Internal Controls Proposal

4 April 2017

Consulting Firm Inc. has been hired to review Auto Parts Inc. company functions. The consulting firm reviewed the cash, sales, accounts receivable, inventory and production functions. Based on this review, the consulting firm has prepared a proposal of internal controls for each function of the company. This proposal will give a background of each function and a list of the proposed internal controls. Cash Auto Parts Inc. manufactures and sells auto parts to car dealerships as well as the general public. Cash receipts come in the form of credit card, electronic payments, cash and check.

Very little cash or check is received through the mail however there may be one or two orders through the mail. The company receives cash at their store location from customers and electronic payments from the dealerships on a daily basis. The sales department is responsible for sales to the dealerships. Cash is not received at the manufacturing plant. However there is a petty cash fund at the plant for incidentals. Cash disbursements are made to purchase supplies and inventory and for daily operations of the plant and store.

In order to prevent errors and fraud, the following controls have been proposed for the cash receipt and disbursement process. Cash Receipts 7 When cash/checks are received in the mail, two people should open the mail. 8 All checks should be endorsed immediately. 9 A list of the cash receipts should be prepared immediately. 10 All cash/checks will go to the cashier’s office where the deposit slip is prepared. 11 Deposits are made daily by 2pm. Any cash receipts that come in after that time is kept in a locked safe until the next day. The supervisor and the lead cashier are the only persons with the key. 2 The list of the cash receipts and remittances will be sent to accounting to be recorded. 13 For receipts at the cash register, the drawer will be counted at the beginning of the cashier’s shift and again at the end. There will be $100 kept on hand in the drawer for change. 14 The lead cashier or supervisor must be present when the drawer is counted. The cashier will complete the form detailing how much cash, credit card and checks are received. This should be compared to the register tape. Both the cashier and supervisor must sign off on the form. 15 At the end of the day, once the drawer is ounted, all cash is locked into the safe until the next day when the deposit will be prepared and sent to the bank. 16 Once the deposit is made, a copy of the slip from the bank should be compared to the cash receipt and remittance list and the general ledger by accounting to ensure all of the receipts were deposited. 17 Bank reconciliations shall be prepared monthly by an employee who does not perform any of the other above functions and reviewed and approved by the supervisor. This should be prepared no later than five days after the bank statement is received for the month. 8 All electronic payments received from dealership orders must be compared to the customer accounts each month once the bank statement is received. 19 All persons handling cash should be bonded. Cash Disbursements 20 Cash disbursements must be authorized by the supervisor in accounts payable. 21 There must be an approved purchase order, invoice and receiving report before payment can be authorized. 22 Payments over $10,000 must have two signatures from persons in the cash disbursement office that are authorized by the board of directors. 3 Pre-numbered blank checks will be locked up in a file cabinet in which only the authorized signers have access to it. 24 The accountant will record journal entries for all cash disbursements. 25 Invoices shall be marked paid to prevent double payment. 26 Bank reconciliations will be performed no later than five days after the bank statement is received for the month and reviewed and approved by the supervisor. 27 For the petty cash fund, any disbursements from this fund must be approved by the manufacturing plant supervisor. The money shall be locked in a safe. 8 Employees who use petty cash must turn in all receipts. 29 There will be no more than $1000 kept for petty cash at the plant. Sales Sales are the driving force of a business and must be accurate and reliable for the company to succeed. The sales cycle starts with a customer request for parts and sets in motion a sequence of procedures in which internal controls are necessary to provide accurate information for the financial statements. The controls include separation of duties, proper authorization, adequate and pre-numbered documents, monthly statements, and internal verification.

The following controls are suggested for sales: 30 Upon receiving a customer order the sales person will search the database for the correct customer number which will pre-fill the shipping information as well as the negotiated pricing for that customer. They will also enter their sales associate number for tracking of sales. 31 If the customer is a new customer the sales person will forward the information on to the sales manager for price negotiation and credit authorization. Once this is complete the sales manager will enter a new customer file with the negotiated pricing and credit limit.

The sales manager will return the order authorization to the sales person for order entry into the system. 32 The sales person will enter the order into the sales system generating a pre-numbered sales order acknowledgement. 33 The sales order acknowledgement will be sent to the customer and the shipping department. 34 The shipping department manager will review the order, checking to make sure stock is available to fill the order. 35 The shipping department manager will generate a packing list based on available stock and forward on to the shipping clerk to fill the order from stock. 6 The shipping clerk will notate the packing list as to the exact quantity being shipped, initial it and return the document to the shipping manager. 37 The shipping manager will review the document and if discrepancies are found will physically check the shipment for accuracy. If accurate the shipping manager will approve the packing list marking the date of shipping, send a copy back to the shipping clerk for shipment, attach a copy to the order acknowledgement and send back to the sales department. 8 The sales clerk will enter the shipment into the computer to generate a pre-numbered invoice which documents the terms of the customers negotiated purchase agreement and the shipping date. 39 At the end of each day the sales invoices are returned to the sales manager who checks the invoices for accuracy, double checks the pre-numbered invoices against the sales transaction log for the day, and signs off on the transactions. 0 If sales returns are authorized a return merchandise authorization number should be issued to the customer and authorized by the sales manager, who handles customer complaints. 41 When the merchandise is received, a pre-numbered receiving report will be issued and the receiving clerk will sign and date indicating the receipt has been made. 42 The receiving report will be entered into the computer system by the sales clerk and a pre-numbered credit memo will be issued. A copy will go to the sales manager for review of correct quantity and correct pricing from the original invoice. 3 If commissions are involved, the sales figures will need to be checked by the sales manager and will be released for payment once accounts receivable shows the invoice has been paid. Accounts Receivable (A/R) The essential activities in the revenue and collection cycle consist of receiving and processing customer orders within the credit granting, delivering goods to customers, billing customers and coding for accounts receivable, and collecting and depositing cash received from customers. The company needs to consider various controls in this department because the cycle can be very vulnerable to fraud.

