CHAPTER 4: The Revenue Cycle
The receive order activity forwards the stock release
Revenue Cycle- it is the direct exchange of finished goods or services for
cash in a single transaction between a seller and a buyer.
Overview…
Revenue Transaction into two phases:
(1) Physical Phase- involving the transfer of assets or services from the seller
to the buyer
(2) Financial Phase- involving the receipt of cash by the seller in payment of
the accounts receivable
Revenue Cycle consists of two major sub systems:
(1) the sales order processing subsystem
(2) the cash receipts subsystem
Two objectives of this chapter:
>The first is to illustrate system functionality, efficiency issues, and workflow
characteristics of different technologies.
>The second is to demonstrate how internal control issues differ between
systems at various points on the technology/human continuum.
“SALES ORDER PROCEDURE”
The tasks involved in receiving and processing a customer order, filling the
order and shipping products to the customer, billing the customer at the
proper time, and correctly accounting for the transaction.
RECEIVE ORDER. The sales process begins with the receipt of a
customer order indicating the type and quantity of merchandise desired.
SALES ORDER contains information such as the customer’s name,
address, and account number; the name, number, and description of the
items sold; and the quantities and unit prices of item.
CHECK CREDIT. Before processing the order further, the customer’s
creditworthiness needs to be established.
Credit Approval Process - it is an authorization control and should
be performed as a function separate from the sales activity.
PICK GOODS.
document (also called the picking ticket) to the pick goods function in the
warehouse.
Verified stock release- After picking the stock, the order is verified
for accuracy
Back-order record - a record which stays on file until the inventories
arrive from the supplier. Back-ordered items are shipped before new sales
are processed.
SHIP GOODS. Before the arrival of the goods and the verified stock release
document, the shipping department receives the packing slip and shipping
notice from the receive order function.
Bill of Lading – it is a formal contract between the seller and the shipping
company (carrier) to transport the goods to the customer.
BILL CUSTOMER. The shipment of goods marks the completion of the
economic event and the point at which the customer should be billed.
The billing function performs the following record-keeping tasks:
• Sends the stock release document to the update inventory records task.
• Forwards the ledger copy of the sales order to the update accounts
receivable task.
• Records the sale in the sales journal.
Sales Journal – it is a special journal used for recording completed sales
transactions. The details of sales invoices are entered in the journal
individually.
Journal Voucher – summarized entries
Accounts Receivable—Control XXXX.XX
Sales XXXX.XX
The journal voucher system eliminates the need for a formal general
journal, which is replaced by a journal voucher file.
UPDATE INVENTORY RECORDS. The inventory control function updates
inventory subsidiary ledger accounts from information contained in the
stock release document.
Cost of Goods Sold XXX.XX
Inventory—Control XXX.XX
UPDATE ACCOUNTS RECEIVABLE RECORDS. Customer records in the
accounts receivable (AR) subsidiary ledger are updated from information
provided by the sales order (ledger copy).
POST TO GENERAL LEDGER. By the close of the transaction processing
period, the general ledger function has received journal vouchers from the
billing and inventory control tasks and an account summary from the AR
function.
2 purposes:
1)The general ledger uses the journal vouchers to post to the following
control accounts
DR CR Accounts Receivable—Control XXXX.XX
Cost of Goods Sold XXX.XX
Inventory Control XXX.XX
Sales XXXX.XX
2) This information supports an important independent verification control.
“Sales Return Procedures”
An organization can expect that a certain percentage of its sales will be
returned. This occurs for a number of reasons, some of which are as follows:
• The company shipped the customer the wrong merchandise.
• The goods were defective.
• The product was damaged in shipment.
• The buyer refused delivery because the seller shipped the goods too late
or they were delayed in transit.
PREPARE RETURN SLIP. When items are returned, the receiving department
employee counts, inspects, and prepares a return slip describing the items.
PREPARE CREDIT MEMO. Upon receipt of the return slip, the sales
employee prepares a credit memo. This document is the authorization for
the customer to receive credit for the merchandise returned.
APPROVE CREDIT MEMO. The credit manager evaluates the circumstances
of the return and makes a judgment to grant (or disapprove) credit. The
manager then returns the approved credit memo to the sales department.
UPDATE SALES JOURNAL. Upon receipt of the approved credit memo, the
transaction is recorded in the sales journal as a contra entry.
UPDATE INVENTORY AND AR RECORDS. The inventory control function
adjusts the inventory records and forwards the credit memo to accounts
receivable, where the customer’s account is also adjusted.
