"]!" .~"~~~" ~

i

.1)

.

,

';---~:::;"':'_.:::"::":~~~~:"":.~' -.-~~:-::.~~- " :.:{',:,;~.f'.,~_~::..f;,i.~'!,'. ..: :,.'.':~,~~,.~.;i.;:',~j.,t..f..~:.., ..'o~:~:.;i..::.~:,~IJ1~,!,Jl:::::; 9

1""11 "I. , I~ji' ,

If! 94 SU3: Financiaf,Consuftjng,andConfrofSelf-Assessf!1entEngagements ".,:..'.." ,.'.: ,:: .0'- .>".'II I.I.'.

I'

ji: .' .0

lJ. ., '" ." 'I, .:. ..o. ..'.0:: ',' '..;~! .,'c Production-orConverslon.~ ...0 :: '...", .;~, :.! , .:;,I".:~...,o.: .1~, ' " " ' ','.. ..o. ..0 0., ..

);;1, " '~'_.'.. .1) o'lnvento~plannin9. .':.'-,:~:",:~!~ .~'o':o'..: .~,.,.. :.,'::'..::',. .0.: :'" .'. I!11~ '. .~': ...:.:' ~~.. ~~::~~.~~~%~~:~:o~«?6tcio'O.dS orpr~~;~~n:;o~...~'~(ti~ ':A, 'f,. .1

[I! _0 " .4) Accounting for costs, defe~e,d <;:asts, and ~~perty;.:,: ,,', , ..!

liil1 .", 5) Storage of produced or converted goods, ; f',Ii - 6) Sh 'lpment .\, "... .','" .I!;!; , 0.. ,.. 'i

II';' '"d.. FinanciaICaPit.z:andPaym~~~,.;,: ,~:::! :,:::.~:'~', ", ,-', ',"." :,.., f

II: ;, :'1) Issuing long-term debt gnq$tock" ::.;. ':.: .',',",' 0!1 2) Paying intereSt .and dividends ,; , , ',; .::1 .., .3). 'Repurchase oTequify\and debt S'ec,uiities'a.nd p~yment at maturity -

IiI -4) " Maintaining! d,etail~d reC6~d~"i~'r paYnien~~of iritere~t; dividends, ,and ~es -.

ill ,::: 5)., 'Pt,Jrcha~esand.sal~s'?finyestment~ .' :-',", ; ..

II 6) Record!ng receipts <:>~ Inter~st and dlvlde~ds :" ' , I '.: .

1, 7) Recording stock optlO~S an9treasury,.sto~k: .'" .., ,. "Ii 8) Accounting for investing and financing, transactions...' " "::1 0 '.'; , ..Ii .,; .' .' eo .p;ersonn,el and,Payr~~i- ;, .';'::" ,," :, ; '.,!'" , ."

Ii 1) Personnel depa.rtri1ent:s',hiring'~f employees', ' ::;. ,. -, ' I! t, ' .".,,;' 2), Personnel d~p~rtme~('~,auth6ri'?:8tionof payroll rat~s, deductions, etc. -: , , 3) T o k., ..".: ,'.,.',! '. ,lmeeepl,ng. 1"'.,.":,.,,;;,,,,, -I " ..' ,.., ; 4). Payroll pr@aration and paym$nt' .".' ' ., .

t '.".'::: :,' ,5):.. _Filing"payi~II t~retu~s a~d paying th.~~~~. ,:' '.". ~_. ~ " '" f~' ". External F,nanclal Reporting, ., ':

" ";" ,', ,', ", ."'0- ,'.' ~- -.1). Preparation of financial statements.. -'..~ :,. '-- -<: ,.' "', ' 1)" Disclosure ofreJated infomiatioh '... "'..

:: 3)' Controls over financial reporting' .."; " 4) Selection of accounting'princip)es:;.',.' ": \": '. ~ ...

::', 5) Unusual.ornorirecurringitemso.-, ,-,:,.., '0, 0 ,.~.. '_._~ ' ., ,., 6) Contingencies

.,013. On the following pages are frYe flowchartsand,accompanyingtables describing the steps in

:'_-", , five basic, accounting cycles and the,.controls in e~tep fQL~n orgaDization larg~ugh

to have an optimal segregation of duties~ .' I 0- .,.-, -,

8. In small- and medium-:sized e~tities, some duties must be combined. The internalauditor must asse~ whether organizational segregation of duties is adequate. -

, -~ ~...

NOTE: EX6ept for manual checks and remittance advrces, the.flowc"'ftarls-presen~~ notassume the use of either a paper~ased or'an~electronic system, Each document symbolrepresents a business activity or control, whether manual or computerized.

NOTE: In the diagrams that follow, documents that originate outside the entity are. .separated by a thick border. -

" -.,.

,

I

"

Assertions. Test of Controls and Substantive Procedures:

Description Type of Assertion Class of Account Presentation

Transaction Balance and

Disclosure1 Are / Were these Occurrence ,.I'

~

present? Existence ,.I'

.2 Recorded at correct Accuracy,.l' ,.I'

amounts? Valuation ,.1',.1'

3 Are all recorded? Completeness ,.I' ,.I' ,.I'

4 Relevance to F/S? Rights and ,.1',.1'

ObligationCut -Off ,.I'

5 Recorded at correct Classification ,.I'

place? Allocation ,.1'.

