The Controller's Function E-Book

Steven M. Bragg

• Herausgeber: John Wiley & Sons
• Kategorie: Fachliteratur
• Serie: Wiley Corporate F&A
• Sprache: Englisch

Seitenzahl: 727

Veröffentlichungsjahr: 2011

Beschreibung

The go-to resource managerial accountants can turn to for sustaining their company's competitive advantage From flex budgeting to detailing the more sophisticated skills like throughput analysis for capital investments and the fast close for public companies, The Controller's Function, Fourth Edition offers numerous real-world examples, expertly balancing both the technical and managerial sides of the job. * Provides an overview of the functions and responsibilities of the controller/management accountant in a corporation * Explores how controllers can better perform their jobs * Offers a solid foundation for those who are new to this area Comprehensive and practical, this book fully defines the role, functions and responsibilities of the managerial accountant in a corporation.

Leseprobe

Contents

Cover

Title Page

Copyright

Preface

Chapter 1: The Controller's Job

Main Job Functions

Job Description

Job Qualifications

Organizational Structure of the Accounting Department

Ethics

Chapter 2: Internal Control

Basic Elements

Controls to Use in Your Business

Elements of Internal Accounting Control

Levels of Controls

Fraud

Auditing for Fraud

Chapter 3: Planning and the Strategic Plan

Strategic Plan Overview

System of Plans

Planning Cycle

Planning Roles

Planning Timing and the Planning Period

Business Mission

Developing Long-Range Objectives

Developing Long-Range Strategies

Chapter 4: Long-Range Financial Plan

Layout and Purpose

Trends of Revenues and Profits

Capital Investments

Cash Flows and Financing Requirements

Risk Analysis

Breakdown by Business Unit/Product Line/Geography

Financial Position

Chapter 5: Annual Plan

System of Plans

Additional Budget Modeling Topics

Annual Planning Cycle

Role of the Controller

Sales Planning: The Base of All Business Plans

Steps in Developing the Near-Term Sales Plan

Methods for Determining the Sales Forecast

Changes in the Sales Mixture

Changes in the Sales Price

Changes in the Cost

Chapter 6: Sales

Role of the Controller

Sales Analysis

Sales Standards

Sales Reports

Product Pricing

Chapter 7: Distribution Expenses

Role of the Sales Manager

Analyzing Distribution Costs

Analyzing by Application

Setting the Distribution Budget

Chapter 8: Direct Materials and Labor

Objectives

Role of the Controller

Types of Cost Systems

Measuring Direct Material Costs

Controlling Direct Material Costs

Controlling Direct Material Quantities

Measuring Direct Labor Costs

Controlling Direct Labor Costs

Target Costing

Chapter 9: Overhead

Need for Overhead Controls

Responsibilities of the Controller

Account Classifications

Fixed and Variable Costs

Cost Allocation

Controlling Overhead

Production Reports

Chapter 10: General and Administrative Expenses

Functions Involved

Accounting for and Allocating Administrative Expenses

Responsibility Accounting

“Unique” Expenses

Controlling Costs

Chapter 11: Cash and Investments

Objectives of Cash Management

Role of the Controller

Cash Collections

Cash Disbursements

Investment of Short-Term Funds

Accounting for Records of Investment

Cash and Investment Controls

Chapter 12: Receivables

Functions of the Credit Department

Shortening the Receivables Cycle

Reserve for Doubtful Accounts

Receivables Fraud and Control

Chapter 13: Inventory

Inventory Management Systems

Inventory Tracking

Physical Inventory Procedure

Inventory Valuation

Inventory Fraud and Controls

Chapter 14: Property, Plant, and Equipment

Role of the Controller

Capital Budgeting

Postproject Appraisals

Other Aspects of Fixed Assets

Chapter 15: Liabilities

Objectives

Controls

Credit Agreement Provisions

Debt Capacity

Bond Ratings

Leverage

Chapter 16: Equity

Role of the Controller

Cost of Capital

Dividend Policy

Long-Term Equity Planning

Repurchasing Common Shares

Capital Stock Records

Chapter 17: Operational Accounting

Create Departmental Job Descriptions

Create a Departmental Training Program

Clear Out Excess Documentation

Streamline the Accounting Workflow

Document All Major Processes

Schedule the Department

Correct the Underlying Causes of Errors

Use of Best Practices

Outsourcing Selected Accounting Functions

Chapter 18: The Fast Close

Different Types of Fast Close

How to Achieve a Fast Close

Enhanced Closing Process

Summary

Chapter 19: SEC Filings

Form 8-K

Annual 10-K and Quarterly 10-Q Reports

Timing of Annual and Quarterly Report Filings

Form S-1

Form S-3

Form S-8

Forms Requiring Payment to the SEC

Fedwire Payments

Chapter 20: Performance Measurements and Trends

Performance Measurements

Trends

Interrelationship of Ratios

Just-in-Time Ratios

Chapter 21: Financial Analysis

Analyzing Financial Statements

Analyzing Working Capital

Analyzing Financing Options

Services Profitability Analysis

The Throughput Analysis Model

Production Outsourcing Decision

New Product Decision

Chapter 22: Cost Reduction

Types of Reports Used for Cost Reduction Analysis

Spend Analysis Overview

Spend Database

Supplier Consolidation Analysis

Parts Consolidation Analysis

Maintenance, Repair, and Operations Item Analysis

Spend Compliance

Spend Analysis Reports

Workforce Reduction Analysis

Workforce Reduction Issues

Workforce Reduction Alternatives

5S Analysis

Check Sheets

Error Quantification

Fixed Cost Analysis

Ishikawa Diagrams

Value Stream Mapping

Waste Analysis

Chapter 23: Taxes

Tax Strategy

Tax Organization

Role of the Tax Manager

Tax Records

Tax versus Book Accounting

Sales and Use Taxes

Proper Classification of Accounts

Chapter 24: Selecting a Financial Information System

Reasons to Purchase Software

Defining Systems Requirements

Existing System Documentation

Joint Sessions

Preparing the Request for Proposal

Distribution of the Request for Proposal

Review of the Vendor's Completed Proposal

Reference Calls

Demonstration

Site Visits

Cost of the System

Final Selection

Contract Negotiations

Postimplementation Review

Appendix New Controller Checklist

About the Author

Free Online Resources by Steve Bragg

Index

Copyright © 2011 by John Wiley & Sons, Inc. All rights reserved.

