MINISTRY OF HIGHER EDUCATION INTERNATIONAL UNIVERSITY OF BAMENDA MOTTO: SERVICE TO MANKIND FOR THE GLORY OF GOD P. O.

BOX 444 BAMENDA, CAMEROUN COURSE TITLE: (340) ACCOUNTING SYSTEMS A TERM PAPER SUBMITTED BY OLALEYE JOHN OLATUNDE MATRICULATION NO: I. U. B./2008/2009/NIG/CO05 TO THE FACULTY OF BUSINESS ADMINISTRATION I .U. B. BAMENDA IN PARTIAL FULFILMENT OF THE REQUIREMENTS FOR THE AWARD OF DOCTORATE DEGREE (PhD ) IN ACCOUNTING SUPERVISED; BY PROF. ILIYA SARKI DONGS

AUGUST 2008

READERS REMARK:.... GRADE: .. TABLE OF CONTENT CHAPTER ONE: INTRODUCTION 1.1 Introduction - 1 1.2 Determining Information Needs 1 1.3 The Cost of Producing Accounting System 2 1.4 Basic Functions of an Accounting System 3 CHAPTER TWO: CHARACTERISTICS OF AN ACCOUNTING SYSTEM. 2.1 Introduction 4 2.2.1 Collection of Economic Data about each Transaction 5 2.2.2 Transaction Analysis 5 2.2.3 Journalising 6 2.2.4 Posting 6 2.3 Phases of the Accounting Information Processing Cycle Completed at the end of Accounting Period. 2.4 Unadjusted Trial Balance 7 2.5 The Accounting Worksheet 7 2.6 Worksheet Completed; Shows the Income Statement, Statement of Retained Earnings, and Balance Sheet. 8

7 -

2.7 9 2.8 CHAPTER

Audits of Financial Statements -

3.1 3.2 3.3 12 3.4 Recording Budgeted Amounts 14 3.5 Classifying and Storing the Recorded Data 14 3.5.1 Ledger Accounts 15 3.5.2 Database Systems 16 3.6 Comparison of Ledger Accounts to a Database 16 CHAPTER FOUR: THE ROLES OF BUSINESS DOCUMENTS 4.1 Introduction 18 4.2 Purchase Requisition 18 4.3 Purchase Orders 18 4.4 Invoices 22 4.5 Receiving Report 23 4.6 Invoice Approval 24 4.7 Debit and Credit Memoranda (Debit Memos, Credit 24 CHAPTER FIVE: INTERNAL CONTROL IN COMPUTER BASED SYSTEM 5.1 Introduction 26 5.2 Limitations of Internal Control 27 5.3 Prevention of fraud 28 5.4 Employee Fraud 29 5.5 Fidelity Bonds 30 5.6 Management Fraud 30 5.7 The Impact of Management Fraud 30 5.8 Protecting Society from management Fraud 32 CHAPTER SIX: INTERNAL CONTROL 6.1 Introduction 34 6.2 Components of Internal Control 34 6.3 The Control Environment -

The Nature of a Financial Audit. 10 THREE: RECORDING TRANSACTIONS, THE NEED FOR SPECIAL JOURNAL Introduction 11 On line, Real Time (OLRT) Systems Traditional periodic input and output

Memos)

11 -

34 6.4 Risk Assessment 35 6.5 Control Activities 35 6.6 Information and Communication 35 6.7 Monitoring 35 6.8 Guidelines for Achieving Strong Internal Control, Establish Clear Lines of Responsibility- 36 6.9 Establish Routine Procedures for processing each type of Transaction 36 6.10 Subdivision of Duties 37 6.11 Accounting Function Separate from Custody of Assets 38 6.12 Other Steps toward Achieving internal Control 38 6.12.1 Internal Auditing 39 6.12.2 Financial Forecasts 39 6.12.3 Competent Personnel 39 6.12.4 Rotation of Employee 40 6.12.5 Serially numbered Documents 40 List of tables Table 1. 21 Table 2. 22 Bibliography 41

CHAPTER ONE; ACCOUNTING SYSTEMS 1.1 Introduction An accounting system consists of the personnel, procedures, devices, and records used by an organization to (l) develop accounting information, and (2) communic ate this in formation to decision makers. The design and capabilities of these s ystems vary greatly, from one organization to the next. In very small businesses , the accounting system may consist of little more than a cash register, a chequ e book, and . In large businesses, an accounting system includes computers, high ly trained personnel, and accounting reports which affect the daily operations o f every department. But In every cast, the basic purpose of the accounting syste m remains the same: to meet the organizations needs for accounting information a s efficiently as possible.

