CHAPTER 16

INTERNAL CONTROL
AFFECTING ASSETS
Expected Learning Outcomes
After studying the chapter, you should be able to

1. Describe the internal control over the major components of assets

of a business enterprise namely
a) Cash
b) Financial Investments
c) Receivables: Accounts and Notes and related revenue accounts
d) Inventories and related Cost of Goods sold
e) Property, Plant and Equipment
Expected Learning Outcomes
2. Understand the potential misstatements (due to fraud and errors) of
the asset accounts and how weakness in internal control increases the
risks of misstatements
CASH
CASH
Ideally, the functions of the finance department and the accounting
department should be integrated in a manner that provides assurance that:
1. All cash that should have been received was in fact received, recorded
accurately and deposited promptly.
2. Cash disbursements have been made for authorized purposes only and
have been properly recorded.
3. Cash balances are maintained at adequate, but not excessive, levels by
forecasting expected cash receipts and payments related to normal
operations. The need for obtaining loans for investing excess cash is thus
made known on a timely basis.
CASH
Guidelines to good cash handling practices in all types of business:
1. Do not permit any one employee to handle a transaction from
beginning to end.
2. Separate cash handling from record keeping.
3. Centralize receiving of cash to the extent practical.
4. Record cash receipts on a timely basis.
5. Encourage customers to obtain receipts and observe cash register
totals.
6. Deposit cash receipts daily.
CASH
7. Make all disbursements by check or electronic funds transfer, with
the exception of small expenditures from petty cash.
8. Have monthly bank reconciliation prepared by employees not
responsible for the issuance of checks or custody of cash. The
completed reconciliation should be reviewed promptly by an
appropriate official.
9. Monitor cash receipts and disbursements by comparing recorded
amounts to forecasted amounts and investigating variances from
forecasted amounts.
Potential Misstatements – Cash Receipts
• Recording fictitious cash receipts
• Failure to record receipts from cash sales
• Failure to record cash from collection at accounts receivable
• Early (late) recognition of cash receipts – “cutoff problems”
Potential Misstatements – Cash Disbursements
• Inaccurate recording of a purchase of disbursements
• Duplicate recording and payment of purchases
• Unrecorded disbursements
 FINANCIAL
INVESTMENTS
FINANCIAL INVESTMENTS
The major elements of adequate internal control over financial
investments include the following:
1. Formal investment policies that limit the nature of investments in
securities and other financial instruments.
2. An investment committee of the board of directors that authorizes and
reviews financial investment activities for compliance with investment
policies.
3. Separation of duties between the executive authorizing purchases and
sales of securities and derivative instruments, the custodian of the
securities, and the person maintaining the records of investments.
FINANCIAL INVESTMENTS
4. Complete detailed records of all securities and derivative instruments
owned and the related provisions and terms.
5. Registration of securities in the name of the company.
6. Periodic physical inspection of securities on hand by an internal
auditor or an official having no responsibility for the authorization,
custody, or record keeping of investments.
7. Determination of appropriate accounting for complex financial
instruments by competent personnel.
Potential Misstatements – Financial Investments
• Misstatement of recorded value of investments
• Unauthorized investment transactions
• Incomplete recording of investments
RECEIVABLES
RECEIVABLES
To understand internal control over accounts receivable and revenue,
one must consider the various components, including
• Control environment
• Risk assessment
• Monitoring
• The (accounting) information and communication system
• Control activities
Potential Misstatements – Revenue/Receivables
• Recording unearned revenue
• Early (late) recognition of revenue – “cutoff error”
• Recording revenue when significant uncertainties exist
• Recording revenue when significant services still must be performed
by seller
• Overestimation of the amount of revenue earned
INVENTORIES AND COST
OF GOODS SOLD
INVENTORIES AND COST OF GOODS SOLD
The term inventories is used in this chapter to include:

1. Goods on hand ready for sale, whether the merchandise of a

trading concern or the finished goods of a manufacturer;
2. Goods in the process of production; and
3. Good to be consumed directly or indirectly in production, such as
raw materials, purchased parts, and supplies.
Potential Misstatements – Inventory/COGS
• Misstatement of inventory costs
• Misstatement of inventory quantities
• Early (late) recognition of purchases – “cutoff problems”
PROPERTY, PLANT AND
EQUIPMENT
PROPERTY, PLANT AND EQUIPMENT
The term property, plant and equipment includes all tangible assets
with a service life of more than one year that are used in the operation
of the business and are not acquired for the purpose of resale. Three
major subgroups of such assets are generally recognized:

1. Land, such as property used in the operation of the business, has

the significant characteristic of not being subject to depreciation.
2. Buildings, machinery, equipment and land improvements, such as
fences and parking lots, have limited service lives and are subject to
depreciation
PROPERTY, PLANT AND EQUIPMENT
3. Natural resources (wasting assets), such as oil wells, coal mines, and
tracts of timber, are subject to depletion as the natural resources are
extracted or removed.
PROPERTY, PLANT AND EQUIPMENT
Other key controls applicable to plant and equipment are as follows:

1. A subsidiary ledger consisting of a separate record for each unit of

property. An adequate plant and equipment ledger facilitate the auditor’s
work in analyzing additions and retirements, in verifying the depreciation
provision and maintenance expenses, and in comparing authorizations
with actual expenditures.
2. A system of authorization requiring advance executive approval of all plant
and equipment acquisitions, whether by purchase, lease or construction.
Serially numbered capital work orders are a convenient means of
recording authorizations.
PROPERTY, PLANT AND EQUIPMENT
3. A reporting procedure assuring prompt disclosure and analysis of
variances between authorized expenditures and actual costs.
4. An authoritative written statement of company policy distinguishing
between capital expenditures and revenue expenditures. A dollar
minimum ordinarily will be established for capitalization; any
expenditures of a lesser amount automatically classified as charges
against current revenue.
5. A policy requiring all purchases of plant and equipment to be
handled through the purchasing department and subjected to a
standard routine for receiving, inspection and payment.
PROPERTY, PLANT AND EQUIPMENT
6. Periodic physical inventories designed to verify the existence,
location and condition of all property listed in the accounts and to
disclose the existence of any unrecorded units.
7. A system of retirement procedures, including serially numbered
retirement work orders (bottom), stating reasons for retirement and
bearing appropriate approvals.
Potential Misstatements – Investment in PPE
• Misstatement of acquisitions of property, plant and equipment
• Failure to record retirements of property, plant and equipment
• Improper reporting of unusual transactions
THANK YOU