AIS problems rather than routine operations.

CHAPTER 1 The information

must identify potential problems in time for
THE INFORMATION ENVIRONMENT
management to take corrective action.
The pyramid shows the business organization
What is a System?
divided horizontally into several levels of
 A group of interrelated multiple
activity. Business operations form the base of
components or subsystems that serve a
the pyramid. These activities consist of the
common purpose
product-oriented work of the organization, such
 System or subsystem?
as manufacturing, sales, and distribution.
 A system is called a subsystem
Operations management is directly
when it is viewed as a component
responsible for controlling day-to-day
of a larger system.
operations. Middle management is
 A subsystem is considered a
accountable for the short-term planning and
system when it is the focus of
coordination
Internal & Externalof activities
Information Flows necessary to
attention.
accomplish organizational objectives. Top
Elements of a System
management is responsible for longer-term
planning and setting organizational objectives.  MULTIPLE COMPONENTS. A system
must contain more than one part.
 RELATEDNESS. A common purpose
relates the multiple parts of the
system.
 SYSTEM VERSUS SUBSYSTEM.
 PURPOSE. A system must serve at
least one purpose, but it may serve
several.
System Decomposition versus System
Interdependency
 System Decomposition
 the process of dividing the system
into smaller subsystem parts
Internal Information Flows  System Interdependency
 Horizontal flows of information used  distinct parts are not self-contained
primarily at the operations level to  they are reliant upon the
capture transaction and operations data. functioning of the other parts of the
Horizontal flow supports operations-level system
tasks with highly detailed information  all distinct parts must be
about the many business transactions functioning or the system will fail
affecting the firm. This includes What is an Information System?
information about events such as the sale An information system is the set of formal
and shipment of goods, the use of labor procedures by which data are collected,
and materials in the production process, processed into information, and distributed to
and internal transfers of resources from users.
one department to another. Transactions
 Vertical flows of information  A transaction is a business event.
 downward flows — instructions,  Financial transactions
quotas, and budgets  economic events that affect the
 upward flows — aggregated assets and equities of the
transaction and operations data organization
 External users fall into two groups:  e.g., purchase of an airline ticket
trading partners and stakeholders.  Nonfinancial transactions
 Exchanges with trading partners include  all other events processed by the
customer sales and billing information, organization’s information system
purchase information for suppliers, and  e.g., an airline reservation — no
inventory receipts information. commitment by the customer
Information Requirements
 Each user group has unique information
requirements.
 The higher the level of the organization,
the greater the need for more aggregated
information and less need for detail.
Information in Business
 Information is a business resource that: What is an Accounting Information
 needs to be appropriately managed System?
 is vital to the survival of  Accounting is an information system.
contemporary businesses  It identifies, collects, processes,
 Management information is thus more and communicates economic
summarized and oriented toward information about a firm using a
reporting on overall performance and wide variety of technologies.
  It captures and records the suppliers, and customers. Internal users
financial effects of the firm’s include management at every level of the
transactions. organization, as well as operations
 It distributes transaction personnel.
information to operations personnel  Data are facts, which may or may not be
to coordinate many key tasks. processed (edited, summarized, or refined)
AIS versus MIS and have no direct effect on the user. By
 Accounting Information Systems (AIS) contrast, information causes the user to
process take an action that he or she otherwise
 financial transactions; e.g., sale of could not, or would not, have taken.
goods Information is often defined simply as
 nonfinancial transactions that processed data.
directly affect the processing of  Data Processing
financial transactions; e.g., addition  Database Management - The
of newly approved vendors organization’s database is its physical
 Management Information Systems repository for financial and nonfinancial
(MIS) process data. We use the term database in the
 nonfinancial transactions that are generic sense. It can be a filing cabinet or a
not normally processed by computer disk.
traditional AIS; e.g., tracking  DATA ATTRIBUTE - The data attribute is
customer complaints the most elemental piece of potentially
AIS Subsystems useful data in the database. An attribute is a
 Transaction processing system (TPS) logical and relevant characteristic of an
- supports daily business operations. central entity about which the firm captures data.
to the overall function of the information  RECORD - A record is a complete set of
system by converting economic events into attributes for a single occurrence within an
financial transactions, recording financial entity class.
transactions in the accounting records  FILES. A file is a complete set of records of
(journals and ledgers), and distributing an identical class.
essential financial information to operations
personnel to support their daily operations.
The TPS consists of three transaction cycles:
the revenue cycle, the expenditure cycle,
and the conversion cycle. Each cycle
captures and processes different types of
financial transactions.
 General Ledger/ Financial
Reporting System (GL/FRS) - produces
financial statements and reports. Summaries
of transaction cycle activity are processed
by the GLS to update the general ledger Data Sources
control accounts.  Data sources are financial transactions
 Management Reporting System that enter the information system from
(MRS) - produces special-purpose reports internal and external sources.
for internal use. This type of reporting is  External financial transactions
called discretionary reporting because the are the most common source of data
organization can choose what information to for most organizations.
report and how to present it. • E.g., sale of goods and
services, purchase of inventory,
General Model for AIS receipt of cash, and disbursement
of cash (including payroll)
 Internal financial transactions
involve the exchange or movement
of resources within the organization.
• E.g., movement of raw
materials into work-in-process
(WIP), application of labor and
overhead to WIP, transfer of WIP
into finished goods inventory, and
depreciation of equipment
Transforming the Data into Information
Functions for transforming data into
information according to the general AIS
model:
1. Data Collection
The elements of the general model:
 Capturing transaction data
 End Users - External users include
 Recording data onto forms
creditors, stockholders, potential investors, • Merging
regulatory agencies, tax authorities, • Calculating
• Summarizing
• Comparing
  Validating and editing the data purchasing. Receiving activities include
2. Data Processing counting and checking the physical
 Classifying  Merging condition of these items.
 Transcribing  Calculating  Stores - takes physical custody of the
 Sorting  Summarizing inventory received and releases these
 Batching  Comparing resources into the production process as
needed.
3. Data Management  Production - production planning, quality
 Storing - task assigns keys to new control, and maintenance
records and stores them in their proper  Marketing - The marketing
location in the database function deals with the strategic problems of
 Retrieving - the task of locating and product promotion, advertising, and market
extracting an existing record from the research.
database for processing. After processing  Distribution - the activity of getting the
is complete, the storage task restores the product to the customer after the sale. This
updated record to it place in the is a critical step.
database.  Personnel - Competent and reliable
 Deleting - the task of permanently employees are a valuable resource to a
removing obsolete or redundant records business. The objective of the personnel
from the database. function is to effectively manage this
4. Information Generation resource.
 Compiling  Finance - The finance function manages
 Arranging the financial resources of the firm through
 Formatting banking and treasury activities, portfolio
 Presenting management, credit evaluation, cash
Characteristics of Useful Information disbursements, and cash receipts.
