In: Accounting
Question 1:
Identify and explain three of the limitations that can affect the effectiveness of a company's internal control.
Question 2:
Which internal control principle is especially difficult for small organizations to implement? Why?
Question 3:
Identify and explain two ways that companies can shorten their cash-to-cash cycle related to accounts receivable.
Question 4:
Describe two ratios that measure current liquidity, and compare the information they provide. Which measure is more likely to produce the lowest result for most companies? Why is this the case?
Question 1:
Following are the mail limitations that affect the effectiveness of company's internal control:-
a) Collusion among employees - Two or more people of different levels of organisation can come together to fail the effective internal control system. Two or more people who are intended by a system of control to keep watch over each other could instead collude to circumvent the system.
b) Human Error - A person involved in a control system could simply make a mistake, perhaps forgetting to use a control step. Or, the person does not understand how a control system is to be used, or does not understand the instructions associated with the system.
c) Management override of controls - Someone on the management team who has the authority to do so could override any aspect of a control system for his personal advantage.
Question 2:
In a very small organisation, it is really very difficult to implement the internal control of "Segregation/Seperation of duties".
This is because in a small organisation, they do not have enough employees for different processes. Generally in a small organisation, there are only 1-2 person who is having all the righs and authorities.
Only one person is responsible to authorise the transaction, record the transaction and be custodian for the same.
So, seperation of duties is very difficult to implement in the small organisation.
Question 3:
Cash is a critical resource for small businesses and their owners. An unprofitable company can quickly run out of cash and cease operations. Profitable companies can also run out of cash due to the levels of working capital and reinvestment required. One way to ensure that a company has sufficient cash on hand to pay its bills is to shorten its cash cycle.
Following are the two ways company can shorten their cash to cash cycle related to accounts receivable,
a) Companies can shorten this cycle by requesting upfront payments or deposits and by billing as soon as information comes in from sales.
b) Businesses can also shorten cash cycles by keeping credit terms for customers at 30 or fewer days and actively following up with customers to ensure timely payments.
Question 4:
Two ratios that measure the current liability are:-
a) Current Ratio
The current ratio divides total current assets by total current liabilities. It is the ratio of liquidity. It shows whether company will be able to pay off their current debts and liabilities versus their current assets or receivables. This ratio provides the most basic analysis regarding the coverage level of current debts by current assets.
b) Quick Ratio
The quick ratio expands on the current ratio by only including cash, marketable securities and accounts receivable in the numerator. The quick ratio reflects the potential difficulty in selling inventory or prepaid assets in the result of an emergency.
Liquidity ratios are most useful when they are used in comparative form. This analysis may be internal or external. For example, internal analysis regarding liquidity ratios involves using multiple accounting periods that are reported using the same accounting methods. Comparing previous time periods to current operations allows analysts to track changes in the business. In general, a higher liquidity ratio shows a company is more liquid and has better coverage of outstanding debts.