Published by John Wiley & Sons, Inc., Hoboken, New Jersey.

Published simultaneously in Canada.

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Library of Congress Cataloging-in-Publication Data:

Bragg, Steven M.

The controller's function : the work of the managerial accountant. — 4th ed. / Steven M. Bragg.

p. cm.

Rev. ed. of: The controller's function / Janice Roehl-Anderson, Steven M. Bragg. 3rd ed.

Includes index.

ISBN 978-0-470-93742-6 (hardback); ISBN 978-1-118-00141-7 (ebk); ISBN 978-1-118-00142-4 (ebk); ISBN 978-1-118-00143-1 (ebk)

1. Managerial accounting. 2. Controllership. 3. Auditing. 4. Budget in business. I. Roehl-Anderson, Janice M. Controller's function. II. Title.

HF5657.4.R63 2011

658.15'11—dc22

2010037967

Preface

This revised edition of The Controller's Function is a complete operations reference manual for the corporate controller. Within these pages the reader will find a comprehensive discussion of how to manage all major aspects of the controller's job, including strategic and annual planning, financial reporting, and managing all aspects of the accounting department, as well as peripheral issues such as control systems, the fast close, filings with the Securities and Exchange Commission cost reduction analysis, software selection and implementation—and much, much more.

This book was written in response to the growing realization that the controller is no longer being called on just to process accounting transactions and issue financial statements, tasks requiring detailed technical knowledge but no considerable management or analysis skill. Instead, the modern controller must exhibit additional mastery of a multitude of management skills, so that the accounting department runs in an efficient and effective manner, offers a detailed analysis of financial statement results, recommends improvements, monitors the activities of other departments, and perhaps even manages the computer systems in a smaller organization. This book gives considerable attention to the most recent advances in all these areas of responsibility, so that the controller will be fully capable of installing and using them to improve his or her company's level of competitive advantage. Included in our coverage of these advances are the use of target costing, activity-based costing, and throughput analysis.

In addition to these more advanced categories, the book also includes such bread-and-butter topics as cash management, internal control systems and fraud prevention, accounts receivable collections, inventory valuation, budgeting, taxes, insurance, and capital budgeting. Because basic and advanced accounting management topics are combined in one volume, the reader has access to the complete reference for mastering the controller's function.

Steven M. BraggCentennial, ColoradoJuly 2011

Chapter 1

The Controller's Job

Today's corporation operates in an increasingly complex environment, where there are far too many activities for a chief executive officer (CEO) to keep track of. To an increasing degree, this monitoring function falls on the shoulders of the controller, who must keep the CEO apprised of the performance of all departments, product sales, costs and profits, control issues in a variety of transaction processing systems, and the impact of new government taxes and other regulations on the conduct of the business. Thus, the controller can reasonably be compared to the ship's navigator, who warns the captain of current or foreseeable problems in the shoals of the business environment that lie ahead and on all sides. In this chapter, we explore the main functions of the controller, what kind of background a controller should have, the positions reporting to the controller, and the role of ethics in the conduct of the job.

Main Job Functions

The controller has a number of distinct job functions. The first four are ones that can be ascribed to any manager in any department. The last two are more specialized and do not refer to management skill. The six functions are:

1.Planning. The controller is responsible for determining who does the work, what work is to be done, and the timing of work completion in the accounting department, especially in regard to the timely processing of transactions and the issuance of accurate financial statements. This also extends to the budget, where the controller guides the budgeting process through other departments.

2.Organizing. The controller is responsible for obtaining and keeping the services of experienced and well-trained accounting personnel; this is by far the most important organizational task. This also involves obtaining sufficient floor space, office equipment, and computer hardware and software to complete all assigned work.

3.Directing. The controller is responsible for ensuring that all employees in the department work together in an orderly manner to achieve the controller's plans.

4.Measuring. The controller is responsible for measuring the performance of all key aspects of the department to ensure that performance matches or exceeds standards and that errors are caught and corrected.

5.Financial analysis. The controller is responsible for the review, interpretation, and generation of recommendations related to corporate financial performance. This requires excellent communication skills (both written and oral), so that the controller's information is properly and effectively conveyed to the other members of the management team.

6.Process analysis. The controller is responsible for periodically reviewing and evaluating the performance of each major process that is involved in the completion of transactions, with the dual (and sometimes conflicting) objectives of maintaining tight financial controls over processes while also running them in a cost-effective and efficient manner.

Job Description

The controller has one of the most complex job descriptions of all company managers because there are so many functional areas for which he or she is responsible. This section provides a detailed job description that is sorted by general category in alphabetical order. The controller's responsibilities are:

Auditing

The scheduling and management of periodic internal audits, as well as the preparation of resulting audit reports and the communication of findings and recommendations to management and the board of directors.The preparation of work papers for the external auditors and the rendering of any additional assistance needed by them to complete the annual audit.

Budgeting

The coordination of the annual budgeting process, including maintenance of the company budget, and the transfer of final budget information into the financial statements.

Control Systems

The establishment of a sufficiently broad set of controls to give management assurance that transactions are processed properly.

Cost Accounting

The coordination of periodic physical inventory counts.The periodic analysis and allocation of costs based on activity-based costing pools and allocation methods.The continual cost review of products currently under development, using the principles of target costing.The periodic compilation and evaluation of inventory costs.

Financial Analysis

The periodic comparison of actual to budgeted results and the communication of variances to management, along with recommendations for improvement.The continuing review of revenue and expense trends and the communication of adverse trend results to management, along with recommendations for improvement.The periodic calculation of a standard set of ratios for corporate financial performance and the formulation of management recommendations based on the results.