 Regardless of physical form or  Accounting - manages the financial
technology, useful information has the information resource of the firm. In this
following characteristics: regard, it plays two important roles in
 Relevance: serves a purpose transaction processing. First, accounting
 Timeliness: no older than the time captures and records the financial effects of
period of the action it supports the firm’s transactions. Second, the
 Accuracy: free from material accounting function distributes transaction
errors information to operations personnel to
 Completeness: all information coordinate many of their key tasks.
essential to a decision or task is  Computer Services
present Accounting Independence
 Summarization: aggregated in  Information reliability requires
accordance with the user’s needs accounting independence.
 Feedback is a form of output that is sent  Accounting activities must be
back to the system as a source of data. separate and independent of the
Feedback may be internal or external and is functional areas maintaining
used to initiate or alter a process. resources.
Information System Objectives in a  Accounting supports these
Business Context functions with information but does
 The goal of an information system is to not actively participate.
support  Decisions makers in these functions
 the stewardship function of require that such vital information
management be supplied by an independent
 management decision making source to ensure its integrity.
 the firm’s day-to-day operations The Computer Services Function
Organizational Structure 1. Distributed Data Processing -
 The structure of an organization helps to Reorganizing the computer services
allocate function into small information processing
 responsibility units that are distributed to end users and
 authority placed under their control
 accountability 2. Centralized Data Processing - All data
 Segmenting by business function is a processing is performed by one or more
very common method of organizing. large computers housed at a central site
Functional Areas
that serves users throughout the
 Inventory/Materials Management - The
organization. Primary areas database
objective of materials management is to
plan and control the materials inventory of administration data processing systems
the company. development systems maintenance.
 Purchasing - responsible for ordering  DATABASE ADMINISTRATION.
inventory from vendors when inventory Centrally organized companies
levels fall to their reorder points. maintain their data resources in a
 Receiving - the task of accepting the
inventory previously ordered by
 central location that is shared by all implementing the database model to
end users data management.
 DATA PROCESSING. The data REA Model
processing group manages the  The REA model is an accounting
computer resources used to perform framework for modeling an
the day-to-day processing of organization’s
transactions. It may consist of the a. economic resources; e.g., assets
following functions: data control, data b. economic events; i.e., affect
conversion, computer operations, and changes in resources
the data library. c. economic agents; i.e., individuals
 SYSTEMS DEVELOPMENT AND and departments that participate in
MAINTENANCE. The information an economic event
needs of users are met by two related d. Interrelationships among
functions: systems development and resources, events and agents
systems maintenance  Entity-relationship diagrams (ERD)
are often used to model these
Potential Advantages of DDP
relationships.
 Cost reductions in hardware and data
entry tasks Accountants as Information System Users
 Improved cost control responsibility  Accountants must be able to clearly
 Improved user satisfaction since control is convey their needs to the systems
closer to the user level professionals who design the system.
 Backup of data can be improved through  The accountant should actively
the use of multiple data storage sites participate in
systems development projects to ensure
Potential Disadvantages of DDP
appropriate systems design.
 Loss of control
 Mismanagement of company resources Accountants as System Designers
 Hardware and software incompatibility  The accounting function is responsible for
 Redundant tasks and data the conceptual system, while the
 Consolidating tasks usually segregated computer function is responsible for the
 Difficulty attracting qualified personnel physical system.
 Lack of standards  The conceptual system determines the
nature of the information required, its
Manual Process Model
sources, its destination, and the
 Transaction processing, information
accounting rules that must be applied.
processing, and accounting are physically
performed by people, usually using paper Accountants as System Auditors
documents.  External Auditors
 Useful to study because:  attest to fairness of financial
a. helps link AIS courses to other statements
accounting courses  assurance service: broader in
b. often easier to understand business scope than traditional attestation
processes when not shrouded in audit
technology  IT Auditors
c. facilitates understanding internal  evaluate IT, often as part of
controls external audit
 The Flat-File Model - The flat-file model  Internal Auditors
describes an environment in which individual  in-house IS and IT appraisal
data files are not related to other files. End services
users in this environment own their data files
rather than share them with other users.
Thus, stand-alone applications rather than
integrated systems perform data processing.
Data Redundancy Problems
 Data Storage - excessive storage costs
of paper documents and/or magnetic form
 Data Updating - changes or additions
must be performed multiple times
 Currency of Information - potential
problem of failing to update all affected
files
 Task-Data Dependency - user’s inability
to obtain additional information as needs
change
 Data Integration - separate files are
difficult to integrate across multiple users CHAPTER 2
THE DATABASE MODEL TRANSACTION PROCESSING
 An organization can overcome the
problems associated with flat files by A Financial Transaction is...
  an economic event that affects the assets  Conversion Cycle:
and equities of the firm, is reflected in its  the production system
accounts, and is measured in monetary (planning, scheduling, and control
terms. of the physical product through the
manufacturing process)
 similar types of transactions are grouped  the cost accounting system
together into three transaction cycles: (monitors the flow of cost
 the expenditure cycle information related to production)
 the conversion cycle  Revenue Cycle: time lag between the
 the revenue cycle two due to credit relations with
The most common financial transactions are customers:
economic exchanges with external parties.  physical component (sales order
Financial transactions also include certain processing)
internal events such  financial component (cash
as the depreciation of fixed assets; the receipts)
application of labor, raw materials, and  Sales order processing. The
overhead to the production majority of business sales are made
process; and the transfer of inventory from one on credit and involve tasks such as
department to another. preparing sales orders, granting
Relationship between Transaction Cycles credit, shipping products (or rendering
of a service) to the customer, billing
customers, and recording the
transaction in the accounts (accounts
receivable, inventory, expenses, and
sales).
 Cash receipts. Cash receipts
processing includes collecting cash,
depositing cash in the bank, and
recording these events in the
accounts (accounts receivable and
cash).
Manual System Accounting Records
A document provides evidence of an economic
event and may be used to initiate transaction
processing. Some documents are a result of
Each Cycle has Two Primary Subsystems transaction processing
 Expenditure Cycle: time lag between  Source Documents - used to capture
the two due to credit relations with and formalize transaction data needed for
suppliers: transaction processing
 physical component
(acquisition of goods)
 financial component (cash
disbursements to the supplier)
 Purchases/accounts payable
system. This system recognizes the
need to acquire physical inventory
(such as raw materials) and places an
order with the vendor.
 Cash disbursements system.
When the obligation created in the  Product Documents - the result of
purchases system is due, the cash transaction processing
disbursements system authorizes the
payment, disburses the funds to the
vendor, and records the transaction by
reducing the cash and accounts
payable accounts.
 Payroll system. The payroll
system collects labor usage data for
each employee, computes the payroll,
and disburses paychecks to the
employees. Conceptually, payroll is a
special-case purchases and cash
disbursements system.  Turnaround Documents - a product
 Fixed asset system. A firm’s document of one system that becomes a
fixed asset system processes source document for another system
transactions pertaining to the  Journals - a record of chronological entry
acquisition, maintenance, and disposal
of its fixed assets.
  special journals - specific classes
of transactions that occur in high
frequency
 general journal - nonrecurring,
infrequent, and dissimilar transactions
 REGISTER. The term register is often
used to denote certain types of special Computer-Based Systems
journals. For example, the payroll  The audit trail is less observable in
journal is often called the payroll computer-based systems than traditional
register. manual systems.
