Internal Control

1. Internal Control 7

3. Management Issues Related to Internal Control The two objectives of a good system of internal control are to ensure The reliability of accounting records and financial statements That the company’s assets are protected

4. Management Issues Related to Internal Control The need for internal controls Use inventory to illustrate the need for internal controls

5. The Need for Internal Controls (cont.) Physical inventory A physical inventory must be taken in both the periodic and the perpetual inventory systems. Inventory includes all salable goods owned by the business, regardless of location. Choice of fiscal year is influenced by the need to take a physical inventory. Technology has an impact on the taking of a physical inventory.

6. The Need for Internal Controls (cont.) Inventory losses result from theft and spoilage and are included in cost of goods sold; these losses are easier to track under the perpetual system than under the periodic system.

7. Management Issues Related to Internal Control Management’s responsibility for internal control Responsibility applies to management of all companies, large and small. The Sarbanes-Oxley Act of 2002 (SOX) applies to all public companies. SOX requires certification of internal controls by the CEO, CFO, and auditor.

10. Internal Control: Components, Activities, and Limitations Internal control has five components: Control environment The control environment reflects management’s philosophy and operating style, the company’s organizational structure, methods of assigning authority and responsibility, and personnel policies and practices. Risk assessment Risk assessment entails identifying areas in which risk of asset loss or inaccuracy in accounting records is especially high.

11. Internal Control: Components, Activities, and Limitations Internal control has five components (cont.): Information and communication Information and communication relates to the accounting system established by management and to the need for clear communication of each individual’s responsibility within that system.

12. Internal Control: Components, Activities, and Limitations Internal control has five components (cont.): Control activities Control activities are the specific procedures and policies established by management to ensure that the objectives of internal control are met. Monitoring Monitoring involves management’s regular assessment of the quality of internal control.

13. Internal Control: Components, Activities, and Limitations Control activities include the following: Requiring authorization for all transactions Recording all transactions Using well-designed documents Implementing physical controls, as over the accounting records Establishing a system of independent periodic checks of records and assets Separating duties Using sound personnel procedures Bonding is a valuable control procedure.

14. Internal Control: Components, Activities, and Limitations At least three factors can contribute to the weakening of a system of internal control: Human error Collusion Changing conditions

17. Figure 1: Internal Controls in a Large Company: Separation of Duties and Documentation

18. Figure 2: Internal Control Plan for Purchases and Cash Disbursements

19. Figure 2: Internal Control Plan for Purchases and Cash Disbursements (cont.)

20. Internal Control over Merchandising Transactions Internal control activities help prevent theft and fraud and promote accuracy in cash records.

21. Internal Control over Merchandising Transactions Internal controls also help management by Keeping enough inventory on hand to sell to customers without overstocking merchandise Keeping sufficient cash on hand to pay for purchases in time to receive discounts Keeping credit losses as low as possible by making credit sales only to customers who are likely to pay on time

22. Internal Control over Merchandising Transactions Control of cash Administrative controls such as a cash budget help maintain adequate inventory and cash levels and minimize credit losses.

23. Control of cash Generally, the following are necessary for good control of cash: Separate the functions of authorization, recordkeeping, and custodianship of cash. Limit the number of people who have access to cash, and designate who those people are. Bond all employees who have access to cash. Keep the amount of cash on hand to a minimum by using banking facilities as much as possible.

24. Control of cash Generally, the following are necessary for good control of cash (continued): Physically protect cash on hand by using cash registers, cashiers’ cages, and safes. Record and deposit all cash receipts promptly, and make payments by check rather than by currency. Have a person who does not handle or record cash make unannounced audits of the cash on hand. Have a person who does not authorize, handle, or record cash transactions reconcile the Cash account each month.

25. Internal Control over Merchandising Transactions Control of cash receipts Two or more persons should handle cash received by mail. Cash received over the counter should be controlled with cash registers and prenumbered sales tickets.

26. Internal Control over Merchandising Transactions The following documents should be used when making a purchase: Purchase requisition A purchase requisition is a formal request for a purchase that a department submits to the company. Purchase order The department responsible for purchasing activities completes a purchase order and sends it to the vendor. Invoice An invoice is the bill that the vendor sends to the buyer.

27. Internal Control over Merchandising Transactions The following documents should be used when making a purchase (continued): Receiving report A receiving report, completed by the receiving department, contains information about the quantity and condition of goods received. Check authorization A check authorization is a document showing that the purchase order, invoice, and receiving report are in agreement and that payment is therefore approved.

28. Internal Control over Merchandising Transactions The following documents should be used when making a purchase (continued): Check When payment is approved, a check is issued to the vendor for the amount of the invoice, less any appropriate discount. A remittance advice should be attached to the check, describing what the check is for. Bank statement When the vendor deposits the check, then the canceled check appears on the bank statement. IF the check amount is incorrect or has been altered, it will show up here.

31. Figure 3: Petty Cash Voucher

32. Petty Cash Funds Petty cash fund Purchase of items of small value Petty cash fund controlled through an imprest system.

33. Petty Cash Funds Establishment of a petty cash fund. A petty cash fund is established for a fixed amount. When payment is made from the fund, the fund’s custodian prepares a petty cash voucher showing the date, amount, and purpose of the expenditure. The person who receives payment signs the voucher.

34. Petty Cash Funds

35. Petty Cash Funds Petty cash fund replenished using Cash Short or Over if necessary. The petty cash fund is replenished periodically and at the end of an accounting period. All the expenses since the last replenishment are debited and Cash is credited. Discrepancies are recorded as Cash Short or Over.

36. Petty Cash Funds