UNIT 5: ACCOUNTING SYSTEMS

5.0 AIMS & OBJECTIVES

After completing this unit, you should be able to:

- understand principles of accounting information systems
- list out the components of accounting information systems
- explain the purpose and use of special journals and subsidiary ledgers
- explain the impacts technology on accounting information systems.

5.1 INTRODUCTION

This unit introduces you to the components and principles of accounting systems.
A system is a way of doing something. There are various ways of doing things.

Let’s say you decided to go home when you go out of your office. There are many ways to do
that: You can either take a taxi or you can walk the whole distance home; you can take the
main road, or you may wish to use a short cut and so forth.

In accounting also, it is true that almost all business record, process and report business
transactions. However, the speed and efficiency of the processing depends on which
accounting system they use.

5.2 COMPONENTS OF AN ACCOUNTING SYSTEM

There are five basic elements of an accounting system. These are:

5.2.1 Source Documents
Source documents provide the basic information to be processed by the accounting system.
Invoices from suppliers, bills sent to customers, and payroll records are some examples of
source documents. You have already seen their meaning and importance in previous chapter.

5.2.2 Input Devices

Input devices capture information from source documents and enable its transfer to the
information-processing component of the system. Journal entries, both paper based and
electronic are a type of input devices.

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5.2.3 Information Processors
An information processor is a system that interprets, transforms and summarizes information
for use in analysis and reporting. The information processing in an accounting system can be
manual or computerized.

Now a days, computer are being increasingly used to process information.

Many businesses in Ethiopia, for example, use the Peachtree accounting software to process
accounting information.

5.2.4 Information Storage

After being input, processed data are usually saved for use in future analysis or report.
Information storage is the component of an accounting system that keeps data in a form
accessible to information processors.

5.2.5 Output Device

Output devices are the means to take information out of an accounting system and make it
available to users. Output devices include printers, and monitors, which provide such outputs
as financial statements, bills to customers and internal reports.

5.3 FUNDAMENTAL PRINCIPLES OF ACCOUNTIG SYSTEMS

5.3.1 Control Principle

Any accounting information system should allow managers to control and monitor business
activities. To achieve this, accounting system must have internal control as an element.
Internal controls are methods and procedures that direct operations to one goal, ensure
reliability of financial reports and safeguard business assets. Internal controls are discussed
separately and at a greater detail in the next chapter.

5.3.2 Relevance Principle

The information that an accounting system provides should be relevant to decision makers.
This means, an information system should be designed to capture data that make difference in
decision. To ensure this, it is important that all decision makers, be considered when
identifying relevant information for disclosure.

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5.3.3 Compatibility Principle
The compatibility principle requires that an accounting system conform to the company’s
activities, personnel and structure. The system must also be customized to the unique
characteristics of the company.

All in all, accounting systems must be consistent with the aims of the company, i.e., they
should work in harmony with company goals.

5.3.4 Flexibility Principle

Accounting information systems must be flexible to adjust to changes in the company, in the
business environment and needs of decision makers. These changes can be technological
developments, consumer tastes or company activities.
A system must be designed to adapt to these and other changes.

5.3.5 Cost-Benefit-Principle
You wouldn’t do anything in your daily life with out first weighing the costs and the benefits.
Likewise, the benefits of performing an activity in an accounting system should be greater
than its costs.

For example, when you decided whether or not to report certain information, you have to
compare the benefits (its usefulness to decision making) and the costs (of computing,
personnel and other indirect costs).

5.4 SPECIAL JOURNALS AND SUBSIDIARY LEDGERS

5.4.1 Subsidiary Ledgers

When a business has so many customers and suppliers, a control account for Accounts
Receivable and a control account for Accounts Payable are established in the general ledger.
But in addition to these, subsidiary ledger for receivables and payables may be added to the
accounting system to show the balances for each individual customer and supplier separately.

A control account is an account in the general ledger that shows the total balances of all the
subsidiary accounts related to it.

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Subsidiary ledger accounts show the details supporting the related general ledger control
account balance. For example, the subsidiary (supporting) accounts for accounts Receivable
may be used to send out to each customer statements showing the balance they owe the
company.

A subsidiary ledger is therefore, a group of related accounts showing the details of the
balance of general ledger accounts.

Subsidiary ledgers are used to relieve the general ledger of a mass of detail. Thereby, the
general ledger trial balance is shortened. What’s more, having separate ledgers promotes the
division of labor as one employee can handle the control account while its subsidiary can be
assigned to another employee.

The relationship between a control account in the general ledger and its subsidiary accounts
can be illustrated as follows in T- account form.

