This is principlesofaccounting.com.
And I'm Larry Walther.
This is Chapter 5.
This is the final module, and it deals with the control structure of a business.
This is a completely different aspect of accounting.
We're not gonna be looking at journal entries and financial statements.
We're instead going to be considering things that organizations need to do
to safeguard assets, to check the reliability and
accuracy of accounting information, to ensure compliance with management policy,
to evaluate operating performance and efficiency.
There are a number of issues in the control structure of a business,
as you can see.
But the control structure really depends upon the accounting system in use,
the general control environment.
Which is the combined effect of a firm's policies and attitudes toward control.
And finally, control procedures which are the specifically integrated components in
the accounting system that help control the transactions and
event processes of the business.
Let's think about some examples of control procedures.
Limited access to assets.
If you supplies or inventory, the only people that need to have access to those
are those that have a need to get access to that inventory.
So you need to control access to assets, only available to persons who
are appropriately authorized and have a need for that access.
Separation of duties is important to reduce errors, the cross-checking feature,
and also to prevent fraud.
If you have multiple parties involved in a particular transaction before payment can
occur, for example, that decreases the opportunity for fraud in the business.
It would require collusion before the fraud could occur and
that's far less likely to occur than one rogue person.
Duty authorization is essential.
Before certain transactions occur it's important that
they be appropriately authorized by someone with the authority to
agree to a transaction on behalf of the business.
Utilization of pre-numbered documents, whether electronic or on paper,
is important.
It identifies missing documents.
It avoids the opportunity for duplication of documents.
Independent verification of records, such as preparation of a bank reconciliation.
Consider that most asset and liability accounts,
there's an additional reference to their balance by virtue of the general ledger.
There's usually some other way you can go about determining whether that reported
number is accurate and correct.
And we need to go to the trouble to independently verify those amounts.
It's also a good idea to have an independent audit by a CPA.
In a merchandising environment,
we can consider a number of specific control issues.
Theft and spoilage are very common in a retail environment.
And so there's a number of what I'm calling front end controls or
controls that would occur at the point where the customer meets the business.
You might have barricades at the entrance to the door to prevent somebody
from driving a car through the front of the door and stealing inventory.
Guards to check bags coming in and out of the store.
Inventory sensors that sense if inventory has not been paid for
and deactivated at a cash stand.
Security cameras.
Expensive inventory items are often in a caged area.
You pick up a ticket at the shelf where the item displayed, take that and
present it before you can actually pick up the merchandise.
Cash drawers that are audited,
daily bank deposits that are made are all important control features.
But not only is it important to have controls at the front end of the business,
it's also important to have controls within the purchasing cycle.
So we might have purchase orders.
Purchases can only be initiated by appropriately trained personnel
with the authority to initiate a transaction .
You may have a purchasing department that shops for the best price and
the best terms .
And then initiates the order by an actual documented purchase order
to initiate the buying activity.
When the goods that are purchased are received, someone should inspect those,
prepare a receiving report that documents the goods were received in good order.
And, of course, you would wanna check that receiving report, or you would wanna check
those goods back to a purchase order and document in the receiving report that what
you're accepting as delivery is something that was in fact ordered by the business.
Bear in mind, a business has hundreds and
hundreds of employees potentially running around.
Without a system to track this activity,
no one would really have a way of knowing what to accept as being delivered and
what was not ordered appropriately by the business.
Finally, when an invoice comes in, someone needs to check the math on the invoice,
compare it to the terms on the purchase order.
And, certainly, also compare that invoice to the receiving report to make sure that
what you're about to pay for was indeed received by the business.
All of these documents should be reviewed before payment is released.
Now those documents can be electronic, there's no need that it all be paper.
But somehow there needs to be an authorization system within the computer
records so that people that are checking off can do so electronically, and
track it back to make sure that everything is appropriate before payment is issued.
Let me generalize about control in closing.
You might think that accountants spend a large part of their time processing
transactions.
But actually, a large part of the time is spent designing systems and
testing systems pursuant to the control environment.
The focus is not so much on specific transactions, although you'll test those
to make sure the accounting system is processing them correctly.
If you find that you have a strong control environment and
an appropriate accounting system that's working as planned,
then you can fairly well rely on that to produce correct financial reports.