Protecting the bottom line – internal financial controls

Are your internal controls out of control?
by michaeleen hinca
As a business grows, so does its need to maintain controls. Accounting rules clearly dictate what “good control” looks and feels like. And when a company processes its data manually, internal controls are easily implemented and clearly monitored.
Add an automated accounting or business system and that same level of control is more difficult to maintain. No doubt, new systems bring greater efficiency for the smaller business that’s eager for growth. While it could be the best way to maximize the strengths of your people, it could also be a red carpet for abuse of power and theft.
Part of the problem is a lack of cross-training or little management overview, but mostly it is the result of the increased efficiency realized by automating the processing. What used to be a two- or three-person job can sometimes be done by one person with the help of an automated system. Managers have to consider how much access each individual involved in the processing of critical data should have.
Consider this case where a person was allowed too much access:
A small construction firm was run by a husband and wife team who processed all the accounting and job costing data manually. After deciding to automate their business, these owners hired a bookkeeper to handle the accounting functions while they focused on keeping their jobs profitable.
The new person appeared to work out well. He was smart, learned the system easily and seemed to enjoy working on his own.
One day, the bookkeeper called in sick. This same day the bank statement arrived. The bookkeeper usually balanced the account but the owner was concerned that the new employee might fall behind. To help, the owner decided to do the reconciliation.
During the analysis, checks were found that were written to the bookkeeper. The owners realized that in two months this employee helped himself to thousands of dollars simply by writing checks to himself, signing them, and cashing them. Later, he would alter the accounting files to bury the fraud and ensure that the accounts would balance.
That extremely painful and costly mistake happened because there were literally no accounting controls in place to protect the company. One person, in this case the bookkeeper, had access to all aspects of processing this company’s data.
To reduce their risk, companies can easily protect themselves in a couple main areas.
Accounts Payable – Good control means that one person writes the checks and another signs them and reconciles the bank statement. To reduce the risk even further, an owner or person with fiduciary interest in the company should reconcile the bank account each month. Also, have canceled checks returned by the bank rather than getting a detailed list of activity. This way the physical documents can be examined.
Accounts Receivable – To control the cash that comes into the business, use pre-numbered invoices or let the system number the invoices automatically. This way, any missing invoices would be easily identifiable. Cash sale transactions can be especially vulnerable. Be sure that all transactions have some sort of corresponding documentation.
General Ledger – Make sure that transactions cannot be changed or deleted. Require credit or debit memos to adjust invoices. For other transactions, insist the users prepare general journal entries with complete descriptions of why the transaction was adjusted.
Inventory Purchases – Most inventory systems have a “preferred vendor” field in the setup screen of each item. While this makes purchasing efficient because the vendor is pre-selected, it does not eliminate the need to “shop around” occasionally to be sure you’re getting the best value for your investment.
Because automation has made it easier for companies to do so much more processing, compiling and manipulating of data, all procedures should be periodically reviewed for deteriorating – or, as in the case of the construction firm, nonexistent controls. To identify where your company could benefit from better internal controls, map out your current processing routines. Then, review your findings with your business advisor or CPA. The important thing is that you take steps today to protect your bottom line.
Michaeleen Hinca is president of AccountNET, an independent consulting firm in Pewaukee that specializes in software evaluation. Sherry Koenig, president of Buy the Numbers Accounting Services in Hartland, assisted with the above article.
May 1998 Small Business Times, Milwaukee

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