UPDATE GENERAL LEDGER. Upon receipt of the journal voucher and
account summary information, the general ledger function reconciles the
figures and posts to the following control accounts:
Inventory-Control XXX.XX
Sales Returns and Allowances XXXX.XX
Cost of Goods Sold XXX.XX
Accounts Receivable—Control XXXX.XX
“Cash Receipts Procedures”
OPEN MAIL AND PREPARE REMITTANCE LIST. A mail room employee opens
envelopes containing customers’ payments and remittance advices.
Remittance advices-contain information needed to service individual
customers’ accounts. This includes payment date, account number, amount
paid, and customer check number.
Remittance list (or cash prelist)-a form where the clerk records each checks
RECORD AND DEPOSIT CHECKS . A cash receipts employee verifies the
accuracy and completeness of the checks against the prelist.
Cash Receipts Journal-it is where all cash receipts transactions, including
cash sales, miscellaneous cash receipts, and cash received on account are
recorded.
UPDATE ACCOUNTS RECEIVABLE RECORDS. The remittance advices are
used to post to the customers’ accounts in the AR subsidiary ledger.
UPDATE GENERAL LEDGER. Upon receipt of the journal voucher and the
account summary, the general ledger function reconciles the figures, posts
to the cash and AR control accounts, and files the journal voucher.
RECONCILE CASH RECEIPTS AND DEPOSITS. Periodically, a clerk from the
controller’s office (or an employee not involved with the cash receipts
procedures) reconciles cash receipts by comparing the following
documents: (1) a copy of the prelist, (2) deposit slips received from the
bank, and (3) related journal vouchers.
Physical Systems-Physical accounting information systems are a
combination of computer technology and human activity. This
technology/human mix creates a continuum of alternative design options
BASIC TECHNOLOGY REVENUE CYCLE-This section presents examples of
basic technology revenue cycle systems. The computers used in these
systems are independent (nonnetworked) personal computers (PCs).
BASIC TECHNOLOGY SALES ORDER PROCESSING SYSTEM-the system that
shows the processes, documents, and data files of a basic technology sales
order system. The following sections outline the key activities in this system.
1. Sales Department
2. Credit Department Approval
3. Warehouse Procedures
4. The Shipping Department
5. The Billing Department
6. Accounts Receivable, Inventory Control, and General Ledger
Departments
BASIC TECHNOLOGY CASH RECEIPTS SYSTEM
1. Mail Room
2. Cash Receipts
3. Accounts Receivable
4. General Ledger Department
5. Controller’s Office
ADVANCED TECHNOLOGY REVENUE CYCLE-Advanced technologies allow
systems designers to integrate accounting and other business functions
through a common information system.
INTEGRATED SALES ORDER PROCESSING SYSTEM-Notice that the functions
of credit checking, accounts receivable updating, customer billing, inventory
updating, and posting to the general ledger are performed automatically by
the central computer system
”Sales Procedures”
1. The system accesses the inventory subsidiary file and checks the
availability of the inventory items requested.
2. If credit is approved, the system adds a record to the sales invoice file
3. The warehouse clerk’s produces a hard-copy printout of the electronically
transmitted stock release document.
4. The shipping department performs its usual task of reconciling the goods
with the packing slip, preparing them for shipment, and selecting a carrier.
5. Upon receipt of the shipping notice, the system automatically performs
the following accounting tasks:
• Updates the customer’s credit history record
• Reduces the quantity-on-hand
• Determines if the inventory quantity-on-hand has fallen below the
reorder point and, if so, adds a record to the purchase requisition file.
• Places an “on-order” flag
• Inserts a shipped date in sales invoice record
• Updates the GL accounts
• The system produces and distributes various management reports
INTEGRATED CASH RECEIPTS SYSTEM-The system presented here and the
discussion presented further in the text assumes an organization in which
customers make payments on account with physical checks that are mailed
to the company.
1. Mail Room
2. Cash Receipts Department
3. Automatic Data Processing Procedures
• Closes the sales invoices
• Posts to the GL accounts.
• Prepares and distributes various management reports
4. Controller’s Office-a clerk in the controller’s office periodically
performs a reconciliation of remittance lists, bank deposit slips, cash
receipts journals, and the GL cash accounts.
REVENUE CYCLE RISKS AND INTERNAL CONTROLS
The following are the primary risks associated with revenue cycle
transactions:
• Selling to un-creditworthy customers
• Shipping customers the wrong items or incorrect quantities
• Inaccurately recording sales and cash receipts transactions in journals and
accounts
• Misappropriation of cash receipts and inventory
• Unauthorized access to accounting records and confidential report
Internal Control Activities as consisting of two major categories:
(1) physical controls and (2) information technology (IT) controls.
These consist of six classes of internal control activities: transaction
authorization, segregation of duties, supervision, accounting records, access
control, and independent verification.
