UNIT 2.

ACCOUNTING SYSTEM AND CONTROL

Contents
2.0. Aims and Objectives
2.1. Introduction
2.2. Accounting System Designed
2.2.1. Principles of Accounting Systems
2.2.2. Accounting System Installation and Revision
2.2.3. Internal Control
2.2.4. Guidelines to Strong Internal Control
2.2.5. Special Journal and Subsidiary Ledger
2.3 Summary
2.4 Answers to Check Your Progress Exercises
2.5 Model Examination Questions
2.6 Reference Books

2.0 AIMS AND OBJECTIVES

The aim of this unit is to create understanding of how accounting system would be designed,
and the significance
significance of the system for internal control purpose. After studding of this unit, you
would be able to:

- describe the principles of properly designed accounting systems

- describe the three phases of accounting system installation and revision, and
- describe and Illustrate the principles of internal control.

2.1. INTRODUCTION

Accounting is often called the language of business. This language is an information system
that provides essential information. Accounting may be defined as system of recording,
classifying, sorting, summarizing and producing reports of significant nature in financial
terms. It is not only reporting but also interpretation of the results. Accounting system is a set
of records (journals, ledgers, worksheets, trial balances, and reports) plus the procedures and
equipment regularly used to process business transaction. Accounting system is used to

17
collect and process data from transactions and events, organize them in useful forms and
communicate results to decision makers.

2.2. ACCOUNTING SYSTEM DESIGNED

2.2.1. Principles of accounting systems: Because of difference in nature of businesses,

number of transactions to be processed, and in the uses made of accounting data, accounting
systems will vary from business to business . However, there are five fundamental principles
of accounting system.

a. Cost – Effectiveness (cost _ benefit) principle, an accounting system must be designed to

meet the specific needs of each business since costs must be incurred in meeting these needs.
The cost must balance benefits. The cost - benefit principle requires that the benefits from the
activity in accounting system to outweigh (greater than) the costs of that activity. The costs
and benefits of an activity. For example, although the reports produced by accounting system
are valuable to decision makes (Internal and external), The value (benefit) must be at least
equal to the cost of producing them such costs include cost of computing, personnel (salary)
and voucher costs.

b. Flexibility to Meet Future Needs. (Flexibility Principle): Accounting systems must be able to
adjust to meet future changes (needs). This principle requires that accounting system be able
to adapt changes in the company (change in accounting principles, organizational changes, to
meet competitive business) changes in data processing technology, new government
regulations, Consumer tastes. A system must be flexible to meet the above changes.

c. Internal control: Internal controls methods and procedures allow managers to control and
monitor business activities. They include policies to direct operations to wards common
goals; procedures to ensure reliable financial reports, safeguarding or protect company assets,
and methods to achieve compliance with laws, and regulations. Internal controls will be
discussed in detail in the next topics.

d. Relevance (Effective Reporting) Principle: Decision makers (internal and external) need
relevant information to make decisions. This principle requires that accounting system must
report useful, understandable, timely and pertinent information for effective decision making.

18
e. Adaptation to organizational structure (compatibility):
(compatibility): accounting systems must be
consistent with the aims of an organization. The systems must confirm with the organizational
structure of each business. The lines of authority and responsibility will affect the
information requirements of each business.

2.2.2. Accounting System Installation and Revision

Before designing and installing an accounting for an organization , the designer must have a
complete knowledge of the business operations. Since accounting systems consist of people,
records (forms), methods, and equipment, the designer should recognize the types, and design
of the forms (vouchers, journals, ledgers, etc) needed and the number and Titles (name) of the
accounts required. Since new information about a business is obtained as a business grows,
the accounting system will need to be revised to meet the expansion of the organization.