 Ledger - a book of financial accounts  The data entry and computer programs
 general ledger - shows activity are the physical trail.
for each account listed on the chart of  The data are stored in magnetic files.
accounts Computer Files
 subsidiary ledger - shows activity  Master File - generally contains account
by detail for each account type data (e.g., general ledger and subsidiary file)
Flow of Information from Economic Event  Transaction File - a temporary file
into the General Ledger containing transactions since the last update
 Reference File - contains relatively
constant information used in processing
(e.g., tax tables, customer addresses)
 Archive File - contains past transactions
for reference purposes
Documentation Techniques
 Documentation in a CB environment is
necessary for many reasons.
 Five common documentation
techniques:
Audit Trail  Entity Relationship Diagram
The accounting records described previously  Data Flow Diagrams
provide an audit trail for tracing transactions  Document Flowcharts
from source documents to the financial  System Flowcharts
statements. Of the many purposes of the audit  Program Flowcharts
trail, most important to accountants is the year- Entity Relationship Diagram (ERD)
end audit. Although the study of financial  A documentation technique to represent
auditing falls outside the scope of this text, the the relationship between entities in a
following thumbnail sketch of the audit process system.
will demonstrate the importance of the audit  The REA model version of ERD is widely
trail. The external auditor periodically evaluates used in AIS. REA uses 3 types of entities:
the financial statements of publicly held  resources (cash, raw materials)
business organizations on behalf of its  events (release of raw materials
stockholders and other interested parties. into the production process)
 agents (inventory control clerk,
vendor, production worker)
Cardinalities
 Represent the numerical mapping
between entities:
 one-to-one
 one-to-many
 many-to-many

Example of Tracing an Audit Trail

Verifying Accounts Receivable

Data Flow Diagrams (DFD)…

 use symbols to represent the processes,
data sources, data flows, and entities in a
system
 represent the logical elements of the
system
 do not represent the physical system
Data Flow Diagram Symbols

Modern Systems versus Legacy Systems

 Modern systems characteristics:
System Flowcharts…
 client-server based and process
 illustrate the relationship among
transactions in real time
processes and the documents that flow
 use relational database tables
between them
 have high degree of process
 contain more details than data flow
integration and data sharing
diagrams
 some are mainframe based and
 clearly depict the separation of functions
use batch processing
in a system
 Some firms employ legacy systems
for certain aspects of their data
processing.
 Accountants need to understand
legacy systems.
Symbol Set for Representing  Legacy systems characteristics:
Manual Procedures  mainframe-based applications
 batch oriented
 early legacy systems use flat files
for data storage
 later legacy systems use
hierarchical and network databases
 data storage systems promote a
single-user environment that
discourages information integration
Computer-Based Accounting Systems
 Two broad classes of systems:
 batch systems
 real-time systems
Batch Processing
 A batch is a group of similar transactions
that are accumulated over time and then
processed together.
System Flowcharts…  The transactions must be independent of
 are used to represent the relationship one another during the time period over
between the key elements--input sources, which the transactions are accumulated
programs, and output products--of computer in order for batch processing to be
systems appropriate.
 depict the type of media being used  A time lag exists between the event and
(paper, magnetic tape, magnetic disks, and the processing.
terminals)
 in practice, not much difference between Steps in Batch Processing/Sequential File
document and system flowcharts  Keystroke - source documents are
Symbol Set for Representing Computer transcribed by clerks to magnetic tape for
Processes processing later
 Edit Run - identifies clerical errors in the
batch and places them into an error file
 Sort Run - places the transaction file in
the same order as the master file using a
primary key
 Update Run - changes the value of
appropriate fields in the master file to
reflect the transaction
 Backup Procedure - the original master
continues to exist and a new master file is
Program Flowcharts… created
 illustrate the logic used in
programs Advantages of Batch Processing
 Organizations can increase efficiency
Program Flowchart Symbols by grouping large numbers of
 transactions into batches rather than there must be no alternative decision that
processing each event separately. provides the same or greater benefit with less
 Batch processing provides control over risk.
the transaction process via control  Justice. The benefits of the decision
figures. should be distributed fairly to those who
Real-Time Systems… share the risks. Those who do not benefit
 process transactions individually at should not carry the burden of risk.
the moment the economic event occurs  Minimize risk. Even if judged acceptable
 have no time lag between the economic by the principles, the decision should be
event and the processing implemented so as to minimize all of the
 generally, require greater resources risks and avoid any unnecessary risks.
than batch processing since they require Computer Ethics
dedicated processing capacity; however,  The analysis of the nature and social
these cost differentials are decreasing impact of computer technology and the
 oftentimes have longer systems corresponding formulation and
development time justification of policies for the ethical use
of such technology.… [This includes]
concerns about software as well as
============================= hardware and concerns about networks
==================== connecting computers as well as
computers themselves.’’
CHAPTER 3  concerns the social impact of computer
Ethics, Fraud and Internal Control technology (hardware, software, and
Ethical Standards telecommunications).
Ethical standards are derived from societal  Three levels of computer ethics: pop,
mores and deep-rooted personal beliefs about para, and theoretical.4
issues of right and wrong that are not  Pop computer ethics is simply the
universally agreed upon. exposure to stories and reports found in
Business Ethics the popular media regarding the good or
Ethics pertains to the principles of conduct bad ramifications of computer
that individuals use in making choices and technology.
guiding their behavior in situations that involve  Para computer ethics involves taking
the concepts of right and wrong. a real interest in computer ethics cases
Why should we be concerned about ethics in the and acquiring some level of skill and
business world? knowledge in the field.
 Ethics are needed when conflicts arise—  The third level, theoretical computer
the need to choose ethics, is of interest to multidisciplinary
 In business, conflicts may arise between: researchers who apply the theories of
 employees philosophy, sociology, and psychology to
 management computer science with the goal of
 stakeholders bringing some new understanding to the
 Litigation field.
Business ethics involves finding the answers to What are the main computer ethics
two questions: issues?
 How do managers decide on what is right  Privacy - The creation and maintenance
in conducting their business? of huge, shared databases make it
 Once managers have recognized what is necessary to protect people from the
right, how do they achieve it? potential misuse of data.
Four Main Areas of Business Ethics  Security—accuracy and confidentiality -
Computer security is an attempt to avoid
such undesirable events as a loss of
confidentiality or data integrity. Security
systems attempt to prevent fraud and
other misuse of computer systems; they
act to protect and further the legitimate
interests of the system’s constituencies.
 Ownership of property - Laws designed
to preserve real property rights have been
extended to cover what is referred to as
intellectual property, that is, software.
 Equity in access
 Environmental issues
 Artificial intelligence
 Unemployment and displacement -
Many jobs have been and are being
PROPORTIONALITY. The benefit from a changed as a result of the availability of
decision must outweigh the risks. Furthermore, computer technology. People unable or
unprepared to change are displaced.
