC and MARS;
and
x Recommendations to improve securing and consistent processing of receipts.
The results of our examination are presented in the attached detailed report. We thank
you, the KCI fiscal officer, and all Corrections personnel for the cooperation and assistance
received during the course of this examination.
Very truly yours,

Crit Luallen
Auditor of Public Accounts

Page 4
Background
KCI discovered
unprocessed checks
totaling over $346,000.

Kentucky Correctional Industries (KCI) is a self-supporting
division of the Kentucky Department of Corrections
(Corrections) that employs hundreds of inmates in the
production of goods and services in Kentucky’s major penal
institutions. In recent years, KCI sales have exceeded $11
million annually.
In April 2004, KCI discovered approximately 250 checks and
loose cash totaling over $346,000 in a manager’s office. These
checks had accumulated over four years. Most of these checks
represented payments for KCI sales. Unprocessed credit
transactions totaling over $31,400 were also discovered in the
office.
As a result of this discovery, the manager’s
employment was terminated, a director was reassigned, and the
Kentucky State Police (KSP) was notified.
On May 4, 2004, Corrections requested our office to
“scrutinize the financial integrity of [KCI], as well as to
examine existing internal control mechanisms.” We then
began an examination of certain financial processes and
internal controls at KCI.

We interviewed key
personnel and examined
flowcharts and other
documentation to gain
an understanding of
KCI’s receipt and
deposit processes.

We interviewed the current KCI fiscal officer and examined
flowcharts prepared by KCI to gain an understanding of the
design and operation of internal controls for the receipt and
deposit processes at KCI. We gained an understanding of both
the current internal control processes and the controls in place
before KCI implemented changes in May 2004. We did not
perform certain interviews due to another pending
investigation.
Generally, the processes involved in executing and recording
KCI sales include the following:
x

Receive customer orders that are subsequently
recorded in ACCPAC, the accounting software used
by KCI;

x

Generate sales orders and transmit these orders to
the KCI warehouse or appropriate KCI plants;

x

Fill orders and deliver the ordered products;

Page 5
x

Generate and transmit invoices and create accounts
receivable in ACCPAC;

x

Receive and log invoice payments; and

x

Transmit deposit items to the Kentucky Department
of the Treasury (Treasury) and record receipt
information
in
ACCPAC
and
in
the
Commonwealth’s accounting system, Management
Administrative Reporting System (MARS).

Upon payment of an existing invoice in ACCPAC, the
customer account receivable is credited for the amount of
payment. If an invoice has not yet been generated, the
payment is deposited and the account is credited upon
generation of the invoice. The latter process occurs when
orders are received from private citizens or entities. These
orders must be pre-paid upon receipt of the order. In these
instances, an invoice is not generated until receipt of goods by
the customer. The pre-payment is deposited and a deferred
revenue liability exists for KCI. Once receipt of goods is
documented by KCI, the invoice is generated and the
corresponding account receivable and deferred revenue are
decreased for the amount of payment.
An accounts receivable report is generated by ACCPAC on a
monthly basis. This report lists all accounts with a balance due
payable to KCI. The fiscal officer reviews the report.
KCI implemented
internal control changes
in May 2004.

Before KCI and Corrections implemented internal control
changes in May 2004, the former administrative branch
manager (former manager) received all incoming checks for
payment of invoices. A daily cash receipts log or other
transmittal listing was not prepared to document the checks
received for each day. Checks were not restrictively endorsed
by KCI upon receipt.
The cash receipts were then forwarded to a separate employee
in the fiscal branch for input into ACCPAC and MARS. The
employee also prepared the transmittal document to be
forwarded to Treasury.

Page 6
Cash receipt documents were prepared at the discretion and
judgment of the former manager. No formal policy was
followed at KCI for preparing and depositing incoming
checks. According to the fiscal officer, KCI prepared about
two to three cash receipt documents per month.
If a payment was received from an agency or individual before
ACCPAC had generated the billing invoice, the check or other
negotiable instrument was held by KCI and not deposited until
the invoice was generated by the ACCPAC system. This delay
could have been months from receipt of check by KCI until
actual deposit. The checks or negotiable instruments were
maintained in the desks of KCI employees and were not stored
in a secure vault.
Findings and
Recommendations
Inadequate segregation
of duties had significant
impact on KCI financial
processes.