The Job of installing (implementing) and revision of an accounting system, is made by

following three phases; these are: (a) systems analysis (b) systems design (c) systems
implementation

a. System Analysis: This phase of installing the accounting system involves with determining
information needs (cash, Inventory, fixed assets, disbursements (expenses). In general, it
includes types of financial information need by the company), determining the sources of
such information (such as vouchers, invoices, register sheets, journals, ledgers etc.,) and the
deficiencies in the procedures and data processing methods currently used. Analysis usually
begins with a view (studying) of organizational structure and the job descriptions of the
employee affected. This is followed by a study of the forms, records, procedures, processing
methods, and reports used by the enterprise. The source of such information is usually found
in the enterprises’ systems manual (compiled reference book).

b. Systems Design: Accounting systems would change as the result of new investigations
obtained by the analysis. As the result, old accounting system may be modified such as
revision of a particular form e.g. (vouchers), and the related procedures and processing
methods; or the new system may be created by changing completely the old accounting
system. Such creation (designing) of part of the preexisted accounting is said to be a design

19
of new system. Once a designer has finished modification or complete changing of old
system by the new, the next task is implementing of the new system.
system

c. Systems Implementations: The final phase of the creation or revision of accounting system
is to carry out, or implement the created or revised accounting system. New or revised forms,
records, procedures, and equipment must be installed (Established). All personnel responsible
for operating the new system must be carefully trained and closely supervised until
satisfactory efficiency is achieved l e.g. For computerized accounting system; from single
entry accounting (such as government accounting) in to double entry accounting system etc.

Check Your Progress Exercise - 1

1. Describe five principles of proper accounting systems

a)…………………………………………………………………………….
a)…………………………………………………………………………….
b) …………………………………………………………………………….
c) …………………………………………………………………………….
d) …………………………………………………………………………….
e) …………………………………………………………………………….

2.2.3. Internal Control

Internal control is a system designed and installed by management for the purpose of
safeguarding assets of the organization and increasing productivity and efficiency so that the
organization will attain its objectives. Internal control policies and procedures vary from
company to company. They depend on the nature of the business and size. Internal control is
made by an entity’s board of directors, management, and other personnel, designed to provide
reasonable assurance regarding the achievement of the objectives of the organization. The
concept of reasonable assurance is very important. Because, no internal control system can
guarantee that all events and activities in an organization contribute to the achievement of its
objectives.

The idea of reasonable assurance arises from two ideas: cost –benefit and the inherent
weakness of the internal control.

20
Cost – benefit – this implies that the benefit should be greater than the cost (such as salary
cost, facility cost (safes, store room, printing of forms, etc.) Reasonable assurance means
that. Internal control is not perfect because only those costs that have greater benefits should
be installed. Inherent weakness means that in any internal control system, there is human
error (faults) and temptation.

Internal control is broadly classed into two: administrative controls and accounting controls.
Administrative control emphasis on control for management decisions, which focuses on
authority, and responsibility for authorization (approval) of information, it includes plans of
organization structural, and procedures and records related to decision process.

Accounting control emphasizes on reliability of financial records and safeguarding assets and
records for providing reasonable assurance ( not 100% assurance) on transactions and
financial information needed for appropriate action.

Some studies suggest that management typically, has the following six-objectives in setting
up good system of internal control.

1. To have reliability (accuracy) of accounting records

2. To safeguard assets and records
3. To increase profitability.
4. To prevent and detect (investigate) frauds and errors.
5. For timely preparation of reliable financial information
6. To comply with laws and regulations. Interview line control structure of an
enterprise, encompasses (1) the control environment which intern includes
management attitude concerning controls, organizational structural and personnel
policies (hiring, training, promotion and compensation policies); (2) the control
procedures which can be applied through out the accounting system for all
enterprise, and (3) accounting system. The last two components will be discussed
in the next topics.

21
2.2.4. Guidelines to Strong Internal Control

The following guide lines (elements) are control procedures (policies) which are used to
achieve enterprises goals, to promote effectives and efficiency.

a. Competent, and Trust Worth, Personnel with Clear Lines of Authority and Responsibility
The successful operation of an accounting system requires procedures to ensure that people
are able to perform the duties to which they are assigned. All accounting employees must be
adequately trained and supervised to perform their jobs. The responsibility of each employee
must be assigned and clearly defined. There should not be overlapping or undefined areas of
responsibility.

b. Separation of Responsibilities (duties) in the Accounting System

No individual should be authorized to order merchandise, verify the receipts of the
merchandise and pay the suppliers. If separations of duties do not exist, the following abuses
(frauds) will be occurred.