Financial Statements

The preparation of all periodic financial statements, as well as their accompanying footnotes.The preparation of an interpretive analysis of the financial statements.The preparation and distribution of recurring and one-time management reports.

Fixed Assets

The annual audit of fixed assets to ensure that all recorded assets are present.The periodic recording of fixed assets in the financial records and their proper recording under the correct asset categories and depreciation methods.The periodic review of fixed assets to determine the existence of any impairment.The proper analysis of all capital expenditure requests.

Policies and Procedures

The creation and maintenance of all policies and procedures related to the control of company assets and the proper completion of financial transactions.The training of department personnel in the use of accounting policies and procedures.The modification of existing policies and procedures to match the requirements of government regulations.

Process Analysis

The periodic review of all processes involving financial analysis to see if they can be completed with better controls, lower costs, or greater speed.

Record Keeping

The proper indexing, storage, and retrieval of all accounting documents.The orderly planning for and scheduling of document destruction, in accordance with the corporate document retention policy.

Tax Preparation

The timely preparation and filing of tax returns, as well as the supervision of all matters relating to corporate taxation, such as conducting an effective tax management program, and both providing and enforcing policies and procedures related to the compliance of all corporate personnel with applicable government tax laws.

Transaction Processing

The timely completion of all accounting transactions at the intervals and in the manner specified in the accounting policies and procedures manual.The proper completion of all transactions authorized by the board of directors or in accordance with the terms of all authorized contracts.The proper approval of those transactions requiring them, in accordance with company policy.

This list may appear overwhelming, but just because the controller is responsible for all of the listed areas does not mean that this person must actually do each one. Instead, the controller is mostly involved in the six job functions noted in the preceding section; in other words, the controller primarily manages the work of other people and ensures that they complete most of the tasks just listed. In particular, a controller can rely on the services of assistant controllers who are responsible for smaller portions of the accounting department.

Job Qualifications

To undertake the job description just described, the controller should have a number of qualifications, which are outlined in this section. Although not all controllers will possess these skills, it is most important to have those related to transaction processing and the production of accurate financial statements because these two areas remain the core of the accounting function. The key job qualifications are:

Analysis of information. The controller must be sufficiently comfortable with financial information to readily understand the meaning of a variety of ratios and trends and what they portend for a company.Communication ability. A key component of the controller's function is compiling information and communicating it to management. If the compiling part of the job goes well, but management does not understand its implications, then the controller must improve his or her communication skills in order to better impart financial information to the management team.Company and industry knowledge. No accounting system is completely “plain vanilla,” because the companies and industries in which it operates have a sufficient number of quirks to require some variation from the typical accounting system. Accordingly, the controller must have a good knowledge of both company and industry operations to know how they impact the operations of the accounting department.Management skill. The controller presumably will have a staff and, if so, will have considerable control over the productivity of that group. Accordingly, the controller must have an excellent knowledge of the planning, organizational, directing, and measurement functions needed to manage the accounting department.Provision of timely and cost-effective services. The controller must run the accounting department as if it were a profit center, so that the most efficient methods are used to complete each task and the attention of the department is focused squarely on the most urgent tasks.Technical knowledge. Creating an accurate financial statement, especially one for a publicly held company, requires a considerable knowledge of accounting rules and regulations. Accordingly, a controller should be thoroughly versed in all generally accepted accounting principles (GAAP). Also, if the controller's company deals with international financial reporting standards (IFRS), a knowledge of IFRS will also be necessary.

Organizational Structure of the Accounting Department

The controller does not operate alone to complete all the tasks outlined through the last few sections. On the contrary, quite a large accounting staff may complete the bulk of the work. In this section, we review the structure of the typical accounting department and the tasks completed by each part of it.

The controller is usually helped by one or more assistant controllers who are assigned different sets of tasks. For example, one may be in charge of the more technically difficult general ledger, tax reporting, financial analysis, cost accounting, and financial reporting tasks, while another covers the major transactions, which are accounts payable, accounts receivable, payroll, and cash application. For smaller organizations, there may also be managers for the human resources and MIS functions who are at the assistant controller level and who also report to the controller. Below these managers are a number of subcategories, staffed either by clerks or degreed accountants, who are responsible for specific tasks. These subcategories are:

Cost accounting. This position is filled by a degreed accountant who conducts job or process costing and verifies the inventory valuation.Financial analysis. This position is filled by a degreed accountant who compiles both standard and special-request analysis reports.Financial reporting. This position is filled by either a degreed accountant or a senior-level bookkeeper who prepares the financial statements and accompanying footnotes, as well as other periodic reports for public consumption if the company is publicly held.General ledger accounting. Frequently combined with the financial reporting function, this is staffed by similar personnel and is involved with the review and recording of journal entries and summary entries for subsidiary journals.Payroll processing. This position is filled by clerks who calculate pay levels and hours worked and generate payments to employees.Tax form preparation and filing. This position is filled by a degreed accountant, frequently with tax experience in a public accounting background, who completes and files all government tax forms.Transaction processing. This position is filled by clerks (usually comprising the bulk of all department headcount) who process all accounts payable, accounts receivable, and cash application transactions in accordance with rigidly defined procedures.

