Question

Explain how each of the following actions strengthens a company’s system of internal control:

a. Separate work functions

b. Hire competent personnel

c. Develop plans and budgets

d. Use control numbers on all business documents

Answer 1

a.

Separate work funtions

Separate work funtions requires that someone other than the person responsible for safety of an asset must maintain the accounts records for the asset. This particular requirement make the companys internal control system much more rigid and stringent.

When a company separates the work of employees, it reduces the posibility of a worker being able to run away with the assets without someone else getting to know what happened. An employee could not steal cash from a company and have the theft go unnoticed unless someone tampers with cash records to cover the shortcomings.

When the responsibilities for some work function is assigned to an employee, that employee is accountable for specific tasks. Should a problem occur, the company can quickly identify the responsible personnel.

When a company gives each employee specific duties, it can trace lost documents or determine how a particular transaction was recorded. Also, the employee responsible for a given task can provide information about that task. Being responsible for specific duties gives people a sense of pride and importance that usually makes them want to perform to the best of their ability.

Adverse effects of not using separate work functions :

Employees are your most important assets and as a small business you are very reliant on your employees. They are representatives with customers, suppliers, and competitors. For this valuable resource to be effective in your business you will need to provide clear direction and define appropriate roles and responsibilities for each employee. Job roles and responsibilities should be clear and preferably be in writing. This will ease the process of separating duties discussed in the next section. New employees will quickly be able to reference back to their responsibilities and understand their roles better.

Small businesses are susceptible to fraud by their own employees as small businesses may have a few employees with multiple roles. Each employee should have specific job responsibilities, preferably in writing to ensure there is no confusion in assigned job roles and responsibilities. Generally, assigning different people the responsibilities of authorizing transactions, recording transactions, and maintaining custody of related assets such as cash and credit cards provides for more effective internal control and less opportunities for misappropriation of assets.

b.

Hiring competent personnel

Internal control policies are effective only when employees follow them. To ensure that they carry out its internal control policies, a company must hire competent employees. Thus, the execution of effective internal control begins with the time and effort a company expends in hiring employees. Once the company hires the employees, it must train those employees and clearly communicate to them company policies, such as obtaining proper authorization before making a cash disbursement. Frequently, written job descriptions establish the responsibilities and duties of employees. The initial training of employees should include a clear explanation of their duties and how to perform them.

c.

Developing plans and budgets:

When most people think of budgets, they think of a typical household budget – given a certain amount of money, how much should be allocated to various expenses? This system usually works fine for individuals, but in the business world there needs to be a lot more involved. Determining how much to spend on various expenses is only half the battle. The other half is for a company to be able to effectively judge its spending financial performance. Regardless of the type of business, the ability to gauge performance using budgets is a matter of life and death in the business world.

Small business owners many times get so involved in the day to day operations of the business that they tend to neglect performing basic review procedures. Business owners should take some time and interest in the financial records. This is an important aspect of fraud prevention. Not a lot of time is required to review monthly revenues, expenditure reports, inventory reports, budget vs. actual amounts, and variance reports. Having a more hands on approach will give the owner invaluable feedback on how the business is performing and where any potential problem areas or poor performance areas may exist. Review of the financial records is a critical component and input for better decision making. The frequency of the review of financial data depends on the volume of transactions and type of business, however, the review of financial data should generally be conducted on a monthly basis.  

d.

Use control numbers on all business documents:

Documentation provides evidence of the underlying transactions. It is the input to establishing proper financial records. Financial documents should be pre-numbered to ensure all transactions are recorded and accounted for. This will help to prevent recording of the same transaction twice, as there should not be any duplicate numbers in your system. With proper numbering of documentation, tracing documents that relate to follow up queries/claims and questions from customers or owners of prior transactions will be easy. Proper documentation would most probably provide satisfactory answers to most, if not all, financial transaction related questions. Furthermore, adequate documentation will ease the process of compiling financial records and completing tax returns.

Many times small businesses run on lean resources and very little time is often spent evaluating information systems. Investing time in this area could add a lot of efficiencies in the long run. List the systems in your business and the key performance measures you need from each. Working systematically though these will help you stay competitive and efficient. Many user-friendly software systems are out there which could shorten processing and operating cycles - and are not that expensive to operate.