Transaction Processing and the Internal Control Process

1. Transaction Processing andthe Internal Control Process Chapter 4

2. Understand the nature of control exposures. Learning Objective 1

3. Controls and Exposures Controls are needed to reduce exposures. An exposure consists of the potential financial effect of an event multiplied by its probability of occurrence. Controls rarely affect the causes of exposures.

4. Deficient revenues Excessive costs Loss of assets Business interruption Statutory sanctions Inaccurate accounting Competitive disadvantages Fraud and embezzlement Common Exposures EXPOSURES

5. Fraud and White-Collar Crime What is white-collar crime? Grouping of illegal activities that are differentiated from other illegal activities in that they occur as part of the occupation of the offender. It often involves the entry of fictitious transactions into an accounting system.

6. Fraud and White-Collar Crime Basic Forms of Theft: Employee theft Employee-outsider theft Management fraud

7. Fraud and White-Collar Crime White-collar crime may result in fraudulent financial reporting. Corporate crimeis a white-collar crime that benefits a company or organization rather than the individuals who perpetrate the fraud.

8. Fraud and White-Collar Crime What is forensic accounting? Forensic accounting is one of several terms used to describe the activities of persons who are concerned with preventing and detecting fraud and white-collar crime.

9. Computer Processingand Exposures Computer processing can increase the risk and/or potential dollar loss of exposures. Mechanical processing of data Mechanical data storage Complexity of processing

10. Control Objectivesand Transaction Cycles Most organizations experience the same types of economic events. These events generate transactions that may be grouped according to four common cycles of business activity. What are these cycles?

11. Control Objectivesand Transaction Cycles Revenue cycle Expenditure cycle Production cycle Finance cycle

12. Control Objectivesand Transaction Cycles Control Objectives: Revenue Cycle Customers should be authorized in accordance with management’s criteria. Prices and terms of goods and services should be authorized in accordance with management’s criteria. All shipments of goods and services provided should result in a billing to the customer. Billings to customers should be accurately and promptly classified, summarized, and reported.

13. Control Objectivesand Transaction Cycles Control Objectives: Expenditure Cycle Vendors should be authorized in accordance with management’s criteria. Employees should be hired in accordance with management’s criteria. Access to personnel, payroll, and disbursement records should be permitted only in accordance with management’s criteria. Compensation rates and payroll deductions should be authorized in accordance with management’s criteria. Amounts due to vendors should be accurately and promptly classified, summarized, and reported.

14. Control Objectivesand Transaction Cycles Control Objectives: Production Cycle The production plan should be authorized in accordance with management’s criteria. Cost of goods manufactured should be accurately and promptly classified, summarized, and reported.

15. Control Objectivesand Transaction Cycles Control Objectives: Finance Cycle The amounts and timing of debt transactions should be authorized in accordance with management’s criteria. Access to cash and securities should be permitted only in accordance with management’s criteria.

16. Discuss the concept of the internal control process. Learning Objective 2

17. External Influences Concerningan Entity and Internal Control The Federal Foreign Corrupt Practices Act of 1977 (FCPA) is a specific legal requirement that concerns many organizations. It requires all companies who are subject to the Securities Exchange Act of 1934 to...

18. External Influences Concerningan Entity and Internal Control ...make and keep books, records, and accounts, which in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the issuer; devise and maintain a system of internal accounting controls sufficient to provide reasonable assurance that...

19. External Influences Concerningan Entity and Internal Control 1. transactions are executed in accordance with management’s authorization; 2. transactions are recorded as necessary; 3. access to assets is permitted only in accordance with management’s authorization; 4. the recorded accountability for assets is compared with the existing assets.

20. External Influences Concerningan Entity and Internal Control Sarbanes-Oxley Act – 2002 5-member Public Company Accounting Oversight Board Restrictions on nonaudit services Role of the audit committee

21. External Influences Concerningan Entity and Internal Control Sarbanes-Oxley Act – 2002 Conflicts of interest Corporate responsibility for financial reports Insider trades during pension fund blackout periods prohibited

22. External Influences Concerningan Entity and Internal Control Sarbanes-Oxley Act – 2002 Prohibition on personal loans to executives and directors Code of ethics Management assessment of internal controls

23. Components of the InternalControl Process An organization’s internal control process consists of five elements: 1. Control environment 2. Risk assessment 3. Control activities 4. Information and communication 5. Monitoring

24. Control Environment The first component of internal control is the control environment. Factors included in the control environment are as follows: Integrity and ethical values Commitment to competence

25. Control Environment Management philosophy and operating style Organizational structure Attention and direction provided by the board of directors and its committees Manner of assigning authority and responsibility Human resource policies and procedures

26. Control Environment What are other aspects of human resources and procedures? Segregation of duties Supervision Job rotation and forced vacation Dual control

27. Risk Assessment The second component of internal control is risk assessment. Risk assessment is the process of identifying, analyzing, and managing risks that affect the company’s objectives.

28. Control Activities The third component of internal control is control activities. These include accounting controls designed to provide reasonable assurance that the following control objectives are met:

29. Control Activities Segregation of duties Design and use of adequate documents and records Access to assets is permitted only in accordance with management’s authorization.

30. Control Activities Independent checks and reviews are made on the accountability of assets and performance. Information processing controls are applied to check the proper authorization, accuracy, and completeness of individual transactions.

31. Information and Communication The fourth component of internal control is information and communication. Information refers to the organization’s accounting system. Communication relates to providing a clear understanding regarding all policies and procedures relating to controls.

32. Information and Communication What is an audit trail? An audit trail is comprised of the documentary evidence of the various control techniques that a transaction was subject to during its processing.

33. Monitoring The fifth component of internal control is monitoring. It involves the ongoing process of assessing the quality of internal controls over time and taking corrective actions when necessary.

34. Identify general and application processing controls. Learning Objective 3

35. Transaction Processing Controls Transaction processing controls General controls Application controls

36. Transaction Processing Controls General Controls: The plan of data processing organization General operating procedures Equipment control features Equipment and data-access controls

37. Transaction Processing Controls Application Controls: Input Processing Output

38. Transaction Processing Controls Transaction Processing Controls: Preventative Detective Corrective

39. Discuss the behavioral assumptions inherent in traditional internal control practices. Learning Objective 4

40. Communicating the Objectivesof Internal Control The principal function of internal control is to influence the behavior of people in a business system.

41. Goals and Behavioral Patterns What are some of the goals of an information system? Productivity Reliability of information Safeguarding of assets

42. Goals and Behavioral Patterns What is collusion? It is agreement or conspiracy among two or more people to commit fraud. What factors may influence an individual’s behavior in a control system? Formal plan of organization and methods employed Groups and informal pressure

43. Describe the techniques used to analyze internal control systems. Learning Objective 5

44. Analysis of InternalControl Processes Internal control processes routinely collect information concerning the following: Fulfillment of duties Transfer of authority Approval Verification

45. Analytical Techniques The internal control questionnaire is a common analytical technique used in internal control analysis. Questionnaires are essentially checklists to ensure that a review does not omit an area of major importance.

46. Analytical Techniques What are other forms of analysis? Write-ups Flowcharts Application control matrix

47. End of Chapter 4