SUMMARY OF REVENUE CYCLE RISKS AND CONTROLS
”Risk of Selling to Un-Creditworthy Customers”
Selling on credit to customers who have not been properly vetted can lead
to excessive bad debt losses.
Physical Controls
TRANSACTION AUTHORIZATION. The objective of transaction authorization
is to ensure that only valid transactions are processed.
SEGREGATION OF DUTIES. An objective of segregation of duties as stated in
Chapter 3 is to separate transaction authorization from transaction
processing.
IT Controls
AUTOMATED CREDIT CHECKING. Credit checking may be performed
automatically by the system as a programmed process control.
“Risk of Shipping Customers Incorrect Items or Quantities”
Shipping customers the wrong items or incorrect quantities may result in
damaged customer relations, excessive sales returns, lost future sales, and
accounting errors.
Physical Controls
INDEPENDENT VERIFICATION. The shipping function verifies that the goods
sent from the warehouse are correct in type and quantity.
IT Controls
SCANNER TECHNOLOGY. Product code scanners in the warehouse and
shipping department will reduce the risk of human error in picking and
shipping incorrect products.
AUTOMATED INVENTORY ORDERING. When an inventory record is updated
to reflect a sale, the computer logic should check to determine if the
reduction in inventory drops the inventory quantity-on-hand to a point
below the inventory reorder point.
*If Quantity-on-Hand < Reorder Point AND On-Order field=zero
“Risk of Inaccurately Recording Transactions in Journals and Accounts”
The following outlines some common revenue cycle errors but is not
intended to be an exhaustive list:
• Sales to customers are incorrectly calculated.
• Sales are recorded in the wrong period.
• Customers are billed for items they did not receive (back ordered).
• Customer cash receipts are inaccurately posted to accounts
• Summaries of sales, accounts receivable, cash receipts, and inventory
levels are incorrectly posted to their respective GL accounts
Physical Controls
TRANSACTION AUTHORIZATION. Cash prelist provides a means for verifying
that customer checks and remittance advices match in amount.
ACCOUNTING RECORDS. How a firm’s source documents, journals, and
ledgers form an audit trail that allows independent auditors to trace
transactions through various stages of processing.
PRENUMBERED DOCUMENTS. (sales orders, shipping notices, remittance
advices, etc.) are sequentially numbered
SPECIAL JOURNALS. By grouping similar transactions together into special
journals
GENERAL LEDGERS. basis for financial statement preparation.
FILES. The revenue cycle employs several temporary and permanent files
that contribute to the audit trail. The following are typical examples:
• Customer order file shows the status of customer orders.
• Shipping log specifies orders shipped during the period.
• Customer records file provides customer credit data.
• Back-order file contains customer orders for out-of-stock items.
• Journal voucher file is a compilation of all journal vouchers.
INDEPENDENT VERIFICATION. The objective of independent verification is
to verify the accuracy and completeness of tasks performed by other
functions in the process.
Independent verification controls in the revenue cycle exist at the following
points:
1) The shipping department reconciles the goods being shipped against the
packing slip
2) The billing function reconciles the original sales order with the shipping
notice
3) Prior to posting to control accounts, the general ledger function
reconciles journal vouchers and summary reports prepared independently
in different functional areas.
IT Controls
DATA INPUT EDITS. A basic assumption in transaction processing system
design is that master files, such as inventory, accounts receivable, and the
general ledger, are “clean” and error free. The following input controls, or
edits, are programmed into the system to minimize the risk from data input
errors:
1. Checks for missing data, numeric-alphabetic data, and valid data values
2. Check digit edits provide control over accessing the wrong accounts when
posting customer sales and cash receipts transactions.
AUTOMATED POSTING TO SUBSIDIARY AND GL ACCOUNTS. The record-
keeping functions, which in the basic technology system were performed
manually by accounting clerks, are automated in the advanced technology
system.
FILE BACKUP. To reduce the risk of data loss, backup procedures need to be
in place.
“Risk of Misappropriation of Cash Receipts and Inventory”
Cash and inventory are the physical assets at risk in the revenue cycle.
Physical Controls
TRANSACTION AUTHORIZATION. The remittance list provides a control
against the loss or theft of checks and remittance advices as they flow
through the system.
SUPERVISION. The individual who opens the mail has access both to cash
(the asset) and to the remittance advice (the record of the transaction).
ACCESS CONTROLS. The following physical access controls should be in
place to help prevent and detect unauthorized access to the firm’s assets:
• Warehouse security, such as fences, alarms, and guards.
• Depositing cash daily in the bank.
• Using a safe or night deposit box for cash.
• Locking cash drawers and safes in the cash receipts department.
SEGREGATION OF DUTIES. ensures that no single individual or department
processes a transaction in its entirety.
