Chapter 5

 TRANSACTION PROCESSING AND INTERNAL CONTROL PROCESS Bodnar/Hopwood AIS 7th Ed 1

Controls and Exposures

 Controls are needed to reduce exposures.

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Control and Exposure

 An exposure consists of the potential financial effect of an event multiplied by its probability of occurrence.

 Controls rarely affect the causes of exposures.

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Excessive Costs

Common Exposures

Deficient Revenue

EXPOSURES

Loss of Assets Bodnar/Hopwood AIS 7th Ed Inaccurate Accounting 4

Business Interruption

Common Exposures

Statutory Sanctions

EXPOSURES

Competitive Disadvantages Bodnar/Hopwood AIS 7th Ed Fraud and Embezzlement 5

White-collar Crime

 a grouping of illegal activities that are differentiated from other illegal activities in that they occur as part of the occupation of the offender Bodnar/Hopwood AIS 7th Ed 6

Fraud and White-Collar Crime

 What are the three basic forms of theft in white-collar crime?

1 Employee theft 2 Employee-outsider theft 3 Management fraud Bodnar/Hopwood AIS 7th Ed 7

Fraudulent Financial Reporting

 intentional or reckless conduct, whether by purposeful act or omission, that results in materially misleading financial statements Bodnar/Hopwood AIS 7th Ed 8

Corporate Crime

 white-collar crime that benefits a company or organization, rather than the individuals who perpetrate the fraud Bodnar/Hopwood AIS 7th Ed 9

Forensic Accounting

 one of several terms which is used to describe the activities of persons who are concerned with preventing and detecting fraud Bodnar/Hopwood AIS 7th Ed 10

The National Association of Certified Fraud Examiners

 provides bona fide qualifications for Certified Fraud Examiners through administration of the Uniform CFE Examination Bodnar/Hopwood AIS 7th Ed 11

Seriousness of Fraud

 More than 75% respondents in survey experienced fraud during the past year, with 23% reporting losses of $1,000,000 or more.

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Computer Processing and Exposures

 Many aspects of computer processing tend to significantly increase an organization's exposure to undesirable events. Bodnar/Hopwood AIS 7th Ed 13

Control Objectives and Transaction Cycles

 Each transaction cycle will have exposures.

 Management should develop detailed control objectives for each transaction cycle.

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Control Objectives and Transaction Cycles

Control Objectives: Revenue Cycle

Customers should be authorized in accordance with management’s criteria.

Prices and terms of goods and services should be authorized in accordance with management’s criteria.

All shipments of goods and services provided should result in a billing to the customer.

Billings to customers should be accurately and promptly classified, summarized, and reported.

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Control Objectives and Transaction Cycles

Control Objectives: Expenditure Cycle

Compensation rates and payroll deductions should be authorized in accordance with management’s criteria.

Amounts due to vendors should be accurately and promptly classified, summarized, and reported.

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Internal Control

 Internal control is a process effected by an entity’s board of directors, management, and other personnel--designed to provide reasonable assurance regarding the achievement of objectives in the following categories: Bodnar/Hopwood AIS 7th Ed 17

Internal Control

 a) reliability of financial reporting,  b) effectiveness and efficiency of operations, and  c) compliance with applicable laws and regulations Bodnar/Hopwood AIS 7th Ed 18

Internal Control Process

 the control environment  risk assessment  control activities  information and communication  monitoring Bodnar/Hopwood AIS 7th Ed 19

Major Premises

 responsibility: management is responsible  reasonable assurance: relative costs and benefits Bodnar/Hopwood AIS 7th Ed 20

The Federal Foreign Corrupt Practices Act of 1977 (FCPA)

 requires all companies subject to the Securities Exchange Act of 1934 to  make and keep books, records, and accounts, ...

 devise and maintain a system of internal accounting controls sufficient to provide reasonable assurances Bodnar/Hopwood AIS 7th Ed 21

Control Environment

 the collective effect of various factors on establishing, enhancing, or mitigating the effectiveness of specific policies and procedures  sets the overall tone Bodnar/Hopwood AIS 7th Ed 22

Control Environment Factors

 management philosophy and operating style  organizational structure  board of directors and its committees  human resource policies and procedures Bodnar/Hopwood AIS 7th Ed 23

Risk Assessment

 the process of identifying, analyzing, and managing risks that affect the company’s objectives Bodnar/Hopwood AIS 7th Ed 24

Control Activities

 The policies and procedures established to help ensure that management directives are carried out.

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Potential Control Activities

 segregation of duties  proper forms for recording of transactions  restricted access to assets  authorization  independent checks Bodnar/Hopwood AIS 7th Ed 26

Information and Communication

 refers to the organization's accounting system, which consists of the methods and records established to identify, assemble, analyze, classify, record, and report the organization's transactions and to maintain accountability for the related assets and liabilities Bodnar/Hopwood AIS 7th Ed 27

Documentation of the Accounting System

 Accounting procedures should be set forth in accounting procedure manuals so that policies and instructions may be explicitly known and uniformly applied.

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Audit Trail

 An audit trail exists if a financial total that appears in a general ledger account can be supported by evidence concerning all the individual transactions that comprise that total and vice versa.

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Monitoring

 involves the ongoing process of assessing the quality of internal controls over time and taking corrective actions when necessary Bodnar/Hopwood AIS 7th Ed 30

Internal Audit

 An internal audit function is common in large organizations to monitor and evaluate controls on an ongoing basis.

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Transaction Processing Controls

 General controls affect all transaction processing.

 Application controls are specific to individual applications.

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General Controls

 plan of data processing organization  general operating procedures  equipment control features  equipment and data-access controls Bodnar/Hopwood AIS 7th Ed 33

Types of Controls

 Preventative controls act to prevent errors and fraud before they happen.

 Detective controls act to uncover errors and fraud after they have occurred.

 Corrective controls act to correct errors.

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Communicating the Objectives of Internal Control

 The system must be designed such that each employee is convinced that controls are meant to prevent difficulties or crises in the operation of the organization that could otherwise affect him or her very personally.

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Analytical Techniques

 internal control questionnaire  application controls matrix Bodnar/Hopwood AIS 7th Ed 36