Internal Controls
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Introduction to Internal Controls
An effective internal control structure includes a company's plan of organization and all the procedures and actions it takes to:
- Protect its assets against theft and waste.
- Ensure compliance with company policies and federal law.
- Evaluate the performance of all personnel to promote efficient operations.
- Ensure accurate and reliable operating data and accounting reports.
Remember that even small companies can benefit from using some internal control measures. Since they often have a bookkeeper or office manager wearing many hats, the owner needs to assume an active role in monitoring his or her business. A simple method is for the owner to get and open all the mail and emails and prepare a listing of the cash received and look for any past due notices from suppliers.
Internal Control Measures
1. Segregation of employee duties
Segregation of duties requires that someone other than the employee responsible for safeguarding an asset must maintain the accounting records for that asset. Also, employees share
responsibility for related transactions so that one employee's work serves as a check on the work of other employees.
When a company segregates the duties of employees, it minimizes the probability of an employee being able to steal assets and cover up the theft. For example, an employee could not steal cash from a company and have the theft go undetected unless someone changes the cash records to cover the shortage. To change the records, the employee stealing the cash must also maintain the cash records or be in collusion with the employee who maintains the cash records.
2. Assignment of specific duties to each employee
When the responsibility for a particular work function is assigned to one employee, that employee is accountable for specific tasks. Should a problem occur, the company can quickly identify the responsible employee. When a company gives each employee specific duties, it can trace lost documents or determine how a particular transaction was recorded. Also, the employee responsible for a given task can provide information about that task. Being responsible for specific duties gives people a sense of pride and importance that usually makes them want to perform to the best of their ability.
3. Rotation of employee job assignments
Some companies rotate job assignments to discourage employees from engaging in long-term schemes to steal from them. Employees realize that if they steal from the company, the next employees assigned to their positions may discover the theft.
Frequently, companies also have the policy that all employees must take an annual vacation. This policy also discourages theft because many dishonest schemes collapse when the employee does not attend to the scheme on a daily basis.
4. Use of mechanical devices
Companies use several mechanical devices to help protect their assets. Check protectors (machines that perforate the check amount into the check), cash registers, and time clocks make it
difficult for employees to alter certain company documents and records.
Computers
• Require computer users to have tight control over storage of programs and data. Just as one person maintains custody over a certain set of records in a manual system, in a computer system one person maintains custody over certain information (such as the accounts receivable subsidiary ledger). Make backup copies that are retained in a different secured location.
• Require passwords (kept secret) to gain entry into data files maintained on the hard disk.
• In situations where a local area network (LAN) links the personal computers into one system, permit only certain computers and persons in the network to have access to some data files (the accounting records, for example).
Computerized accounting systems do not lessen the need for internal control. In fact, access to a computer by an unauthorized person could result in significant theft in less time than with a manual system.
5. Source documents
Companies should maintain complete and accurate accounting records. One or more business documents support most accounting transactions. These source documents are an
integral part of the internal control structure. A source document is an original document, such as an invoice or a cancelled check, which contains essential details that will either support or substantiate a transaction. It doesn’t have to be a paper document, as electronic records are acceptable. Depending on the nature of your business, the types of source documents that you need to retain will vary.
Internal source documents are created and used within your business. They’re often used to make decisions about different aspects of your business, such as assisting with forecasting, setting pricing, and maintaining accurate financial records.
External documents originate from an outside company and enables you to prove that your business completed a transaction with another business. They’re useful when preparing your taxes and substantiating transactions if questioned by the IRS.
Good bookkeeping software will generate most if not all of these source documents for you.
Purchase Workflow Source Documents
When the business records a purchase transaction, it should produce copies of the following four documents:
- Purchase Requisition
A purchase requisition is a written request from an employee inside the company to the purchasing department or responsible employee to purchase certain items (products and services).
- Purchase Order
A purchase order is a document sent from the purchasing department or responsible employee to a supplier requesting that merchandise or other items be shipped or supplied (service) to the purchaser.
- Purchase Invoice
An invoice is the statement sent by the supplier to the purchaser requesting payment for the merchandise shipped or service rendered.
- Receiving Report
A receiving report is a document prepared by the receiving department showing the descriptions and quantities of all items received from a supplier in a particular shipment. A copy of the purchase order can serve as a receiving report if the quantity ordered is omitted. Then, because receiving department personnel do not know what quantity to expect, they will count the quantity received more accurately. For services, a report is prepared acknowledging that the service was rendered.
These four documents together serve as authorization to pay for merchandise and services and should be checked against the accounting records. Without these documents, a company might fail to pay a legitimate invoice, pay fictitious invoices, or pay an invoice more than once. Companies can accomplish proper internal control only by periodically checking the source documents of business transactions with the accounting records of those transactions.
Sales Workflow Source Documents
When the business records a sales transaction the following documents are used:
- Sales Quotes
A sales quote is a document that tells a potential customer how much your product or service will cost. It’s also known by the name of a business quote. It’s not a legally binding contract but rather a formal notice of the estimated price. It also introduces your company and product or service range, so it’s a good idea to provide an item-by-item breakdown of everything included in the quote.
