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Internal Controls in the Different Transaction Cycles

REVENUE CYCLE

Process:
1. Receipt of order from customer
2. Granting of credit
3. Shipment of goods
4. Billing
5. Recording of sales

Documents:
1. Customer order
2. Sales order
3. Sales invoice
4. Official receipt
5. Shipping documents (bill of lading, delivery receipt)
6. Credit memo
7. Remittance advice
8. Statement of account

Documentation
1. Pre-numbering - All documents should be pre-numbered in a sequence, so that completeness and validity are easy to
verify.
2. Cross-referencing - All documents should be cross-referenced, so that it is easy to trace from the original order through
to the records.

Objectives of controls:
1. Sales are made to valid customers
2. Sales are recorded accurately
3. All sales are recorded
4. Cash is collected within a reasonable period

Major controls

Sales
1. Credit granted by credit department
2. Sales orders and invoices prenumbered and controlled
3. Sales returns are presented to receiving clerk who prepares a receiving report which supports prenumbered sales
return credit memoranda

Receivables
1. Subsidiary ledger reconciled to control ledger regularly
2. Individual independent of receivable posting reviews statements before sending to customers
3. Monthly statements sent to all customers
4. Write-offs approved by management official independent of recordkeeping responsibility (e.g. the treasurer is
appropriate)

Common fraud
1. Fictitious sales
2. Chanel stuffing
3. Recording write-offs/returns to conceal theft

COLLECTIONS CYCLE

As regards fraud:
Completeness – have all cash received recorded and not stolen?
Existence/Occurrence – have all reported collection actually received?

Common fraud
1. Kiting
2. Lapping
3. Skimming
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Personnel/department involved
1. Mailroom
2. Cashier
3. Accounts receivable subsidiary ledger clerk
4. General ledger control/general accounting
5. Controller

Major Controls
1. Segregation of duties
a. Incoming customer cash and checks are segregated upon receipt and processed by different people
b. Postings to accounts receivable
c. Handling of customer inquiries concerning their account balances
d. Individuals who reconcile the bank accounts should not handle cash or record cash transactions
2. Prelisting of receipts or use of cash register
 Establishes the receipt of the asset
 Helps ensure that all receipts are recorded and accounted for
3. Restrictive endorsements of checks
 The restrictive endorsement helps prevent modifications and theft of customer payments.
 Customer checks should be restrictively endorsed for deposit when received.
 Crossing the check or stamping it for deposit only.
4. Independent Bank Reconciliations
a. Reconciliation of items received with items recorded (control totals)
b. Periodic reconciliation of the bank accounts
5. Use of turnaround remittance advices
6. Use of lockboxes and electronic fund transfers
 No intervention by company employee.
7. Cash deposited daily
8. Employees handling cash are bonded
9. Other controls
a. Cash registers should need keys to open. These keys identify the member of staff.
b. Cash registers require staff to enter PRODUCTS rather than amounts – to stop over charging (and then
stealing the excess).
c. Price lists should be easily accessible to customers, to avoid overcharging.
d. Person who receive cash should not be authorized to grant discount

ACQUISITIONS AND PAYMENTS CYCLE

Process
1. Requisition
2. Purchasing
3. Receiving
4. Storage
5. Accounts payable
6. Treasury

Objective of Controls in the Acquisitions Cycle

1. Purchases are only made when there is a genuine need.
2. Value for money is achieved.
3. Goods/services delivered are what was ordered.
4. Quality of goods/services delivered is satisfactory.
5. Liabilities are recorded completely and accurately.
6. Only valid liabilities are paid.
7. Liabilities are paid in a sensible, commercial timescale

Documents:
1. Purchase requisition
2. Purchase order (and blind purchase order)
3. Receiving report (vs. delivery receipt)
4. Vendors invoice
5. Voucher (voucher package)
6. Cheque
7. Vendor masterfile
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Common errors
1. Purchases are recorded for goods in transit where ownership has not transferred yet
2. Provisions have not been recorded, therefore understated
3. Payments are posted to the wrong vendor account

Common Fraud
1. Deliberate recording of purchases in the next accounting period
2. Using fictitious vendor allowances to reduce accounts payable
3. Issuing payments to fictitious vendors and steal the funds
4. Payments to vendors twice
5. Theft of assets

Major Controls - Acquisitions

1. Authorization for changes to vendor masterfile
2. Use of blind purchase order
3. Receiving personnel should be independent of warehouse
4. There should be documentation of the physical transfer of item from one department to another
5. Three-way matching of PO, RR and Invoice
6. Suppliers’ monthly statements compared with recorded payables

Major Controls – Cash Disbursements

1. Payment by check
2. Signing of check by individual with proper authority (preferably more than signatory for large amounts)
3. Segregation of payment approval and accounts payable functions
4. Careful examination of the supporting documents by the check signer before signing the check
5. Marking supporting documents “paid”
6. Use of password (preferably by 2 different passwords of 2 people) before electronic payments are released.
7. Physical control over blank, voided and signed checks.