Many factors affect the structure of the accounting system within a particular o rganization. Among the most important are (1) the companys needs for accounting i nformation, and (2) the resources available for operation of the system. 1.2 Determining Information Needs The types of accounting information that a company must develop vary with such f actors as the size of the organization, whether it is publicly owned, and the ph ilosophy of management the need for some types of accounting information may be prescribed by law For example, income tax regulations require every business to have an accounting system which can measure the company s taxable income and exp lain the nature and the company s income tax return. In Nigeria, Federal Inland Revenue laws require publicly owned and Private Liability Limited companies to prepare financial statements in conformity with accepted accounting principles. These statements must be filed with the Securities Exchange Commission, distribu ted to stockholders, and made available to the public. Other types of accounting information are required as matters of practical . For example, every business needs to know the amounts receivable from each customer and the amounts owed to each creditor. Although much accounting information clearly is essential to business open manag ement still have many choices as to the types and amount of accounting informati on to be developed. For example, should the accounting system of a departmental store measure separately the sales of each department and of different types of merchandise? The answer to such questions depends upon how useful management con siders the information to be, and also the cost of developing the information. 1.3 The Cost of Producing Accounting System Accounting systems should be cost effective that is, the value of the informatio n produced should exceed the cost of producing it. Management has no choice but to produce the types of accounting reports required by law. In other cases, howe ver, management may use cost effectiveness as the criterion for deciding whether or not to produce the information. In recent years, the development and installation of computer-based accounting s ystem has increased greatly the types and amount of accounting information which * be produced in a cost-effective manner. 1.4 Basic Functions of an Accounting System In developing information about the financial position of a business and its op erations, every accounting system performs the following basic functions;: 1. Interpret and record the effects of business transactions. 2. Classify the effects of similar transactions in a manner that permits determ ination of the various totals and subtotals useful to management and used in acc ounting reports. 3. Summarize and communicate the data contained in the system to decision maker s. The differences in accounting systems arise primarily in the manner and which th ese functions are performed.

CHAPTER TWO: CHARACTERISTICS OF AN ACCOUNTING SYSTEM 2.1 Introduction An accounting system, regardless of the size of a business, is designed to colle ct, process, and report periodic financial information about the entity. Financi al reports are prepared at the end of each reporting period, often called the ac counting period. For external reporting, the reporting period is one year, which may, or may not, be the calendar year (January 1 to December 31). Therefore, du ring each reporting period, the accounting system must systemat-ically collect a

nd process economic data about all of the transactions completed by the entity. This collecting and processing activity is called the accounting information pro cessing cycle. It is called a cycle because it must be repeated each accounting period for the new economic data. This processing cycle involves a series of sequ ential phases (steps), starting with the transactions and extending, in the acco unting system, through the accounting period and finally to the preparation of t he required financial statements income statement, balance sheet, and statement of changes in financial position. We will discuss the primary sequential phases in the information processing cycle in the order in which they usually are accom plished. The phases completed during the accounting period are summarized below.

2.2.1 Collection of economic data about each transaction This phase is a continuing activity that collects source documents (such as sale s invoices) from all of the transactions as they occur. The collection process i nvolves all operations of the entity and a large number of employees (including non accountants). Source documents provide data to be analyzed and recorded in t he accounting system. The source documents must be collected in a timely manner and must provide complete and accurate data about each transaction. 2.2.2 Transaction analysis This phase is an analysis of source documents to identify and measure the econom ic impact of each transaction on the entity in terms of the basic account-ing mo del: Assets = Liabilities + Owners Equity, and Debits = Credits. It requires de termination of the specific asset, liability, and owners equity accounts that sh ould be increased and/or decreased to properly reflect the economic consequences of each transaction. 2.2.3 Journalizing This phase involves recording by date the analysis of each transaction in the jo urnal in the Debits = Credits format. Thus, the economic impacts of each transac tion on the entity are recorded first in the journal in chronological order. 2.2.4 Posting This phase involves transferring the data in the journal to the ledger. The ledg er has separate accounts; one for each kind of asset, liability, and owners equ ity. Thus, posting to the ledger reorders the data from the chronological order in the journal to the classifications in the fundamental accounting model Assets = Liabilities + Owners Equity. The ledger is viewed as the basic accounting rec ord because it provides appropriately classified economic data about the entity that will be used to complete the remaining phases of the accounting information processing cycle (including preparation of the periodic financial statements)., 2.3 Phases of the Accounting Information Processing Cycle Completed at the End of the Accounting Period.

The specific procedures associated with the remaining phases are discussed in de tail in this section. 2.4 Unadjusted trial balance At the end of the accounting period, after all current transactions have been re corded in the journal (journalized) and then posted to the ledger; a listing of all ledger accounts and their balances is prepared. This listing is called the u nad-justed trial balance. This trial balance has two purposes: (a) it can be use d to check the two accounting equalitiesAssets = Liabilities + Owners Equity, an d Debits = Creditsand (b) it provides basic data needed to, prepare the financial statements. This trial balance is called unadjusted because it does not include the effects of the adjusting entries .