(a) Placing orders with suppliers on the basis of friendship rather than on price,
quality and other objective factors.
(b) Indifferent and routine verification of the quantity and the quality of goods
received.
(c) Conversion of goods to the personnel use of the employee.
(d) Carelessness in verifying the validity and accuracy of invoices.
(e) Payment of invoices

When the responsibility for purchasing, receiving and paying are divided among three
persons, or departments, the possibilities of the above abuses are minimized.

c. Separation of Operations and Accounting Control Procedures (Policies ):

It should exist to ensure that the responsibility for maintaining the accounting records are
separated from the responsibility for engaging in business transactions and for the custody of
assets, for example, the employee entrusted with (assigned) to handle cash receipts from
credit customers should not have access to the journal or ledger. Separation of two functions
reduces the possibilities of the possibilities of error and embezzlement (theft).

22
d. Physical Control Over Assets and Records
The security measures should be used to safeguard business assets and assure reliable
accounting data. Different techniques, include use of Bank account, cash register (machine),
Insurance, locked warehouse, fencing of a company, locked cabinets for accounting records.

e. Independent Review (Verification): to determine whether internal control procedures

(policies), which are discussed above, are being effectively applied, these procedures should
be periodically reviewed (verified) and evaluate by internal auditors. These auditors must be
independent of the employees responsible for operations. Internal auditors should report any
weakness and recommend changes to correct them.

f. Accounting System: is a Part of Internal Control of an Enterprise- without information of

provided by an accounting system, management would lack ability to plan and direct
operations (make decisions) in acheiving enterprise goals. The principles of accounting
system which are discussed in earlier lesson should be applied for effective accounting
system.

Check Your Progress Exercise - 2

1. Describe, in short, main principles of effective (strong) internal control.
a) …………………………………………………………………………….
b) …………………………………………………………………………….
c) …………………………………………………………………………….
d) …………………………………………………………………………….
e) …………………………………………………………………………….

2.2.5. Special Journals and Subsidiary Ledger

Basic accounting system is the manual system with one journal, and general ledger. For Big
company’s, special journals and subsidiary ledgers are also part of accounting system. What
is the importance of special journals? Because, a general journal is an all-purpose journal, we
can record only transaction using a general journal means that each debit and each credit
entered must be individually posted to its respective ledger account. This requires time and
effort in posting individual debits and credits. Costs of posting accounts can be reduced by

23
organizing transactions into common groups and providing a separate special journal. Special
journal is used in recording and posting transactions of similar type. Most transactions of
merchandise for example, fall into four groups:- Sales on credit, purchases on credit, cash
receipts, and cash disbursements.

The use of special journals along with general journal is presented as follows:
Sales journal cash receipts journal purchases journal
For recording for recording cash for recording credit
credit sales receipts purchas

Cash Disbursement journal General journal

For recording cash payment for recording transaction not in
Special journal

The general journal continues to be used for transactions not covered by special journals and
for adjusting, closing and correcting entries.

Special journals are efficient tools in helping journalize (recording) and post transaction. It is
done by accumulating debits and credits of similar transactions, which allows us to post
amounts entered in the columns as column totals rather than as individual amounts.

Subsidiary ledger is a listing of individual accounts with a common characteristic. Subsidiary

ledger supports the general ledger with defiled information on specific accounts, with
removes unnecessary details from the general ledger. There are several subsidiary ledgers-
equipment, inventory, A/R, A/payable ledgers, etc. Two of the most important are amounts
due from customers, called accounts receivable, and amounts owed to creditors called
accounts payable. These two common subsidiaries are known as:

(1) Accounts Receivable ledger- which is used to record (store ) transactions data with
individual customer-

(2) Accounts payable ledger-, which is used to record (store) transactions data with
individual creditors.