Understandability ,.I'

Assertions and Related Audit Procedures (General):

The auditor obtains audit evidence by undertaking audit procedures to do the following:

.Obtain an understanding of the entity and its environment to assess the risks of materialmisstatement at the financial statement and assertion levels (risk assessment procedures)

.Test the operating effectiveness of controls in preventing, or detecting and correcting, materialmisstatements at the assertion level (tests of controls)

.Detect material misstatements at the assertion level (substantive procedures)

The auditor must always perform risk assessment procedures to provide a satisfactory assessment ofrisks.

Tests of controls are necessary to test the controls to support the risk assessment, and also whenft, substantive procedures alone do not provide sufficient appropriate audit evidence Substantive.procedures must al s be carried out for material classes of transactions, account b

~ disc osures:.--:,

The audit procedures described in the table below can be used as risk assessment procedures, tests of

p e ene s Classes of transactions (a) Review of post year-end

Account balances itemsPresentation and (b) Cut-off testingdisclosure (c) Analytical review

(d) Confirmations(e) Reconciliations to controlaccounts [:.

...

.

Rights and Account balances (a) Reviewing invoices for proofobligations Presentation and that item belongs to the

disclosure company

(b) Confirmations with thirdarties

Valuation and Account balances (a) Matching amounts to invoicesallocation Presentation and (b) Recalculation

disclosure (c) Confirming accounting policyconsistent andreasonable(d) Review of post year-end

-_.payments and invoicese Ex ert valuation

Existence Account balances (a) Physical verification

(b) Third party confirmationsc Cut-off testin

Occurrence Classes of transactions (a) Inspection of supportingPresentation and documentationdisclosure (b) Confirmation from directors

that transactions relate tobusinessc Ins ection of items urchased

Accuracy Classes of transactions (a) Recalculation of correctPresentation and amountsdisclosure (b) Third party confirmation

cAnal ical reviewClassification Classes of transactions (a) Confirming compliance withand Presentation and law and accounting

understandability disclosure standards

(b) Reviewing notes forunderstandabilit

Cut-off Classes of transactions (a) Cut-off testing.

bAnal ical review

Class of Transactions:XXX Co.

Statement of comprshensive IncomesFor the year ended

r

'I .I

1_53 -

.STUDY UNIT FIVE

SPECIFIC CONTROLS

(17 pages of outline)

This is the .second of three study units on control. The first subunit is devoted to the cycles in the

accounting process, one of the primary concerns of internal as well as external auditors. The second

subunit addresses The IIA's classification of management controls [Sawyer, Dittenhofer, and Scheiner

in Sawyer's IntemalAuditing (Altamonte Springs, FL, The Institute of Internal Auditors, 5th ed., 2003,

pages 63~64; 82-86)]. Both topics have been covered by many questions.

5.1 ACCOUNTING CYCLES AND ASSOCIATED CONTROLS.-

.'. .

~"'8!lY lluestions on the CIA exam address controls. Few such questions are answerable based onmemorization of lists. Moreover. no text can feasibly present comprehensive lists of procedures~ Thus. acandidate must be able to apply reasoning processes and knowledge of auditing concepts to unfamiliarsituations involving controls.

1. Internal auditors apply ~gagem~nt (audit) pro.cedures to obtain s~~t,fel~relevant, and useful information (evidencertO achieve the int~rnal audit engagement's

objectives.

a. For example, internal auditors may perform assurance engagements in whid1 tl-,eymust evaluate the reliability of the Qutput of an accounting information system. Suchan engagement involves substantive testing of the balances and transactions. Ita1so .involves tests of the adequacy and effectiveness of controls to determine the

..;,: effectiveness of accounting and control systems and procedures.

b. Consulting engagements also require the gathering, analysis, synthesis, ~ndevaluation of information rel~vant tQ t.he engagement objective~.

hev-ers:-orComRre~on =

.2. Internal auditors should be proficient in analysis, ~':!th~is, and evaluation-Ihjsprint-!p~---~applies .I;Iotonly in selecting procedures and evaluating controls but atso in -cvcr/othc::-aspect of engagement work. These are higher levels of comprehension than rotememorization, concept learning, _.and problem solving. -

a. Anal is results i nderstan .a si s ofcircumst s or process.

This~n .tandin sho~Jd_~p.pl b.. gth_~ e.le!}:!~_Q!~__NP_JQ.!h~_r_e_,-~_~iQ~?blp_9.1h~ ~C'~r1'(')(.J elements of a.situatio set of circums anc s, 0 cess. Thus, analysis is a means Ij

...OT.U an Ing a whoT!bY s~yin~~part~dthe~~a~ionsh~ps to each o~her U~ an~to the who)e. It requ~r~~~ucti~~ reasoning,_':I!hlch .~Jea9hlr:!ga ~on~luslon i~ e..{.J. ft, about specifics that necessarily follows from general premises. ~ .

f " 1) For example, in anengagem.ent to evaluate the effectiveness .and efficiency of --.