Control account in the Subsidiary accounts in the

General Ledger Accounts Receivable subsidiary
Ledger
Accounts Receivable Customer A Customer B
2001 2001 2001
Dec. 31 Dec. 31 Dec. 31
Bal. 10,000 Bal. 1,000 Bal. 4,000

Customer C Customer D

2001 2001
Dec. 31 Dec. 31
Bal. 2,000 Bal 3,000

As you can see the sum of all balances in the subsidiary accounts (1,000 + 2,000 + 4,000 +
3,000) on December 31, 2001 is equal to the balance in the control account (10,000).

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When a transaction is recorded as a journal entry, it must indicate which of the subsidiary
ledger accounts is affected. Posting will be made to both the control account and the
subsidiary ledger account.

Example
A Br. 450 sale was made on account to Gome Balcha on January 2, 20X2. The journal entry
would be:
Jan. 2 Accounts Receivable-Gome 450
Sales 450

The Br. 450 would be posted as a debit to both the Account Receivable control account in the
general ledger and G.Balcha’s account in the subsidiary ledger. The credit would, of course,
be to the Sales account in the general ledger.

The following can be a summary of what’s discussed above:

General ledger
Control Account Subsidiary ledger
Accounts Receivable Accounts Receivable subsidiary
Ledger (account for each customer)
Accounts Payable Accounts Payable subsidiary
Ledger (account for each supplier)
Office Equipment, Equipment subsidiary ledger
Delivery Equipment, (Account for each item of
Office Furniture equipment).

5.4.2 Special Journals

A general journal is an all-purpose journal where we can record any transaction. However, as
the transactions of a company increase, it is better to use special journals along with the
general journal to record transactions of similar type in one, such as sales on account or cash
payments. Special journals record transactions of a similar nature.

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Special journals are designed to systematize the original recording of major transactions,
which occur very repeatedly.

The number and format of special journals used by a company depends on the nature and size
of the company’s business transactions.

The following are some of the typical examples of special journals used by most
merchandising businesses.

1. Sales Journals 2. Cash Receipt journal

for recording credit sales. for recording cash receipts.

3. Purchase journal
4. Cash payment journal
for recording credit
for recording cash
purchases.
payments

5. General journal
for transactions not
recorded in any of the
special journal

5.4.2.1 advantages of using special journals

A- Time is saved in journalizing. The amount of writing is reduced because it is not
necessary to repeat the account titles printed already at the top of the special columns
for every debit and credit.

B- Time is saved in posting- many amounts are posted as column totals rather than
individually.

C- Detail is eliminated from the general ledger column. Totals are posted to the ledger
means that detail is left in the special journals.

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 D- Division of labor is promoted. Several persons can work simultaneously on the
accounting records. This allows management to fix responsibility and quickly locate
errors.

E- Management analysis is aided. The special journal can be useful to management in

analyzing classes of transactions, such as sales, because similar transactions are in one
place.

5.4.2.2 Sales Journal

The sales journal is used to record sales of merchandise on credit; sales on cash are recorded
in a cash receipts journal. Sales of assets other than merchandise on credit are recorded in the
general journal.
Each transaction recorded in the sales journal has a debit to Accounts Receivable and a credit
to Sales. Therefore, only one column is needed for these two accounts. The posting reference
(P/R) column is not used when transactions are recorded; instead this column is used when
posting.
Posting
Sales journal entries are posted as shown with the arrow line in the illustration. Individual
transactions in the sales journal are posted regularly (daily) to subsidiary customer accounts in
the accounts receivable subsidiary ledger. These postings keep customer accounts up to date.
The sales journals amount column is totaled at the end of the period. The total is debited to
accounts Receivable and credited to sales.

The other special journals are illustrated below. Their operation is almost similar to the sales
journal.

5. 5 COMPUTER TECHNOLOGY AND ACCOUNTING SYSTEMS

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Computer technology can be divided into two broad categories: hardware and software.

Computer hardware-is
hardware-is the physical equipment in a computerized accounting information
system. The physical equipment includes processing units, hard drives, modems, monitors,
printers, etc.

Computer software-
software- is the program that directs the operation of computer hardware.
Peachtree and Sun system are some example of accounting software that help to process
information.

Computer technology reduces the time and effort devoted to record keeping tasks.
Accountants can now concentrate on analysis and managerial type decisions and work with
less effort directed at record keeping tasks.

One added advantage of a computerized accounting system (as opposed to a paper-based

manual system) is that various computers in an organization can be networked. Networking
means linking or connecting computers with each other to give different users and different
computers access to a common database and programs.

5.6 SUMMARY

Although accounting systems vary from business to business the broad principles discussed in
this unit apply to all systems.

These principles are the control, relevance, compatibility, flexibility and cost -benefit
principle.

5.9 GLOSSARY

General ledger -the principal ledger that contains all the balance sheet and income statement
accounts.