A properly designed internal control structure separates one
individual from having control over two or more of the
following duties and responsibilities of a transaction or
operation:
authorization, custody, recordkeeping, and
reconciliation. Ideally, different employees would perform
each of the four control functions. However, limited resources
prevent KCI from assigning each function to a separate
employee. In the absence of properly segregated duties,
compensating controls should be in place.
The former KCI manager possessed the ability to authorize,
record, and reconcile transactions. Further, the manager
maintained custody of checks or other negotiable instruments
received by KCI. During the scope of this examination, no
compensating controls were in operation to reduce the risk of
one person performing these functions. In May 2004, KCI
implemented compensating controls that included providing
transaction documentation to Corrections’ management,
independent of the cash receipt process, for review.
KCI has also hired a new fiscal branch employee to assume
specific duties to further segregate financial control
procedures. Hiring a new fiscal employee allows KCI the
opportunity to segregate duties among its staff by assigning
responsibilities consistent with a strong internal control
structure.

Page 7
Recommendations

We recommend that KCI continue to provide transaction
documentation to Corrections’ management for independent
review. Further, we recommend that KCI’s Chief Financial
Officer (CFO) be responsible for the reconciliation duties and
perform an additional independent review of financial activity
reports.

Negotiable instruments
were not restrictively
endorsed by KCI upon
receipt.

KCI did not restrictively endorse checks or other negotiable
instruments upon receipt. A restrictive endorsement on checks
or other negotiable instruments deters the potential for theft or
other loss. Even though Treasury does not require state
agencies to restrictively endorse checks or other negotiable
instruments at the agency level, Treasury encourages agencies
to restrictively endorse checks received before forwarding the
checks or negotiable instruments to Treasury for deposit.

Recommendations

We recommend that KCI restrictively endorse checks
immediately upon receipt. The endorsement should be made
by the individual assigned to open incoming mail.

Deposits were not made
on a timely basis.

Before May 2004, KCI prepared cash receipt documents for
depositing incoming cash receipts at the sole discretion of the
former manager. The lack of a formal policy led to KCI only
preparing two to three cash receipt documents per month for
transmittal to Treasury for deposit. Furthermore, incoming
checks were not adequately secured by the former manager
from the time of receipt by KCI to transmittal to Treasury for
deposit.
In May 2004, KCI began forwarding cash receipts to Treasury
on a daily basis for deposit. In addition, a cash receipt
document is prepared for each check or negotiable instrument
received by KCI.

Recommendations

We recommend that KCI continue to forward cash receipts to
Treasury on a daily basis for deposit. We again recommend
that the negotiable instrument be restrictively endorsed.

A remittance advice is
not included with sales
invoices.

KCI does not include a remittance advice with its sales
invoices. A remittance advice is the part of a sales invoice
sent to a customer that should be returned with the customer’s
payment. At a minimum, a remittance advice should include
the customer’s name, account number, invoice number, and
purchase amount.

Page 8
Due to the lack of a remittance advice, KCI is sometimes
unaware of which sales invoices to credit when customer
payments are received. This creates inefficiencies as staff
must search all outstanding invoices for the customer to
identify which invoices comprise the payment amount. A
customer may also make a single payment for multiple
invoices. Without a remittance advice associated with each
purchase made, KCI employees must, through trial and error,
determine the specific invoices being paid.
Recommendations

We recommend that KCI send remittance advices along with
sales invoices mailed to its customers. Ideally, remittance
advices should be the only documents forwarded to the
accounting office for crediting customer accounts. The
payments received and the daily spreadsheet log for each
payment should be forwarded to an individual separate from
the posting function. However, we recognize the limited
number of staff at KCI available to perform the posting and
depositing functions. In the absence of fully segregated duties,
we recommend that KCI management perform regular
systematic reviews of posting and depositing activity.