  Misuse of computer documents, securities fraud, and actions
Legal Definition of Fraud against whistleblowers
 False representation - false statement
or disclosure Employee Fraud
 Material fact - a fact must be substantial  Committed by non-management
in inducing someone to act personnel
 Intent to deceive must exist  Usually consists of: an employee taking
 The misrepresentation must have resulted cash or other assets for personal gain by
in justifiable reliance upon information, circumventing a company’s system of
which caused someone to act internal controls
 The misrepresentation must have caused
injury or loss Management Fraud
 Perpetrated at levels of management
above the one to which internal control
structure relates
 Frequently involves using financial
statements to create an illusion that an
entity is healthier and prosperous than it
actually is
 Involves misappropriation of assets, it
frequently is shrouded in a maze of
complex business transactions
Fraud Schemes
Three categories of fraud schemes according to
the Association of Certified Fraud Examiners:
A. fraudulent statements - are associated
with management fraud.
B. corruption - involves an executive,
Enron, WorldCom, Adelphia - Underlying manager, or employee of the organization in
Problems collusion with an outsider.
Lack of Auditor Independence: auditing firms C. asset misappropriation - The most
also engaged by their clients to perform non common fraud schemes involve some form of
accounting activities asset misappropriation in which assets are
Lack of Director Independence: directors who either directly or indirectly diverted to the
also serve on the boards of other companies, perpetrator’s benefit.
have a business trading relationship, have a A. Fraudulent Statements
financial relationship as stockholders or have  Misstating the financial statements to
received personal loans, or have an operational make the copy appear better than it is
relationship as employees  Usually occurs as management fraud
Questionable Executive Compensation  May be tied to focus on short-term
Schemes: short-term stock options as financial measures for success
compensation result in short-term strategies  May also be related to management
aimed at driving up stock prices at the expense bonus packages being tied to financial
of the firm’s long-term health statements
Inappropriate Accounting Practices: a B. Corruption
characteristic common to many financial  BRIBERY. Bribery involves giving,
statement fraud schemes offering, soliciting, or receiving things of
 Enron made elaborate use of special value to influence an official in the
purpose entities. performance of his or her lawful duties
 WorldCom transferred transmission line  ILLEGAL GRATUITIES. An illegal
costs from current expense accounts to gratuity involves giving, receiving,
capital accounts. offering, or soliciting something of value
Sarbanes-Oxley Act of 2002 - Its principal because of an official act that has been
reforms pertain to: taken. This is similar to a bribe, but the
 Creation of the Public Company transaction occurs after the fact
Accounting Oversight Board (PCAOB)  CONFLICTS OF INTEREST. Every
 Auditor independence—more employer should expect that his or her
separation between a firm’s attestation employees will conduct their duties in a
and non-auditing activities way that serves the interests of the
 Corporate governance and employer. A conflict of interest occurs
responsibility—audit committee when an employee acts on behalf of a
members must be independent and the third party during the discharge of his or
audit committee must oversee the her duties or has self-interest in the
external auditors activity being performed
 Disclosure requirements—  ECONOMIC EXTORTION. Economic
increase issuer and management extortion is the use (or threat) of force
disclosure (including economic sanctions) by an
 New federal crimes for the individual or organization to obtain
destruction of or tampering with
 something of value. The item of value Exposures of Weak Internal Controls (Risk)
could be a financial or economic asset,  Destruction of an asset
information, or cooperation to obtain a  Theft of an asset
favorable decision on some matter under  Corruption of information
review.  Disruption of the information system
Preventive, Detective, and Corrective
 Foreign Corrupt Practice Act of 1977: Controls
 indicative of corruption in business
world
 impacted accounting by requiring
accurate records and internal
controls
C. Asset Misappropriation
 Skimming involves stealing cash from an
organization before it is recorded on the
organization’s books and records.
 Cash larceny involves schemes in which
cash receipts are stolen from an
organization after they have been SAS 78 / COSO
recorded in the organization’s books and Describes the relationship between the firm’s…
records. An example of this is lapping, in  internal control structure,
which the cash receipts clerk first steals  auditor’s assessment of risk, and
and cashes a check from Customer A.  the planning of audit procedures
 Check tampering involves forging or How do these three interrelate?
changing in some material way a check The weaker the internal control structure, the
that the organization has written to a higher the assessed level of risk; the higher the
legitimate payee. risk, the more auditor procedures applied in the
 Payroll fraud is the distribution of audit.
fraudulent paychecks to existent and/or Five Internal Control Components: SAS 78 /
nonexistent employees. Most common COSO
type of fraud and often occurs as 1. Control environment
employee fraud 2. Risk assessment
 Examples: 3. Information and communication
 making charges to expense 4. Monitoring
accounts to cover theft of asset 5. Control activities
(especially cash) 1: The Control Environment
 lapping: using customer’s check  Integrity and ethics of management
from one account to cover theft  Organizational structure
from a different account  Role of the board of directors and the
 transaction fraud: deleting, audit committee
altering, or adding false  Management’s policies and philosophy
transactions to steal assets  Delegation of responsibility and authority
Internal Control Objectives According to  Performance evaluation measures
AICPA SAS  External influences—regulatory agencies
1. Safeguard assets of the firm  Policies and practices managing human
2. Ensure accuracy and reliability of resources
accounting records and information 2: Risk Assessment
3. Promote efficiency of the firm’s  Identify, analyze and manage risks
operations relevant to financial reporting:
4. Measure compliance with management’s  changes in external environment
prescribed policies and procedures  risky foreign markets
Modifying Assumptions to the Internal  significant and rapid growth that
Control Objectives strain internal controls
 Management Responsibility  new product lines
The establishment and maintenance of a  restructuring, downsizing
system of internal control is the responsibility of  changes in accounting policies
management. 3: Information and Communication
 Reasonable Assurance  The AIS should produce high quality
The cost of achieving the objectives of internal information which:
control should not outweigh its benefits.  identifies and records all valid
 Methods of Data Processing transactions
The techniques of achieving the objectives will  provides timely information in
vary with different types of technology. appropriate detail to permit proper
Limitations of Internal Controls classification and financial
 Possibility of honest errors reporting
 Circumvention via collusion  accurately measures the financial
 Management override value of transactions
 Changing conditions--especially in
companies with high growth
  accurately records transactions in  general (everyday procedures) or specific
the time period in which they (non-routine transactions) authorizations
occurred Segregation of Duties
Information and Communication  In manual systems, separation between:
 Auditors must obtain sufficient knowledge of  authorizing and processing a
the IS to understand: transaction
 the classes of transactions that are  custody and recordkeeping of the
material asset
 how these transactions are initiated  subtasks
[input]  In computerized systems, separation
 the associated accounting records and between:
accounts used in processing [input]  program coding
 the transaction processing steps involved  program processing
from the initiation of a transaction to its  program maintenance
inclusion in the financial statements Supervision
[process]  a compensation for lack of segregation;
 the financial reporting process used to some may be built into computer systems
compile financial statements, disclosures, Accounting Records
and estimates [output]  provide an audit trail
[red shows relationship to the general AIS Access Controls
model]  help to safeguard assets by restricting
4: Monitoring physical access to them
The process for assessing the quality of internal Independent Verification
control design and operation  reviewing batch totals or reconciling
[This is feedback in the general AIS model.] subsidiary accounts with control accounts
 Separate procedures—test of controls by
internal auditors
 Ongoing monitoring:
 computer modules integrated into
routine operations
 management reports which
highlight trends and exceptions
from normal performance
[red shows relationship to the general AIS
model]
Physical Controls in IT Contexts
5: Control Activities Transaction Authorization
 Policies and procedures to ensure that the  The rules are often embedded within
appropriate actions are taken in response computer programs.
to identified risks  EDI/JIT: automated re-ordering of
 Fall into two distinct categories: inventory without human
 IT controls—relate specifically to intervention
the computer environment Segregation of Duties
 Physical controls—primarily pertain  A computer program may perform many
to human activities tasks that are deemed incompatible.