IT Controls
MULTILEVEL SECURITY. In a basic technology environment, segregation of
duties is accomplished by physically separating individuals and the data over
which they have custody.
“Risk of Unauthorized Access to Accounting Records and Reports”
Accounting information is at risk to unauthorized access from outsiders as
well as employees of the organization. The motives for accessing accounting
information include:
• Attempts to perpetrate a fraud such as creating a false sales order
• Theft of data
• Malicious acts such as corrupting and deleting financial data.
Physical Controls
ACCESS CONTROLS. Source documents and accounting records need to be
physically protected..
SEGREGATION OF DUTIES. The organization should be so structured that
the perpetration of a fraud requires collusion between two or more
individuals.
IT Controls
PASSWORDS. Digital accounting records are vulnerable to unauthorized and
undetected access.
MULTILEVEL SECURITY. Employs programmed techniques that permit
simultaneous access to a central system
Two common methods for achieving multilevel security:
Access control list (ACL) - method assigns privileges, such as the right to
perform computer program procedures and access data files, directly to the
individual.
Role-based access control (RBAC)- involves creating standard tasks (e.g.,
cash receipts processing) called roles.
 *Role is assigned access privileges to specific data and procedures,
such as the right to add a record to the cash receipts journal.
POINT-OF-SALE (POS) SYSTEMS-are used extensively in grocery stores,
department stores, and other types of retail organizations. In this example,
the organization maintains no customer accounts receivable; all
transactions are for cash, checks, or bank credit/debit cards.
DAILY PROCEDURES
First, the checkout clerk scans the Universal Product Code (UPC) label on
the items being purchased with a laser light scanner. The scanner, which is
the primary input device in the POS system, may be handheld or mounted
on the checkout counter.
END-OF-DAY PROCEDURES. At the end of the day (it’s night
HAHAHAHAHA), the cash receipts clerk prepares a three-part deposit slip for
the total amount of the cash received. One copy is filed and the other two
accompany the cash to the bank.
POINT-OF-SALE CONTROL ISSUES. The POS environment, however, is
associated with unique risks that give rise to the need for additional
physical controls.
• Authorization
• Supervision
• Access Control
• Accounting Records
• Independent Verification
REENGINEERING USING EDI (electronic data interchange)
Doing Business via EDI
EDI technology was devised to expedite routine transactions between
manufacturers and wholesalers, and between wholesalers and retailers.
REENGINEERING USING THE INTERNET
Doing Business on the Internet
Thousands of organizations worldwide have home pages on the Internet to
promote their products and solicit sales.
CHAPTER 5: The Expenditure Cycle Part I: Purchases and Cash
Disbursements Procedures
Overview….
The objective of the expenditure cycle is to convert the organization’s cash
into physical materials and human resources it needs to conduct business.
>The time lag between these events splits the procurement process into
two phases: (1) the physical phase, involving the acquisition of the resource,
and (2) the financial phase, involving the disbursement of cash.
>The principal features of the two major subsystems that constitute the
expenditure cycle: (1) the purchases processing subsystem and (2) the cash
disbursements subsystem.
>This chapter is organized into two main sections. The first section provides
an overview of the conceptual system, including the logical tasks, the key
entities, the sources and uses of information, and the flow of key documents
through an organization. The second section deals with physical systems,
which are composed, to varying degrees, of technology and human activity.
“THE CONCEPTUAL SYSTEM”
“Purchases Processing Procedures “-
-include the tasks involved in identifying inventory needs, placing the order,
receiving the inventory, and recognizing the liability.
MONITOR INVENTORY RECORDS. Firms deplete their inventories by
transferring raw materials into the production process (the conversion
cycle) and by selling finished goods to customers (revenue cycle).
PREPARE PURCHASE ORDER. The prepare purchase order function receives
the purchase requisitions, which are then sorted by the vendor if necessary.
RECEIVE GOODS. Most firms encounter a time lag (sometimes a significant
one) between placing the order and receiving the inventory.
*blind copy-contains no quantity or price information about the
products being received. Purpose: to force the receiving clerk to count and
inspect inventories prior to completing the receiving report
UPDATE INVENTORY RECORDS.
-standard cost system carry their inventories at a predetermined
standard value regardless of the price actually paid to the vendor
 -actual cost inventory ledger requires additional financial
information, such as a copy of the supplier’s invoice when it arrives.
SET UP ACCOUNTS PAYABLE. During the course of this transaction, the set
up AP function has received and temporarily filed copies of the PO and
receiving report
“Vouchers Payable System”
-Under this system, the AP department uses cash disbursement vouchers
and maintains a voucher register.
