Transaction Processing and the Internal Control Process Chapter

Transaction Processing and the Internal Control Process Chapter 4 2004 Prentice Hall Business Publishing, Accounting Information Systems, 9/e, by Bodnar/Hopwood 4– 1

Learning Objective 1 Understand the nature of control exposures. 2004 Prentice Hall Business Publishing, Accounting Information Systems, 9/e, by Bodnar/Hopwood 2

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. 2004 Prentice Hall Business Publishing, Accounting Information Systems, 9/e, by Bodnar/Hopwood 3

Common Exposures Excessive costs Business interruption Inaccurate accounting Deficient revenues EXPOSURES Fraud and embezzlement Loss of assets Statutory sanctions Competitive disadvantages 2004 Prentice Hall Business Publishing, Accounting Information Systems, 9/e, by Bodnar/Hopwood 4

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. 2004 Prentice Hall Business Publishing, Accounting Information Systems, 9/e, by Bodnar/Hopwood 5

Fraud and White-Collar Crime Employee theft Employee-outsider theft Management fraud 2004 Prentice Hall Business Publishing, Accounting Information Systems, 9/e, by Bodnar/Hopwood 6

Fraud and White-Collar Crime White-collar crime may result in fraudulent financial reporting. Corporate crime is a white-collar crime that benefits a company or organization rather than the individuals who perpetrate the fraud. 2004 Prentice Hall Business Publishing, Accounting Information Systems, 9/e, by Bodnar/Hopwood 7

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. 2004 Prentice Hall Business Publishing, Accounting Information Systems, 9/e, by Bodnar/Hopwood 8

Computer Processing and Exposures Computer processing can increase the risk and/or potential dollar loss of exposures. Mechanical processing of data Mechanical data storage Complexity of processing 2004 Prentice Hall Business Publishing, Accounting Information Systems, 9/e, by Bodnar/Hopwood 9

Control Objectives and 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. 2004 Prentice Hall Business Publishing, Accounting Information Systems, 9/e, by Bodnar/Hopwood 10

Control Objectives and Transaction Cycles Revenue cycle Expenditure cycle Production cycle Finance cycle 2004 Prentice Hall Business Publishing, Accounting Information Systems, 9/e, by Bodnar/Hopwood 11

Control Objectives and Transaction Cycles 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. 2004 Prentice Hall Business Publishing, Accounting Information Systems, 9/e, by Bodnar/Hopwood 12

Control Objectives and Transaction Cycles 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. 2004 Prentice Hall Business Publishing, Accounting Information Systems, 9/e, by Bodnar/Hopwood 13

Control Objectives and Transaction Cycles 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. 2004 Prentice Hall Business Publishing, Accounting Information Systems, 9/e, by Bodnar/Hopwood 14

Control Objectives and Transaction Cycles 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. 2004 Prentice Hall Business Publishing, Accounting Information Systems, 9/e, by Bodnar/Hopwood 15

Learning Objective 2 Discuss the concept of the internal control process. 2004 Prentice Hall Business Publishing, Accounting Information Systems, 9/e, by Bodnar/Hopwood 16

External Influences Concerning an 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. . . 2004 Prentice Hall Business Publishing, Accounting Information Systems, 9/e, by Bodnar/Hopwood 17

External Influences Concerning an 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. . . 2004 Prentice Hall Business Publishing, Accounting Information Systems, 9/e, by Bodnar/Hopwood 18

External Influences Concerning an 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. 2004 Prentice Hall Business Publishing, Accounting Information Systems, 9/e, by Bodnar/Hopwood 19

External Influences Concerning an Entity and Internal Control 5 -member Public Company Accounting Oversight Board Restrictions on nonaudit services Role of the audit committee 2004 Prentice Hall Business Publishing, Accounting Information Systems, 9/e, by Bodnar/Hopwood 20

External Influences Concerning an Entity and Internal Control Conflicts of interest Corporate responsibility for financial reports Insider trades during pension fund blackout periods prohibited 2004 Prentice Hall Business Publishing, Accounting Information Systems, 9/e, by Bodnar/Hopwood 21

External Influences Concerning an Entity and Internal Control Prohibition on personal loans to executives and directors Code of ethics Management assessment of internal controls 2004 Prentice Hall Business Publishing, Accounting Information Systems, 9/e, by Bodnar/Hopwood 22