Two Types of IT Controls  Thus the crucial need to separate
 General controls—pertain to the entity program development, program
wide computer environment operations, and program maintenance.
 Examples: controls over the data Supervision
center, organization databases,  The ability to assess competent
systems development, and employees becomes more challenging
program maintenance due to the greater technical knowledge
 Application controls—ensure the integrity required.
of specific systems Accounting Records
 Examples: controls over sales order  ledger accounts and sometimes source
processing, accounts payable, and documents are kept magnetically
payroll applications  no audit trail is readily apparent
Six Types of Physical Controls Access Control
 Transaction Authorization  Data consolidation exposes the
 Segregation of Duties organization to computer fraud and
 Supervision excessive losses from disaster.
 Accounting Records Independent Verification
 Access Control  When tasks are performed by the
 Independent Verification computer rather than manually, the need
Physical Controls for an independent check is not
Transaction Authorization necessary.
 used to ensure that employees are  However, the programs themselves are
carrying out only authorized transactions checked.
  credit reference file (may not be
needed)
 salesperson file (may be a master
file)
 Sales history file
 cash receipts history file
 accounts receivable reports file
Sales Order Processing
Sales order procedures include the tasks
involved in receiving and processing a customer
order, filling the order and shipping products to
the customer, billing the customer at the proper
time, and correctly accounting for the
transaction.
RECEIVE ORDER
 Begins with a customer placing an order
 The sales department captures the
CHAPTER 4 essential details on a sales order
The Revenue Cycle form.
 Sales Order - captures vital information
such as the customer’s name, address,
and account number; the name, number,
and description of the items sold; and the
quantities and unit prices of each item
sold
 After creating the sales order, a copy of it
is placed in the customer open order
file for future reference. The open order
file thus enables customer service
employees to respond promptly and
accurately to customer questions.
CHECK CREDIT
 The transaction is authorized by obtaining
credit approval by the credit department.
 The credit approval process is an
Journal Vouchers/Entries (How do we get authorization control and should be
them?) performed as a function separate from
 Billing Department prepares a journal the sales activity. In our conceptual
voucher: system, the receive-order task sends the
Accounts Receivable sales order (credit copy) to the check-
DR credit task for approval.
Sales  Sales information is released to:
CR  Billing
 Inventory Control Dept. prepares a journal  Warehouse (stock release or
voucher: picking ticket)
Cost of Goods Sold DR  Shipping (packing slip and
Inventory CR shipping notice)
 Cash Receipts prepares a journal voucher: PICK GOODS
Cash DR  The receive order activity forwards the
Accounts Receivable stock release document (also called the
CR picking ticket) to the pick goods function, in
the warehouse.
Revenue Cycle Databases  The merchandise is picked from the
Warehouse and sent to Shipping. After
 Master files picking the stock, the order is verified for
 customer master file accuracy and the goods and verified stock
 accounts receivable master file release document are sent to the ship
 merchandise inventory master file goods task.
 Transaction and Open Document  Stock records are adjusted.
Files SHIP GOODS
 sales order transaction file  The merchandise, packing slip, and
• open sales order transaction bill of lading are prepared by Shipping
file and sent to the customer.
 sales invoice transaction file  Shipping reconciles the merchandise
 cash receipts transaction file received from the Warehouse with the
 Other Files sales information on the packing slip.
 shipping and price data reference  Shipping information is sent to Billing.
file BILL CUSTOMER
 The billing function awaits notification forwarded to the inventory control function for
from shipping before it bills. The bill- posting. At the end of the period, total sales
customer function receives the sales order returns are summarized in a journal voucher and
(invoice copy) from the receive order task. sent to the general ledger department.
This document is placed in an S.O. pending UPDATE INVENTORY AND AR RECORDS.
file until receipt of the shipping notice, The inventory control function adjusts the
which describes the products that were inventory records and forwards the credit memo
actually shipped to the customer. Upon to accounts receivable, where the customer’s
arrival, the items shipped are reconciled account is also adjusted.
with those ordered and unit prices, taxes, UPDATE GENERAL LEDGER.
and freight charges are added to the invoice Sales Return Journal Entry
copy of the sales order. The completed G/L posts the following to control accounts:
sales invoice is the customer’s bill, which Inventory—Control DR
formally depicts the charges to the Sales Returns and Allowances DR
customer. Cost of Goods Sold CR
 Billing compiles and reconciles the Accounts Receivable—Control CR
relevant facts and issues an invoice to the
customer and updates the sales journal. Cash Receipts Processes
Information is transferred to: Involve receiving and securing the cash;
 Accounts Receivable (A/R) depositing the cash in the bank; matching the
 Inventory Control payment with the customer and adjusting the
 A/R records the information in the correct account; and properly accounting for and
customer’s account in the accounts reconciling the financial details of the
receivable subsidiary ledger. transaction.
 Inventory Control adjusts the inventory OPEN MAIL AND PREPARE REMITTANCE
subsidiary ledger. ADVICE.
 Billing, A/R, and Inventory Control submits A mail room employee opens envelopes
summary information to the General containing customers’ payments and remittance
Ledger dept., which then reconciles this advices. Remittance advices contain information
data and posts to the control accounts in needed to service individual customers’
the G/L. accounts. This includes payment date, account
 The sales journal is a special journal number, amount paid, and customer check
used for recording completed sales number. Mail room personnel route the checks
transactions. The details of sales invoices and remittance advices to an administrative
are entered in the journal individually. At the clerk who endorses the checks ‘‘For Deposit
end of the period, these entries are Only’’ and reconciles the amount on each
summarized into a sales journal voucher, remittance advice with the corresponding check.
which is sent to the general ledger task for The clerk then records each check on a form
posting. called a remittance list (or cash prelist), where
 The AR summary figures should equal the all cash received is logged.
total debits to AR reflected in the journal  A mail room clerk prepares a cash
vouchers for the transaction period. By prelist and sends the prelist and the
reconciling these figures, the general ledger checks to Cash Receipts.
function can detect many types of errors.  The cash prelist is also sent to A/R
Sales Return Procedures and the Controller.
PREPARE RETURN SLIP. RECORD AND DEPOSIT CHECKS.
When items are returned, the receiving  Cash Receipts:
department employee counts, inspects, and  verifies the accuracy and
prepares a return slip describing the items. completeness of the checks
The goods, along with a copy of the return slip,  updates the cash receipts journal
go to the warehouse to be restocked. The  prepares a deposit slip
employee then sends the second copy of the  prepares a journal voucher to send
return slip to the sales function to prepare a to G/L
credit memo.  A/R posts from the remittance advices to
PREPARE CREDIT MEMO. the accounts receivable subsidiary ledger.