*vouchers payable file. This file is equivalent to the open AP
POST TO GENERAL LEDGER. The general ledger function receives a journal
voucher from the AP department and an account summary from inventory
control.
“The Cash Disbursements System”
The cash disbursements system processes the payment of obligations
created in the purchases system.
IDENTIFY LIABILITIES DUE. Each day the AP clerk reviews the open AP file
for items due for payment.
PREPARE CASH DISBURSEMENT. The cash disbursements clerk receives the
AP packet and reviews the documents for completeness and clerical
accuracy.
*check register/cash disbursements journal – where in the clerk
prepares a check and records the check number, dollar amount, and other
pertinent data recorded
UPDATE AP RECORD. The AP packet is then filed in the closed AP file, and an
account summary is prepared and sent to the general ledger function.
POST TO GENERAL LEDGER. The approved journal voucher is then filed. This
concludes the cash disbursements procedures.
“Physical Systems”
The objectives of this section are to:
(1) illustrate accounting information systems (AIS) functionality and work
flow patterns under different levels of technology and
(2) demonstrate how the internal control profile changes as the
technology/human mix changes.
BASIC TECHNOLOGY EXPENDITURE CYCLE
This section presents examples of basic technology expenditure cycle
systems. The computers used in these systems are independent (non-
networked) PCs.
Basic Technology Purchases Processing System-The following sections
outline the key activities in this system.
INVENTORY CONTROL. The process begins when the inventory control clerk
prints purchase requisitions
PURCHASING DEPARTMENT. receives the purchase requisitions, sorts them
by vendor, and adds a record to the digital open purchase order file
RECEIVING. The clerk receives the goods and the packing slip from the
vendor and reconciles the goods with the blind copy of the PO.
AP DEPARTMENT. When the supplier’s invoice arrives, the AP clerk
reconciles the invoice, purchase order, and receiving report (three-way
match) and prepares an AP packet, which in this paper-oriented system is
simply a folder containing the reconciled supporting documents.
GENERAL LEDGER DEPARTMENT. Receives a journal voucher from the AP
department and an account summary from inventory control.
Basic Technology Cash Disbursements System-The tasks performed in each
of the key processes are discussed next.
AP DEPARTMENT. AP clerk reviews the AP packets in the open AP file for
items due, and sends the supporting docs to the cash disbursements dep’t
CASH DISBURSEMENTS DEPARTMENT. The clerk receives the AP packets
and reviews the documents for completeness and clerical accuracy.
AP DEPARTMENT. Upon receipt of the AP packet, the AP clerk removes the
liability by debiting the vendor’s digital AP subsidiary record.
GENERAL LEDGER DEPARTMENT. Based on the journal voucher from cash
disbursements and the account summary from accounts payable, the
general ledger clerk uses the department PC to post to the GL control
accounts and files the documents. This concludes the cash disbursements
procedures.
ADVANCED TECHNOLOGY EXPENDITURE CYCLE-Integration improves
operational performance and reduces costs by eliminating non value-added
tasks. Integration improves operational performance and reduces costs by
eliminating non value-added tasks.
INTEGRATED PURCHASES PROCESSING SYSTEM-Labor-intensive activities
that characterize the basic technology system add greatly to the cost of
system operation and result in human error.
Computer Operations -The purchases computer application performs the
following tasks automatically:
1. The system reads the purchases requisition file for items that
need to be replenished.
2. Hard-copy purchase orders are prepared and sent to the vendor.
3. A record is added to the open PO file.
4. A digital transaction listing of POs is created
Receiving Department - When the goods arrive, the receiving clerk accesses
a blind copy of the open PO file in real time by entering the PO number
taken from the packing slip. The following tasks are performed
automatically by the system:
1. A record is added to the receiving report file.
2. Quantities of items received are matched against the open PO
record, and the PO is closed by placing the receiving report number
in the PO closed flag.
3. The inventory subsidiary records are updated to reflect the
receipt of the inventory items.
4. The general ledger inventory control account is updated.
Accounts Payable Department-The following tasks are performed
automatically by the system:
1. Using the PO number as a common attribute, the system links the
vendor invoice to the associated purchase order and receiving
report records.
2. The system reconciles the supporting documents and creates a
virtual AP packet to authorize payment.
3. The system displays the virtual AP packet on the AP clerk’s
computer screen for review.
4. Assuming no discrepancies that demand the AP clerk’s
intervention, the system automatically approves payment and sets a
payment due date.
INTEGRATED CASH DISBURSEMENTS SYSTEM
The following procedures are performed on items that are due:
1. Checks are automatically printed, signed, and distributed to the mail
room for mailing to vendors.
2. The payments are automatically recorded in the check register file.
3. Vendor invoices are closed by placing the check number in the closed flag
field.