The positions most likely to be needed by a controller are those responsible for transactions, which are the clerks responsible for billing, collections, payables, and payroll. Here are the job requirements for these positions:

Billing Clerk: This position is accountable for creating invoices and credit memos, issuing them to customers by all necessary means, and updating customer files. Principal accountabilities are:

Issue invoices to customersIssue monthly customer statementsUpdate customer filesProcess credit memosUpdate the customer master file with contact informationTrack exceptions between the shipping log and invoice registerEnter invoices into customer invoicing web sitesSubmit invoices by electronic data interchange

Collections Clerk: This position is accountable for collecting the maximum amount of overdue funds from customers, which may include a variety of collection techniques, legal claims, and the selective use of outside collection services. Principal accountabilities are:

Stratify collection activities to maximize cash receiptsIssue dunning letters to overdue accountsContact customers regarding overdue accountsIssue payment commitment lettersNegotiate the return of unpaid merchandiseMonitor cash on delivery or COD roll paymentsIssue credit hold notificationsRecommend that accounts be shifted to a collection agencyProcess small claims court complaintsRecommend bad debt write-offs

Payables Clerk: This position is accountable for verifying proper payment approval, processing payments in a timely manner, and ensuring that discounts are taken. Principal accountabilities are:

Match supplier invoices to authorizing purchase orders and proofs of receiptTake all economical supplier discountsObtain payment approvals for non–cost of goods sold invoicesProcess expense reportsProcess procurement card paymentsIssue stop payments and void checksIssue reminders to suppliers regarding uncashed checksPay supplier invoices when dueResearch supplier requests for paymentProcess value-added tax reclamationsMonitor supplier W-9 form submissionsIssue positive pay data to the bankUpdate the supplier master file

Payroll Clerk: This position is accountable for collecting timekeeping information, incorporating a variety of deductions into a periodic payroll, and issuing pay and pay-related information to employees. Principal accountabilities are:

Collect and summarize timekeeping informationObtain supervisory approval of time card discrepanciesObtain overtime approvalsCalculate commissionsProcess garnishment requestsProcess employee advances and paybacksProcess and close periodic payrollsPrint and issue paychecksProcess direct deposit paymentsProcess paycard paymentsCalculate and deposit payroll taxesProcess employment verificationsProcess and issue annual W-2 forms to employees

In a smaller company, the controller may also inherit all the finance and office management functions, which means that some of the staff will be responsible for analyzing and monitoring customer credit, investing funds, supervising risk management, monitoring the phone system, and arranging for the repair of office equipment. Conversely, a larger company will not only separate these added functions, but may also move the financial analysis function under the control of the chief financial officer. Thus, the exact layout of the accounting department will depend to a large extent on the size of the company and the presence of other managers.

There can be several levels of controller within a company. The corporate controller is located at the corporate headquarters, while each division may have its own controller. There will likely be plant controllers at each location, as well. In most organizations, the controller reports directly to the most senior on-site executive. For example, the plant controller reports to the plant manager, the division controller reports to the division manager, and the corporate controller reports to the chief financial officer or president. All three levels of controllership noted here have many of the same functional responsibilities that the corporate controller has on a company-wide basis.

The corporate controller must decide if accounting operations through all company locations are to be centralized, decentralized, or occupy a position somewhere in between. Many controllers favor centralization because they can more tightly manage the function and have fewer worries about accounting control issues arising at some far-off company location. However, not all aspects of the accounting function are so amenable to centralization. Some of the reasons why decentralization should at least be considered as an option are:

The local organization and retention of accounting information avoids some excuses for inactivity or poor performance because “the report was late” or “the report was wrong.”The information sent to a central location often is duplicated at the local site; that duplication can be avoided by processing it locally.The widespread distribution of accounting responsibility in the field allows a company to more quickly train promising accounting managers and evaluate them for promotion.The presence of a local accountant can assist in the rapid investigation and resolution of problems that would be impossible from a central location.

Offsetting these arguments in favor of decentralization are a number of factors in favor of centralization. The primary reasoning behind the bulk of the pro-centralization approach is that the efficient use of employees to complete a high volume of transactions will keep accounting costs down to a bare minimum. The reasons are:

The accounting staff can be shifted between tasks to meet peak workloads.The use of centralized transaction processing may have a sufficient amount of volume to justify the use of expensive computer hardware and software that will considerably improve efficiency, though it would be cost-prohibitive for a smaller division to use.The use of a centralized staff may allow for the added expense of a tailored training program for accountants that will increase their efficiency, but which would be too expensive to create for the smaller numbers of accountants at a single division location.The use of a centralized operation may allow for the hiring of more experienced (and expensive) accounting personnel who can do a better job of managing the department.

Thus, the controller has arguments for using either approach to organizing the department. If a company has a highly diversified group of divisions, then their transactions, chart of accounts, and processes may differ so wildly from each other that it makes no sense to centralize the accounting department. However, a company with cookie-cutter divisions that are essentially identical in their operating characteristics may be ideal for accounting centralization. In many cases, though, the correct method is to opt for a slightly more expensive middle ground, using a centralized transaction processing organization, but also paying for a small local staff that can process exception transactions, investigate variance problems on behalf of the central organization, and also be a training ground for junior accounting managers from the central accounting office.

Ethics

The controller is in the uniquely difficult position of having a significant impact on the level of ethics practiced throughout a company. If the controller tends to wink at monetary indiscretions or alter the timing or amount of accruals or other transactions in order to influence reported financial results, then this attitude gradually will percolate down through the organization, until management suddenly finds that the entire company is rife with ethical problems of all kinds. The alternative approach is for the controller to adopt a methodical and rigorous approach to ethical problems, as is outlined in this section.

The first step by the controller is to convince the management team, and the president in particular, that the company must adopt a written ethical standard and force the rest of the organization to adhere to it through regular audits. Once the code of ethics and all related standards of conduct are complete, the management team as a whole must present them to employees and continue to reiterate, both by example and communication, that these principles are a significant foundation underlying all company operations.

Using these preliminary guidelines, the controller can then expand the concept and promulgate a series of additional guidelines in specific areas related to accounting. Some of them are:

Attaining annual business plan objectivesCompliance with Securities and Exchange Commission (SEC) and other securities laws and regulationsEmployee discriminationGifts and payments of money for no return considerationLeave for military or other federal serviceMeals and entertainment expense reportingPeriod-end accounting adjustmentsPolitical contributionsPreservation of assetsRestrictive trade practicesUse of the company carWorkplace safety

Only by adhering closely to these ethical guidelines, and by clearly communicating to the accounting staff that they are the corporate law, will the controller alter the mind-set of the company as a whole (and the accounting department in particular) in the direction of using the highest possible ethical standards.