Some of the most fraud schemes in accounts receivable are: Lapping that can happened when many payments from customers are received; Fictitious receivables that are usually set up to mask fictitious sale by recording a sale trough a receivable account that never get collected, and eventually written off; Improper posting of credits as return, discounts, or written- offs that can be posted in a customer’s account to disguise a fraud Procedures to prevent any of those fraud schemes consist of: Detailed control that include comparison of the checklist and the records to customer’s credit accounts on the daily posting to ensure that the payments are applied to the correct customers. This procedure will test the accounts receivable lapping to find the existence of credits given to customers for whom no payments were received. Verify the accurateness of customer accounts balance by sending monthly current statements to customers to identify if any discrepancies exist between the accounting records and customer records. Reconciliation of customer’s accounts in a period basis. The transaction must be recorded only when the final invoice is issued to the customers which can be consider as a backup for each account. To enhance the controls for the accounts receivable cycle, the company should have a segregation of duties.

Recommendations for the company to consider include: 44 Employees responsible for issuing and authorizing credit limits should not have the ability to record adjustments to customer accounts. 45 Access to modifying sales pricing should be restricted to the employee responsible with accounts receivable without the approval of his/her manager. 46 Employees who have the ability to modify the accounts receivable balance should not receive payments. 47 Credit adjustments need to be reviewed by a supervisory-level employee. 48 Employees responsible for collections should not have access to customer payments. Inventory Inventory is an area where fraud may occur and oftentimes, go unnoticed for long periods of time.

Conducting inventory counts on a regular, consistent basis will help in detecting potential errors, miscounts and misstatements concerning inventory values. Misstatements in inventory can cause false representations on the financial statements. The following checklist of controls should be used to minimize areas vulnerable to fraud with respect to inventory observation and counts. 49 A listing of individuals responsible for taking the physical inventory counts should be supplied. These individuals should remain independent from the acquisition and procurement departments to prevent false counts. Ideally, an outside firm or a supervisor from the accounting department should conduct these counts. 50 The date and time(s) of the inventory counts should be recorded.

Many times, inventory counts take place over a period of days and it is imperative to record when counts occur to match up with the values in the inventory system at that given time. 51 Inventory counts will be recorded on a preformatted spreadsheet that details each item that is typically in inventory that includes a description of the item, model number (if applicable) and measurement of quantity (for example: each, dozen, gross, etc. ) Additional columns will be provided to manually write in the quantity counted during the inventory count. Additional lines are provided at the end of the spreadsheet to identify items not preprinted on the listing, but observed in the inventory count. 2 Obsolete and/or worn items will be recorded on a separate spreadsheet, similar to the one used for counts and items shall be documented and removed from the shelves for disposal or return to manufacturer. 53 During inventory counts, the plant will suspend operations to prevent any items from moving. Counts should occur after production and sales hours so as to not impede regular business and provide the most efficient inventory counts. 54 In the event that counts take place during business hours, any employee that needs to remove a part that is scheduled for a count should document the item being removed from storage as well as notify the supervisor in charge of the count. If goods are received during the counts, these items shall be set aside and entered into the system after the count is completed. 5 Upon completion of all counts, data from the preprinted spreadsheets will be entered into a master spreadsheet for comparison against actual numbers on hand as per the inventory tracking system. 56 Items that do not match up will be counted again and any variance should be documented, researched and corrected in the inventory system by a manager. Production The management team of Auto Parts Inc. determines the production of parts from analyzing the sales forecast. Management will then create the production plan. Production work orders are then created to build the required parts. The production plan will provide general information to auditors for a complete understanding of production of a particular part, the production work order and inventory plan provide the details needed to complete the audit.

Both documents list details of raw materials, approval for requisition of materials and labor. The production work order is the tracking instrument which will follow the inventory through the production cycle and requires signatures from each of the different staging areas. Completed production work orders are recorded in the production report for the Cost Accounting Department. Production Risk and Controls In production, parts are built on work orders. The each work order will designate the desired of parts needed to build `the product was well as the amount of product needed. The raw materials are pulled form inventory and placed in a kit for the build.

As production builds the product, each part needs a serial number and counts for the inventory records 57 Production orders will contain list of material and quantities 58 Requisition orders will move raw materials in to production 59 Production orders will be approved by production planner/schedule 60 Material requisitions will be sent to coast accounting department with signatures of production coordinator & material inventory keep. Requisition order will be compared to production order. 61 Employees will tack their time for each project. Time will be tracked on time card with product cost accounting will reconcile labor costs associated with production orders from pay roll department. 62 Production reports and completed work orders will be reviewed by quality control department to complete the work order. 3 Production Supervisor will need to verify final count of finished product. Inventory control will entered production into inventory records Conclusion Team A consulting has proposed the above listed internal controls for the different functions of Auto Parts Inc. in order to help prevent and detect errors and fraud. It is also a good idea to have an inspection periodically to ensure the controls are operating as effectively. If these controls are implemented, this should help the company as well as an audit run more efficiently. Reference Louwers, T. , Ramsay, R. , Snason, D. , & Strawser, J. (2007). Auditing and assurance services: A look beneath the surface (2nd ed. ). New York, NY: McGraw Hill/Irwin.

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