4. The general ledger AP control and cash accounts are updated.
5. Reports detailing these transactions are transmitted via a terminal to the
AP and cash disbursements departments for management review and filing.
EXPENDITURE CYCLE RISKS AND INTERNAL CONTROLS
The following are the primary risks associated with expenditure cycle
transactions:
• Unauthorized inventory purchases
• Receiving wrong items, incorrect quantities, or damaged goods
• Inaccurately recording purchases and cash disbursement transactions in
journals and accounts
• Misappropriation of cash and inventory
• Unauthorized access to accounting records and confidential reports.
“Risk of Unauthorized Inventory Purchases”
Physical Controls
TRANSACTION AUTHORIZATION. to ensure that only valid transactions are
processed.
IT Controls
AUTOMATED PURCHASE APPROVAL. The objective of automated purchase
approval is to prevent unauthorized purchases from unapproved vendors
“Risk of Receiving Incorrect Items, Quantities, or Damaged Goods”
Physical Controls
INDEPENDENT VERIFICATION. When goods arrive from the supplier,
receiving clerks verify that the items are correct in type and quantity and
inspect them for condition.
SUPERVISION. to ensure that the clerks properly carry out these important
duties.
IT Controls
SCANNER TECHNOLOGY. The basic concept of inspection can be enhanced
through the use of IT controls.
” Risk of Inaccurately Recording Transactions in Journals and Ledgers”
The following outlines some common expenditure cycle errors but is not
intended to be an exhaustive list:
• Purchases from vendors are incorrectly calculated.
• Accounts payable go unrecorded or are recorded in the wrong period.
• Vendor bills customers for items they did not receive (back ordered).
• Vendor cash payments are inaccurately posted to accounts payable.
• Summaries are incorrectly posted to their respective GL accounts.
Physical Controls
TRANSACTION AUTHORIZATION. The AP function authorizes cash
disbursements via the AP packet.
ACCOUNTING RECORDS. Tto maintain an audit trail adequate for tracing a
transaction from its source document to the financial statements
INDEPENDENT VERIFICATION. The general ledger function provides an
important independent verification in the system.
IT Controls
INPUT DATA EDITS. Input controls are edits that focus on the integrity of
transaction data being entered into the application. The following edits are
to minimize input errors.
1. Controls, including checks for missing data, numeric-alphabetic
data, and invalid data values.
2. Check digit control will provide control over accessing the wrong
accounts.
ERROR MESSAGES. Any mismatch conditions should produce an error
message to the computer operator.
AUTOMATED POSTINGS TO SUBSIDIARY AND GL ACCOUNTS. Works that
performed manually by accounting clerks, are automated in the advanced
technology system.
” Risk of Misappropriation of Cash and Inventory”
The greatest risk of inventory theft occurs in the receiving department and
the warehouse.
Physical Controls
SUPERVISION. Inadequate supervision can create an environment
conducive to the theft of inventories in transit.
INDEPENDENT VERIFICATION. This control is called a three-way match and
involves the following three documents:
1. The PO, which shows that the purchasing agent ordered only the
needed inventories from a valid vendor.
2. The receiving report, which is evidence of the physical receipt of
the goods, their condition, and the quantities received.
3. The supplier’s invoice, which provides the financial information
needed to record the obligation as an account payable.
SEGREGATION OF DUTIES—INV. CONTROL FROM INV. WAREHOUSE-an
auditor should be able to reconcile inventory records to the physical
inventory
SEGREGATION OF DUTIES—AP FROM CASH DISBURSEMENTS-Segregating
these functions greatly reduces the potential for this type of fraud.
IT Controls
AUTOMATED THREE-WAY MATCH AND PAYMENT APPROVAL. An
automated three way match replicates the manual counterpart as follows:
When the AP clerk receives the supplier’s invoice, the clerk accesses the
system and adds a record to the vendor invoice file.
MULTILEVEL SECURITY. It allows multiple individuals to simultaneously
access a system, but provides segregation of duties to limit their access
privileges and activities.
“Risk of Unauthorized Access to Accounting Records and Reports”
Accounting information is at risk to unauthorized access from outsiders as
well as employees of the organization. The motives for accessing accounting CHAPTER 6: The Expenditure Cycle Part II: Payroll Processing and
information include: Fixed Asset Procedures
• Attempts to perpetrate a vendor fraud. The Conceptual Payroll System
• Theft of physical inventory. Access to inventory records allows the The nature of payroll processing, however, creates the need for specialized
perpetrator to conceal the theft. procedures for the following reasons
• Malicious acts such as corrupting or deleting financial data. 1. A firm can design general purchasing and disbursement procedures that
Physical Controls apply to all vendors and inventory items.