2.5 The accounting worksheet The worksheet is prepared before the financial statements are prepared and befo re the adjusting and closing entries are recorded. The completed worksheet provid es all of the data needed to complete the remaining end-of-period phases by brin ging together in one place, in an orderly way, the (1) unadjusted trial balance, (2) adjusting entries, (3) income statement, (4) statement of retained earnings , (5) balance sheet, and (6) the closing entries. 2.6 Worksheet completed; shows the income statement, statement of retained earni ngs, and balance sheet. The sequential steps used to develop the worksheet are: Set up the worksheet format by entering the appropriate column headings. The lef t column shows the account titles (taken directly from the ledger). There are si x separate pairs of debit-credit money columns. Notice that the last six debit-c redit columns show the data for the financial statements. Enter the unadjusted trial balance as of the end of the accounting period direct ly from the ledger into the first pair of debit-credit columns. When all of the current entries for the period, excluding the adjusting entries, have been recor ded in the journal and posted to the ledger, the amounts for the unadjusted tria l balance are the balances of the respective ledger accounts. Before going to th e next step, the equality of the debits and credits in the unadjusted trial bala nce should be tested. The second pair of debit-credit columns, headed "Adjusting Entries," is completed by developing and then entering the adjusting entries directly on the worksheet . The pair of debit-credit columns headed "Adjusted Trial Balance" is completed. A lthough not essential, this pair of columns helps to assure accuracy. The adjust ed trial balance is the line-by-line combined amounts of the unadjusted trial ba lance, plus or minus the amounts entered as adjusting entries in the second pair of columns. For those accounts that were not affected by the adjusting entries, the unadjusted trial balance amount is carried directly across to the Adjusted Trial Balance column. After each line has been completed, the equality of the de bits and credits under Adjusted Trial Balance is checked. The amount on each line, under Adjusted Trial Balance, is extended horizontally across the worksheet and entered (a) as a debit, if it is a debit under Adjusted Trial Balance, or as a credit, if it is a credit under Adjusted Trial Balance; and (b) under the financial statement heading (income statement, retained earning s, or balance sheet) on which it must be reported. 2.7 Audits of Financial Statements A financial audit an examination of a company s financial statements performed b y a firm of certified public accountants (CPAs) or Chartered Accountants. The pu rpose of this audit is to provide people outside the organization with an indepen dent expert s opinion as to whether the financial statements constitute a fair pr esentation. Auditors use the phrase "fair presentation" to describe financial sta tements which are complete, unbiased, and in conformity with generally accepted accounting principles. 2.8 The Nature of a Financial Audit The financial statements of a business are prepared by the company s management. An audit of these financial statements is intended to bridge the "credibility ga p" which otherwise might exist between the company s management and the users of these statements. For the auditors opinion to have credibility, however, the i ndependent auditors must (1) be independent of the company issuing the statement s and of its management, and (2) have a sound basis for their opinion. The concept of independence means that the auditors have no relationships with the company issuing the statements that might lessen the auditors ability to re nder an unbiased opinion. Auditors not only must be independent; they also must a ppear to be independent of the issuing company. Otherwise, the users of financial

statements may not have confidence in the auditors report. The term audit desc ribes the investigation which the auditors undertake to provide the sound basis for their opinion. As part of a financial statement audit, the CPAs consider and evaluate the inter nal control of the company issuing the statements. This evaluation gives them a "feel" for the accuracy and reliability of the information in the company s acco unting system.

CHAPTER THREE: RECORDING TRANSACTIONS, THE NEED FOR SPECIAL JOURNAL 3.1 Introduction A journal sometimes is called the "book of original entry" because it is the acc ounting records in which the effects of transactions are first recorded. Journa ls come in different forms. In fact, many journals are machines rather than shee ts of papers. The general journal is unique among journals because it can be used to type of b usiness transaction. The flexibility of a general journal makes it ideal for ter m paper illustrations. However, this flexibility also makes the general journal a relatively inefficient device for recording large numbers of routine transacti ons. Most businesses use various special journals to speed the recording of transact ions. These special journals include, for example, cash registers, in point-of-s ale terminals, and check-writing machines. For an accounting system to effectiv e, routine transactions must be recorded by clerical personnel or by machine pro fessional accountants. 3.2 On-Line, Real-Time (OLRT) Systems There normally is some delay the time a transaction occurs and the time that it s effects are posted into the control ledger accounts. In manual accounting syst ems and many computers based system sales transactions are not posted until the end of the day. Payroll data generally are recorded only at the end of each pay period. If accounting information is required at periodic intervals (such as mon th-end), these short delays may be of no consequence. In some cases, however, managers and employees need information that is up-to-da te. Bank tellers, for example, often need to know the current balance to a custo mer s bank account. Airline ticket salespeople need up-to-date information about the number of seats still available on specific flights. Sales clerks may need to know, how many units of a particular product are in stock. 3.3 Traditional periodic input and output

