Question

seven main function in the accounting systems for credit sales and receipt transaction with a brief description of each function

control activities that should be implemented to mitigate risk associated with ordering of goods functions

Answer 1

Explanation to the above problem is as under:

Control Activities of Credit Sales and Cash Receipt Transactions:

1) Transaction Authorization
The objective of transaction authorizationis to ensure that only valid transactions are processed.
i. Credit Check: Credit checking of prospective customer is a credit department function. This department ensures the proper application of the firm’s credit policies. The principal concern is the creditworthiness of the customer. In making this judgment, the credit department may employ various techniques and tests.The complexity of credit procedures will vary depending on the organization, its relationship with the customer, and the materiality of the transaction. Credit approval for the first-time customers may take time. Credit decisions that fall within a sales employee’s general authority (such as verifying that the current transaction does not exceed the customer’s credit limit) may be dealt with very quickly. Whatever level of test is deemed necessary by company policy, the transaction should not proceed further until credit is approved.
ii. Return Policy: Because credit approval is generally a credit department function, that department authorizes the processing of sales returns as well. An approval determination is based on the nature of the sale and the circumstances of the return. The concepts of specific and general authority also influence this activity. Most organizations have specific rules for granting cash refunds and credits to customers based on the materiality of the transaction. As materiality increases, credit approval becomes more formal.
iii. Remittance List (Cash Prelist): The cash prelist provides a means for verifying that customer checks and remittance advices match in amount. The presence of an extra remittance advice in the AR department or the absence of a customer’s check in the cash receipt department would be detected when the batch is reconciled with the prelist. Thus, the prelist authorizes the posting of a remittance advice to a customer’s account.
2) Segregation of Duties: Segregating duties ensures that no single individual or department processesa transaction in its entirety. The number of employees and the volume oftransactions being processed influence how to accomplish the segregation. Three rules guide systems designers in this task:
i. Transaction authorization should be separate from transaction processing: Within the revenue cycle, the credit department is segregated from the restof the process, so formal authorization of a transaction is an independent event.The importance of this separation is clear when one considers the potentialconflict in objectives between the individual salesperson and the organization.Often, compensation for sales staff is based on their individual sales performance.In such cases, sales staff have an incentive to maximize sales volume and thusmay not adequately consider the creditworthiness of prospective customers. By acting in an independent capacity, the credit department may objectively detect risky customers and disallow poor and irresponsible sales decisions.
ii) Asset custody should be separate from the task of asset record keeping: The physical assets at risk in the revenue cycle are inventory and cash,hence the need to separate asset custody from record keeping. The inventorywarehouse has physical custody of inventory assets, but inventory control (anaccounting function) maintains records of inventory levels. To continue the set asks would open the door to fraud and material errors. A person with combined responsibility could steal or lose inventory and adjust the inventory records to conceal the event.Similarly, the cash receipts department takes custody of the cash asset,while updating AR records is an account receivable (accounting function)responsibility. The cash receipts department typically reports to the treasurer, whohas responsibility for financial assets. Accounting functions report to thecontroller. Normally these two general areas of responsibility are performedindependently.
iii. The organization should be structured so that the perpetration of a fraudrequires collusion between two or more individuals: The record-keeping tasks need to be carefully separated. Specifically, thesubsidiary ledger (AR and inventory), the journals (sales and cash receipts), andthe general ledger should be separately maintained. An individual with totalrecord-keeping responsibility, in collusion with someone with asset custody, is ina position to perpetrate fraud. By separating these tasks, collusion must involvemore people, which increases the risk of detection and therefore is less likely to occur.
3) Supervision: Supervision can also provide control in systems that are properly segregated. For example, the mail room is a point of risk in most cash receiptssystems. The individual who opens the mail has access both to cash (the asset)and to the remittance advice (the record of the transaction). A dishonest employeemay use this opportunity to steal the check, cash it, and destroy the remittance advice, thus leaving no evidence of the transaction. Ultimately, this sort of fraudwill come to light when the customer complains after being billed again for the same item and produces the cancelled check to prove that payment was made. By the time the firm gets to the bottom of this problem, however, the perpetrator may have committed the crime many times and left the organization. Detecting crimesafter the fact accomplishes little; prevention is the best solution. The deterrent effect of supervision can provide an effective preventive control.
