Principles of Accounting - Essay Example

Principles of Accounting I By: The internal controls of any company are put in place to limit or prevent fraud and other forms of loss of revenue. These controls are only as good as the people who are implementing them therefore there are some limitations to accounting internal controls (Money Instructor, 2010). One such limitation is in the fact that humans are responsible for all aspects and as humans, we all can make mistakes. A proper internal control system will catch mistakes before they are in financial statements, reports, etc but weak internal control systems will not even detect the mistake until an auditor notices it. Why is it important to eliminate as many mistakes as possible before the auditors look at it? Mainly because the longer it takes an auditor to go through your books, the more money it will cost your company. Another limitation would be that the internal controls may not account for individuals being in collusion with one another in an effort to deceive. If management gives false information or produces documents that are not real then it would be hard for the internal control system to detect that these documents are intended to deceive. The primary focus of an audit in regards to the internal control system is to make sure that it is reliable (Lin & Wu, 2009). If a falsified document is submitted to the accounting clerk who processes it correctly and it goes through all of the channels there would be no need to consider the internal controls of the company to be unreliable. Employees are not private detectives nor are they familiar with every single company that the business can come into contact with therefore they may not know that a particular invoice is from a fictitious company or from a company owned by the CEO’s friend. An example of an internal control procedure could be that the receptionist opens the mail and distributes anything that needs to be entered to the appropriate people. For example, any account payable invoices will go to the A/P clerk and any money received will go to the A/R clerk. This will be done after the receptionist creates a log of everything received for the accounts payable and accounts receivable departments. The A/P clerk would then enter all of the payables into the system and give them to the A/P manager for payment. The A/R clerk would enter all of the money received and give a report to the A/R manager. The A/P manager would then pay bills according to a preset schedule such as weekly, bi weekly, or monthly. The A/R manager would then pass the money along to another person who would make the deposits. The A/P manager would then pass along the invoices along with the checks to a check signer who would then check the invoices against the checks before signing them. After the deposit is made the deposit slip will be placed with the supporting documents and given to a file clerk for filing. The same would happen with the A/P check stubs and the supporting documents for those payments. This internal control would not allow any of the people mentioned to perform two consecutive steps thereby alleviating an opportunity to steal or cover up a theft. Another internal control could be that all checks and cash received is copied and attached to the invoice that is being paid. This way if anyone needs to go back through the information to see if something was stolen or not recorded, they could always use the records for verification. Another way of internal control is to have management monitor the internal controls by pulling information every now and then to see if certain processes and procedures were being followed. In this way the management would be conducting an internal audit. Some symptoms of a weak internal control system (State of California, 2007) are as follows: Lack of operation manuals or manuals that are not updated. Internal control weaknesses are not acted upon in a timely manner. Organizational authority and responsibility are not identified clearly or do not exist. The above symptoms are only an example and only represent the entire list. There are others and they may vary from company to company but the general idea is there: weak internal controls do not help the company but hinder it from increasing shareholder value. The missing adjusting entry for prepaid insurance was significant because it would make the revenue overstated meaning that profit would also be overstated. It would also make the assets seem higher than they truly are. If the prepaid insurance entry was a debit to prepaid insurance and a credit to cash (as it should have been) then the adjusting entry would have been an expense of 500 per month and a reduction in prepaid insurance (an asset) of 500 per month. If the adjusting entry was not made then the expense would not have been recorded nor would the reduction in the asset be recorded (NetMBA, 2010). Adjusting entries are extremely important in these cases because they allow for anything that may have been missed throughout the course of day to day activities. Prepaid insurance is an adjusting entry that is often overlooked due to the fact that it is something the company expects to pay but what is not realized is that when you prepay insurance for an entire year or a period longer than a month, the remainder is considered an asset. The same can be said for prepaid rent although prepaid rent is usually uncommon. It is less likely that someone would prepay rent than prepay insurance. Accounting data can be used in many different ways. It can be used to determine whether or not the company should borrow money, sell stock, or dissolve the company. It can also be used to determine how to reduce costs by employee layoffs, finding new vendors, or some other means such as outsourcing. If the company is constantly losing money or if revenue is on a steady decline then the managers can use the accounting data to figure out what is causing it. Revenue and expenses drive the company’s income. Revenue is the ‘sale of products or services and earnings from interest and dividends’ (Revenues, 2010). Expenses are the costs of doing business. Income is what is left from the revenues after the expenses are paid (A-Systems Corp, 2010). If the company is losing money or if revenue is constantly declining the company can use the accounting data to determine what they need to do to turn things around. They may notice that they have started buying supplies, goods, etc from a company that charges more. They may also notice that the average revenue from their customers has gone down. Many things can be ascertained from the accounting records. Another way to use accounting data to make decisions is by using the information to determine if they need to borrow money. The company’s cash flow might indicate that they will not have enough in the next month, year, or further in the future to pay back a loan or a bill so they may need to borrow money or sell more stock to make sure they can. Some companies might also realize that current revenues and cash are not adequate to keep the number of employees they have or it may only be enough to keep them for a limited period of time. Accounting information is invaluable to any company whether it is a big one or small one. Bibliography A-Systems Corp. (2010). Accounting Terms. Retrieved November 27, 2010, from A-Systems.net: http://www.a-systems.net/accounting-terms.htm Lin, H. H., & Wu, F. H. (2009). Limitations of Section 404 of the Sarbanes-Oxley Act. Retrieved November 27, 2010, from The CPA Journal: http://www.nysscpa.org/cpajournal/2006/306/essentials/p48.htm Money Instructor. (2010). Internal Controls of an Accounting System. Retrieved November 27, 2010, from www.moneyinstructor.com: http://www.moneyinstructor.com/doc/internalcontrol.asp NetMBA. (2010). Adjusting Entries. Retrieved November 27, 2010, from www.netMBA.com: http://www.netmba.com/accounting/fin/process/adjusting/ Revenues. (2010). Retrieved November 27, 2010, from New York State Society of Certified Public Accountants: http://www.nysscpa.org/glossary/term/553 State of California. (2007). Internal Control. Retrieved November 27, 2010, from www.ca.gov: http://sam.dgs.ca.gov/TOC/20000/20050.htm Read More