OLRT System Real time input and output

An on-line, real-time (OIRT) accounting system has the ability to keep certain a c-counting records completely current. As a practical matter, OLRT systems must he computer-based. The phrase "on-line" refers to input devices and output devic es with direct and immediate access to the computer-based records. "Real-time" means how, reflecting; the idea that the records are up-to-date. In an OLRT system, some types of transactions are recorded as they occur. Manage rs and employees then may use computer terminals to view up-to-date information, the diagram at the top of this page illustrates the traditional and OLRT approa ches to recording and receiving accounting information. The point-of-sale termin als used in many retail stores are examples of on-line input devices. When sales are recorded on these terminals, the general ledger and subsidiary ledger accou nts may be updated immediately. Thus, managers and employees may use computer te rminals to access up-to-date information about sales, inventories, and accounts receivable. (Notice that point-of-sale terminals are located on the sales floor, not the accounting department. If transactions are to be recorded as they occur , the input devices must be located where these transactions take place.) Even in a system with OLRT capabilities, not all accounting records are kept con tinuously depreciation expense, for example, is recorded only at the end of each accounting-period. Many other expenses, such as-utility bills, arc recorded onl y as bills "are (or as payment Is made).The accounting records which are kept c ontinuously up-to-date usually are limited to the general and subsidiary ledger a ccounts for cash, accounts receivable, inventory, accounts payable, and sales re venue. 3.4 Recording Budgeted Amounts Up to this point, we have discussed recording in the accounting system only the1 results of actual business transactions. Many businesses also enter into their ac counting system advance forecasts (or budgets) of the levels of activity expected in future periods. Often, separate budgets are developed for each department wi thin the business. As the actual results are recorded in the system, reports are prepared showing the differences between the forecasts and the actual results. These reports aid managers in evaluating departmental performance. 3.5 Classifying and Storing the Recorded Data Two methods of classifying and storing data in accounting systems are in widespr ead use: ledger accounts and computer databases. 3.5.1 Ledger Accounts In both manual and computer-based accounting systems, the effects of business tr ansactions are classified in terms of the company s chart of ledger accounts. A c hart of accounts is simply a listing of the ledger account titles used by the bus iness. In designing the ledger of a given business, questions arise as to the extent of detail needed in the chart of accounts. For example, should one ledger account be used for advertising expense, or should separate accounts be maintained for ne wspaper advertising, direct mail advertising, and television advertising? The extent of detail needed in the chart of accounts depends upon the types of i n-formation that management considers useful. The information appearing in finan cial statements and income tax returns is highly summarized; therefore, the prepa ration of these types of reports does not require a very detailed chart of accou nts. Management, however, usually finds more detailed accounting information usef ul in planning and controlling business operations. For example, management may w ant separate information about the revenue and expenses of each department withi n the business. The chart of revenue and expense accounts often is designed along lines of manag

erial responsibility. Thus, the chart of accounts may include separate revenue an d expenses for each department (or other area of managerial responsibility). Thi s responsibility accounting system provides top management with information usefu l in evaluating the performance of individual departments and of department manag ers. A general ledger with a great many accounts would quickly become unwieldy and di fficult to use. Therefore, the accounts showing a detailed breakdown of specific assets, liabilities, revenue, and expenses usually are placed in a subsidiary l edger. Only the related controlling account appears in the general ledger. 3.5.2 Database Systems A database provides greater flexibility in the classification of data than even the most detailed chart of ledger accounts. When transaction data are stored in a database, they may be sorted according to a variety of criteria. A database consists of unclassified data, which have not yet been grouped into c ategories. However, the data are accompanied by various classification codes. Eac h of these codes enables the computer quickly to classify (or "sort") the data a ccording to different characteristicsor combinations of characteristics. 3.6 Comparison of Ledger Accounts to a Database In a ledger-based system, the effects of transactions are classified in terms of specific ledger accounts at the time transactions are recorded. In a database, the effects of transactions are stored in an unclassified format, but are "coded" so that the computer can sort through the data and find the items that meet var ious criteria. Thus, data are classified as necessary to meet requests for speci fic types of accounting records and reports. The basic differences between a led ger account system and a database are illustrated below. It is important to recognize that a database is not a substitute for a ledger. R ather, databases are used to provide management and employees with additional inf ormation about certain types of transactions. Ledger Account System

Database System

CHAPTER FOUR; THE ROLES OF BUSINESS DOCUMENTS 4.1 Introduction We have made the point that strong internal control requires subdivision of duti es among the departments of the business, how does each department know that the other departments have fulfilled their responsibilities? The answer lies in the use of carefully designed business documents. Some of the more important business