Chapter 2

Internal Control

Perhaps the most important function of the controller is to create and maintain the corporate financial control system. Doing so involves documenting the existing control structure, eliminating redundant controls, and adding new controls to cover potential risks arising out of new business situations. In order to properly assess risks, the controller must have a firm grasp of the general types of fraud and how to prevent them. This knowledge should extend to legally required controls over assets, such as those listed in the Foreign Corrupt Practices Act and the Sarbanes-Oxley Act. This chapter provides an overview of these topics.

Basic Elements

Many policies and procedures have been established to achieve the specific objectives of an organization. This set of procedures is called the internal control structure. Technically, appropriate control procedures apply to every function, to every activity of the enterprise. The emphasis in this chapter is on those controls relevant to a proper recording of transactions (income, expenses, assets, liabilities, and net worth) and the proper reporting thereof, together with safeguarding the assets of the business. The applicable control objectives, discussed later in this chapter, are a basic concern of the controller.

The controller should be aware of the various types of controls that must be interlinked to create a control system that adequately safeguards the company assets: accounting controls, administrative controls, and primary operational controls.

Accounting controls are defined as the plan of organization and all methods and procedures that are concerned with the safeguarding of assets and the reliability of the financial records. They generally include such controls as the systems of authorization and approval; separation of duties concerned with record-keeping and accounting reports from those concerned with operations or asset custody; physical controls over assets; and internal auditing. It was these controls with which historically the independent accountant was primarily concerned.

Administrative controls comprise the plan of organization and all methods and procedures that relate to operational efficiency and adherence to managerial policies and that usually are concerned only indirectly with the financial records. Included would be such controls as statistical analyses, time and motion studies, performance reports, employee training programs, and quality control.

Primary operational control concerns the establishment of policy and basic guidelines by which an enterprise will be directed as a means of achieving the business objectives.

Given the recent broadening of the traditional definition of controls, and the various statements on the subject, it facilitates discussion if the internal control structure of an entity is divided in two parts:

1. Control environment

2. Accounting systems

Control Environment

A company's control environment is the corporate atmosphere in which the accounting (and other) controls exist and in which the financial statements are prepared. It reflects management's commitment to an effective system of internal control. The control segment has recently been given increased importance in general analysis of controls. It represents the collective effort of many factors, including:

Management philosophy and operating style. This factor concerns “the tone at the top” and includes a broad range of topics that influence the control environment, including:Emphasis on meeting profit goals, targets, or budgetsBasic attitude about risk takingAttitude about the need for controlsAttitude about the importance and sanctity of the financial statements, both internal and publishedOrganization structure. How are the organizing, planning, directing, and controlling of operations handled? On a decentralized basis? Does strong central control exist? Does one person or do a few individuals dominate the company?Functioning of the board of directors and the board committees. Does the board exert influence or largely follow the dictates of the CEO? Does it examine or discuss important policies and procedures? Does an audit committee composed of outside directors exist? Does it oversee accounting policies and procedures, including controls? Does it meet independently with the outside auditors and with internal auditors?Methods of assigning authority and responsibility. Are policy matters such as ethical standards, conflicts of interest, and competitive response discussed?Management control methods. This category involves the heart of operational control—how management delegates authority to others and effectively supervises all company activities—and includes:The planning system, both short and long termThe measurement system, comparing actual with planned performance, and communication of the results to appropriate individualsThe methods of taking timely and corrective action to bring actual performance at least to budgeted levelsThe methods of developing procedures, modifying systems, and monitoring systems and proceduresThe existence and effectiveness of an internal audit function. Included in the audit function are the proper authority, organization structure and status, properly qualified personnel, and adequate resources.Personnel policies and procedures. This category includes policies and procedures for hiring, training, evaluating, promoting, and compensating personnel so that a proper and adequate corps of employees is available and permitted to carry out their assigned responsibilities.Influence of external factors. Although external influences are largely outside the control of an organization, how management monitors and deals with outside influences, such as legislative and regulatory bodies, international events, and economic trends, and how it complies with the requirements, is germane to accomplishing the company's objectives.

How management copes with these factors reveals the overall attitude of the board of directors and top management concerning ethics and the significance of proper controls. Anyone searching for fraud could use these control elements to narrow the search area; for example, if a department had a poor attitude toward controls, then an auditor might consider that department to be a high-risk area.

Controllers should understand how these various factors actually operate in their areas of responsibility; that is to say, it is one thing to have written policies and procedures, but another to know that they are followed. Management may give lip service to certain policies but act in ways that condone departures from the standard. In the control environment, the controller's attention should be on the same matters that would warrant examination by an independent auditor.

As the internal control structure becomes more widely discussed among management members, many operating managers regard the matter as primarily a financial or accounting concern and not theirs. Because many evaluations have been made by either internal auditors or independent accountants, managers sense no direct tie-in to corporate governance and the achievement of the corporate objectives, such as profitability, growth, and adherence to ethical standards. What is needed, and what is occurring in many companies, is the education of operating management about their role in the control system.

One company, in an effort to educate all department managers, held a series of one-day seminars for the professional and management staff of the organization. In these meetings, the business objectives for each department were stated by the departmental vice president and supplemented by group discussion. The “control mechanisms,” or actions required to accomplish each department's objectives, were reviewed for their effectiveness. The relationship of the elements of internal control to the attainment of departmental objectives was appraised.

Although the elements may differ by organization, the example company covered these control segments as meaningful to its operating management:1

Organization controls: Personnel standards, a plan of organization, and the corporate cultureSystem development and change controlsAuthorization and reporting controls; planning and budgeting; accountabilityAccounting system controlsSafeguarding controls: Protection of assets and avoidance of unintentional risksManagement supervisory controls: Supervision and management informationDocumentation controls: Formal policies and procedures; systems documentation

The objective of the approach was to involve all of management in the educational process and make use of the company's control system to attain departmental objectives.