ACCESS CONTROL. A firm must limit access to documents that control its 2. General expenditure activities constitute a relatively steady stream of
physical assets purchasing and disbursing transactions
SEGREGATION OF DUTIES. 3. Writing checks to employees requires special controls. Combining payroll
IT Controls and trade transactions can encourage payroll fraud.
PASSWORD CONTROL
MULTILEVEL SECURITY. PAYROLL SYSTEM GENERAL TASKS
Personnel Department-The personnel department prepares and submits
personnel action forms to the prepare payroll function
Production Department- the employees prepare two types of time records:
job tickets and time cards. Job tickets capture the time that individual
workers spend on each production job. Time cards capture the time the
employee is at work.
Update WIP Account-After cost accounting allocates labor costs to the WIP
accounts, the charges are summarized in a labor distribution summary and
forwarded to the general ledger function
Prepare Payroll-they receive pay rate and withholding data from the
personnel department and hours-worked data from the production
department. A clerk in the payroll department then performs the following
tasks:
1. Prepares the payroll register, showing gross pay, deductions, overtime
pay, and net pay.
2. Enters this information into the employee payroll records
3. Prepares employee paychecks
4. Sends the paychecks to the distribute paycheck function.
5. Files the time cards, personnel action form, and copy of the payroll
register (not shown).
Distribute Paycheck -A form of payroll fraud involves submitting time cards
for nonexistent employees.
Prepare Accounts Payable The clerk reviews the payroll register for
correctness and prepares copies of a cash disbursement voucher for the
total amount of the payroll.
Prepare Cash Disbursement-Upon receipt of the voucher packet, the cash
disbursement function prepares a single check for the entire amount of the
payroll and deposits it in the payroll imprest account.
UPDATE GENERAL LEDGER They receive the labor distribution summary
from cost accounting, the disbursement voucher from accounts payable,
and the journal voucher from cash disbursement.
THE PHYSICAL PAYROLL SYSTEM
BASIC TECHNOLOGY PAYROLL SYSTEM-The following key tasks are
represented in the flowchart:
1. Personnel action and time and attendance information from the
personnel and production departments
2. The payroll department reconciles this information, calculates the payroll,
and sends the paychecks to the paymaster for distribution to employees.
3. Cost accounting receives information regarding the time spent on each
job from production.
4. Accounts payable receives payroll summary information (payroll register)
5. The general ledger department reconciles summary information from
cost accounting and accounts payable.
ADVANCED TECHNOLOGY PAYROLL SYSTEM For moderate-sized and large
organizations, payroll processing is often integrated within the human
resource management (HRM) system. The HRM system captures and
processes a wide range of personnel-related data, including employee
benefits, labor resource planning, employee relations, employee skills,
internal training, and personnel actions.
Human Resources-HR clerks enter data into the employee records file in
real time from terminals
Cost Accounting-The cost accounting department enters job cost data in
real time to create the labor usage file.
Employee Timekeeping- Modern business is increasingly characterized by
telecommuting employees working from multiple locations, both
domestically and internationally.
Biometric time clocks/Magnetic swipe ID cards/Proximity
cards/Mobile remote devices
Data Processing-At the end of the work period, the following tasks are
performed in a batch process:
1. Labor costs are distributed to various WIP, overhead, and expense
accounts.
2. An online labor distribution summary file is created.
3. Payroll is calculated, and an online payroll register is created from the
time and attendance file and the employee records file.
4. The employee records file is updated.
5. Paychecks are prepared, signed, and distributed to the employees.
6. Funds sufficient to cover the full amount of the payroll are transferred to
the payroll imprest account
7. Digital journal vouchers are entered into the journal voucher file.
PAYROLL SYSTEM RISKS AND INTERNAL CONTROLS
As noted in previous chapters, an objective of internal control is to mitigate
the risk from errors and fraud. The following are the primary risks
associated with payroll system transactions:
• Inaccurately recording payroll transactions in accounts.
• Misappropriation of cash through payroll fraud.
• Unauthorized access to payroll records and confidential employee data.
“Risk of Inaccurately Recording Transactions”-The following outlines some
possible payroll system errors:
• Time and attendance data are incorrectly calculated.
• Wages payable go unrecorded or are recorded in the wrong period.
• Employee earnings and cash payments are inaccurately posted to
employee records or are posted to the wrong employee.
• Payroll register, AP, and cash disbursements amounts are incorrectly
posted to their respective GL accounts
 Physical Controls
ACCOUNTING RECORDS. The control objective of accounting records is to
maintain an audit trail. The audit trail for payroll includes the following
documents:
1. Time cards, job tickets, and disbursement vouchers.
2. Journal information
3. Subsidiary ledger accounts
4. GL accounts
INDEPENDENT VERIFICATION. The following are examples of independent
verification controls in the payroll system:
1. Time and Attendance. Before submitting time cards to payroll, the
supervisor must verify their accuracy and sign them.