Management did not
perform reviews and
reconciliations of KCI
financial reports.

Certain checks received by KCI were not deposited over four
years. According to the fiscal officer, the former manager was
responsible for periodically reviewing accounts receivable
reports. As indicated previously, the former manager also
maintained custody of incoming checks from customers. The
former manager had complete oversight of the cash receipts
process. Because management reviews and reconciliations
were not performed prior to May 2004, the undeposited checks
and related outstanding accounts receivable were not detected
for a considerable length of time.
Currently, the fiscal officer reviews an accounts receivable
aging report on a monthly basis. This report is sorted by 30day time intervals up to 120 days and identifies all accounts
with outstanding balances within each time interval.

Recommendations

We recommend that KCI continue to produce accounts
receivable aging reports for management.
KCI should
investigate items outstanding longer than 30 days. Ideally, the
report should be distributed to an individual not involved in the
cash receipts transaction process, such as the CFO, and others
for review.

Page 9
Data entry errors and
other weaknesses
resulted in a $177,000
variance between
ACCPAC and MARS
transactions.

We performed an automated reconciliation between accounts
posted as paid in ACCPAC and deposit information entered
into MARS. Specifically, for fiscal years 2003 and 2004 we
reconciled all payment transactions in ACCPAC made through
inter-accounts to deposit transactions entered into MARS.
Inter-account payments are transfers of funds between state
agencies.
Our electronic reconciliation identified a $177,862.11
discrepancy between ACCPAC and MARS. The majority of
the discrepancy appears to be due to incomplete data entry or
consists of transaction amounts posted as paid in ACCPAC
with an inter-account reference number that did not match a
corresponding inter-account reference number in MARS.
Other discrepancies are identified due to inconsistent data
entered in ACCPAC. Details of these discrepancies will be
provided to the agency for their further review.

Recommendations

We recommend KCI continue to attempt to reconcile the
discrepancy between ACCPAC and MARS. To facilitate the
reconciliation process in the future, we further recommend that
KCI require the transaction reference number be entered in
ACCPAC. Transaction data from ACCPAC and MARS
should be reconciled monthly. The reconciliation should be
performed, or at least reviewed, by someone not involved in
routine daily operations. Monthly, the CFO should review
amounts entered in ACCPAC and reconcile the amounts to
data also entered in MARS. This process could be automated
as recommended in the following comment.

KCI does not enter data
consistently in ACCPAC
and MARS.

In the past, KCI captured data in ACCPAC that was also
entered in MARS. However, because it was difficult for KCI
personnel to track payments from customers into ACCPAC,
KCI began entering the customer check number into ACCPAC
instead of the deposit documentation data entered in MARS.
While this change allowed KCI personnel to quickly retrieve
customer payment information, it compromised KCI’s ability
to ensure that all payments from customers were posted
correctly and timely in MARS.

Page 10
KCI also assigns multiple customer numbers to the same
customer. This occurs because sales people use various names
to describe the same customer and ACCPAC allows the same
vendor to be added with different name variations. For
example, the Department of Corrections may be entered as
Dept. of Corrections, Corrections Department, or Corrections
Dept., etc. Each variation is assigned a separate customer
number even though the vendor may be the same.
While assigning multiple customer numbers to one customer
may not have a direct impact on KCI’s ability to process and
deposit payments received, it is an inefficient practice and
could impact the accuracy of financial reports generated from
ACCPAC and deter a detailed reconciliation of activity.
Recommendations

We recommend that KCI add an additional field or sub-field in
ACCPAC that allows the same unique data for a specific
transaction to be entered into ACCPAC that is also entered
into MARS. KCI management should perform periodic
reconciliations of transactions posted in ACCPAC to
transactions posted in MARS. To expedite the process, we
recommend that KCI automate the reconciliation of ACCPAC
and MARS transactions. This can be accomplished by
extracting relevant KCI transactions from MARS into a file
using Seagate Info or Crystal Reports. An extract file of
ACCPAC transactions for the same period should be created.
Both extract files should be imported into Access and sorted
by the transaction reference numbers. The two files should
then be merged into a single file matching the unique data.
Those transactions that do not create a match should be
investigated.
Further, we recommend that KCI instruct and require its sales
staff to complete sales orders using the master listing of
existing customers and customer numbers to eliminate
assigning new customer numbers to already existing
customers.