; L~ ~ production-capacity, the internatauditor mustdefe"Frnine wl'lether- ..

cust~me~. ordersshou~d b? accept~d at a 10wer-than.-usu~1 price. .Variables.to I~.consider Include ~butlon m~gl!! g~n~rat~~t ava!l.9blp prnnllrtjnn C2Q..9S1ity. i

and psychological and economIc effects on other cuStomers. ~ t ;1; r ~ , Ii

;,..;:

'-.:. .\ '. \

-~

+ SU 5: Specific Controls

J

b. Synthesis involves developing standards and generalizations for a situation, set ofcircumstances. or a process. It is a means of combining individual components or

? ,'2.. parts to produce a whole. Synthesis requires inductive reasoning, which is>f w( ,1.- reaching a generalized conclusion from particular instances.

(b 1) For example,. the development of an e~gag.e~ent work ~rogr3m is t~e17 documentation of the procedures for IdentIfyIng, analYZing, evaluatIng, and

7e.-11d tA.Y. recording.information.. For this purpose, the internal auditors must synthesize

many factors, including (a) the engagement objectives, (b) prior results,(c) organizational changes, (d) legal and r~gulatory issues, (e) identified risks,(f) technical aspects of the engagement, (g) information obtained during the'preliminaiy survey, (h) budgetary and other resource limits, and (i) many othermatters.

c. Evaluation is relating a situation, set of circumstances, or process to predetermined orsynth,esized standards. ~uation ~sual~l:!~l1SJ1h ;In;ll¥~i~ ;Inri ~~nthesis.

1) For example, intemat auditors rely on their training, experience, understanding,.and seasoned judgment (if not intuition) to assess the quality of a situation, setof circumstances, or process (or its elements). ..'

2) For example, multiple-choice questions consist of a series of either true or falsestatements with one exception (the correct answer). If the question isevaluative, all of the answer choices will be true or false, but one answer will bebetter than the others. Thus, the statement "The most important nonfinancial.issue that a company should consider is ...n requires evaluation of qualitativevariables.

3. Segregation of Duties

a. The s~.l'-o'""ture of me Drgan.ization and the assignment of job duties snouid segregateresponsibilities so that one individual is not able to perpetrate and conceal errors orfraud.

b. For any given transaction, the following three functions should be performed indifferent areas of the organization:

1) Authorization ofth~ transaction2) Recording of the transaction3) ~ustodY qv~r th~ assets associated-with the traRSaction- -.-"'-:'

LO (\, Q) u..:J- ( D 1\ , ..:. ,-~ ij _As ~ways, cost-benefit criteria must be considered. ~

--I

:: i

CIA candidates must understand segreg?tion of duties, a basic principle of internal control. Expect multiplequestions on this topic. .

.

T l' c '2.

,

SU 5: Specific Contra!s 155

4. Organizational Hierarchy

a. In a medium-sized or larger organization., adequate segregation of duties can beachieved by separating the responsibilities of th~ following corporate-levelexecutives:

VP of Chief Accounting Chief Financial VP of VP of .

Operations Officer (Gontroller) Officer (Treasurer) Administration Human Resource~

Sales Accounts Receivable Cash Receipts Mail Room Human ResourcesPurchasing Billing Cash DisbursementsWarehouse Accounts Payable Credit

Receiving General LedgerShipping Inventory Control '---

Production Cost Accounting

Payroll

.5. Accounting Cycles

a. The accounting process can be .jQcrlbed in terms of five cycles:

1) Sales to customers on credit and recognition of receivables2) Collection of cash from customer receivables :'3) Purchases on credit and r.ecognition of payables4) Payment of cash to satisfy trade payables5) Payment of employees for work performed and al~ocation of costs

, b. On the following pages are five. fjowc.~arts and accompanying tables depicting thesteps in the cydes and the co~ in each step for an organization large enough tohave an optima! segregation of &~"ti~

1} Iii sma!~ and rediurT,-sized§ ~, Sa::T":ce dUties must be combined. T~--internal auditolmtlSt-g.sse:::~!!-~~~~~~i~~§~~iQn -:oraiJties ~-aae-auate. :====

.--=-~ ,NQTE: Except for,manual checks and remittance advices, the flowcharts presented do notassume use of either a pap.er-based or an electronic system~ Each document symbolrepresents a business activity. or control, whether manual or. computerized.

NOTE: In the diagrams that follow, do~um~nts that originate outside the:~ ~e-denQ!~~-with a thick border. .,

~

---" ,- -:

Y.l ~ ~;

SU 5: Specific Controls:

: Sales-Receivables Cycle '.. ..C~~. operations~ L. Controller ] ~asurerJ

Inventory Accounts GeneralJstomer ~ Warehouse fulling Control Receivable Legoer .GlgQj!

III I

II '

I MatchIIIIII-I--,

Ad<l\owI-

edgment

,

IFigure 5-1

--.-

p {(9()J c.J?Oy t .o,~ cJoJ (If 1(DW d;~10\1/V\

..