documents used in controlling purchases of merchandise is summarized on the foll owing page. 4.2 Purchase Requisition A purchase requisition is a request from the sales department or stores departmen t (warehousing) for the purchasing department to order merchandise. Thus, the pu rchasing department is not authorized to order goods unless it has first receive d purchase requisition. A copy of the purchase requisition is sent to the accou nting department, 4.3 Purchase Orders Once a purchase requisition has been received, the purchasing department determin es the lowest-cost supplier of the merchandise and places an order. This order i s documented in a purchase order. A purchase order Issued by Fairway Pro Shop to Adams Manufacturing Company is illustrated below: Several copies of .a purchase order are usually prepared. The original is sent t o the supplier; it constitutes an authorization to deliver the merchandise and t o submit a bill based on the prices listed. A second copy is sent to the departm ent that initiated the purchase requisition to show that the requisition has bee n acted upon. Another copy is sent to the accounting department of the buying co mpany. The issuance of a purchase order does not call for any entries in the ac counting records of either the "prospective buyer or seller. The company which r eceives an order 4.4 Business Document Initiated by Sent to Purchase requisition Departmental sales Original to purchasing Issued when quantity managers or stores department; copy to of goods on hand falls department accounting depar tment below established reorder point Purchase order Issued when order is Purchasing Original to sell ing placed; indicates type, department company (vendor, quantities, and prices supplier); copie s to of merchandise ordered department requi sitioning goods and the accounting department Invoice Confirms that goods Seller (supplier) Accounting depar tment have been shipped and of buying compan y requests payment Receiving report Based on count and Receiving: Original to acco unting inspection of goods department of department; copies to received buying company purchasing depar tment and to department requisit ioning goods Invoice approval form Based upon the Accounting Finance departme nt, to documents listed department of support issuance

of above; authorizes to payment of the. ng department purchase invoice opy of the check

buying company

check; returned accounti with a c

PLEASE ENTER OUR ORDER FOR THE FOLLOWING: QUANTITY DESCRIPTION PRICE TOTAL 15 sets 50 dozen Model S irons X3Y Shur-par golf balls N120.00 14.00 N1,800.00 700.00 N2,500.00 FAIRWAY PRO SHOP BY: Dr. Dangana does not consider that a sale has been made until the merchandise is delivered. At that point ownership of the goods changes, and both buyer and seller should m ake accounting entries to record the transaction. 4.4 Invoices When a manufacturer or wholesaler receives an order for its products, it takes t wo actions. One is to ship the goods to the customer and the other is to send th e customer an Invoice. By the act of shipping the merchandise, the seller is giv ing up ownership of one type of asset, inventory; by issuing the invoice, the sel ler is recording ownership of another form of asset, an account receivable. An invoice contains a description of the goods being sold, the quantities, price s, credit terms, and method of shipment. The illustration below shows an invoice issued by Adams Manufacturing Company in response to the previously illustrated purchase order from Fairway Pro Shop

Table 2 INVOICE ADAMS MANUFACTURING COMPANY 19 UNION STREET BAUCHI CITY, NIGERIA

INVOICE NO. 782

Table 1 PURCHASE ORDER FAIRWAY PRO SHOP 10 Fairway Avenue, Sabo Kano TO: Adams Manufacturing Company 19 Union Street___________ Bauchi City, Nigeria

DATE November 10, 2007 SHIP VIA Jones Truck Co. TERMS 2/10, n/30

SOLD TO: Fairway Pro Shop 10 Fairway Avenue Sabo Kano Nigeria. SHIPPED TO: SAME TERMS 2/10, n/30 QUANTITY DESCRIPTION PRICE TOTAL 15 sets 50 dozen Model S irons X3YShur-Par golf balls N120.00 14.00 N1,800.00

INVOICE DATE Nov, 15. 2007_ YOUR PURCHASE ORDER NO. 999_ DATE SHIPPED November 15,07_ SHIPPED VIA Jones Thick Co.

700.00

N2,500.00 From the viewpoint of the seller, an invoice Is a stiles Invoice; from the buyer s viewpoint it is a purchase invoice. The invoice is the basis for an entry in t he accounting records of both the seller and the buyer because it evidences the transfer of ownership of goods. At the time of issuing the invoice, the selling company makes an entry debiting Accounts Receivable and crediting Sales. The buy ing company, however, does not record the invoice as a liability until the invoic e has been approved for payment. 4.5 Receiving Report Evidence that the merchandise has been received in good condition is obtained fro m the receiving department. The receiving department receives all incoming goods , inspects them as to quality and condition, and determines the quantities receiv ed by counting, measuring, or weighing. The receiving department then pre-pares a serially numbered report for each shipment received; one copy of this receivin g report is sent to the accounting department for use in approving the invoice f or payment. 4.6 Invoice Approval Form The approval of the invoice in the accounting department is accomplished by compa ring the purchase requisition, the purchase order, the invoice, and the receivin g report. Comparison of these documents establishes that the merchandise describ ed in the invoice was actually ordered, has been received In good condition, and was billed at the prices specified in the purchase order. The person who performs these comparisons then records the liability (debit inve ntory, credit Accounts Payable) and signs an invoice approval form authorizing p ayment of the invoice by the finance department. 4.7 Debit and Credit Memoranda (Debit Memos, Credit Memos) Merchandise purchased on account is unsatisfactory and is to be returned to the supplier (or if a price reduction is agreed upon), a debit memorandum may be prep ared by the purchasing company and sent to the supplier. The debit memorandum in forms the supplier that the buyer has debited (reduced) its liability to the sup plier and explains the circumstances. Upon being informed of the return of damaged merchandise (or having agreed to re duction in price) the seller will send the buyer a credit memorandum indicating

that the account receivable from the buyer has been credited (reduced). Notice that issuing a credit memorandum has the same effect upon a customer s ac count as does receiving payment from the customer that is, the account receivabl e is credited (reduced). Thus, an employee with authority to issue credit memora nda should not he allowed to handle cash receipts from customers. If both of the se duties were assigned to the same employee, that person could abstract some of the cash collected from customers and conceal this theft by issuing fictitious c redit memoranda.