4) Accounting Records: This control is also an important operational feature of well-designedaccounting systems. Sometimes transactions get lost in the system. By followingthe audit trail, management can discover where an error occurred. Several specificcontrol techniques contribute to the audit trail.
i. Prenumbered Documents: Prenumbered documents (sales orders, shippingnotices, remittance advices, and so on) are sequentially numbered by the printerand allow every transaction to be identified uniquely. This permits the isolationand tracking of a single event (among many thousands) through the accountingsystem. Without a unique tag, one transaction looks very much like another.Verifying financial data and tracing transactions would be difficult or evenimpossible without prenumbered source documents.
ii. Special Journals: By grouping similar transactions together into special journals, the system provides a concise record of an entire class of events. For this purpose, revenue cycle systems use the sales journal and the cash receipts journal.
iii. Subsidiary Ledgers: Two subsidiary ledgers are used for capturing transaction event details in the revenue cycle: the inventory and AR subsidiary ledgers. Thesale of products reduces quantities on hand in the inventory subsidiary records and increases the customers’ balances in the AR subsidiary records. The receipt of cash reduces customers’ balances in the AR subsidiary records. These subsidiary records provide links back to journal entries and to the source documents thatcaptured the events.
iv. General Ledgers: The general ledger control accounts are the basis forfinancial statement preparation. Revenue cycle transactions affect the followinggeneral ledger accounts: sales, inventory, cost of goods sold, AR, and cash.Journal vouchers that summarize activity captured in journals and subsidiary ledgers flow into the general ledger to update these accounts. Thus we have a complete audit trail from the financial statements to the source documents via thegeneral ledger, subsidiary ledgers, and special journals.
v. Files: The revenue cycle employs several temporary and permanent files that contribute to the audit trail.
5) Access Controls: Access controls prevent and detect unauthorized and illegal access to the firm’s assets. The physical assets at risk in the revenue cycle are inventories and cash.
Limiting access to these items includes:
i. Warehouse security, such as fences, alarms, and guards.
ii. Depositing cash daily in the bank.
iii. Using a safe or night deposit box for cash.
iv. Locking cash drawers and safes in the cash receipts department.Information is also an important asset at risk. Access control over information involves restricting access to documents that control physical assets including source documents, journals, and ledgers. An individual with unrestricted access to records can effectively manipulate the physical assets of the firm. The following examples of access risks in the revenue cycle:
1. An individual with access to the AR subsidiary ledger could remove his or her account (or someone else’s) from the books. With
no record of the account, the firm would not send the customer monthly statements.
2. Access to sales order documents may permit an unauthorized individual totrigger the shipment of a product.
3. An individual with access to both cash and the general ledger cash accountcould remove cash from the firm and adjust the cash account to cover the act.
6) Independent Verification
The objective of independent verification is to verify the accuracy and completeness of tasks that other functions in the process perform. To be effective, independent verifications must occur at key points in the process where errors can be detected quickly and corrected.Independent verification controls in the revenue cycle exist at the following points:
1. The shipping function verifies that the goods sent from the warehouse arecorrect in type and quantity. Before the goods are sent to the customer, thestock release document and the packing slip are reconciled.
2. The billing function reconciles the original sales order with the shipping noticeto ensure that customers are billed for only the quantities shipped.
3. Prior to posting to control accounts, the general ledger function reconciles journal vouchers and summary reports prepared independently in differentfunction areas. The billing function summarizes the sales journal, inventorycontrol summarizes changes in the inventory subsidiary ledger, the cashreceipts function summarizes the cash receipts journal, and accounts receivablesummarizes the AR subsidiary ledger.Discrepancies between the numbers supplied by these various sources willsignal errors that need to be resolved before posting to the general ledger can take place. For example, the general ledger function would detect a sales transaction
that had been entered in the sales journal but not posted to the customer’s account
in the AR subsidiary ledger. The journal voucher from billing, summarizing total credit sales, would not equal the total increases posted to the AR subsidiaryledger. The specific customer account causing the out-of-balance condition wouldnot be determinable at this point, but the error would be noted.