PAYROLL CYCLE

Objectives of Controls:
1. Pay the right people
2. At the right rate
3. For valid work done
4. And deal correctly with taxes and other deductions

Importance of Consideration of Payroll Cycle in Audits

 Material amounts
 Affects inventory cost
 Fraud, e.g.:
o Falsification of work hours
o Creation of fictitious employees
o Terminated employees continue to be paid

Personnel/department involved:
1. Timekeeping
2. Human resource/personnel
3. Payroll
4. Treasury
5. General Accounting

Documents
1. Employment records and employee masterfile
2. Time cards
3. Job time tickets
4. Payroll register
5. Paychecks

Major Controls
1. Segregation of duties
a. Authorization to employ and pay
o Human Resource hire new employees (based on requisitions from user departments)
o Human Resource maintain personnel records – hire date, department, salary, position
o Human Resource to promptly send termination notices to payroll
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b. Supervision
o All base pay data (hours, absences, time-off, etc.) should be approved by an employee’s immediate
supervisor.
c. Timekeeping and Cost Accounting
o Data on which pay is based (hours worked or jobs completed) should be accumulated independent of
other function
o If paid hourly:
1. use of time clocks or other similar tools
2. Department supervisor should compare job time tickets with employee clock cards signed
by employees
o For salaries employees
1. Use of time sheets also requiring supervisor approval
d. Payroll check preparation
o Payroll department computes salary, creates Payroll Register, prepares unsigned checks for
signature by Treasurer/CFO
o Payroll should not have authority to initiate changes in hours/rates nor the ability to sign checks

e. Check Distribution
o Direct deposit to bank account
o If manually distributed – by a paymaster with no other payroll function
o Employees should show identification before receiving paychecks
o Unclaimed payroll: investigated by an independent party and
1. If in cash – deposited in a separate bank account
2. If check – locked in a safe
o Internal audit to regularly compare personnel files with payroll files
2. Use of imprest payroll account
a. A bank account to which the exact amount of payroll for the pay period is transferred from the employer’s
general cash account.
b. Limits exposure to payroll fraud
c. Allows delegation of payroll check signing duties
d. Separates routine payroll disbursements from other disbursements
e. Simplifies bank reconciliation
3. Use of service organizations
 Considered part of an entity’s information system when those services affect the initiation, execution,
processing, or reporting of the entity’s transactions.
 In that case, controls put in place by the service organization are considered part of the user organization’s
information system.

INVENTORY
1. Inventory counts are taken and compared with inventory master files
2. Count at least once a year. If perpetual system, may be on a cyclical basis throughout the year.
3. Cost accounting records include cost information for materials, direct labor and overhead
4. Monitor inventory levels
5. Use of bar codes or RFID tags
6. Use of sprinklers, fire alarms, temperature controls on warehouses and production floor
7. Controls over physical security of inventories

INVESTMENTS
1. Segregation of duties
a. Authorization of purchase or sale (commonly, BOD)
b. Custodian (preferably an independent third-party custodian, who has no direct contact with entity employees, or
joint control by two company officials), and
c. Maintenance of detailed record of investments.
2. Investments not held by an independent third party custodian should be kept in a safe deposit box.
3. The internal auditor or some other party not otherwise associated with investments should periodically count the
investments in the safe deposit box and reconcile the securities counted with the investment subsidiary ledger.

PROPERTY AND EQUIPMENT

Major Transactions
 Purchases
 Repairs and maintenance
 Depreciation
 Disposal
 Revaluation
 Leasing
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Major controls:
1. Acquisition
a. Requisition approved by top management
b. Acquisitions are tied to capital budget, which BOD usually approves
c. Variances from this budget are promptly investigated
d. BOD also approves acquisitions of assets over a certain amount, regardless of whether these assets are
purchased or constructed

2. Subsidiary ledgers
a. Detailed information of each asset is kept in the subsidiary ledger.
b. Includes asset’s description, identification number, location, acquisition date, cost, depreciation method, and
depreciation.

3. Physical security
a. Safeguard against theft, destruction, unauthorized disposition
b. Use of asset tags/serial numbers identification plates.
c. Comparison of the serial number on the identification plate to that listed in the control account.
d. Periodic physical inspection
4. Written Policies
a. Capitalization
b. Depreciation

5. Disposition
1. Retirement of assets be documented on a sequentially numbered work order containing authorization and
reason for retirement. This will be the basis for recording cash received and for removing the asset and its
accumulated depreciation from the subsidiary ledger.
2. Those who authorize a disposal should not be permitted to actually dispose of the asset. (authorization and
custody)

FINANCING CYCLE

Major Controls - Debt

1. Adequate documentation of all financing agreements.
2. Authorization of new debt financing by the BOD or management.
3. Detailed records of long-term debt, including interest and principal payments and the amortization of bond premiums
and discounts.

Major Controls – Equity

1. All stock issuances, dividend declarations, and treasury stock purchases must be authorized by the board of
directors. Evidence of these events should be recorded in the minutes of board meetings.
2. Use of an independent stock registrar and/or stock transfer agent who ensures that stock issuance comply with the
articles of incorporation, prepares stock certificates, and maintains records of shares authorized, issued, and
outstanding.
3. If stock transfer agent is not used:
1. An officer is responsible for ensuring that stock transactions comply with the articles of incorporation and
regulatory requirements and should maintain the stock certificate book.
2. Individual who maintains the stock certificate book should have no accounting responsibilities.
4. There should be a periodic independent reconciliation of the stock certificate book with the number of shares
outstanding.