,.."1

.SU 5: Specific Controls -157

Sales-Receivables Cycle

Function: Authorization Custody Recording

Department: Customer Sales Credit Billing Shipping Warehouse Inventory Accounts GeneralControl ReCeivable Ledger

Step Business Activity Embedded Control

1 Sales receives a customer order for Reconciling sequentially numbered salesmerchandIse, prepares a sales order, and orders he1ps ensure that customer orders areforwards it to Credit. legitimate.

2 Credit performs a credit check on the Ensures that ggods are shipped only to actualI

customer. 1f the customer is creditWorthy, customers and that the account is unlikely tot Credit approves tt)e sales order. become delinquent. .

3 Credit sends the approved sales order to Notifies these departments that a legitimate, Sales, Warehouse, Shipping, Billing, and sale has been made. .

Inventory Control. .

4 Upon receipt of an approved sales order, The customer's expectation of receiving goodsSales sends an acknowledgment to the reduces the chances of misrouting orcustomer. misappropriation.

5 Upon receipt of an approved sales order, Ensures that merchandise is removed fromWarehouse pulls the merchandise, prepares a Warehouse only as part of a legitimate sale.

I packing slip, and forwards both to Shipping. I

i 6 I Shipping verifies that the goods received from Ensures th~t the correct goods are shipped. I.WarehQuse match the-approved sales order,prepares a bill of lading, and sends theshipment to the customer.

7 Shipping forwards the packing slip and bill of Notifies these departments that the goods havelading to Inventory Control and Billing. actually been shipped.

8 Upon receipt of the packjng slip and bill of -~ures that inventory unit counts are updatedlading, Inve-ntoryconrr:ol matches-them with once the goods have actually been shipped. -

'the approved sales order and updates the Updating inventory and GL files separately-inventory system. : .provides an additionat-aecOtlnting controlWhe

; .they are periodically reconciled.

9 Upon receipt of the packing slip and :bill of Ensures that customers are billed for all goods,lading, Billing matches them with the" and only those goods, that were actuallyapproved sales order, prepares an invoice, shipped. Reconciling sequentially numberedand sends it to the customer. 1f the invoice is invoice transactions helps preventpaper-based, a remittance advice is included misappropriation of goods.for use in the cash receipts cycle. i

10 Sales receives the invoice from Billing and Prevents double shipment of completed orders tcupdates the sales order file. and allows followup pf partially filled C?rders. --"

11 Accounts Receivable receives the invoice from Ensures that customer accounts are keptBilling and posts a journal entry to the AR file. current.

12 Accounts Receivable prepares a summary of Updating AR and GL files separately providesall invoices for the day and forwards it to an additional accounting control when they areGeneral Ledger for posting of the total to the periodically reconciled.GL file.

"";

158 SU 5: Specific Controls

Cash Receipts Cycle

I Admin. J I Treasurer I I Controller I

Cash Accounts GeneralCustomer Mail Room Receiots Receivable Ledger .6.gn.!s

c~~~~~~)" , .

$ .check $ $ Checks $ $ Checks $ $ Checks $

!: Remitta.~

I-I

I ' i ~ I("'-",,"," D-'-..:.::" Rec:prL A.=c I. ,~.

~~-r- r:-. ~--I I' -, , : : ,lie :I ..a.aT.o. : : I il J' ,

, : ~I ! I

1

IFigure 5-2

--"- -

-"

-~-~~~

SU 5: Specific Controls -159

Cash Receipts Cycle

Function: Authorization Custody Recording

Department: Customer Bank Mail Cash Accounts Genera!Room Receipts Receivable Ledger

Step Business Activity Embedded Control

1 Mail Room opens customer mail. Two clerks Reduces risk of misappropriation by a singleare present at all times. Customer checks employee.are immediately endorsed "For Deposit Only."Remittance advices are separated.

2 Mail Room repares a remltta~ce listil;l9 of Remit+tance listing provid-es a control total forall checks received during the day and -later reronciliation.forwards it with the checks to Cash Receipts.

3 Cash Receipts prepares a deposit slip and Bank provide~s independent evid.E;!nce that thedeposits checks io Bank. Bank v~lidates the full amount was deposited.deposit slip. .

4 Upon receipt of the validated deposit slip, Ensures that the cash receipts journal isCash Receipts posts a journal entry to the updated for the amount actually deposited.cash receipts journal.

5 Mail Room also sends the remittance listing Updating AR and GL files separately providesto General Ledger for posting of the total to an adffrtional accountir.g contra! when theythe ~I fil e ., = r~n,..,.;~h, ~ :i ~ O'f .~. ~ t'~. ,,-,'-"..-al') 1'::"'""-" n..-C'I-I.

6 Mail Room also sends the remittance listing Ensures that customer accounts are keptand remittance advices to Accounts current.Receivable for updating of customeraccounts.

7 Accounts Receivable periodically sends Customers will complain about mistakenacco u nt statements to customers showing billings or missing payments.

-all sa1esand payment activity.. .--

-' -

.

-) SU 5: Specific Controls

Purchases-Payables Cycle .'Operations I I Controller I

Inventory Accounts GeneralVendor Receiving Warehouse Control Purchasing Pa~able Ledger

c=~~=)

PurC,'"'GSE I Daily PO~5!" ! Summary

/-JI I I

I II I

Goods Goods .Goods I II II Match I Match

Packina I I-I I

Slip I I

I II I

I 11r-;;:~~ePOf1

l ~ .I,-

co~

yI L .., ..-: -~ -

.Figure 5-3

....