CHAPTER FIVE: INTERNAL CONTROL IN COMPUTER BASED SYSTEM 5.1 Introduction Computers do not eliminate the need for internal control. In fact, most recent c ases of large-scale fraud have occurred in companies with computer-based account ing systems. An outside computer consultant for a major bank once used the bank s computer sy stem to transfer =N=10 million of the bank s money into his personal account at a nother bank. The consultant s knowledge of the bank s computer system enabled hi m to commit this fraud. He had observed how bank employees used the computer to m ake legitimate transfers of funds. In addition, he had noticed that the "secret" computer codes used in these transfers were, posted on the wall next to the comp uter terminal. Despite the preceding Case in Point, computer-based accounting systems lend them selves well to the implementation of internal control procedures. One such proce dure is the use of access codes, or passwords, which limit access to the account ing system to authorized users. Access controls also identify the user responsibl e for each entry. (Obviously, these access codes should not be posted on the wal l.) In fact, computer-based accounting systems create many opportunities for impleme nting internal control procedures which might not be practical in a manual accou nting system. When on line terminals are used to record credit sales, the salesperson enters t he customers credit cash number into the system. The computer then determines whe ther the proposed sales transaction will cause the customer s account balance to exceed any predetermined credit limit. Also, the computer compares the custome r s card number with a list of credit cards reported lost or stolen. If either o f these procedures indicates, that credit should not be extended to this custome r, the computer immediately notifies the salesperson not to make the sale. 5.2 Limitations of Internal Control Although internal control is highly effective in increasing the reliability of a ccounting data and in safeguarding assets, it does not provide complete protecti

on against fraud, theft, or errors. For example, controls based upon a subdivisi on of duties may be defeated at least temporarily by collusion among two or more employees. Carelessness also may cause a breakdown in internal control. In designing a system of internal control, the question of cost cannot be ignore d. A system of internal control should be cost effective. A system which is too elaborate may entail greater expense than is justified by the protection gained. Internal control is more difficult to achieve in a small business than in a larg e one. In a business with only a few employees, it may not be possible to arrang e an adequate subdivision of duties. Also, such internal control features as an internal audit staff simply may not be practical. An essential element of maintaining a reasonable degree of internal control in a small business is active participation by the owner in strategic control proced ures. For example, the owner of small business often is the only person authoriz ed to sign checks. The owner also may count the cash receipts at the end of each business day, and assume responsibility for depositing these receipts in to the bank. In summary, the system of Internal control like an accounting system should he t ailored to meet the specific needs of the organization. 5.3 Prevention of Fraud Perhaps-the-most highly-publicized objective of internal control is the preventi on of fraud. Fraud may be defined as the deliberate misrepresentation of facts w ith the intent of deceiving someone. If the purpose of this deception is persona l gain or causing harm to another, fraud may be a criminal act. In discussing th e role of the internal control in preventing acts of fraud, it is useful to dist inguish between errors in the accounting records and irregularities. Accountants use the term errors to refer unintentional mistakes. Irregularities, on the other hand, refer to intentional mistakes, entered into accounting recor ds or accounting reports for some fraudulent purpose. Irregularities may be furt her subdivided into the classifications of employee fraud and management fraud. 5.4 Employee Fraud Employee fraud refers to dishonest acts performed against the- company by its em ployees. Examples of employee fraud include theft of assets, charging lower sale s prices to favored customers, receiving kickbacks from suppliers, overstating h ours worked, padding expense accounts, and embezzlement. (Embezzlement is a theft of assets which is concealed by falsification of the accounting records.) If one employee handles all aspects of a transaction, the danger of employee fra ud increases. Studies of fraud cases suggest that individuals may be tempted int o dishonest acts if given complete control, of company property. Most of these p ersons, however, would not engage in fraud if doing so required collaboration wi th other employees. Thus, subdivision of duties is believed to reduce the risk o f employee fraud. In addition to subdivision of duties, the risk of employee fraud is reduced by s uch control procedures as investigating the backgrounds of job applicants, perio dic rotation of employees to different job assignments, and frequent comparisons of assets actually on hand with the quantities shown in the accounting records. 5.5 Fidelity Bonds. No system of internal-control can provide absolute protection against losses fro m dishonest employees. Therefore, many companies require that employees handling cash or other negotiable assets be bonded. A fidelity bond is a type of insuranc e contract in which the bonding company agrees to reimburse an employer up to ag reed naira limits for losses caused by fraud or embezzlement by bonded employees . 5.6 Management Fraud Management fraud refers to deliberate misrepresentations made by the top managem ent of a business to persons outside of the business organization. This type of