Upon receipt of the return slip, the sales  Periodically, a summary of the
employee prepares a credit memo. This postings is sent to G/L.
document is the authorization for the customer  G/L department:
to receive credit for the merchandise returned.  reconciles the journal voucher from
APPROVE CREDIT MEMO. Cash Receipts with the summaries
The credit manager evaluates the from A/R
circumstances of the return and makes a  updates the general ledger control
judgment to grant (or disapprove) credit. The accounts
manager then returns the approved credit  The Controller reconciles the bank
memo to the sales department. accounts.
UPDATE SALES JOURNAL. SALES ORDER PROCESSING (Departments
Upon receipt of the approved credit memo, Involved)
the transaction is recorded in the sales journal Sales Department
as a contra entry. The credit memo is then
 The sales process begins with a customer company policy will dictate whether credit
contacting the sales department by telephone, department approval (not shown) is required.
mail, or in person. The sales department records Processing the Credit Memo
the essential details on a sales order. The objective of the sales return system is to
Credit Department Approval reverse the effects of the original sales
To provide independence to the credit transaction. Billing records a contra entry into
authorization process, the credit department is sales return, and allowance journal inventory
organizationally and physically segregated from control debits the inventory records to reflect
the sales department. When credit is approved, the return of goods. The AR clerk credits the
the sales department clerk pulls the various customer account
copies of the sales orders from the pending file CASH RECEIPTS PROCEDURES
and releases them to the billing, warehouse, and Mail Room
shipping departments. Customer payments and remittance advices
Warehouse Procedures arrive at the mail room, where the envelopes are
The next step is to ship the merchandise, opened. The checks are sent to the cashier in
which should be done as soon after credit the cash receipts department, and the
approval as possible. The warehouse clerk remittance advices are sent to the AR
receives the stock release copy of the sales department.
order and uses this to locate the inventory. The Cash Receipts
inventory and stock release are then sent to the The cashier records the checks in the cash
shipping department. Finally, the warehouse receipts journal and promptly sends them to the
clerk records the inventory reduction in the bank, accompanied by two copies of the deposit
stock records. slip. Periodically, the employee prepares a
The Shipping Department journal voucher and sends it to the general
The shipping clerk reconciles the products ledger department.
received from the warehouse with the shipping Controller’s Office
notice copy of the sales order received earlier. In this case, someone from the controller’s
When the order is correct, a bill of lading is office periodically performs a bank reconciliation
prepared, and the products are packaged and by comparing deposit slips returned from the
shipped via common carrier to the customer. bank, account summaries used to post to the
The clerk then enters the transaction into the accounts, and journal vouchers.
shipping log and sends the shipping notice and
stock release to the billing department. Summary of Internal Controls
The Billing Department
The shipping notice is proof that the product
has been shipped and is the trigger document
that initiates the billing process. Upon receipt of
the shipping notice and stock release, the billing
clerk compiles the relevant facts about the
transaction (product prices, handling charges,
freight, taxes, and discount terms) and bills the
customer. The billing clerk then enters the
transaction into the sales journal and distribute
documents to the AR and inventory control
departments. Periodically, the clerk summarizes
all transactions into a journal voucher and sends
this to the general ledger department.
Accounts Receivable, Inventory Control,
and General Ledger Departments
Upon receipt of sales documents from the
billing department, the AR and inventory control
clerks update their respective subsidiary
ledgers. Periodically they prepare journal
vouchers and account summaries, which they Authorization Controls
send to the general ledger department for  Proper authorization of transactions
reconciliation and posting to the control (documentation) should occur so that only
accounts. valid transactions get processed.
SALES RETURN PROCEDURES  Within the revenue cycle, authorization
Receiving Department should take place when:
The sales return process begins in the  a sale is made on credit
receiving department, where personnel receive, (authorization)
count, inspect for damage, and send returned  a cash refund is requested
products to the warehouse. The receiving clerk (authorization)
prepares a return slip, which is forwarded to the  posting a cash payment received to
sales department for processing. a customer’s account (cash pre-list)
Sales Department
Upon receipt of the return slip, the clerk Segregation of Functions (Three Rules)
prepares a credit memo. Depending on the 1. Transaction authorization should be
materiality and circumstance of the return, separate from transaction processing.
 2. Asset custody should be separate from  Access to assets and information
asset record-keeping. (accounting records) should be limited.
3. The organization should be so structured  Within the revenue cycle, the assets to
that the perpetration of a fraud requires protect are cash and inventories and
collusion between two or more access to records such as the accounts
individuals. receivable subsidiary ledger and cash
journal should be restricted.
 Sales Order Processing Independent Verification
 credit authorization separate from  Physical procedures as well as record-
SO processing keeping should be independently
 inventory control separate from reviewed at various points in the system
warehouse to check for accuracy and completeness:
 accounts receivable sub-ledger  shipping verifies the goods sent
separate from general ledger from the warehouse are correct in
control account type and quantity
 Cash Receipts Processing  warehouse reconciles the stock
 cash receipts separate from release document (picking slip) and
accounting records packing slip
 accounts receivable sub-ledger  billing reconciles the shipping
separate from general ledger notice with the sales invoice
Supervision  general ledger reconciles journal
 Often used when unable to enact vouchers from billing, inventory
appropriate segregation of duties. control, cash receipts, and
 Supervision of employees serves as a accounts receivable
deterrent to dishonest acts and is Automating the Revenue Cycle
particularly important in the mailroom.  Authorizations and data access can be
Accounting Records performed through computer screens.
 With a properly maintained audit trail, it is  There is a decrease in the amount of
possible to track transactions through the paper.
systems and to find where and when errors  The manual journals and ledgers are
were made: changed to disk or tape transaction and
 pre-numbered source documents - master files.
(sales orders, shipping notices,  Input is still typically from a hard copy
remittance advices, and so on) are document and goes through one or more
sequentially numbered by the printer and computerized processes.
allow every transaction to be identified  Processes store data in electronic files
uniquely. This permits the isolation and (the tape or disk) or prepare data in the
tracking of a single event (among many form of a hardcopy report.
thousands) through the accounting  Revenue cycle programs can include:
system.  formatted screens for collecting
 special journals - By grouping similar data
transactions together into special  edit checks on the data entered
journals, the system provides a concise  instructions for processing and
record of an entire class of events. storing the data
 subsidiary ledgers - These subsidiary  security procedures (passwords or
records provide links back to journal user IDs)
entries and to the source documents that  steps for generating and displaying
captured the events. output
 general ledger - he general  To understand files, you must consider the
ledger control accounts are the basis record design and layout.
for financial statement preparation.  The documents and the files used as
 Files - The revenue cycle employs input sources must contain the data
several temporary and permanent files necessary to generate the output reports.
that contribute to the audit trail. The
following are typical examples:
 Open sales order file shows the CHAPTER 5
status of customer orders. Purchases and Cash Disbursements
 Shipping log specifies orders shipped Procedures
during the period.
 Credit records file provides customer
credit data.
 Sales order pending file contains open
orders not yet shipped or billed.