..

,

c

;0 SU 5: Specific Controls

Purchases-Payables Cycle

'Operations I I Controller I

Inventory Accounts Genera!Vendor Receiving Warehouse Control Purchasing Pa~able Ledger

(=~~~~)Purchase Purchase

li-;;~~~:l Daily pol_:~J .Summary

I I II ,I I

Goods Goods I II II Match I Match

Packina I I-I I

Slip I II II I

Iy

co~

yL__.;.. °- '- 1

..-.Figure 5-3

.... ...

~"i

,. .'.,

, SU 5: Specific Controls 161

Purchases-Payables Cycle

Function: Authorization Custody Recording

Department: Inventory Purchasing Vendor Receiving Warehouse Accounts GeneralControl Payable Ledger

Step Business Activity Emb~dded Control

1 Inventory Control prepares a purchase Predetermined inventory levels trigger-requisition when inventory approaches the authorization to initiate purchase transaction.reorder point and sends it to Purchasing and Reconciling sequentially numbered salesAccounts Payable. orders helps ensure that customer orders are

legitimate.! 2 I Purchasing locates authorized vendor in, Ensures that goods are bought only from

I vendor file and prepares a purchase order. vendors who have been preapproved for

.reliability.

3 Purchasing sends the purchase order to' Vendor prepares merchandise for shipment.Vendor, Receiving, and Accounts Payable. .

~~~ copy has blank quantities. ,Receiving is put on notice to expect

I shipment.

! Accounts Payable is put on notice that liability! to this vendor is about to increase.i .

! 4 A.ccounts Payable prepares a summary of all Updating AP and GL files separately provides, purchase orders issued that day and' an additional accounting control when they

forwards it to General Ledger for posting of are periodically reconciled.the total to the GL file.

S Goods arrive at Receiving with a packing Because quantities are blank on Receiving's

slip. copy of the purchase order, employees-cannot assume the' order is correct as

--receivetl and must count Items.

6 Rec'eiving prepares a receiving report and Detects discr:epancies between the vendor ---orwards it with the goods to Warehouse. : packing slip a;nd actual goods received:-- -

7 Warehouse verifies that goods received Detects any loss or damage betweenmatch those listed on the receiving, report. Receiving and Warehouse.

8 Receiving sends the receiving report and Ensures that inventory records are current.

packing slip.to Inventory Control for Updating inventoryandGLfiles separatelymatching with the purchase requisition and provides an additional accounting controlupdating of jnventory records. when they are periodi<::ally reconciled.

---

Receiving also sends the receiving report to Prevents double payment of completed ordersPurchasing for matching with the purc~ase and allows followup of partially filled orders. '.,

ord~..r andc.upq?t.iQ99tthe_purcha?~ o!derfi.ie,

Receiving also sends the receiving report toAccounts Payable for matching with thepurchase order and purchase requisitionand updating of the AP file.

162 SU5: Specific Controls -~.1~~"-~::-- .-~-l

Cash Disbursements Cycle

I Controller II Treasurer I

Accounts General CashVendor Purchasina Payable Ledger Disbursements

C~~~~~)

II

Ii

.~+~~TI Y

.' .r::::::~; ~l:J.Recan. 'L:j:J! ~'" i Cast-.I"

---~--~~~~~-IFiie rife I ~

I

Figure 5-4

=-, -"

..

..~

.'

SU 5: Specific Confrols -163,

Cash Disbursements Cycle. I

Function: Authorization Custody Recording

Department: Vendor Purchasing Cash Accounts GeneralDisbursements Payable Ledger

Step BusIness Activity Embedded Control

1 Purchasing receives a vendor invoice and Ensures that vendors are timely paid fDrremittance advice. The remittance advice is goods received and ~hat Purchasing canseparated and filed. The invoice is matched follow up on partially filled orders,with the purchase order file and approved forpayment. The purchase order is marked asclosed, and the approval is forwarded toAccounts Payable.

2 Accounts Payable matches the approved Ensures that the invoice is for goods actuallyvendor invoice with the AP file and issues a received and that duplicate payment cannotpayment voucher to Cash Disbursements. be made.

.3 Upon-receipt of a payment voucher with an Ensures that payments are made only whenapproved vendor invoice, Cash goods have actually been received.Disbursements issues a check and forwardsit to Purchasing.

4 Purchasing sends the remittance advice with Settles liability to Vendor.the check to Vendor. I.

5 Cash Disbursements prepares a check Ensures that the cash disbursementsjoumalregister of all checks issued during the day is updated for the total of checks requested.and posts a journal entry to the cash receipts

journal.

6 The check register is also forwarded to Updating AP and GL files separately providesGeneral Ledger for posting of the total to the an ~dditional accounting control when they~~: -are' periodically reconciled.

--= ~--- ..

-"...'0; "'-

164 SU 5: Spec.ificControls

Payroll Cycle