2. Accounts Payable. The AP clerk verifies the accuracy of the payroll
register before creating a disbursement voucher that transfers funds to the
imprest account.
3. General Ledger. The general ledger department provides verification of
the overall process by reconciling the labor distribution summary and the
payroll disbursement voucher.
IT Controls
DATA INPUT EDITS. Input controls verify the integrity of transaction data
being entered into the application.
ERROR MESSAGES. Any mismatch when posting time card or personnel
action data to employee records should produce an error message to the
computer operator.
FILE BACKUP. Backup procedures need to be in place to reduce the risk of
data
AUTOMATED POSTING TO ACCOUNTS.
“Risk of Misappropriation of Cash through Payroll Fraud”-Payroll frauds
come in two general forms:
1. The first is the nonexistent employee who receives a paycheck.
2. The second type of payroll fraud involves overpayment of an employee.
Physical Controls
TRANSACTION AUTHORIZATION.The personnel action form helps payroll
keep current the employee records.
SEGREGATION OF DUTIES-The following segregations of duties reduce the
risk of various forms of payroll fraud:
1. The timekeeping function and the personnel function should be
separated.
2. The individual employee paychecks are not negotiable instruments until
the payroll check is deposited into the imprest account at the bank.
3. The use of an independent paymaster to distribute checks (rather than
the employee’s supervisor) helps verify the existence of employees.
SUPERVISION. Sometimes, employees clock in for another worker who is
late or absent.
ACCESS CONTROL. The assets associated with the payroll system are labor
and cash.
IT Control
Input controls to reduce these risks include the following:
1. Limit tests to detect excessive hours reported per period.
2. Biometric scanners, swipe cards, and PINs
3. Automated tests to validate employee time cards
4. Paycheck direct deposit options for employees
“Risk of Unauthorized Access to Payroll Records and Confidential
Employee Data”- Payroll information is at risk to unauthorized access from
outsiders as well as employees of the organization. The motives for
accessing accounting information include:
• Malicious acts such as corrupting or deleting payroll data.
• Theft of confidential employee information
•Attempts to perpetrate a payroll fraud.
IT Controls
PASSWORDS.
MULTILEVEL SECURITY.
Outsourcing the Payroll Function-Many organizations outsource their
payroll function by transferring all payroll processing tasks to a third-party
provider.
Advantages and Risks Associated with Payroll Outsourcing The primary
advantage of payroll outsourcing is cost savings.
The Conceptual Fixed Asset System
Fixed assets are the property, plant, and equipment used in the operation
of a business. The specific objectives of the fixed asset system are to:
1. Process the acquisition of fixed assets as needed and in accordance with
formal management approval and procedures.
2. Maintain adequate accounting records of asset acquisition, cost,
description, and physical location in the organization.
3. Maintain accurate depreciation records for depreciable assets in
accordance with acceptable methods.
4. Provide management with information to help plan for future fixed asset
investments.
5. Properly record the retirement and disposal of fixed assets.
THE LOGIC OF A FIXED ASSET SYSTEM
The process involves three categories of tasks: asset acquisition, asset
maintenance, and asset disposal
Asset acquisition usually begins with the departmental manager (user)
recognizing the need to obtain a new asset or replace an existing one.
Asset maintenance involves adjusting the fixed asset subsidiary account
balances as the assets (excluding land) depreciate over time or with usage.
Asset Disposal When an asset has reached the end of its useful life or when
management decides to dispose of it, the asset must be removed from the
fixed asset subsidiary ledger.
(2) updating the accumulated depreciation and book value fields in the
subsidiary records,
(3) posting the total amount of depreciation to the affected GL accounts
(depreciation expense and accumulated depreciation), and
(4) recording the depreciation transaction by adding a record to the journal
voucher file
Disposal Procedures-When the clerk deletes the record from the fixed asset
subsidiary ledger, the system automatically
(1) posts an adjusting entry to the fixed asset control account in the general
ledger,
(2) records loss or gain associated with the disposal
(3) prepares a journal voucher
FIXED ASSET SYSTEM RISKS AND CONTROLS
• Authorization Controls
• Supervision Controls
• Independent Verification Controls

THE PHYSICAL FIXED ASSET SYSTEM

Acquisition Procedures- the process begins when the fixed asset accounting
clerk receives a receiving report and a cash disbursement voucher.
Asset Maintenance The fixed asset system uses the depreciation schedules
to record end-of-period depreciation transactions automatically. The
specific tasks include
(1) calculating the current period’s depreciation,