Internal Control - Transaction Cycles

Question 1

List segregation of duties for revenue cycle

Answer 1

Separate the execution (authorization), record-keeping (accounting), and custody (access) functions

1. Credit to customers should be granted by an independent department (separate from sales staff which may be paid on commission and which may have an incentive to view everyone as “creditworthy”).
2. An independent employee should review the statements to customers.
3. Returns should be accounted for by an independent clerk in the shipping/receiving area.

Question 2

List physical controls for revenue cycle

Answer 2

1. Computer passwords should be used to limit unauthorized access to the accounting systems.
2. Any inventory involved should be secured with access limited to authorized personnel.

Question 3

List authorization controls for the revenue cycle

Answer 3

The entity’s transactions should be executed as authorized by management.

1. Management should review the terms of sales transactions and indicate that approval on the sales invoice (billing).
2. Management should usually establish “general” approvals of transactions within specified limits and specifically approve transactions outside of those prescribed limits.
3. Management should approve the entity’s adjusting journal entries.

Question 4

List performance reviews for the revenue cycle

Answer 4

1. The entity’s recorded sales should be compared to appropriate budgets and forecasts.
2. Related accounting documents should be compared on a timely basis – for example, sales invoices and shipping documents should be compared to verify that the sales transactions were recorded in the proper period, which is referred to as proper “cutoff.”

Question 5

List EDP/IT (Information Processing) controls in the revenue cycle

Answer 5

1. Important accounting documents (e.g., shipping documents and sales invoices) should be prenumbered and the numerical sequence should be accounted for.
2. An aged trial balance for accounts receivable should be agreed (or reconciled) to the general ledger control account; the aging provides important information about the quality of the receivables and the need for follow-up audit procedures.

Question 6

What are common examples of control activities?

Answer 6

Remember “SCARE”

1. Segregation of Duties - seperate
   
   1. authorization/execution
   2. custody
   3. record keeping function
2. Controls (physical) - access to assts limities to authorized personel
3. Authorization - transactions in accordance with management’s authorization
4. Reviews (performance) - auditor should compare actual performance to budgets and forecasts and analyze relationships
5. EDP/IT (Information processing) - make sure general and application controls are working properly

Question 7

List the segregation of duties for the cash reciepts cycle

Answer 7

1. A listing of cash receipts (sometimes referred to as a “remittance listing” or “log of cash receipts”) is prepared upon opening the mail in the mail room; checks are restrictively endorsed immediately (“for deposit only…”).
2. Cash-related activities, which are handled by separate personnel as appropriate are as follows:
   
   1. Opening the mail: handling the checks received, and verifying the accuracy of the payment indicated on the enclosed “remittance advice” (the stub returned with the customer’s payment on account).
   2. Making the deposit – deposits should be made daily.
   3. Applying payments received to the appropriate customers’ accounts receivable.
   4. Preparing the bank reconciliation on a timely basis.

Question 8

What are physical controls related to the cash receipts cycle?

Answer 8

1. Employees with access to cash receipts should be “bonded,” which is a type of insurance for which the employer pays an insurance premium and which involves background checks on the applicable employees.
2. Receipts should be deposited daily, not accumulated in someone’s desk drawer for an occasional deposit.
3. Access to cash receipts (including access to documents) should be limited to those authorized – that includes the appropriate use of passwords.
4. The company might use a “lockbox” whereby payments from customers are directly received by the bank, thereby avoiding the company’s mail room.

Question 9

List authorization controls in the cash receipts cycle

Answer 9

1. Adjusting journal entries should be approved by management.
2. Bank reconciliations should be appropriately reviewed with the reviewer’s approval indicated

Question 10

List performance review activities for the cash receipts cycle

Answer 10

1. inital cash receipts listing from the mail room should be compared tothe total according to the cash receipts journal, and traced to that day’s bank deposit to show that what was recieved was, in fact, deposited
2. the cash accounts should be reconciled with the bank statements on a timely basis by someone not involved in handling cash receipts or updating the accounting records

Question 11

List EDP/IT (information processing) control activities for the cash receipts cycle

Answer 11

1. In general, there should be adequate documentation supporting transactions and account balances (important documents should be prenumbered and the numerical sequence properly accounted for).
2. For cash transactions received “on site,” there should be adequate “point of sale” cash registers and use of prenumbered receipts.

Question 12

List segregations on duties for the expenditures/disbursments cycle

Answer 12

1. A separate purchasing department handles the purchasing activities (after a duly approved request for goods or services has been received from the department making the request).
2. The purchasing personnel (execution function) are independent of those in receiving (custody function) and in accounting (record-keeping function), including the accounts payable personnel. The accounts payable personnel should also be independent of those involved in processing the related cash disbursements.
3. Bank reconciliations are prepared by someone not having other involvement in handling cash receipts, cash disbursements, or record keeping.

Question 13

List authorization controls for the expenditures/disbursments cycle

Answer 13

1. All adjusting journal entries should be approved by management.
2. Only authorized personnel should be able to order goods and services on the company’s behalf.
3. The department requesting the purchase of goods or services should indicate their acceptance of the goods or services received and approval, before payment is made.