Controlling Account-
Account- a summarizing account in the general ledger, which represents a
summary of subsidiary accounts.

Subsidiary ledger - a group of accounts, which contain detail regarding a controlling,

account.

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Purchaser journal - a special journal for recording purchase of merchandise or other items
on account.

Cash payment journal-

journal- a special journal for recording payments of cash for any purpose.

Sales journal - a special journal for recording sale of merchandise on account.

Cash Receipts journal-

journal- a special journal for recording receipt of cash from any source.

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UNIT 6. INTERNAL CONTROL
Content
6.0 Aims & Objectives
6.1 Introduction
6.2 The Purpose of Internal Control
6.3 Components of Internal Control
6.3.1 The Control Environment
6.3.2 The Accounting System
6.3.3 Control Procedures
6.3.3.1 Requiring Authorization
6.3.3.2 Establishing Responsibility
6.3.3.3 Maintaining Adequate Records
6.3.3.4 Insuring Assets and Bonding Key Employees
6.3.3.5 Separating Record Keeping From Custody of Assets
6.3.3.6 Dividing Responsibility for Related Tasks (transactions)

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 6.3.3.7 Rotating Duties
6.3.3.8 Applying Technical Controls
6.3.3.9 Performing Regular and Independent Reviews
6.4 Technology and Internal Control
6.5 Limitations of Internal Control
6.6 Summary
6.7 Answer to Check Your Progress Exercise
6.8 Model Examination Questions
6.9 Glossary

6.0 AIMS & OBJECTIVES

After you have read this unit, you should be able to:
- explain the purpose of internal control
- identify components of internal control
- describe how technology impacts internal control and,
- list out the limitations of internal control
6.1 INTRODUCTION

A company’s internal control structure consists of the policies and procedures established to
insure that the company’s goals will be achieved.

As a company grows in size, it becomes difficult to maintain control over all phases of
operation. Therefore, management needs to delegate authority and rely on the control
structure in order to achieve adherence to enterprise goals.

6.2 THE PURPOSE OF INTERNAL CONTROL

Managers use an internal control system to monitor and control business operations. An
internal control system is all the policies and procedures managers use to:
 Protect business assets from theft and misuse. For example, what can be done to
protect cash from theft and misuse?
 Ensure reliability of accounting records. That is, how reliable and accurate are our
records and reports regarding Accounts Receivable, for instance.

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  Promote efficiency of operation. Efficiency means achieving organizational goals by
using as minimum resources as possible.
 And make employees adhere to company policy.

6.3 COMPONENTS OF INTERNAL CONTROL

The internal control structure can be divided in to three elements?

6.3.1 The Control Environment

The control environment of an organization represents the overall attitude and awareness of
both management and employees about the importance of controls.

The control environment is influenced by such factors as management’s philosophy &

operating style, the organizational structure of the business and personnel policies.

6.3.2 The Accounting System

The accounting system consists of the methods and records established by management to
identify, record, process and report a company’s transactions, and to provide assurance that
the objectives of internal control are being met.

6.3.3 Control Procedures

Internal control procedures vary from company to company. They depend on the nature of the
business and of its size.

The following are common procedures that you find in the internal control of many
organizations.

6.3.3.1 Requiring Authorization

Management should properly authorize all transactions and activities before they take place.

For example, selling on credit requires management’s approval.

6.3.3.2 Establishing Responsibility

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Proper internal control requires responsibility for each task to be clearly established and
assigned to one person. Otherwise, if responsibility is not identified, it is difficult to say who
is at fault (responsible) when a problem occurs.

For example, if we allow two sales clerks to share access to (use) the same cash register, it
would be difficult to take which sales clerk accountable when and if there is a cash shortage.

6.3.3.3 Maintaining Adequate Records

Reliable records are a source of information that management uses to monitor company
operations. For example, when detailed records of office equipment are kept, items are
unlikely to be lost or stolen with out the discrepancy being noticed.

6.3.3.4 Insuring Assets and Bonding Key Employees

Good internal control dictates that assets be adequately insured against causality. In addition,
employees handling cash should be bonded. Bonding an employee means buying an insurance
policy against losses from theft by that employee.

6.3.3.5 Separating Record Keeping From Custody of Assets

A person who controls or has access to an asset must not keep that asset’s accounting records.
This prevents the loss of the asset from theft because the person who has control over the
asset knows that another person keeps records of the asset. The record keeper doesn’t have
access to the asset and therefore, has no reason to falsify records.

For a fraud to be committed in such a system, the two people must agree (-this is called
collusion). Collusion is usually less likely to occur.

6.3.3.6 Dividing Responsibility for Related Tasks (transactions)

In order to ensure that the work of one employee serves as a check on another, responsibility
for a series of related transactions should be divided between two or more individuals (or
employees) or departments.