Accounting System

Another element of the internal control structure is the accounting system. The proper direction of the accounting system is one of the principal responsibilities of the controller. An effective accounting system encompasses those principles, methods, and procedures, as well as those records that will:

Identify properly and record all valid transactionsDescribe the transactions on a timely basis and in sufficient detail to permit proper classification of transactions for financial reportingDetermine the time period in which the transactions occurred so as to permit recording in the proper accounting periodMeasure the value of the transaction in a manner that permits recording of the proper monetary value in the financial statementsPermit proper presentation of the transactions and related required disclosures in the financial statements

Appraising the Control System

Given the inappropriate activity by some businesspeople, such as the issuance of fraudulent financial statements, kickbacks, and bribery, the adequacy of the control systems takes on increased importance. Yet such a determination usually cannot be done quickly or easily. An analytical and detailed approach probably is desirable. Some representative actions in the area of procedure, some essential elements in the control system, and a suggested assignment of responsibility for different phases of control are discussed in the next few sections.

There are two fundamental steps to be taken by management in evaluating internal controls. First, management must identify the principal activities, risks, and exposures in each operating component of the business and define the control objectives related to those activities. Second, management must describe, perhaps by flowcharts, and understand the various systems used to process transactions, safeguard assets, and prepare the financial reports. Management then uses this information to evaluate the system, giving particular attention to possible significant weaknesses, in order to ascertain that the system provides reasonable assurance that the control objective can be achieved.

Identifying the Activities, Risks, and Control Objectives

One way to identify a company's principal activities and control objectives is to separate the typical company into four basic operating components and define the control objectives of the various activities in each component. Suggested components are sales, production or service, finance, and administration. Examples of control objectives are:

Sales control objectives. That correct billings are produced for shipped products or services rendered, customer credit is checked prior to approving orders, and customer returns are approved.Production or service control objectives. That minimal scrap occurs as products are created, the correct quantities of products are produced, and pilferage is kept to a minimum.Finance control objectives. That cash receipts are deposited on the day of receipt, petty cash is issued only with proper authorization, and bad debts are properly authorized before being removed from the receivables ledger.Administration control objectives. That office equipment is purchased only with the proper authorization, vacations are taken only with previous authorization, and hiring occurs only after proper authorization.

Another approach is to identify types of transactions common to most businesses. Each transaction flow is a grouping of related events, and the focus is on whether appropriate control exists over each step in the transaction through the processing system. Some suggested transaction cycles are the revenue cycle, production cycle, payments cycle, and time cycle (economic events caused by time, such as an interest accrual). In any event, whatever approach is used results in the identification of major functions and the control objectives for each.

In reviewing operations, transactions, or cycles, the possibility of loss or risk (or error in the financial statements) should be considered in an effort to minimize theft, for example, and to provide early warning of other potential loss, including:

Loss or destruction of assetsFraud or embezzlementStatutory sanctions or violationsExcessive costs or insufficient revenuesUnacceptable accountingErroneous recordingExpropriation

Understanding Control Systems

Accounting transactions should be clearly flowcharted, so that they can be studied for possible weaknesses by the controller's staff. This review involves a businessperson's perspective of what should be done, a consideration of things that can go wrong, and a recognition of the accounts that would be affected. Any issues concerning the control of those transactions should be documented.

When reviewing the flowcharts for control weaknesses, five general control objectives should be kept in mind:

1.Authorization. Was the transaction authorized by management? This could be evidenced in a general way by establishing related policies, contract authorization limits, investment limits, standard price lists, and so on. Or, in a given situation, a specific authorization may be needed.

2.Recording. Transactions should be recorded in the proper account, at the proper time (proper cutoff), with the proper description. No fictitious transactions should be recorded, and erroneous material or incomplete descriptions should be avoided.

3.Safeguarding. Physical assets should not be under the physical custody of those responsible for related record-keeping functions. Access to the assets should be restricted to certain designated individuals.

4.Reconciliation. Periodic reconciliations of physical assets to records, or control accounts, should be made. Some examples are bank reconciliations, securities inventories and physical inventories of raw material, and work in process and finished goods to control accounts.

5.Valuation. Provision should be made for assurances that the assets are properly valued in accordance with generally accepted accounting principles—and that the adjustments are made.

Controls to Use in Your Business

This section describes over 140 controls that can be used throughout a company's accounting systems. They are organized first by their appearance on the balance sheet (e.g., cash controls first, investments controls second, etc.), followed by controls for revenue and then for a number of miscellaneous topics, including foreign exchange, hedges, and leases. Not all are recommended for installation; on the contrary, the controller should pick and choose from this list based on the corporate requirements, keeping in mind the cost-effectiveness of each control. The controls list follows.

Cash2

1.Control check stock. This is a key control. All check stock must be locked up when not in use. Otherwise, it is a simple matter for someone to take a check from the bottom of a check stack (where its loss will not be noticed for some time), forge a signature on it, and cash it. The key or combination to the lock must be kept in a safe place, or else this control will be worthless.

2.Control signature plates. This is a key control. Many companies use either signature plates or stamps to imprint an authorized signature on a check, thereby saving the time otherwise required of a manager to sign checks. If someone obtains access to a signature plate and some check stock, he or she can easily pay him- or herself the contents of the entire corporate bank account. The best control is to lock up signature plates in a different storage location from the check stock, so a perpetrator would be required to break into two separate locations in order to carry out a really thorough check fraud.

3.Separate responsibility for the cash receipt and bank reconciliation functions. If a person has access to both the cash receipt and bank reconciliation functions, it is much easier to commit fraud by altering the amount of incoming receipts, and then pocketing the difference. To avoid this, each function should be handled by different people within the organization.

4.Perform bank reconciliations. Although widely practiced and certainly necessary, bank reconciliations are not preventive controls, and so this step should be implemented after the control of check stock and signature plates. Bank reconciliations are most effective when completed each day; this can be done by accessing the daily log of cash transactions through the company's bank's Internet site. By staying up-to-date on reconciliations, evidence of fraudulent check activity can be discovered more quickly, allowing for faster remedial action.

