Internal Control

Chapter 9: Internal Control Overview

• Objective: Evaluate financial information for effective planning and management.
• Key concepts include applications of internal control principles over various business aspects: cash, inventory, non-current assets, accounts payable and accounts receivable.
• Understand limitations of internal control systems.

Nature and Importance of Internal Control

• Internal control ensures assets are safeguarded and operational efficiency is improved.
• Importance: Prevents fraud and inefficiencies in operating procedures.
• Components of internal control:
  • Safeguarding assets
  • Adhering to necessary laws and policies
  • Ensuring valid financial reports and records
  • Continuous improvement in effectiveness and efficiency.

Types of Internal Control

Administrative Control

• Purpose:
  • Reduce errors
  • Promote operational efficiency
  • Minimize waste.

Accounting Control

• Purpose:
  • Maximize efficiency
  • Safeguard assets
  • Ensure accuracy and authorization of transactions and records.

Internal Control Over Cash

• Ensures cash is secure and accounts for all transactions:
  • Segregation of duties (different employees for various tasks such as receiving and recording cash)
  • Use of secure, lockable containers for cash collection
  • Regularly change safe combinations if cash is kept in a safe
  • Count cash in private, secure areas
  • Daily or weekly banking based on cash volumes
  • Document cash transactions with receipts or controlled databases.

Internal Control Over Inventory

• Protects inventory from losses due to spoilage, theft, and mishandling:
  • Clothing retailer controls:
  • Shield fabric from sun damage
  • Use protective packaging
  • Lock display cabinets
  • Maintain guidelines for employee actions
  • Ice-cream manufacturer controls:
  • Rotate perishable items
  • Use sturdy shelves and secure refrigeration
  • Install security systems.

Managing and Controlling Inventory

• Inventory consists of raw materials, work in progress, and finished goods.
• Key issues to manage:
  • Awareness of trends and customer needs
  • Ordering and inventory replenishment
  • Managing selling prices according to competition
  • Prioritizing older stock for sale before new items.

Internal Control Over Non-Current Assets

• Protection and efficient use of non-current assets:
  • Maintain an asset register
  • Formal approval for new asset purchases
  • Secure storage of all assets
  • Utilize proper depreciation methods
  • Conduct regular security audits and maintain insurance.

Internal Control Over Accounts Payable

• Effective management to prevent missed payments:
  • Communicate with creditors promptly if payment issues arise
  • Forecast cash flow trends against due dates
  • Utilize automated systems for bill tracking and alerts.

Internal Control Of Accounts Receivable

• Consider credit policies and monitor collections:
  • Ensure timely billing and maintain records in order
  • Regularly reconcile accounts to identify delinquencies
  • Establish clear procedures for determining bad debts.

Considerations When Supplying Credit to Customers

• Benefits and risks of lending to customers:
  • Bad debts occur if customers fail to pay
  • Essential to evaluate customer credit history and collateral.

Limitations of Internal Control

• No system is infallible:
  1. Small staff sizes hinder separation of duties
  2. Human errors can occur, leaving systems vulnerable
  3. High costs of maintaining proper controls may lead to inadequate systems or recent changes becoming ineffective.

Key Terms

• Bad Debt: A receivable deemed uncollectible.
• Credit History: Past borrowing and repayment record.
• Internal Control: Methods to safeguard assets and ensure adherence to regulations and policies.