~~~ ~~~~ I Controller "I ~~~~Human Cost Accounts General Cash

Resources Production TimekeeDing Ac~unting Payroll Pa~able Ledger Disbursement ~

~~~ I I. ~ ed AuIhotized Rat

and Deductions and Dedudicx1s

I MaId!

I !I

: [.ct:-;-~ i 1

! i T cxe!S n

I !

! I! I; I; :

I I! ;! 1 .....

;~~ II II II I' I(=;=;n.~ ! .r TL-~..:J

~ ~ . ~ ~ 0 0 I (::::~~=1I .Job Pa~11 AP R~. GL ~Ius~ Sla1ejRCost Records File File

ecords

I A AI ~~___I

Figure 5-5

---:.-- :-. -

~- ....

..

'""f

, SU 5: Speciilc Controls -165

Payroll Cycle tFunction: Authorization Custody Recording

Department: Human Production Cash Bank Time:- Cost Payroll Accounts GeneralResources Disbursements, keeping Accounting Payatile Ledger

Step Business Activity Embedded Control

1 Human Resources sends a list of authorized Ensures that, only actual persons are carrie;d onemployees, pay rates, and deductions to Payroll. the payrol,l and that rates of pay and withholding

amounts are accurate.

2 Employees register the start and end times of their Mechanically or electronically captures employeeworkdays on clock cards. work hours.

3 Employee$: recard tiT.-1E '...'Ori<ed on various tasks I' Ajiows accumuiati<?n of labor costs by job as well

on job time tickets. as tracking of direct and indirect labor.

4 At the end of the pay period, a production Ensures that employees worked only-puthorizedsupervisor approves clock cards and job time hours.tickets and forwards them to Timekeeping.

5 Timekeeping reconciles the clock cards and job Ensures that employees are paid only for actualtime tickets. hours worked.

6 Timekeeping prepares a summary of hours Ensures that direct labor costs are appropriatelyworked by job ar.c fOrtY-ards it to Cost Accounting assigned to jobs.for updating of h.e job records.

.! ? .Tjr:,eke--ep!!1g P"""=-;::.3.;-=S =. s,-:7:-:!"7:a:i of h:u:.!rS ~ =;:s:~rr-es that emptcye9s are pa:c the p:-~per I

worked by employee and forwards it 10 Payro.ll. amount.Payroll rrlatches it with the authorized employeelist, prepares a payroll register, and updates the .payroll records.

8 Accounts Payable receives the payroll register Ensures that a payable is accrued.from Payroll, prepares a payment voucher, andforwards it along with the payroll register to CashDisbursements. .--

Accounts Payable ~Iso forwards the payroll 'Updating AP and GL .files separately provides an---'egister1fJ' Generat-L-edger-for:posting of the total additional-=accounting control when they ar,e .

to the GL file. periodically reconc.-jled. :

10 Accounts Payable forwards the payroll register Authorizes the movement of cash into the payrolland payment voucher to Cash Disbursements. imprest account.

11 I Cash Disbursements compares the payment Ensures that. the correct amount is transferred to

voucherwiththepayrolf registeriotal and initiates thepayroUimprest account and governmentalappropriate bank transfers. authorities.

12 Cash Disbursements executes three bank Use of an imprest payroll account allows idle fundstransfers. to be Invested ana funasrefated to uncashed

checks to be isolated... --,

Federal taxes withheld are transferred to the U.S. .

Treasury.

State taxes withheld are transferred to the state

government.

13 Employees paid by manual check are given Ensures that Payroll or supervisory person~elchecks by Treasury personnel, not by Payroll or cannot perpetrate fraud through the creation oftheir su pervisors. fictitious employees.

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166 SU 5: Specific Controls

Core Concepts.Internal auditors should be proficient in anaiys~s, synthesis, and evaluation.

.The following are cycles in the accounting process: (1) sales-receivables, (2) cash receipts,

(3) purchases-payables, (4) cash disbursements, and (5) payroll.

Stop and review! You have completed the outline for this subunit. Study multiple-choice

questions 1 through 13 beginning on page 169.

5.2 MANAGEMENT CONTROLS

1. Sawyer provides definitions of control and lists the mea~ of ach~yjD!JS.D~ The

following is a de~nitio~ of §'fro\froman internal~~~~~~ ~rspeg~ r

The ~mplQyme~.9lj}j1~J11~ devised in an enterprise to pLQ!.!l.QJ§, d~

restrain, govern, and ~f.KJ!JlQ[I its ~Qu.C\ Rr.tivitie.<\ fnrlhe purDose of

s~ tha~~ rise ob'ectives are m .Ta@sem~ans of control inclu~

)5' ut are not./i. form of organization, policies, systems, procedures,

r instructions, standattfs, committees, charts of accounts, forecasts, budgets,

.sche-dules, reportS', records, checklists, methods, devices, and internal

auditing.

2. Sawyer descri~es seven means of control:

Qrganizati6n ! '

a. Organization, as a means of control, IS an a roved Intentional structurin of roles

economically.-.V1) Responsibilities should be divided so that no one person will control all phases

of any transaction. See Subunit 5.1.

-"",,2) Managers should have the authority to take the action necessary to discharge

their responsibilities.

-v/J) , Individual responsibility always should be clearly defined so that it can be

I 0 ~ C)\o1 Jc><Lneither ~iQ§t~P-P-e&~~d~ -.

~~__~oj;>fficial who assigns responsibIlity and delegates authoritx to subordinates

should nave an effec1iVe system of follow-up. Its purpose IS to ensure that

tasks assigned are properly canried out.:~) Thp indivi.dtl.aI~--wh,(}m=atrtOOrity-is=d~I,egare.~fleWe~lowed to ~xercis.e -

that autHority wlthqut close supervision. But they should check with their