 Back-order file contains customer
orders for out-of-stock items.
 b is a compilation of all journal
vouchers posted to the general ledger.
Access Controls
  reconciles the inventory amount with the
account summary received from
inventory control
DFD for Cash Disbursements System
Cash Disbursements System
 Periodically, A/P searches the open
vouchers payable file for items with
payments due:
 A/P sends the voucher and
supporting documents to Cash
Disbursements
 A/P updates the accounts payable
subsidiary ledger
 Cash Disbursements:
 prepares the check
 records the information in a check
Goals of the Expenditure Cycle
register (cash disbursements
 The goal of providing needed resources to
journal)
organization can be broken down into
 returns paid vouchers to accounts
several objectives:
payable, mails the check to the
 purchase from reliable vendors
supplier
 purchase high quality items
 sends a journal voucher to G/L:
 obtain best possible price
Accounts Payable DR
 purchase only items that are
Cash CR
properly authorized
 G/L department receives:
 have resources available when they
 the journal voucher from cash
are needed
disbursements
 receive only those items ordered
 a summary of the accounts payable
 ensure items are not lost, stolen,
subsidiary ledger from A/P
or broken
 The journal voucher is used to update the
 pay for the items in a timely
general ledger.
manner
 The accounts payable control account is
reconciled with the subsidiary summary.
AP & CASHDISBURSEMENT (Departments
A Purchase System
Involved)
 Begins in Inventory Control when
inventory levels drop to reorder levels
Inventory Control
 A purchase requisition (PR) is prepared
Note that to provide proper authorization
and copies to be sent to Purchasing and
control, the inventory control department is
Accounts Payable (A/P)
segregated from the purchasing department,
 Purchasing prepares a purchase order
which executes the transaction.
(PO) for each vendor and sends copies to
Purchasing Department
Inventory Control, A/P, and Receiving
The purchasing department receives the
 Upon receipt, Receiving counts and
purchase requisitions, sorts them by vendor,
inspects the goods.
and prepares a multipart PO for each vendor.
 A blind copy of the PO is used to
Receiving Department
force workers to count the goods.
Goods arriving from the vendor are
 A receiving report is prepared and copies
reconciled with the blind copy of the PO. Upon
sent to the raw materials storeroom,
completion of the physical count and inspection,
Purchasing, Inventory Control, and A/P.
the receiving clerk prepares a multipart
 A/P eventually receives copies of the PR,
receiving report stating the quantity and
PO, receiving report, and the supplier’s
condition of the inventories. One copy of the
invoice.
receiving report accompanies the physical
 A/P reconciles these documents, posts to
inventories to the storeroom. Another copy is
the purchases journal, and records the
sent to the purchasing department, where the
liability in the accounts payable
purchasing clerk reconciles it with the open PO.
subsidiary ledger.
AP Department
 A/P periodically summarizes the entries in
When the invoice arrives, the AP clerk
the purchases journal as a journal
reconciles the financial information with the
voucher which is sent to the General
documents in the pending file, records the
Ledger (G/L) department.
transaction in the purchases journal, and posts it
Inv-Control or Purchases DR
to the supplier’s account in the AP subsidiary
Accts Payable-Control CR
ledger (voucher register)
 A/P also prepares a cash disbursements
General Ledger Department
voucher and posts it in the voucher
The general ledger department receives a
register.
journal voucher from the AP department and an
 G/L department:
account summary from inventory control. The
 posts from the accounts payable journal
general ledger clerk reconciles these and posts
voucher to the general ledger
to the inventory and AP control accounts. With
this step, the purchases phase of the  segregation of duties
expenditure cycle is completed.  Documentation
THE CASH DISBURSEMENTS SYSTEMS  Asset Accountability Controls
(Departments involved)  Management Practices
AP Department  Data Center Operations Controls
Each day, the AP clerk reviews the open  Authorization Controls
vouchers payable (AP) file for items due and  Access Controls
sends the vouchers and supporting documents Authorization Controls
to the cash disbursements department.  Purchases of inventory should be
Cash Disbursements Department authorized by the Inventory Control
The cash disbursements clerk receives the department, not by purchasing agents
voucher packets and reviews the documents for  Accounts Payable authorizes the
completeness and clerical accuracy. For each payments of bills, not the cash
disbursement, the clerk prepares a three-part disbursements clerk, who writes the
check and records the check number, dollar checks
amount, voucher number, and other pertinent Traditional Segregation of Duties
data in the check register. The check, along with  Warehouse (stores)
the supporting documents, goes to the cash  Inventory control
disbursements department manager, or  Accounts payable
treasurer, for his or her signature. The  General ledger
negotiable portion of the check is mailed to the  Requisitioning
supplier. The clerk returns the voucher packet  Purchases
and check copy to the AP department and files  Purchases returns and allowances
one copy of the check. Finally, the clerk  Cash disbursements
summarizes the entries made to the check Supervision
register and sends a journal voucher to the  Within the expenditure cycle,
general ledger department. supervision is of highest importance
General Ledger Department in the Receiving department, where
the inventory arrives and is logged in
Expenditure Cycle Database by a receiving clerk. Need to
 Master Files minimize:
 supplier (vendor) master file  failures to properly inspect the
 accounts payable master file assets
 merchandise inventory master file  theft of the assets
 Transaction and Open Document Access Controls
Files  Access to:
 purchase order file  inventories (direct)
 open purchase order file  cash (direct)
 supplier’s invoice file  accounting records (indirect)
 open vouchers file Independent Verification
 cash disbursements file  A/Payable dept. verifies much of the work
 Other Files done within the expenditure cycle.
 supplier reference and history file  PR, PO, receiving reports, and
 buyer file suppliers’ invoices must be
 accounts payable detail file checked and verified by A/P.
 G/Ledger dept. verifies:
 the total obligations recorded equal
the total inventories received
Summary of Internal Controls  the total reductions in accounts
payable equal the total
disbursements of cash

CHAPTER 6
Payroll Processing and Fixed Asset
Procedures

(Departments Involved)
Personnel Department
The personnel department prepares and
submits personnel action forms to the prepare
payroll function. These documents identify
employees authorized to receive a paycheck
and are used to reflect changes in hourly pay
rates, payroll deductions, and job classification.
Personnel action form is used to advise payroll
of an increase in an employee’s salary.
General Internal Controls Production Department
 Organization controls
 Production employees prepare two types of The general ledger function receives the
time records: job tickets and time cards. Job labor distribution summary from cost
tickets capture the time that individual workers accounting, the disbursement voucher from AP,
spend on each production job. Cost accounting and the journal voucher from cash
uses these documents to allocate direct labor disbursements. With this information, the
charges to work-in-process (WIP) accounts. Time general ledger clerk makes the following
cards capture the time the employee is at work. accounting entries:
These are sent to the prepare payroll function From the Labor Distribution Summary
for calculating the amount of the employee’s Work-in-Process (Direct labor)
paycheck. XXX.XX
Update WIP Account (Cost Accounting Factory Overhead (Indirect labor)
Department) XXX.XX
After cost accounting allocates labor costs to Wages Payable
the WIP accounts, the charges are summarized XXX.XX
in a labor distribution summary and
forwarded to the general ledger function. Transaction Authorization
Prepare Payroll A form of payroll fraud involves submitting
The payroll department receives pay rate time cards for employees who no longer work
and withholding data from the personnel for the firm. To prevent this, the personnel
department and hours worked data from the action form helps payroll keep the employee
production department. A clerk in payroll then records current. This document describes
performs the following tasks. additions, deletions, and other changes to the
1. Prepares the payroll register showing gross employee file and acts as an important
pay, deductions, overtime pay, and net pay. authorization control to ensure that only the
2. Enters this information into the employee time cards of current and valid employees are
payroll records processed.
