Fap I PPT 2014 Ch-4

CHAPTER FOUR
ACCOUNTING SYSTEMS AND

INTERNAL CONTROLS
Basic Accounting Systems
An accounting system is the methods and procedures
for collecting, classifying, summarizing, and reporting
a business’s financial and operating information.
Accounting systems evolve through a three-step
process as a business grows and changes.
1. Analysis
2. Designed
3. Implemented
Analysis
 which consists of;
 Identifying the needs of those who use the
business’s financial information and
 Determining how the system should provide this
information.
Designed
 A very basic manual system was designed. This system
included a chart of accounts, a two-column journal, and
a general ledger.
Implemented
 The system was used to record transactions and prepare
financial statements.
Internal Control
 Businesses use internal controls to guide their operations,
safeguard assets, and prevent abuses of their systems.
Objectives of Internal Control

 The objectives of internal control are to provide reasonable
assurance that:
1. Assets are safeguarded and used for business purposes.
2. Business information is accurate.
3. Employees comply with laws and regulations.
 Internal control can safeguard assets by preventing theft, fraud,
misuse, or misplacement.
 One of the most serious breaches of internal control is employee
fraud.
 Employee fraud is the intentional act of deceiving an employer
for personal gain
Elements of Internal Control
 How does management achieve its internal control
objectives?
Management is responsible for designing and applying five
elements of internal control to meet the three internal
control objectives. These elements are:
1. The control environment
2. Risk assessment
3. Control procedures
4. Monitoring
5. Information and communication
Control Environment
A business’s control environment is the overall attitude of
management and employees about the importance of controls.
One of the factors that influences the control environment is;
Management’s philosophy and operating style.
Organizational structure,
Personnel policies
Management’s philosophy and operating style; that
overemphasizes operating goals and deviates from control policies
may indirectly encourage employees to ignore controls. For
example, the pressure to achieve revenue targets may encourage
employees to fraudulently record sham sales.
Organizational structure; The business’s organizational structure,
which is the framework for planning and controlling operations,
also influences the control environment.
Personnel policies; involve the hiring, training, evaluation,
compensation, and promotion of employees. In addition, job
descriptions, employee codes of ethics, and conflict-of-interest
policies are part of the personnel policies.
Risk Assessment
All organizations face risks. Examples of risk include
changes in customer requirements, competitive threats,
regulatory changes, changes in economic factors such as
interest rates, and employee violations of company
policies and procedures.
Management should assess these risks and take necessary
actions to control them, so that the objectives of internal
control can be achieved.
Once risks are identified, they can be analyzed to estimate
their significance, to assess their likelihood of occurring,
and to determine actions that will minimize them.
Control Procedures
Control procedures are established to provide

reasonable assurance that business goals will be
achieved, including the prevention of fraud.
The following control procedures that can be integrated
throughout the accounting system are;
I. Competent Personnel, Rotating Duties, and
Mandatory Vacations
II. Separating Responsibilities for Related Operations
III.Separating Operations, Custody of Assets, and
Accounting
IV.Proofs and Security Measures
Monitoring
Monitoring the internal control system locates
weaknesses and improves control effectiveness.
The internal control system can be monitored through
either ongoing efforts by management or by separate
evaluations.
Ongoing monitoring efforts may include observing
both employee behavior and warning signs from the
accounting system
Information and Communication
Information and communication are essential elements of

internal control.
Information about the control environment, risk
assessment, control procedures, and monitoring are
needed by management to guide operations and ensure
compliance with reporting, legal, and regulatory
requirements.
Management can also use external information to assess
events and conditions that impact decision making and
external reporting.
Manual Accounting Systems
Accounting systems may be either manual or

computerized.
Since an understanding of manual accounting systems
assists managers in recognizing the relationships that
exist between accounting data and accounting report
Subsidiary Ledgers
A large number of individual accounts with a common
characteristic can be grouped together in a separate ledger called a
subsidiary ledger.
The primary ledger, which contains all of the balance sheet and
income statement accounts, is then called the general ledger.
Each subsidiary ledger is represented in the general ledger by a
summarizing account, called a controlling accounts
The individual accounts with customers are arranged in
alphabetical order in a subsidiary ledger called the accounts
receivable subsidiary ledger, or customers ledger.
The individual accounts with creditors are arranged in alphabetical
order in a subsidiary ledger called the accounts payable subsidiary
ledger, or creditors ledger.
Special Journals
 One method of processing data more efficiently in a

manual accounting system is to expand the all-purpose
two-column journal to a multicolumn journal.
 Special journals are a method of summarizing
transactions, which is a basic feature of any accounting
system.
 The next logical extension of the accounting system is to
replace the single multicolumn journal with several
special journals
 The all-purpose two-column journal, called the general
journal or simply the journal
Manual Accounting System: The Revenue
and Collection Cycle
The revenue and collection cycle consists of providing
services on account and collecting cash from
customers.
Revenues earned on account create a customer
receivable and will be recorded in a revenue journal.
Customers’ accounts receivable are collected and will
be recorded in a cash receipts journal.
Internal control is enhanced by separating the function
of recording revenue transactions in the revenue
journal from recording cash collections in the cash
receipts journal.
Revenue Journal
The revenue journal is used only for recording fees earned on
account.
Cash fees earned would be recorded in the cash receipts journal.
The sale of products is recorded in a sales journal, which is similar
to the revenue journal.
Revenue journal
Cash Receipts Journal
All transactions that involve the receipt of cash are recorded in a

cash receipts journal. Thus, the cash receipts journal has a column
entitled Cash Dr.,
Accounts Receivable Control and Subsidiary
Ledger
After all posting has been completed for the month, the
sum of the balances in the accounts receivable subsidiary
ledger should be compared with the balance of the
accounts receivable controlling account in the general
ledger.
If the controlling account and the subsidiary ledger do
not agree, the error or errors must be located and
corrected
Computerized Accounting Systems
Computerized accounting systems are similar to manual
accounting systems
The main advantages of a computerized accounting
system are
The simultaneous recording and posting of
transactions, to general and subsidiary ledger accounts.
The high degree of accuracy than manual systems and
The timeliness of reporting to provide management
current account balance information to support
decision making, since account balances are posted as
the transactions occur
An example of the revenue and collection cycle using
QuickBooks and Peachtree Accounting .
E-commerce
One survey has indicated that over 60% of businesses are
embracing e-commerce in some form.
Using the Internet to perform business transactions is
termed e-commerce.
When internet transactions are between a company and a
consumer, it is termed B2C e-commerce (business-to-
consumer)
When it is B2B e-commerce involves Internet transactions
between a business and another business (business-to-
business).
E-commerce can be used to improve the speed and
efficiency of the revenue/collection and purchase/
payment cycles.
More elaborate e-commerce applications involve planning
and coordinating suppliers, customers, and the product
design process
End of chapter four

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CHAPTER FOUR

ACCOUNTING SYSTEMS AND

Objectives of Internal Control

Control procedures are established to provide

Information and communication are essential elements of

Accounting systems may be either manual or

 One method of processing data more efficiently in a

All transactions that involve the receipt of cash are recorded in a

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