Components of the Internal Control 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 2004 Prentice Hall Business Publishing, Accounting Information Systems, 9/e, by Bodnar/Hopwood 23

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 2004 Prentice Hall Business Publishing, Accounting Information Systems, 9/e, by Bodnar/Hopwood 24

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 2004 Prentice Hall Business Publishing, Accounting Information Systems, 9/e, by Bodnar/Hopwood 25

Control Environment What are other aspects of human resources and procedures? Segregation of duties Supervision Job rotation and forced vacation Dual control 2004 Prentice Hall Business Publishing, Accounting Information Systems, 9/e, by Bodnar/Hopwood 26

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. 2004 Prentice Hall Business Publishing, Accounting Information Systems, 9/e, by Bodnar/Hopwood 27

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: 2004 Prentice Hall Business Publishing, Accounting Information Systems, 9/e, by Bodnar/Hopwood 28

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. 2004 Prentice Hall Business Publishing, Accounting Information Systems, 9/e, by Bodnar/Hopwood 29

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. 2004 Prentice Hall Business Publishing, Accounting Information Systems, 9/e, by Bodnar/Hopwood 30

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. 2004 Prentice Hall Business Publishing, Accounting Information Systems, 9/e, by Bodnar/Hopwood 31

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. 2004 Prentice Hall Business Publishing, Accounting Information Systems, 9/e, by Bodnar/Hopwood 32

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. 2004 Prentice Hall Business Publishing, Accounting Information Systems, 9/e, by Bodnar/Hopwood 33

Learning Objective 3 Identify general and application processing controls. 2004 Prentice Hall Business Publishing, Accounting Information Systems, 9/e, by Bodnar/Hopwood 34

Transaction Processing Controls Transaction processing controls General controls Application controls 2004 Prentice Hall Business Publishing, Accounting Information Systems, 9/e, by Bodnar/Hopwood 35

Transaction Processing Controls The plan of data processing organization General operating procedures Equipment control features Equipment and data-access controls 2004 Prentice Hall Business Publishing, Accounting Information Systems, 9/e, by Bodnar/Hopwood 36

Transaction Processing Controls Input Processing Output 2004 Prentice Hall Business Publishing, Accounting Information Systems, 9/e, by Bodnar/Hopwood 37

Transaction Processing Controls Preventative Detective Corrective 2004 Prentice Hall Business Publishing, Accounting Information Systems, 9/e, by Bodnar/Hopwood 38

Learning Objective 4 Discuss the behavioral assumptions inherent in traditional internal control practices. 2004 Prentice Hall Business Publishing, Accounting Information Systems, 9/e, by Bodnar/Hopwood 39

Communicating the Objectives of Internal Control The principal function of internal control is to influence the behavior of people in a business system. 2004 Prentice Hall Business Publishing, Accounting Information Systems, 9/e, by Bodnar/Hopwood 40

Goals and Behavioral Patterns What are some of the goals of an information system? Productivity Reliability of information Safeguarding of assets 2004 Prentice Hall Business Publishing, Accounting Information Systems, 9/e, by Bodnar/Hopwood 41

Goals and Behavioral Patterns 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 2004 Prentice Hall Business Publishing, Accounting Information Systems, 9/e, by Bodnar/Hopwood 42

Learning Objective 5 Describe the techniques used to analyze internal control systems. 2004 Prentice Hall Business Publishing, Accounting Information Systems, 9/e, by Bodnar/Hopwood 43

Analysis of Internal Control Processes Internal control processes routinely collect information concerning the following: Fulfillment of duties Transfer of authority Approval Verification 2004 Prentice Hall Business Publishing, Accounting Information Systems, 9/e, by Bodnar/Hopwood 44

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. 2004 Prentice Hall Business Publishing, Accounting Information Systems, 9/e, by Bodnar/Hopwood 45

Analytical Techniques What are other forms of analysis? Write-ups Flowcharts Application control matrix 2004 Prentice Hall Business Publishing, Accounting Information Systems, 9/e, by Bodnar/Hopwood 46

End of Chapter 4 2004 Prentice Hall Business Publishing, Accounting Information Systems, 9/e, by Bodnar/Hopwood 4 – 47