MP111 Lecture 6 Internal Control of business
- 1. Dr Mohammad T Hossain Week 6 Internal Control and Bank Reconciliation MP111 Accounting Management Decisions
- 2. Introduction SHAREHOLDERS(OWNERS) EMPLOY DIRECTORS AND MANAGERS (AGENTS) TO CONDUCT THE BUSINESS, IN THE INTEREST OF THE OWNERS THE MANAGERS ASSUME A STEWARDSHIP FUNCTION AND ARE EXPECTED TO MANAGE THE BUSINESS IN THE BEST INTEREST OF THE PRINCIPALS A KEY RESPONSIBILITY IS TO CONTROL OPERATIONS
- 3. Internal Control • Safeguard the assets the business uses in its operations • Encourage adherence to business policies • Promote operational efficiency (obtain the best outcome at the lowest cost) • Ensure accurate and reliable accounting records The organisational plan and all the related measures that an entity adopts to: • Administrative controls • Accounting controls Includes both
- 4. Cont... Internal controls are developed by management after: considering the size and nature of the business, The costs and benefits of the control Safeguarding assets is important because all organisations need assets in order to conduct business Most effective when employees at all levels adopt the organisations goals, objectives and ethical standards
- 5. Effective System of Internal control COMPETENT, RELIABLE AND ETHICAL PERSONNEL ASSIGNMENT OF RESPONSIBILITIES PROPER AUTHORISATION SEPARATION OF DUTIES INTERNAL AND EXTERNAL AUDITS DOCUMENTS AND RECORDS ELECTRONIC DEVICES AND COMPUTER CONTROLS OTHER CONTROLS
- 6. Cont... Competent, reliable and ethical personnel Paying the salaries necessary to attract top quality employees, training them to do their job well, and supervising their work all help a business to build a competent staff Assignment of responsibilities Each employee is a assigned certain responsibilities E.g. accountants are responsible for approving invoices for payment Proper Authorisation Any deviation from standard policy requires proper authorisation
- 7. Cont... Separation of duties ⚫ Divides the responsibilities for transactions between two or more people or departments ⚫ Examples: ⚫ Separation of operations from accounting ⚫ Separation of the custody of assets from accounting ⚫ Separation of the authorisation of transactions from the custody of related assets ⚫ Separation of duties within the accounting function
- 8. Cont... Internal and external audits ⚫ An audit is an examination of the firms financial statements and the accounting systems, controls and records that produced them ⚫ Internal auditors are employees of the organisation reporting to the audit committee. Their role is to examine whether employees follow the procedures of the organisation. ⚫ External auditors are independent third parties that are engaged by the organisation to ensure that financial statements are prepared in accordance to the law.
- 9. Cont... Documents and records These are usually source documents such as invoices and purchase orders Documents should be pre-numbered to discourage fraudulent activities Other controls Alarms, sensors etc... These are controls that are required beyond the accounting function
- 10. Real World Examples London Philharmonic Orchestra (2009) ⚫ Who was involved? ⚫ What was effective/ineffective about the internal control system? ⚫ How much was lost/Stolen? Barings Bank (1995) ⚫ Who was involved? ⚫ What was effective/ineffective about the internal control system? ⚫ How much was lost/Stolen?
- 11. The Bank Account Safeguarding cash There are two records of the business’ cash. The Cash at bank account (organisations general ledger) The bank statement (where the physical cash is held) The amount in these two records are rarely equal But both are correct. Reason for differences are due to Items we know but the bank does not know…yet (eg. Un- deposited cheques). Items the bank knows but we did not know (eg. EFT deposits and withdrawals and bank fees).
- 12. Bank reconciliation To reconcile these two bank account records the following steps are required: 1. Start with both the bank statement and cash at bank figures 2. Add and subtract from the balances of the bank statement any amounts that does not appear on the bank statement 3. Journalise the items that appear on the bank statement but not on the business cash account 4. Compare the adjusted balances of both accounts 5. If there are any errors, notify the bank.
- 13. Lecture demonstration problem Date Transaction Description Withdrawals Deposits Balance 1-Jan Balance Brought forward 6,556.12 4-Jan Deposit 1,000.00 Deposit 112.00 Dishonoured cheque 52.00 7,616.12 5-Jan Chq 656 100.00 Chq 335 100.00 7,416.12 8-Jan Deposit 194.60 7,610.72 12-Jan Chq 332 3,000.00 Chq 333 150.00 Chq 334 100.00 4,360.72 17-Jan EFT - collection of rent 904.03 5,264.75 20-Jan EFT – Insurance 361.00 4,903.75 26-Jan Bank Collection 2,114.00 7,017.75 31-Jan Interest 28.01 7,045.76 Service charge 14.25 7,031.51 Chq 336 1,100.00 5,931.51 Total 4,977.25 4,352.64 5,931.51
- 14. Cont... General Ledger: Cash at Bank
- 15. Compare the statements. Find the differences... ⚫ January 31 deposit of $1591.63 does not appear on the bank statement ⚫ Bank error. Cheque No. 656 is not one of our cheques. ⚫ Cheque No.s 337-341 do not appear on the bank statement. That is, they not yet presented. ⚫ Cheque No. 333 for $150, recorded as a cash payment in the books at $510. This is our error. Adjustment of $360 required.