Question 14

List physical controls for the expenditures/disbursments cycle

Answer 14

1. There should be appropriate physical control over unused checks to limit access to authorized personnel.
2. Employees with the ability to initiate cash disbursements should be “bonded.”
3. Access to cash disbursements or to related documents should be limited to authorized personnel.

Question 15

List performance review controls for the expenditures/disbursements cycle

Answer 15

1. An appropriate employee should compare the suppliers’ monthly statements with recorded payables.
2. An appropriate employee should compare the purchase order, “receiver,” and vendor’s invoice for agreement to establish that the invoice is for goods and services received and as authorized. (The invoice should be approved before payment is made and available cash discounts for prompt payment should be taken.)

Question 16

List EDP/IT (information processing) controls for the expenditures/disbursements cycle

Answer 16

1. Detailed records should be maintained to support the general ledger payable account.
2. Prenumbered purchase orders should be used (and the numerical sequence accounted for).
3. Prenumbered checks should be used (and the numerical sequence accounted for).
4. The supporting documents (including vendors’ invoices) should be canceled as “paid” immediately upon payment to prevent double payments.
5. Two signatures should be required on checks. (Any signature plates should be kept in a secure place to prevent unauthorized use.)

Question 17

List the segregation of duties for the payroll cycle

Answer 17

1. The following activities should be performed by different personnel when circumstances permit:

a. Establishing and maintaining employee files in the personnel department.
b. Timekeeping.
c. Payroll preparation and updating the accounting records.
d. Check distribution.
e. Reconciling the payroll bank account with the general ledger account.

2. The treasurer should typically sign the payroll checks.
3. An appropriate departmental supervisor should distribute the payroll checks to employees in that department.
4. Unclaimed checks should be controlled. That is, they should be returned to treasury, secured, and eventually destroyed, if not claimed within an appropriate time.

Question 18

List the physical controls related to the payroll cycle

Answer 18

1. Access to personnel files (containing sensitive information) should be limited to authorized personnel.
2. Access to payroll checks should be limited to authorized personnel.
3. Personnel with access to payroll checks should be “bonded.”

Question 19

List the authorization controls related to the payroll cycle

Answer 19

1. Payroll should be authorized by a responsible official.
2. Payroll computations should be verified by an independent person.
3. Overtime payments should be approved by management.
4. Payroll for management should also be appropriately reviewed and approved.

Question 20

List the performance review controls related to the payroll cycle

Answer 20

1. A company should maintain current and accurate payroll information (which should be periodically matched with information in the personnel files).
2. The payroll checks written should be reconciled to the payroll register, serving as the supporting accounting record for each payroll period.
3. Other appropriate reconciliations should be made on a timely basis: for example, in a manufacturing environment, someone should reconcile the job cost time sheets to time clock cards. (For strict internal control purposes, a company should use time clocks where possible.)

Question 21

List the EDP/IT (information processing) controls related to the payroll cycle

Answer 21

1. Payroll checks should be prenumbered (and the numerical sequence accounted for).
2. A company should maintain a separate checking account specifically for payroll transactions to establish more accountability and control over these important transactions.

Question 22

List the segregation of duties related to the production/manufacturing cycle

Answer 22

a. To the extent possible, the company should separate the authorization of inventory-related transactions, the custody of (or access to) inventory, and the accounting record keeping activities.
b. Sales returns (inventory) should be immediately counted by the receiving clerk and a “receiver” (that is, a receiving document) prepared to verify the quantity and condition of the goods received.

Question 23

List the physical controls related to the production/manufacturing cycle

Answer 23

a. Access to the inventory should be limited to authorized personnel (the inventory should be physically secured with access restricted to personnel having authorized keys or passcodes).
b. Access to the important accounting documents, including applicable shipping documents, should be limited to authorized personnel.

Question 24

List the authorization controls related to the production/manufacturing cycle

Answer 24

a. The acquisition and distribution of inventory should be consistent with management’s authorization.
b. Management should establish general approvals of transactions within specified limits, and specifically approve transactions above those limits.
c. Any adjusting journal entries (including sales returns and allowances, or adjustments to inventory, such as write-downs) should be approved by management.

Question 25

List the performance review controls related to the production/manufacturing cycle

Answer 25

a. Actual inventory should be compared periodically to recorded inventory (and any unusual differences should be investigated).
b. In a manufacturing context, appropriate reconciliations should be made of underlying accounting records (including applicable job order cost sheets or process cost worksheets) to the applicable inventory-related general ledger accounts.

Question 26

List the EDP/IT (information processing) controls related to the production/manufacturing cycle

Answer 26

a. The company should use prenumbered purchase orders for raw materials and components of production, along with prenumbered “receivers,” the receiving document. (The numerical sequence of these documents should be properly accounted for.)
b. The company should consider using a perpetual inventory system for items with high cost per unit.
c. The company should maintain adequate support for related general ledger control accounts.