fraud often involves the issuance of fraudulent financial statements intended to mislead investors and creditors. 5.7 The Impact Of Management Fraud Management fraud differs from employee fraud because top management is a willing participant in the fraudulent acts. A characteristic of management fraud is that management uses its position of trust and authority to override the system of in ternal control and to enrich itself at the expense of the company and/or outside rs. The persons most often injured by management fraud are investors and creditor s. However, the company s employees and customers and the general public also may be harmed severely. The basic purpose of accounting is to aid decision makers in allocating and usin g economic resources efficiently. Cases of management fraud are far more destruc tive to this basic purpose than are most cases of, employee fraud. The damage ca used by employee fraud usually is limited to relatively small losses incurred by a specific company. Of course, these losses may be passed on to the company s cu stomers in the form of higher prices. Seldom, however, does employee fraud force a business into bankruptcy or affect the efficient allocation of resources thr oughout the economy. When the financial statements of large companies are altered to mislead investor s and creditors, however, the resulting losses may be enormous. In addition, the misallocation of economic resources may be so great as to affect the national e conomy. Management fraud is not commonplace in bur society. The managers and directors o f most large business organizations are people of indisputable integrity. Howeve r, even a few isolated instances of management fraud can severely damaged the ec onomy. When ever a large publicly owned company engages in fraud, investors, cre ditors, and the public tends to lose confidence in the business community and th e financial reporting process. This loss of confidence may create doubts and reservations which impede the effi cient allocation of investment capital for many years. 5.8 Protecting Society from Management Fraud Internal controls are not generally designed to protect outside decision makers from the possibility of management fraud. Internal controls are designed to assu re management that the companys objectives are being met, including the generatio n of reliable financial information. However, top management may be able to over ride internal controls when it comes to reporting to individuals outside the org anization. One effective internal control over top management is active particip ation in the business by the companys board of directors specifically to over see the external financial reporting process of the company. In addition, an effect ive internal auditing department helps to prevent and detect management fraud, e specially when it has direct access to the board of directors or its audit commi ttee. To engage in large scale fraud, management generally must get lower level employ ees to go along with the scheme, often by intimidation. Specially, many people in the companys accounting department may become aware of a large scale fraud. Presu mably, some of these people would refuse to participate in the fraud and would b low whistle on a dishonest management. Finally, financial audits by certified public accountants help to prevent and de tect fraudulent financial statements before they are used by outside decision ma kers.

CHAPTER SIX: INTERNAL CONTROL 6.1 Introduction The need for internal control is common to all organizations. The term internal control refers to all measures taken by management to ensure that the organizati

on (1) operates efficiently and effectively, (2) produces reliable financial inf ormation, and (3) complies with applicable laws and regulations. In short, inter nal control consists of those measures designed to keep the business operating "o n track." Collectively, the internal control procedures in place within a given organization are described as the internal control structure, or the system of i nternal control. 6.2 Components of Internal Control The accounting profession recently has published an in-depth study of internal c ontrol structures, called Internal ControlIntegrated Framework. This framework de scribes five basic components of internal control. . 6.3 The control environment, Consisting of management s philosophy, style, and ethical values, and also, inc luding the manner in which these concepts are communicated, throughout the organ ization. 6.4. Risk assessment, Risk assessment involving the means by which a business identifies and manages t he risks that threaten that type of organization. For example, if changes in Int erest rates can significantly affect the profits of a business, the organization should take steps to anticipate changes in rates and minimize the losses that m ight result. 6.5 Control activities , meaning the policies and procedures established to ensure that management s dir ectives are being followed. Periodic performance reviews of departments and of k ey personnel are examples of control activities. 6.6 Information and communication The means by which the organization identifies, records, and communicates inform ation to decision makers. In large part, information and communication is handled by the accounting system. 6.7 Monitoring, Which describes the procedures employed to determine that the internal control s tructure is working effectively? Internal auditing is an example of a monitoring procedure. Virtually every organizationsmall or largeneeds to establish control procedures in each of these areas. The nature of these procedures, however, varies greatly fr om one organization to the next. Internal control is not an "end in itself." Lik e an accounting system, an internal control structure should be cost effectivethat is, the procedures employed to achieve internal control should never cost more t han the benefits derive 6.8 Guidelines for Achieving Strong Internal Control Establish Clear Lines of Re sponsibility Every organization should indicate clearly the persons or departments responsible for such functions as sales, purchasing, receiving incoming shipments, paying bi lls, and maintaining accounting records. The lines of authority and responsibili ty can be shown in an organization chart. The organization chart should be suppo rted by written job descriptions and by proce-dures manuals that explain in deta il the authority and responsibilities of each person or department appearing in the chart. 6.9 Establish Routine Procedures for Processing Each Type Of Transaction If management is to direct the activities of a business according to plan, every transaction should go through four separate steps: It should be authorized, app roved, executed, and recorded. For example, consider the sale of merchandise on