5.Reconcile petty cash. There tends to be a high incidence of fraud related to petty cash boxes since money can be removed from them more easily. To reduce the incidence of these occurrences, unscheduled petty cash box reconciliations can be initiated, which may catch perpetrators before they have covered their actions with a false paper trail. This control can be strengthened by targeting those petty cash boxes that have experienced unusually high levels of cash replenishment requests.

6.Require that bank reconciliations be completed by people independent of the cash receipts and disbursement functions. The bank reconciliation is intended to be a check on the activities of those accounting personnel handling incoming and outgoing cash, so it makes little sense to have the same people review their own activities by completing the reconciliation. Instead, it should be done by someone in an entirely different part of the department, and preferably by a senior person with a proven record of reliability.

7.Require that petty cash vouchers be filled out in ink. Anyone maintaining a petty cash box can easily alter a voucher previously submitted as part of a legitimate transaction and remove cash from the petty cash box to match the altered voucher. To avoid this, all vouchers should be completed in ink. To be extra careful, users should be required to write the amount of any cash transactions on vouchers in words instead of numbers (e.g., “fifty-two dollars” instead of “52.00”) since numbers can be modified more easily than words.

8.Compare the check register to the actual check number sequence. With prenumbered checks, the check numbers listed in the computer's check register should be compared to those on the checks. If a check were to be removed from the check stock, then this action would become apparent when the check number on the check stock no longer matches the check number in the computer system.

If the check stock is on a continuous sheet, as is used for sheet-fed dot-matrix printers, then the more likely way for a perpetrator to steal checks would be to detach them from the top or bottom of the stack of check stock. In this case, the problem can be detected by keeping separate track of the last check number used, as well as of the last check number on the bottom of the stack. Unfortunately, many accounting clerks keep such a list of check numbers used with the check stock, so a perpetrator can easily alter the last number listed on the sheet while stealing checks at the same time. For this reason, the list of check numbers used should be kept in a separate location.

9.Review uncashed checks. All checks that have not been cashed within 90 days of their check dates should be reviewed. In a few cases, it may be possible to cancel the checks, thereby increasing the available cash balance. This review can also highlight checks that have gone astray. By placing stop payment orders on these checks, the company can keep them from being cashed by other parties, while new checks can be issued to the proper recipients.

10.Route incoming cash payments through a lockbox. Having customers send payments directly to a bank lockbox eliminates a number of control points within a company since it no longer has to physically handle any forms of cash. Some payments will inevitably still be mailed directly to the company, but the proportion of these payments will drop if customers are promptly asked to send future payments to the lockbox address.

11.Verify amount of cash discounts taken. A cash receipts person can falsely report that customers are taking the maximum amount of early payment discounts when they have not actually done so and can pocket the amount of the false discount. This can be detected by requiring that photocopies of all incoming checks be made and then tracing payments on which discounts have been taken back to the copies of the checks. This is a less common problem area, because it requires a perpetrator to have access to both the receipts and payments aspects of the accounting operation, and so is a less necessary control point.

Investments

Transfers between Available-for-Sale and Trading Investments

1.Require board approval of substantial changes in investment account designations. Management can modify the amount of reported gains or losses on investments by shifting investment designations from the “available-for-sale” investment portfolio to the “trading” portfolio. If the gain or loss on such a change in designation is significant, the board of directors should be notified in advance of the reason for the change and its impact on the level of earnings.

Investments: Transfers of Debt Securities among Portfolios

1.Impose investment limits. When investing its excess funds, a company should have a policy that requires it to invest only certain amounts in particular investment categories or vehicles. For example, only the first $100,000 of funds are insured through a bank account, so excess funding beyond this amount can be shifted elsewhere. As another example, the board of directors may feel that there is too much risk in junk bond investments and so will place a general prohibition on this type of investment. These sorts of policies can be programmed into a treasury workstation, so that the system will automatically flag investments that fall outside a company's preset investment parameters.

2.Require authorizations to shift funds among accounts. A person who is attempting to fraudulently shift funds out of a company's accounts must have approval authorization on file with one of the company's investment banks to transfer money out to a noncompany account. This type of authorization can be strictly controlled through signatory agreements with the banks. It is also possible to impose strict controls over the transfer of funds between company accounts since a fraudulent person may uncover a loophole in the control system whereby a particular bank has not been warned not to allow fund transfers outside of a preset range of company accounts, and then shift all funds to that account and thence to an outside account.

Prepaid Expenses

1.Reconcile all prepaid expense accounts as part of the month-end closing process. By conducting a careful review of all prepaid accounts once a month, it becomes readily apparent which prepaid items should be converted to an expense. The result of this review should be a spreadsheet that itemizes the nature of each prepaid item in each account. Since this can be a time-consuming process involving some investigative work, it is best to review prepaid expense accounts shortly before the end of the month, so that a thorough review can be conducted without being cut short by the time pressures imposed by the usual closing process.

2.Review all employee advances with the payroll and payables staffs at least once a month. A common occurrence is for an employee to claim hardship prior to a company-required trip and request a travel advance. Alternatively, an advance may be paid when an employee claims that he or she cannot make it to the next payroll check. Whatever the reason for these advances, they will be recorded in an employee advances account, where they can sometimes be forgotten. The best way to ensure repayment is a continual periodic review, either with the accounts payable staff who process employee expense reports (against which travel advances should be netted) or the payroll staff (who deduct pay advances from future paychecks).

3.Require approval of all advance payments to employees. The simplest way to reduce the burden of tracking employee advances is not to make them in the first place. The best approach is to require management approval of any advances, no matter how small they may be.

Receivables

1.Confirm payment terms with customers. Receivable collections can be particularly difficult when the sales staff has established side agreements with customers that alter payment terms—especially when the sales staff does not communicate these new terms to the collections department. The existence of these deals can be discovered by confirming payment terms at the time of invoice creation with selected customers and then working with the sales manager to reprimand those sales staff members who have authorized special terms without notifying anyone else in the company.