- 16. Compare .. Bank Statement Date Transaction Description Withdrawls Deposits Balance 1-JanBalance Brought forward 6,556.12 4-JanDeposit 1,000.00 Deposit 112.00 Dishonoured cheque 52.00 7,616.12 5-Jan Chq 656 100.00 Chq 335 100.00 7,416.12 8-JanDeposit 194.60 7,610.72 12-Jan Chq 332 3,000.00 Chq 333 150.00 Chq 334 100.00 4,360.72 17-JanEFT - collection of rent 904.03 5,264.75 20-JanEFT – Insurance 361.00 4,903.75 26-JanBank Collection 2,114.00 7,017.75 31-JanInterest 28.01 7,045.76 Service charge 14.25 7,031.51 Chq 336 1,100.00 5,931.51 Total 4,977.25 4,352.64 5,931.51 Cash at Bank Account
- 17. Compare .. Bank Statement Date Transaction Description Withdrawls Deposits Balance 1-JanBalance Brought forward 6,556.12 4-JanDeposit 1,000.00 Deposit 112.00 Dishonoured cheque 52.00 7,616.12 5-Jan656 100.00 335 100.00 7,416.12 8-JanDeposit 194.60 7,610.72 12-Jan332 3,000.00 333 150.00 334 100.00 4,360.72 17-JanEFT - collection of rent 904.03 5,264.75 20-JanEFT - Insurance 361.00 4,903.75 26-JanBank Collection 2,114.00 7,017.75 31-JanInterest 28.01 7,045.76 Service charge 14.25 7,031.51 336 1,100.00 5,931.51 Total 4,977.25 4,352.64 5,931.51 Cash at Bank Account
- 18. Compare .. Bank Statement Date Transaction Description Withdrawls Deposits Balance 1-JanBalance Brought forward 6,556.12 4-JanDeposit 1,000.00 Deposit 112.00 Dishonoured cheque 52.00 7,616.12 5-Jan656 100.00 335 100.00 7,416.12 8-JanDeposit 194.60 7,610.72 12-Jan332 3,000.00 333 150.00 334 100.00 4,360.72 17-JanEFT - collection of rent 904.03 5,264.75 20-JanEFT - Insurance 361.00 4,903.75 26-JanBank Collection 2,114.00 7,017.75 31-JanInterest 28.01 7,045.76 Service charge 14.25 7,031.51 336 1,100.00 5,931.51 Total 4,977.25 4,352.64 5,931.51 Cash at Bank Account
- 19. Adjust the Bank Statement Balance Adjust Bank statement balance for item that you know that the Bank does not know yet, such as: ⚫ Unpresented Cheques ⚫ Un-recorded Deposits ⚫ Bank Errors Bank Balance 5931.51 Add: Deposit in Transit 1591.63 Correction of bank error (add back withdrawal) 100.00 7623.14 Less: Outstanding Cheques - not yet presented to bank (Nos. 337-341) (1350.14) Adjusted Bank Balance 6273.00
- 20. Compare the statements. Find the differences... ⚫ Cheque No. 333 for $150, recorded as a cash payment in the books at $510. This is our error. Adjustment of $360 required. ⚫ EFT Deposit of rent from tenant for $904.03. ⚫ EFT Payment of Insurance for $361 ⚫ Bank charges for Dishonored Cheque and Service Charge. ⚫ Bank Deposit for Interest earned.