credit. Top management has the authority and responsibility to authorize credit sales to categories of customers who meet certain standards. The credit departmen t is responsible for approving a credit sale of a given dollar amount to a parti cular customer. The transaction is executed by the shipping department, which shi ps or delivers the merchandise to the customer. Finally, the transaction is reco rded in the accounting department by an entry debiting Accounts Receivable and c rediting Sales. 6.10 Subdivision of Duties Perhaps the most important concept in achieving internal control is an appropriat e subdivisionor separationof duties. Responsibilities should be assigned so that n o one person or department handles a transaction completely from beginning to en d. When duties are divided in this manner, the work of one employee serves to ver ify that of another and any errors which occur tend to be detected promptly. To illustrate this concept, let us review the typical procedures followed by a w holesaler in processing a credit sale. The sales department of the company is res ponsible for securing the order from the customer; the credit department must ap prove the customer s credit before the order is filled; the stock room assembles the goods ordered; the shipping department packs and ships the goods; the billin g department prepares the sales invoice; and the accounting department records t he transaction. Each department receives written evidence of the action by the other departments and reviews the documents describing the transaction to see that the actions ta ken correspond in all details. The shipping department, for instance, does not re lease the merchandise until after the credit department has approved the customer as a credit risk. The accounting department does not record the sale until it h as received documentary evidence that (1) an order was received from a customer, (2) the extension of credit was approved, (3) the merchandise was shipped to th e customer, and (4) a sales invoice was prepared and mailed to the customer. 6.11 Accounting Function Separate from Custody of Assets Basic to the separation of duties is the concept that an employee who has custod y of an asset (or access to an asset) should not maintain the accounting record f or that asset. If one person has custody of assets and also maintains the accoun ting records, there is both opportunity and incentive to falsify the records to conceal a shortage. However, the person with custody of the asset will, not be i nclined to waste it, steal it, or give it away if he or she is aware that- anoth er employee is maintaining a record of the asset. 6.12 Other Steps toward Achieving Internal Control Other important internal control measures include the following: 6.12.1 Internal auditing. Virtually every large organization has an internal auditing staff. The objective s of the internal auditors are to monitor and improve the system of internal control. Int ernal auditors test and evaluate internal controls in all areas of the organization and prepare reports to top management on their findings and recommendations. Much wo rk of internal auditors may be described as operational and compliance auditing. 6.12.2 Financial forecasts, A plan of operations is prepared each year setting goals for each division of t he business, as, for example, the expected volume of sales, amounts of expenses, and future cash balances. Actual results are compared with forecasted amounts m onth by month; this comparison strengthens control because variations from plann ed results are investigated promptly. 6.12.3. Competent personnel Even the best-designed system of internal control will not work well unless the people using it are competent. Competence and integrity of employees are in part developed through training programs, but they also are related to the policies f

or selection of personnel and to the adequacy of supervision: 6.12.4 Rotation of employee The rotation of employees from one job assignment to another may strengthen inte rnal control. When employees know that another, person will soon be taking over their duties, they are more likely to maintain records with care and to follow e stablished procedures. The rotation of employees also may bring to light errors or Irregularities caused by the employee formerly performing a given task. 6 .12.5 Serially numbered documents. Documents such as checks, purchase orders, and sales invoices should be serially numbered. If a document is misplaced or concealed, the break in the sequence of numbers will call attention to the missing item.

Bibliography Alan Pizzey (2001) Accounting and Finance .A firm Foundation Chritopher S Ola (2001) Accounting for Inflation in Nigeria Generally Accepted Accounting Principles (GAAP) U.S. Generally Accepted Accounting Principles (GAAP) Nigeria Financial Accounting Standard Board Statement No.52 Harry Johnson and Austin.Whtram (1982); A Practical Foundation in Accounting London 1st edition Horby; A. S (1970) Oxford Advance Learners Dictionary of Current English E.I.B.S. Joe B. Hoyle Thomas R. Schaffer Timothy S. Daipinik (2001) Advanced Accounting 6th Edition John J Wild (2003) Financial Accounting (2003) 2nd edition Penne Ainsworth, Dan Dennis, R. David plume Lathy L Larson (1997) Introduction to Accounting Richard D. Irwin (1973) Financial Statement, Form and Analysis and Interpretatio n, inc. USA sixth edition Robert Libby Patricia Libby. Daniel C Short (1998) Financial Accounting

Stephen A. Ross & Co (1996) Essential of Corporate Finance Suk H. kim, Seung H. kim (1996) 3rd edition Global corporate Finance The International Accounting Standards Committee (IASC) 1973 Tim Connolly and Garry Asworth, Managing Customers for Profit. The Nigerian Acco untant October/ December (1995) The Wall Street journal for Wednesday February, 2000