3. Prepares employee paychecks . Segregation of Duties
4. Sends the paychecks to the distribute The time-keeping function and the personnel
paycheck function. function should be separated. Segregating key
5. Files the time cards, personnel action form, aspects of the payroll transaction between AP
and copy of the payroll register (not shown). and cash disbursement functions returns control
Distribute Paycheck to the process. AP reviews the work done by
A form of payroll fraud involves submitting payroll (payroll register) and approves payment.
time cards for nonexistent employees. To Cash disbursements then writes the check to
prevent this, many companies use a paymaster cover the total payroll. None of the employee
to distribute the paychecks to employees. This paychecks is a negotiable instrument until the
individual is independent of the payroll process payroll check is deposited into the imprest
—not involved in payroll authorization or account.
preparation tasks. If a valid employee does not Supervision
claim a paycheck, the paymaster returns the Sometimes employees will clock in for
check to payroll. The reason the check went another worker who is late or absent.
unclaimed can then be investigated. Supervisors should observe the time-keeping
Prepare Accounts Payable (Accounts process and reconcile the time cards with actual
Payable Department) attendance.
The accounts payable (AP) clerk reviews the Accounting Records
payroll register for correctness and prepares The audit trail for payroll includes the following
copies of a cash disbursement voucher for the documents:
amount of the payroll. The clerk records the 1. Time cards, job tickets, and disbursement
voucher in the voucher register and submits the vouchers.
voucher packet (voucher and payroll register) to 2. Journal information, which comes from the
cash disbursements. A copy of the disbursement labor distribution summary and the payroll
voucher is sent to the general ledger function. register.
Prepare Cash Disbursement (Cash 3. Subsidiary ledger accounts, which contain the
Disbursement Department) employee records and various expense
Upon receipt of the voucher packet, the cash accounts.
disbursements function prepares a single check 4. The general ledger accounts: payroll control,
for the entire amount of the payroll and deposits cash, and the payroll clearing (imprest) account.
it in the payroll imprest account. The employee Access Controls
paychecks are drawn on this account, which is The assets associated with the payroll
used only for payroll. Funds must be transferred system are labor and cash. Both can be
from the general cash account to this imprest misappropriated through improper access to
account before the paychecks can be cashed. accounting records. Similarly, control over
The clerk sends a copy of the check along with access to all journals, ledgers, and source
the disbursement voucher and the payroll documents in the payroll system is important, as
register to the AP department, where they are it is in all expenditure cycle systems.
filed (not shown). Finally, a journal voucher is Independent Verification
prepared and sent to the general ledger The following are examples of independent
function. verification controls in the payroll system:
Update General Ledger
1. Verification of time. Before sending time cards should indicate the current location of the asset.
to payroll, the supervisor must verify their The ability to locate and verify the physical
accuracy and sign them. existence of fixed assets is an important
2. Paymaster. The use of an independent component of the audit trail.
paymaster to distribute checks (rather than the Asset Disposal
normal supervisor) helps verify the existence of When an asset has reached the end of its
the employees. The supervisor may be party to useful life or when management decides to
a payroll fraud by pretending to distribute dispose of it, the asset must be removed from
paychecks to nonexistent employees. the fixed asset subsidiary ledger. It begins when
3. Accounts payable. The AP clerk verifies the the responsible manager issues a request to
accuracy of the payroll register before creating a dispose of the asset. Like any other transaction,
disbursement voucher that transfers funds to the disposal of an asset requires proper
the imprest account. approval. The disposal options open to the firm
4. General ledger. The general ledger are to sell, scrap, donate, or retire the asset in
department provides verification of the overall place. A disposal report describing the final
process by reconciling the labor distribution disposition of the asset is sent to the fixed asset
summary and the payroll disbursement voucher. accounting department to authorize its removal
from the ledger.
FIXED ASSETS are the property, plant, and Authorization Controls
equipment used in Fixed asset acquisitions should be formal and
the operation of a business. These are relatively explicitly authorized. Each transaction should be
permanent items that often collectively initiated by a written request from the user or
represent the largest financial investment by the department. In the case of high-value items,
organization. Examples of fixed assets include there should be an independent approval
land, buildings, furniture, machinery, and motor process that evaluates the merits of the request
vehicles. A firm’s fixed asset system processes on a cost-benefit basis.
transactions pertaining to the acquisition, Supervision Controls
maintenance, and disposal of its fixed assets. Because capital assets are widely distributed
Asset Acquisition throughout the organization, they are more
Usually begins with the departmental susceptible to theft and misappropriation than
manager (user) recognizing the need to obtain a inventories that are secured in a warehouse.
new asset or replace an existing one. Therefore, management supervision is an
Authorization and approval procedures over the important element in the physical security of
transaction will depend on the asset’s value. fixed assets. Supervisors must ensure that fixed
Department managers typically have authority assets are being used in accordance with the
to approve purchases below a certain organization’s policies and business practices.
materiality limit. Capital expenditures above the Independent Verification Controls
limit will require approval from the higher Periodically, the internal auditor should
management levels. This may involve a formal review the asset acquisition and approval
cost-benefit analysis and the formal solicitation procedures to determine the reasonableness of
of bids from suppliers. Once the request is factors used in the analysis. These include the
approved and a supplier is selected, the fixed useful life of the asset, the original financial
asset acquisition task is similar to the cost, the proposed cost savings as a result of
expenditure cycle procedures described in acquiring the asset, the discount rate used, and
Chapter 5, with two noteworthy differences. the capital budgeting method used in the
First, the receiving department delivers the analysis. The internal auditor should verify the
asset into the custody of the user/manager location, condition, and fair value of the
rather than a central store or warehouse. organization’s fixed assets against the fixed
Second, the fixed asset department, not asset records in the subsidiary ledger. In
inventory control, performs the record-keeping addition, the automatic depreciation charges
function. calculated by the fixed asset system should be
Asset Maintenance reviewed and verified for accuracy and
Involves adjusting the fixed asset subsidiary completeness.
account balances as the assets (excluding land)
depreciate over time or with usage. The method
of depreciation and the period used should
reflect, as closely as possible, the asset’s actual
decline in utility to the firm. The depreciation of
fixed assets used to manufacture products is
charged to manufacturing overhead and then
allocated to WIP. Depreciation charges from
assets not used in manufacturing are treated as
expenses in the current period.
Depreciation calculations are transactions
that the fixed asset system must be designed to
anticipate internally when no external event
(source document) triggers the action. An
important record used to initiate this task is the
depreciation schedule. Each subsidiary record