This is usually referred to as segregation of duties.

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For example, no one individual should be authorized to order merchandise, to receive
merchandise, and to pay the supplier. If one employee is allowed to do these all by herself
(alone), she can place orders with a supplier on the basis of friendship rather than price and
quality; convert goods to her personal use; pay false invoices; and so forth.

6.3.3.7 Rotating Duties

It is advisable to rotate clerical personnel periodically from job to job. This would help them
broaden their understanding of the system. In addition and more importantly, they know that
others would in the future perform their jobs (when rotated). This discourages them to deviate
from prescribed procedures because they fear that the employee who takes up their job will
discover it.

6.3.3.8 Applying Technical Controls

Cash register, check protectors, time clocks, mechanical counters, and personal identification
scanners are examples of control devices that can improve internal control.

A cash register has a locked in tape or electronic file, which makes record of each cash sale.

A check protector perforates the amount written on a check in to its face and makes it difficult
to change the amount.

A time clock registers the exact time an employee arrives and leaves from the job.

Mechanical change and currency counters quickly and accurately count amounts.

Personal scanners limit access to some places only to authorized individuals.

6.3.3.9 Performing Regular and Independent Reviews

Regular reviews of internal control systems are needed to ensure that procedure are followed.
Internal auditors who are not directly involved in the operations of the business usually
perform these reviews. This encourages an evaluation on the efficiency and effectiveness of
the internal control system.

Check Your Progress Exercise -1

1. Give one set of related tasks as an example, that you think is desirable to divide and to
rotate employees.

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…………………………………………………………………………………………………
…………………………………………………………………………………………………
…………………………………………………………………………………………………

6. 4 TECHNOLOGY AND INTERNAL CONTROL

Technology impacts an internal control system in many important ways. Some of these are:

 Technologically advanced systems allow saving time in processing information.

 They allow a regular review and more extensive testing of records as information can
be easily and rapidly accessed.
 Technologically advanced systems reduce the number of errors in processing
information provided the software and data entry are correct.
 They are so efficient these days that they require fewer employees. This makes
separation of crucial responsibilities difficult. The duties of these employees,
therefore, must be monitored to minimize the risk of error or fraud.

6.5 LIMITATIONS OF INTERNAL CONTROL

No internal control system is perfect. The most serious limiting factors are human error and
human fraud.

Human error can occur from negligence, fatigue or confusion. Human fraud involves a
deliberate act by employees to defeat internal controls for personal gains.

Another important limiting factor of an internal control system is the cost-benefit

consideration. This means that the cost of an internal control system must not exceed its
benefits.

We can’t employ an internal control system simply because it is good. We have to weigh its
costs against its benefits.
For instance, not all companies need to computerize their accounting system if the cost of
automating the system is greater than the benefits.

Check Your Progress Exercise -2

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1. Can collusion be taken (seen) as a limitation of internal controls? Explain.
…………………………………………………………………………………………………
…………………………………………………………………………………………………
…………………………………………………………………………………………………

6.6 SUMMARY

Internal control consists of the control environment,

environment, the accounting system and control
procedures that work in line with the company’s policy to:
 Protect assets from fraud and misuse
 Ensure completeness and reliability of financial statements
 Ensure efficiency of operations and
 Ascertain every employee adheres to the company’s policies

6.7 ANSWER TO CHECK YOUR PROGRESS EXERCISES

Check Your Progress Exercise - 1
One employee shouldn’t be allowed to issue goods, to collect cash and keep the records when
merchandise is sold in a merchandising company.
Check Your Progress Exercise - 2
Yes, in every internal control the system works only if two employees do not agree (collude)
to break the system. Therefore, every system has the inherent limitations of collusion.

6.8 MODEL EXAMINATION QUESTIONS

1. Write brief answers for the following questions.

a. What are the main objectives of internal controls and how are these objectives
achieved?
b. Why should record keeping for assets be separated from custody over the assets?

2. Musina is a government owned public enterprise that is growing rapidly. The

organization’s bookkeeper left town suddenly after the manager discovered that a large
sum of money has disappeared over the past 18 months. An audit showed that the
bookkeeper has written and signed several checks in the name of his fiancé and then

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 recorded the payments as salary expense. His fiancé, who cashed the checks but never
worked for Musina, also left town with the bookkeeper.

Evaluate Musina’s internal control system. Which principles (procedures) of internal

control seem to have been ignored?

6.9 GLOSSARY OF TERMS

Collusion - agreement between two or more employees to commit fraud.

Segregation of duties - assigning responsibility of related tasks to various employees.

Control procedures-
procedures- the various ways through which an organization tries to protect fraud
and achieve other internal control objectives.

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