superiors in case of exceptions.

~ People should be required to account to thei( superiors for the manner in which

they have discharged their responsibilities.

A} The organization should be flexible enough to permit changes in its structure

when operating plans, policies, and objectives change.

~) Organizational structures shou1d be as simple as possible.

# Organization charts and manuals should be prepared. They help plan andcontrol changes in, as well as provide better understanding of, the organization. -, chain of authority. and assignment of re.sponsibilities. -

Policies

b. A policy is any stated principle that requires. guides, or restricts action. Policies

should follow certain principles.

T

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.SU 5: Specific Controls" -167,

1) Policies should be clearly stated in writing in systenJatically organize.d

handbooks, manuals, or other publications. and properly approved. ~wheil--

e or a.' ulture is stron the nee f r reduced. n a strong culture, sub tial training results in a hi h de ree of

e tanc~ of or anization's key values. -:-:::!--s, ~ch values~ i~nse!Lheld and widely shared. .

eo-

2) Policies should be systematically communicated to all officials and a'ppropriate

employees of the organization..

3) Policies must conform with applicable laws and regulations. They should be

consistent with objectives and general policies prescribed at higher levels.

4) Policies should be designed to promote the conduct of authorized activities in an

effective, efficient, and economical manner. They should provide a satisfactory

degree of assurance that resources are suitably safeguarded.

5) Policies should be periodically reviewed. They should be revised when

circumstances change. :-

Procedures .c. .Procedures are methods employed to carry out activities in conformity wittl:prescribed

policies. The same principles applicable to policies also are applicable 11:>

procedure$. In addition,

1): To reduce the possibility of fraud and error, procedures sh<;>uld be so

coordinated that one employee's work is automaticalry checked by another

who is independently performing separate prescribed duties. The extent to

which automatic internal checks should be built into the system of control

depends on many factors. Examp!es are (a) degree of :is~ (b) cost OT.

preventive procedures, (c) availability of personnel, (d) operational impact, and

(e) feasibility .

2) For non mechanical operations, prescribed procedures should not be so

detailed as to ~ the use of judgment. :

3) To promote maximum efficiency and economy. prescribed procedures should

be as simple and as inexpensive as possible..

_~~4) P~~res sho~ ~otbe o,!e.rl~pping, cQnflicting, o.r duplicative.

~) Procedures should be periodicallyreviewecf and improved as necessary.

-Personnel-_- d. ; Peopie hired or assigned s.hould have the qualifications to do the jobs assigned to

them. The best form of control over the performance of individuals is ~upervision.

.Hence, high standarQs of ~upervision should be established. The following practices~elp improve control: .

1) Newemployee~shouJdbe investigated as to hones~yandreliabillty.

2) Employees should be given training that provides the opportunity for

improvement and keeps them inform.ed of new policies, and procedures.

3) Employees shourd of

other segments of the organization. They wilr better understand how and -.'where theirjob~~ti~tq)~e~r~.ani~ation as a~h~I~. .,

4) The performan~e of all employees should be periodically reviewed to see

whether all essential requirements of their jobs are being met. Superior

performance should be given appropriate recognition. Shortcomings should

be discussed with employees so that they are given an opportunity to improve

their performance or upgrade their skills.

"-

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168 SU 5: SpecifIC Controls T

Accountinge. Accounting is the indispensable means of financial control over activities andresources. It is a framework that can be fitted to assignments of responsibility.Moreover I it is the financial scorekeeper of the organization. The pr-oblem lies in what

scores to keep. Some basic principles for accounting systems follow:

1) Accounting should fit the needs of managers for rational decision making, rather

than the dictates of a textbook or check list.

2) Accounting should be based on lines of responsibility.3) Financial reports of operating results should parallel the organizational units

responsible for carrying out operations.4) Accounting should permit ,controllable costs to be identified.

§udgetinQ f. A budget is a statement of expected results expressed in nurrl~rical terms. As acontrol, it sets a standard for inpu'1 of resources and what should be achieved as

ou.tput and outcomes.1) Those who are responsible for meeting a budget should participate in its

preparation. .

2) Those responsible for meeting a budget should be provided with adequateinformation that compares budgets with actual events and shows reasons for

any significant variances. .3) Ali subsidiary budgets sr.ouid :ie into the overall bud';,et.4) Budgets should set measurable objectNes. Budgets .?or:;;, rT.eaningless unless

~ ~,,' .,1-", +\-.-" L ~ ...,.,.~II'alla~cl~ ",'IV" (VII] ""t] "G-""::' ~"-~~--,

5) Budgets should help sharp-=n tj-,e organizational strJcture. Objective, J