- Sales Orders
A sales order is a document that provides the details of an order and the terms of the transaction. It’s created by the seller after a buyer submits a purchase order. If a purchase order is not involved in the sale, the seller creates the sales order after the customer agrees to purchase a product.
- Packing Slips
A packing slip describes the items shipped to a customer, and so supports the recordation of a sale transaction. A copy of it may be used to audit whether deliveries have taken place.
- Sales Invoices
A sales invoice is a document that’s prepared for customers after purchasing goods or receiving services from the business. It’s a document given to or sent to the customer after the sale.
- Sales Receipts
A sales receipt is simply a record of a transaction issued at the point of sale. This might be an email sent to the customer for online purchases, or a paper slip printed out from a cash register.
In its most basic form, it acknowledges that a seller has been paid for goods or services. The receipt is always issued by the seller and given to the buyer. It’s provided only after the goods have been transferred or services have been rendered and the client has paid in full.
- Contracts
A contract of sale is an agreement between a seller and a buyer. The seller agrees to deliver or sell something to a buyer for a set price that the buyer has agreed to pay. With these contracts, the transfer of ownership happens when the buyer pays and the seller delivers.
- Memberships and Subscriptions Documents
A membership or subscription document is essentially a contract between your business and each of your members.
- Bid and Proposal Sheets
A bid proposal is an offer to do a certain scope of work for a specified price, usually in a specified amount of time.
- Shipping Documents
Shipping documents, as the name suggests, are the documents necessary to transport an item from one location to another. They’re made up of applicable records, forms, and certificates that provide information about the item being shipped.
Cash Receipts And Payments Workflow Source Documents
- Check
A check is a written, dated, and signed draft that directs a bank to pay a specific sum of money to the bearer. It serves as an instruction for a financial institution to transfer funds from the payor’s account to the payee or the payee’s account.
- Credit Card Receipt
A credit card receipt is a document summarizing the details of a credit card transaction between a merchant and a customer. It serves as proof of purchase and contains essential information such as the name of the merchant, date, time, and amount of the transaction.
- Cash Register Tape
A cash register tape can be used as evidence of cash sales, which supports the recording of a sales transaction. A sales receipt is simply a record of a transaction issued at the point of sale. This might be an email sent to the customer for online purchases, or a paper slip printed out from a cash register.
- Bank Deposit Slips
A deposit slip is a small paper form that a bank customer includes when depositing funds into a bank account. It states the date, the name of the depositor, the depositor’s account number, and the amounts being deposited. The deposit slip serves as proof that the bank acknowledged receiving the funds from the customer.
- Cash Receipts Listing (Mailed in payments)
A cash receipts listing is a detailed record or report that outlines all the payments received by a business within a specific period.
- Remittance Advices
A remittance advice is a document or notification sent by a customer to a business to inform them that an invoice has been paid. It serves as proof of payment and helps in matching invoices with payments. Remittance advices typically includes essential information such as the payer’s name and address, supplier’s details, payment method, amount paid, and invoice number.
- Bank Statement
A bank statement is a summary of all the transactions that have occurred in a bank account over a specific period, usually monthly. It includes details such as deposits, charges, withdrawals, beginning and ending balances for the period, and any interest earned. Account holders receive bank statements from their banks either in paper or digital form to help them track their expenses, monitor spending, and detect any fraudulent activities or errors.
- Online Payments
Online bill pay, also known as electronic bill payment, is a service offered by many banks and credit unions that allows customers to make payments for bills electronically. This service enables users to manage all their payments in one place, eliminating the need to write checks or visit various websites to pay different bills. With online bill pay, users can set up automatic payments,
receive alerts when bills are due, and even pay bills that don’t have an online presence using paper checks.
- Credit Card Statement
A credit card statement is a summary of your credit card activity throughout a billing cycle. It includes important information such as account details, a summary of account activity, payment information, late and minimum payment warnings, notice of changes to interest rates and account terms, a record of individual transactions, and details on fees and interest charges.
- Merchant Credit Card Statement
A merchant credit card statement is a comprehensive document provided by a payment processor to merchants who accept credit or debit card payments. This statement details all transactions,
sales activities, processing fees, and other relevant financial information related to the merchant’s account for a specific period, usually a month. The merchant credit card statement serves as an itemized record of the payments processed, fees charged, and services rendered by the payment processor during the previous month. It includes essential information such as transaction amounts, fees deducted, chargeback activity, and other financial data that impact the merchant’s revenue and expenses.
Designate Employee Approvals
Assign employees the authority to sign and approve these documents.
The source documents are all crucial documents for creating a "paper" trail for your company’s transactions.
Some content courtesy of:
LICENSES AND ATTRIBUTIONS
Accounting Principles: A Business Perspective. Authored by: James Don Edwards, University of Georgia & Roger H. Hermanson, Georgia State University.
Project: The Global Text Project . License: CC BY: Attribution
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