2.Require approval of bad debt write-offs. A common form of fraud is for a collections person to write off an invoice as a bad debt and then pocket the customer payment when it arrives. Companies can avoid this situation by requiring management approval of all bad debt write-offs (although staff members usually are allowed to write off small balances as an efficiency measure). Management should be particularly wary when a large proportion of bad debt requests come from the same collections person, indicating a possible fraud pattern.

3.Require approval of credits. Credits against invoices can be required for other reasons than bad debts—incorrect pricing or quantities delivered, incorrect payment terms, and so on. In these cases, management approval should be required not only to detect the presence of false credit claims, but also to spot patterns indicating some underlying problem requiring correction, such as inaccurate order picking in the warehouse.

4.Match invoiced quantities to the shipping log. It is useful to spot-check the quantities invoiced to the quantities listed on the shipping log. Doing so allows for the detection of fraud in the billing department caused by invoicing for too many units, with accounting staff members pocketing the difference when it arrives. This is a rare form of fraud since it generally requires collaboration between billing and cash receipts staff members, and so the control is needed only where the fraud risk clearly exists.

5.Verify invoice pricing. The billing department can commit fraud by issuing fake invoices to customers at improperly high prices and then pocketing the difference between the regular and inflated prices when the customer check arrives. Having someone compare the pricing on invoices to a standard price list before invoices are mailed can spot this issue. As was the case for the last control, this form of fraud is possible only when there is a risk of collaboration between billing and cash receipts staff members, so the control is needed only when the fraud risk is present.

Inventory in Transit

1.Audit shipment terms. Certain types of shipment terms will require that a company shipping goods must retain inventory on its books for some period of time after the goods have physically left the company or that a receiving company record inventory on its books prior to its arrival at the receiving dock. Although in practice most companies will record inventory only when it is physically present, this is technically incorrect under certain shipment terms. Consequently, a company should perform a periodic audit of shipment terms used to see if there are any deliveries requiring different inventory treatment. The simplest approach is to mandate no delivery terms under which a company is financially responsible for transportation costs.

2.Audit the receiving dock. A significant problem from a record-keeping perspective is that the receiving staff may not have time to enter a newly received delivery into the corporate computer system, so the accounting and purchasing staffs have no idea that the items have been received. Accordingly, items sitting in the receiving area should be compared regularly to the inventory database to see if they have been recorded. Supplier billings also can be compared to the inventory database to see if items billed by suppliers are not listed as having been received.

3.Reject all purchases that are not preapproved. A major flaw in the purchasing systems of many companies is that all supplier deliveries are accepted at the receiving dock, irrespective of the presence of authorizing paperwork. Many of these deliveries are verbally authorized orders from employees throughout the company, and often these employees are not authorized to make such purchases or are not aware that they are buying items at high prices. This problem can be eliminated by enforcing a rule that all items received must have a corresponding purchase order on file that has been authorized by the purchasing department. By doing so, the purchasing staff can verify that there is a need for each item requisitioned and that it is bought at a reasonable price from a certified supplier.

Inventory Accounting

1.Conduct inventory audits. If no one ever checks the accuracy of the inventory, it will gradually vary from the book inventory, as an accumulation of errors builds up over time. To counteract this problem, schedule a complete recount of the inventory from time to time or an ongoing cycle count of small portions of the inventory each day. Whichever method is used, it is important to conduct research in regard to why errors are occurring, and attempt to fix the underlying problems.

2.Control access to bill of material and inventory records. The files containing bills of material and inventory records should be accessible to only a very small number of well-trained employees. By limiting access in this way, the risk of inadvertent or deliberate changes to these valuable records will be minimized. The security system should also store the keystrokes and user access codes for anyone who has accessed these records, in case evidence is needed to prove that fraudulent activities have occurred.

3.Keep bill of material accuracy levels at a minimum of 98 percent. The bills of material are critical for determining the value of inventory as it moves through the work-in-process stages of production and eventually arrives in the finished goods area since they itemize every possible component that comprises each product. These records should be regularly compared to actual product components to verify that they are correct, and their accuracy should be tracked.

4.Pick from stock based on bills of material. An excellent control over material costs is to require the use of bills of material for each item manufactured and then require that parts be picked from the raw materials stock for the production of these items based on the quantities listed in the bills of material. By doing so, a reviewer can hone in on those warehouse issuances that were not authorized through a bill of material since there is no objective reason why these issuances should have taken place.

5.Require approval to sign out inventory beyond amounts on pick list. If a standard pick list is used to take raw materials from the warehouse for production purposes, then this should be the standard authorization for inventory removal. If production staff members require any additional inventory, they should go to the warehouse gate and request it, and the resulting distribution should be logged out of the warehouse. Furthermore, any inventory that is left over after production is completed should be sent back to the warehouse and logged in. By using this approach, the cost accountant can tell if there are errors in the bills of material that are used to create pick lists since any extra inventory requisitions or warehouse returns probably represent errors in the bills.

6.Require transaction forms for scrap and rework transactions. A startling amount of materials and associated direct labor can be lost through the scrapping of production or its occasional rework. This tends to be a difficult item to control since scrap and rework can occur at many points in the production process. Nonetheless, the manufacturing staff should be well trained in the use of transaction forms that record these actions, so that the inventory records will remain accurate.

7.Restrict warehouse access to designated personnel. Without access restrictions, the company warehouse is like a large store with no prices—just take all you want. This does not necessarily mean that employees are taking items from stock for personal use, but they may be removing excessive inventory quantities for production purposes, which leads to a cluttered production floor. Also, this leaves the purchasing staff with the almost impossible chore of trying to determine what is in stock and what needs to be bought for immediate manufacturing needs. Consequently, a mandatory control over inventory is to fence it in and closely restrict access to it.

8.Segregate customer-owned inventory. If customers supply a company with some parts that are used when constructing products for them, it becomes very easy for this inventory to be mingled with the company's own inventory, resulting in a false increase in its inventory valuation. Although it is certainly possible to assign customer-specific inventory codes to these inventory items in order to clearly identify them, a more easily discernible control is to physically segregate these goods in a different part of the warehouse.

Inventory Valuation

1.Audit inventory material costs.