24
Individual accounts in subsidiary ledger are arranged (recorded) alphabetically. One account
is used for each customer or creditor. Another name for a counts Receivable ledger is
customer's subsidiary ledger, and another name for accounts payable ledger is creditors
subsidiary ledger. Accounts Receivable account –is controlling account, which summarizes
all A/Receivable subsidiary Ledger accounts, and a counts payable account is a controlling
account which summarizes all accounts in a subsidiary ledger.

Check Your Progress Exercise - 3

1. Describe the importance of special journals and subsidiary ledgers.

…………………………………………………………………………….
…………………………………………………………………………….
…………………………………………………………………………….
………………………………………………………………

2.3 SUMMARY

Although accounting systems vary from business to business, the following broad principles
will apply to all systems: cost-effectiveness balances, Flexibility to meet future needs,
adequate internal controls, effective reporting, and Adaptation to organizational structure.

Accounting system installation and revision involves three parts: (1) Analysis of information
needs, (2) design of the new system, and (3) implementation of proposals.

The internal control structure of enterprise consists of the detailed policies and procedures
which guide reasonable assurance that an entities objectives will be achieved. The internal
control structure consists of three elements: (1) The control environment (2) the control
procedure, (3) the accounting system.

Depending upon the variety and the amount of data included in the database, various
processing methods –manual and computerized- may be used.

In manual methods, subsidiary hedgers and journals (special journals) may be used to
maintain separate records for each creditor and debtor. When subsidiary dredgers are used,
each subsidiary ledger is represented in the general ledger by summarizing account, called a

25
controlling account. The sum of the balances of the accounts in subsidiary ledger most agree
with the balances of the related controlling account.

2.4 ANSWERS TO CHECH YOUR PROGRESS QUESTIONS

Check Your Progress Exercise - 1

1. Cost-effectiveness
2. Flexibility to meet future needs
3. Must allow (help) manager to monitor and control business activity
4. Relevance
5. Compatibility

Check Your Progress Exercise - 2

1. Competent, trustworthy personnel with clear lines of authority and Responsibility.
2. Separation of duties in accounting system.
3. Separation of duties of operational and accounting procedures.
4. Physical control over assets.
5. Independent Renew (Verification)

Check Your Progress Exercise - 3

- Subsidiary ledgers may be used to maintain separate records for each creditor
and debtor.
- The special journals used to reduce the processing time and expenses of
recording a large number of transactions in a manual system.

2.5 MODEL EXAMINATION QUESTIONS

1. The final phase of the revision of accounting system that involves the installing (carry
out) of the designed system is termed as:

A) systems analysis B) systems design

C) systems implementation D) none of the above

2. The detailed procedures (guideline) used by management to direct, and co-ordinate

operations so that enterprise goals can be achieved are called:

26
 A) systems Analysis B) Internal controls
C) systems design D) systems implementation

3. Payment of cash for the purchase of merchandise would be recorded in the:

A) Purchase journal B) cash payments journal
C) Sales journal D) cash receipts journal

4. When there are large numbers of individual accounts with a common characteristic, It is
common to place (records) them in a separate ledger called:

A) Subsidiary ledger B) creditor’s ledger

C) Accounts payable ledger D) accounts receivable ledger
5. The controlling account in the general ledger that summarizes the debits and credits to the
individual customers accounts in the subsidiary ledger is called:

A) Accounts payable B) Accounts Receivable

C) Sales D) Purchases

1) Analysis, 2) design, and 3) Implementation

2.6 REFERENCE BOOKS

1. Principles of Auditing, Witington and Panny, 11th ed.

2. Fundamental Accounting principles, Fifth ed, Kermit D. Larson, John J. wild, Barbara
chiappetta, 1999
3. Accounting principles, Fess, Warren, 16th Ed.
4. Roger H. Flermansony James D. Edwards and R.F. Salmlnson, 1989 Accounting
Principles.

27