- 21. Compare .. Bank Statement Date Transaction Description Withdrawls Deposits Balance 1-JanBalance Brought forward 6,556.12 4-JanDeposit 1,000.00 Deposit 112.00 Dishonoured cheque 52.00 7,616.12 5-Jan656 100.00 335 100.00 7,416.12 8-JanDeposit 194.60 7,610.72 12-Jan332 3,000.00 333 150.00 334 100.00 4,360.72 17-JanEFT - collection of rent 904.03 5,264.75 20-JanEFT - Insurance 361.00 4,903.75 26-JanBank Collection 2,114.00 7,017.75 31-JanInterest 28.01 7,045.76 Service charge 14.25 7,031.51 336 1,100.00 5,931.51 Total 4,977.25 4,352.64 5,931.51 Cash at Bank Account
- 22. Compare .. Bank Statement Date Transaction Description Withdrawls Deposits Balance 1-JanBalance Brought forward 6,556.12 4-JanDeposit 1,000.00 Deposit 112.00 Dishonoured cheque 52.00 7,616.12 5-Jan656 100.00 335 100.00 7,416.12 8-JanDeposit 194.60 7,610.72 12-Jan332 3,000.00 333 150.00 334 100.00 4,360.72 17-JanEFT - collection of rent 904.03 5,264.75 20-JanEFT - Insurance 361.00 4,903.75 26-JanBank Collection 2,114.00 7,017.75 31-JanInterest 28.01 7,045.76 Service charge 14.25 7,031.51 336 1,100.00 5,931.51 Total 4,977.25 4,352.64 5,931.51 Cash at Bank Account
- 23. Adjust the Cash at Bank Account Adjust Cash at Bank Account balance for items that the Bank knew but you did not know until now. ⚫ EFT Receipts and payments ⚫ Bank fees ⚫ Errors by you. We now use Journals to correct the Cash at Bank account. DESCRIPTION Cash at Bank Account 3294.21 Add: EFT Receipts 904.03 Bank Collection 2114.00 Interest Revenue 28.01 Correction of error (Chq No.333) 360.00 6700.25 Less Dishonored Cheque fees 14.25 Service Charges 52.00 (66.25) EFT Insurance Payment (361.00) Adjusted Bank Balance 6273.00
- 24. Journals to correct the Cash at Bank Account ACCOUNT DEBIT CREDIT Accounts Payable (error means AR understated) 360.00 Accounts Receivable or Unearned Revenue (EFT deposits and Bank collections from customers) 3018.03 Interest Revenue 28.01 Bank Fees Expense 66.25 Insurance Expense (if automatic EFT each month) 361.00 Cash at Bank 2978.79
- 25. Accounting for Sale of Inventory ⚫ When we sell inventory there are TWO journals required. ⚫ To record the sale ⚫ To record the reduction in inventory
- 26. Accounting for Sale of Inventory ⚫ Example: Smart Clothing Limited sells business and ”smart” casualware. ⚫ On 2 Mar. The business bought 40 shirts on account, for $30 each. ⚫ On 4 Mar They sold 6 shirts for $50 each (sales are in cash) ⚫ Prepare the journal entries for these transactions
- 27. Accounting for Sale of Inventory Date Account Debit Credit 2 Mar 22 Inventory - Shirts 1200 Accounts Payable 1200 Purchase of 40 shirts @ $30 each 4 Mar 22 Cash 300 Sales Revenue 300 Cost of Goods Sold 180 Inventory - Shirts 180 Sale of 6 shirts, costing $30, @ $50 each
- 28. Accounting for GST ⚫ In many countries there is a broad-based tax on consumption, which is understood to mean final consumption by households. ⚫ In many countries this is often called a VAT (Value Added Tax). In Australia, we call it GOODS and SERVICES TAX or GST ⚫ The tax is collected through a staged process. Each business in the supply chain takes part in the process of controlling and collecting the tax then remitting the difference between the GST imposed on its taxed inputs and the GST imposed on its taxed outputs. ⚫ Thus, the tax is collected on the “value added” at each stage of production and distribution. ⚫ Source: OECD INTERNATIONAL VAT/GST GUIDELINES November 2015
- 29. Accounting for GST ⚫ The price quoted on purchases and sale of goods or services can be in two forms: ⚫ Price PLUS GST. Where the GST is calculated and added to the price quoted. ⚫ Price Includes GST. Where the price quoted already includes GST
- 30. Accounting for Price Plus GST Lets use our Smart Clothing Example. ⚫ Smart Clothing Limited sells business and ”smart” casualware. ⚫ On 2 Mar. The business bought 40 shirts on account, for $30 each plus GST ⚫ On 4 Mar They sold 6 shirts for $50 each plus GST ⚫ Prepare the journal entries for these transactions with GST of 10%.
- 31. Accounting for Sale of Inventory Date Account Debit Credit 2 Mar 22 Inventory - Shirts 1200 GST Liability (10% x 40 x $30) 120 Accounts Payable 1320 Purchase of 40 shirts @ $30 each Plus GST 4 Mar 22 Cash 330 GST (10% x 6 x $50) 30 Sales Revenue 300 Cost of Goods Sold 180 Inventory - Shirts 180 Sale of 6 shirts costing $30 @ $50 each Plus GST
- 32. Accounting for Price Including GST Lets use our Smart Clothing Example. ⚫ Smart Clothing Limited sells business and ”smart” casualware. ⚫ On 2 Mar. The business bought 40 shirts on account, for $33 each including GST ⚫ On 4 Mar They sold 6 shirts for $55 each including GST ⚫ Prepare the journal entries for these transactions with GST of 10%.
- 33. Accounting for Sale of Inventory Date Account Debit Credit 2 Mar 22 Inventory – Shirts (10/11 x 40 x $33) 1200 GST Liability (1/11 x 40 x $33) 120 Accounts Payable 1320 Purchase of 40 shirts @ $33 each Incl GST 4 Mar 22 Cash 330 GST (1/11 x 6 x $55) 30 Sales Revenue (10/11 x 6 x $55) 300 Cost of Goods Sold 180 Inventory - Shirts 180 Sale of 6 shirts costing $30 @ $55 each Incl GST