KCI’s written policies
and procedures are
outdated.

KCI has established written policies and procedures for
processing cash receipts and accounts receivable. However,
the policies and procedures are outdated, having not been
modified since possibly the late 1980s. The policies do not
reflect current KCI operations.

Page 11
Recommendations

We recommend that KCI update its policies and procedures
manual for all its internal operations. This update should
include changes already made by KCI as well as the
recommendations offered in this report. Further, the policies
and procedures manual should be readily accessible to each
employee.

KCI has deposited over
$338,000 of payments
discovered in the former
manager’s office.

KCI personnel discovered approximately 250 checks, loose
cash, and unprocessed credit transactions from customers in
the office of the former manager in April 2004. The total
amount of checks, cash, and credit charges was $377,751.86.
KCI immediately began the process of cataloging the
payments. KCI also contacted vendors and researched all
available supporting documentation in order to properly
deposit these payments.
We verified that KCI has deposited $338,241.34 of the
$377,751.86 of unprocessed payments discovered in the
former manager’s office.
In addition, $34,908.67 was
identified either as duplicate payments from customers or
payments received by KCI that should have been routed to
other state agencies. As of September 2004, KCI continues its
efforts to recover the remaining undeposited amount of
$4,601.85. These payments could not be processed by banks
due to the time period elapsed between the original date of
payment and discovery of the payments in April 2004. KCI
has notified these customers and requested payments be sent to
KCI.

Recommendation

We recommend that KCI continue to pursue payment from
customers whose original checks cannot be processed by banks
due to the time period elapsed since the original date of
payment.

We designed and
performed audit
procedures to detect
irregular transactions.

In addition to the audit procedures identified above, we
performed specific testing procedures designed to detect
exceptions of the normal receipting, depositing, and
accounting processes. Specifically, we tested transactions
posted in ACCPAC with unusual transaction references posted
in the CREFNO column, which provides payment reference
information.

Page 12
Normally, the CREFNO column contains transaction
references to supporting documentation also posted in MARS.
For our testing purposes, we sorted the transactions in
ACCPAC from fiscal years 2003 and 2004 and selected those
transactions posted with unusual transaction references in the
CREFNO column.
KCI identified 84 transactions totaling $39,338.53 in
ACCPAC with unusual CREFNO references.
These
transactions were posted as paid in ACCPAC but were not
entered into MARS and no corresponding deposit was made
on or near the date of posting. When it was identified that
these transactions were not invoiced, KCI initiated interaccount transactions to collect the amount due. Subsequently,
we were able to trace 79 of the 84 transactions identified
totaling $38,707.25 to deposit documentation provided by KCI
or to MARS information. Based on the information in MARS
and supporting documentation provided by KCI, we were
unable to reconcile five of the 84 transactions totaling $631.28.
In addition to the transactions identified by KCI, we identified
58 transactions with unusual CREFNO references totaling
$28,825.50. We were able to trace 23 of the 58 transactions
identified totaling $4,328.44 to referenced information in
MARS. Based on information provided in ACCPAC and
MARS, we were unable to determine whether the remaining
35 transactions totaling $24,497.06 were entered in MARS and
corresponding deposits were made.
We are referring the 84 and 35 transactions, totaling
$63,835.59, identified above to the KSP for further
investigation of potential criminal activity.
Recommendations

We recommend that KCI continue its efforts to ensure all
amounts posted as paid in ACCPAC are deposited in the most
expeditious manner possible. In order to ensure that a
complete and accurate reconciliation can be performed, we
also recommend that KCI enter data unique to a specific
transaction into both ACCPAC and MARS. The data must be
consistently and accurately entered into ACCPAC and MARS
to be of value.

DEPARTMENT OF CORRECTIONS’ RESPONSE

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