Question

7.a) Describe the six principles of internal controls that is highlighted in our textbook.  Provide at least one example for each of the six principles.  If a principle has more than one meaning, include all meanings described in our book.

7b) Which of the principle(s) of internal control apply to most businesses?

7c) Explain the difference between segregation of duties principle and establishment of responsibility principle. Provide examples of each principle that would help in our understanding of the difference between these two principles. Examples should differ from your 7a) examples provided above.

Answer 1

Answer :

7 a) : Six principles of internal controls :

1. Establishment of Responsibility :

An essential characteristic of internal control is the assignment of responsibility to specific individuals. Control is most effective when only one person is responsible for a given task. Establishing responsibility includes the authorization and approval of transactions.

2.Segregation of Duties :

Segregation of duties is indispensable in a system of internal control. The rationale for segregation of duties is that the work of one employee should, without a duplication of effort, provide a reliable basis for evaluating the work of another employee. There are two common applications of this principle:

Try to recall a trip to the bank. Does the teller receiving the money for deposit take the money to bookkeeping and record the deposit? Why not?

• The responsibility for related activities should be assigned to different individuals.
• The responsibility for record keeping for an asset should be separate from the physical custody of the asset.

Related Activities:

• When one individual is responsible for all of the related activities, the potential for errors and irregularities is increased.
• Related purchasing activities should be assigned to different individuals. Related purchasing activities include ordering merchandise, receiving goods, and paying (or authorizing payment) for merchandise.
• Related sales activities also should be assigned to different individuals. Related sales activities include making a sale, shipping (or delivering) the goods to the customer, and billing the customer.

Record Keeping Separate from Physical Custody :

• The custodian of the asset is not likely to convert the assets to personal use if one employee maintains the record of the assets that should be on hand and a different employee has physical custody of the assets.

When a cashier at the grocery store ends a shift, does the cashier walk out and let someone else work out of the same cash drawer? What is the usual procedure?

3 .Documentation Procedures ;

• Documents provide evidence that transactions and events have occurred.
• Documents should be prenumbered and all documents should be accounted for.
• Source documents for accounting entries should be promptly forwarded to the accounting department to help ensure timely recording of the transaction and event.

Why are checks and invoices sequentially numbered? What happens to voided checks?

4 .Physical, Mechanical, and Electronic Controls :

Physical controls relate primarily to the safeguarding of assets. Mechanical and electronic controls safeguard assets and enhance the accuracy and reliability of the accounting records. Use of physical, mechanical, and electronic controls is essential. Examples of these controls include:

• Safes, vaults, and safety deposit boxes for cash and business papers.
• Locked warehouses and storage cabinets for inventory and records.
• Computer facilities with pass key access or fingerprint or eyeball scans.
• Alarms to prevent break-ins.
• Television monitors and garment sensors to deter theft.
• Time clocks for recording time worked.

Why do you receive a cash register receipt at a fast food restaurant, a grocery store, or a department store? Why do some stores post signs that say “If you do not receive a receipt, we will pay you $5”? What should a movie theater do with its Saturday night receipts?

5. Independent Internal Verification :

• Independent internal verification involves the review, comparison, and reconciliation of data prepared by employees.
• Verification should be made periodically or on a surprise basis.
• Verification should be done by an employee independent of the personnel responsible for the information.
• Discrepancies and exceptions should be reported to a management level that can take appropriate corrective action.
• In large companies, independent internal verification is often assigned to internal auditors.
  • Internal auditors are employees of the company who evaluate on a continuous basis the effectiveness of the company’s system of internal control.
  • They periodically review the activities of departments and individuals to determine whether prescribed internal controls are being followed.

Would the cashier count the money in the cash drawer at the end of the workday? Would the person writing the checks prepare the bank reconciliation? Why or why not?

6. Human Resource/Other Controls :

• Bonding of employees who handle cash.
• Rotating employees' duties and requiring employees to take vacations.

Insurance companies bond employees of other companies who handle cash. Bonding employees is much like having an insurance policy that will reimburse the company if an employee steals money.

7b) Which of the principle(s) of internal control apply to most businesses?

Answer : The principles of internal control are the concepts that require management to set procedures in place to ensure company assets are safeguarded. In other words, these are the principles management uses to establish the ways to protect company assets.

Segregation of duties is one of the most recognizable and common controls in most organizations, so we will look at that one. It’s a good control to make sure that the recording and record keeping functions are separate from the actual handling of cash. This is why the cashier is in charge of collecting cash from customers and possibility delivering it to the bank deposit box. The bookkeeper or the accounting department is in charge of recording the cash receipts and doing the bank reconciliations.

This way one single person can’t take the money from the customer, embezzle it, and cover up the thief with fraudulent bookkeeping. If two people perform these jobs, the only way fraud will be able to work is if each person is in collusion with the other. Obviously, two colluding employees are far less likely than a single employee stealing.

This is just one example of how the segregation of duties principle can be applied to a company’s internal controls procedures.

7 c) difference between segregation of duties principle and establishment of responsibility principle.

Answer:

Segregation of employee duties Segregation of duties requires that someone other than the employee responsible for safeguarding an asset must maintain the accounting records for that asset. Also, employees share responsibility for related transactions so that one employee’s work serves as a check on the work of other employees.

When a company segregates the duties of employees, it minimizes the probability of an employee being able to steal assets and cover up the theft. For example, an employee could not steal cash from a company and have the theft go undetected unless someone changes the cash records to cover the shortage. To change the records, the employee stealing the cash must also maintain the cash records or be in collusion with the employee who maintains the cash records.

Assignment of specific duties to each employee When the responsibility for a particular work function is assigned to one employee, that employee is accountable for specific tasks. Should a problem occur, the company can quickly identify the responsible employee.

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

The following internal control principles explained earlier apply to cash receipts transactions as shown:

• Establishment of responsibility - Only designated personnel (cashiers) are authorized to handle cash receipts.
• Segregation of duties - Different individuals receive cash, record cash receipts, and hold the cash.

The principles of internal control apply to cash disbursements as follows:

• Establishment of responsibility - Only designated personnel (treasurer) are authorized to sign checks.
• Segregation of duties - Different individuals approve and make payments; check signers do not record disbursements.