budgeting standards are difficult to set in a confused combination ofsubsystems. Budgeting is therefore a form of discipline and coordination.

BegortinQ g. In most organizations, management functions and makes decisions on the basis ofreports it receives. Thus, reports shouid be lirrlely, accurate, meaningful, andeconomical. The following are some p:rinciples for establishing a satisfast9:-'j inter~ .

reporting system:-i)- Rep°r:ts shbOIODe---m-ade-inac~~~s"stgn~punsibi1ities. --

2) Individuals or units should be required to report only on those matters for which:

they -are responsible.3) The cost of accumulating data and preparing reports should be weighed against

the benefits to be obtained from them.4) Reports should be as simple as possible and consistent with the nature of the

subject matter. They should include only information that serves the needs ofthe readers. Common classifications and terminology should be used as

much as possible to avoid confusion.5) When appropriate, performance reports should show comparisons with '- ".predeterminec;i standards of cost, quality I and quantity. Controllable costs "

should be segregated.6) When performance cannot be reported in quantitative terms, the reports should

be designed to empha'size exceptions or other matters requiring management

attention.7} .For maximum value, reports s!1ould be timely. Timely reports based partly on

estimates may be more useful than delayed reports that are more precise.8) Report recipients should be pol!ed periodically to see whether they still need

the reoorts thev are receiving or whether the repprts could be improved.

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, SU 5: Specific Controls 169

3. Imposed control and self-control are approaches to management control

Imposed Control

a. Imposed control is the traditional, m~chanical approach. It measures perfprmance;, against standards and then takes corrective action through the individual responsible

v for the function or area. being evaluated..

1) Though common, it has the drawback that corrective action ~ends to come after/ performance. The result may be a response to poor performance rather-than

V its prevention.

Self-Control

b. Self-control is an increasingly important approach. It evaluates the entire process ofmanagement and the functions performed. Thus, it attempts to improve that orocessinstead of sim I correcting the specific performance Of the manager. Iv.ar'.a~mentby objectives (MBO) is an example.

.Core ConceRts

.Sawyer lists the following means of control: (1) organization, (2) policies, (3) protedures,-(4) personnel, (5) accounting, (6) budgeting, and (7) reporting.

Stop and review! You have comp'eted the outline for this subunit. Study multtple-choicequestions 14 ~t:rough 30 beginning on page 173.

QUESTIONS '\' .-

:J. I f'-CCOlfntm

1. An internal auditor ted that the accounts Answer (Aj is correct. (CIA, adapted).receivable department is eparate from other REQUIRED: The area viewed as an internal controlaccounting activities. Cre .is approved by a weakness of ti"Je organization.separate credit department. ontrol accounts and DISCUSSION: The accounts receivable manager has thesubsidiary ledgers are balanc monthly. Similarly, ability to perpetrate irregularities because (s)he performsaccounts are aged monthly. Th accounts receivable iocompatible functions. Authorization and recording ofmanager writes off delinquent ac unts after 1 year, transactions s~ould be ~ep.arate. Thus, ?ome~ne o~tside theor sooner if a bankruptcy or other u usual accounts receivable department should authonze wnte-offs.cj[Cj,Jmstances are involved. Credit emoranda are Answer (8) is incorrect. Credit approval i~ an authorization ---

prenumbered and must correlate with ceiving function that is properly segregated fra;mthe record keeping.reports. Which of the following areas Id be viewed function. Answer (C) is incorrect. Monthly aging is appropriate. 'as an internal cOfltrol w~s~-.Oljtle_ab v~ Answer -(I;».is incon:ect. The ~ocedures regard~g credit

-organiZation? ---memoranda are standard controls.

A. Write-offs of delinquent accounts.

8. Credit approvals.

C. Monthly aging of receivables. ~

D. Handling of credit memos. ~

2. Checks from customers are received in the ". swer (C) is correct. (CIA, adapted)organization's mail room each day. What controls 'EQUIRED: The controls that should be in place toshould be in place to safeguard them? safeg rd checks. ,

.DIS SSION: An employee who does not have access to ~.

..' .other ~~r should open the mail and prepa!e a list of checks.l!... Establishing a separate post office box for receiv~~ Th check '.isting will later be re~onciled with tJ:Ie.daily

customer payments. bank dep~sit a entries to accounts receivable. A restnctive

B Forw --d:-- _II -h"'_'_- . 0 th o ca.-h!."'r upon endorserT1~l".I.t (10 eposit only") will put transferees on notice to."""'\:}""""-'""""'_"'- ,'. ..,

receipt. act accordin~ (tha~s, deposit the check in the organization saccountJ. ,

C. Req';lir~n9 a specific mail clerk to list and Answer (A) 'ffi inco ~t. Requiring a specific mail clerk .to listrestncbvely endorse each check. and restrictively ehdorse ch check provides more protection

." r' ..than establishing a \eparat post office box for customerD. ProVIding bonding prote_bon for mall clerks. payments: Answer (8) ~s inc~rect. The sa~e. p~rson should not

~th :~~ce;lve and de~s~t. c;:he?~. Ans~er (0) IS Incorrect: