Elements of a proper internal control system
Internal control means the plans and checks a business uses so that its assets are safe, its records are correct, and staff follow the rules. Good systems have these elements:
- Separation of duties: the person who handles an asset (cash, stock) is not the person who records it. One person cannot both make and hide a mistake.
- Authorization: purchases, refunds and payments need approval by a named person, with limits.
- Documents and records: pre-numbered invoices, receipts and cheques, so a missing number shows at once.
- Physical safeguards: locks, safes, passwords, cameras, limited access to stock rooms and software.
- Independent checks: someone else compares records with reality: cash counts, stock counts, bank reconciliations, internal and external audit.
- Hiring and training: honest, trained staff; job rotation and compulsory holidays help uncover fraud.
Controls lower risk but never remove it: two people can work together (collusion) to get around them, and controls cost money.
Control over assets: cash, POS reconciliation and petty cash
Cash receipts
Ring up every sale on the cash register / POS. At day end a supervisor counts the till, removes the opening float, and compares the cash with the POS total. Deposit cash in the bank daily.
If cash is 1,250 but the POS says 1,260: Cash 1,250 Dr. + Cash Short and Over 10 Dr. / Sales 1,260 Cr. If cash is more than the POS total, Cash Short and Over is credited. A debit balance is treated as an expense; a credit balance as other income.
Cash payments
Pay by cheque or bank transfer with approval, never from sales cash. Reconcile the bank statement every month.
Petty cash (imprest system)
- Set up a fixed fund: Petty Cash 100 Dr. / Cash 100 Cr.
- Pay small bills from it with a signed voucher each. No entry yet.
- Replenish: total the vouchers (say postage 30, supplies 40, delivery 12 = 82). Postage 30, Supplies 40, Delivery 12 Dr. / Cash 82 Cr. The fund is back to 100.
Other assets
Count stock regularly, tag equipment with numbers, and keep a list of who holds which item.
Budgets: planning and controlling
A budget is a money plan for the future, often shown as a budgeted income statement and balance sheet. It helps in two ways:
- Planning: managers set targets for sales, costs and cash before the year starts.
- Controlling: each month, actual results are compared with the budget. A big variance (difference) is investigated. Example: budgeted supplies 2,000, actual 2,900 โ variance 900 unfavourable; find out why.
The role and work of an auditor
An auditor examines the records and the controls. An internal auditor works for the company and checks that controls work all year. An external auditor is an independent professional accountant who gives an opinion on whether the financial statements are true and fair (follow the accounting standards and have no material errors).
Auditors test samples of transactions, match them to documents, count assets, confirm balances with banks and customers, and report weaknesses to management. A clean (unmodified) opinion makes lenders and investors trust the statements.
Key formulas and definitions
- Cash short (expense) = POS total โ cash counted (if positive)
- Cash over (income) = cash counted โ POS total (if positive)
- Petty cash replenishment = fixed float โ cash left = total of vouchers
- Variance = actual โ budget
Worked examples
1. Till cash counted 3,480 (after removing the float). POS total 3,500. Record the day's sales.
Short 20. Cash 3,480 Dr. + Cash Short and Over 20 Dr. / Sales 3,500 Cr.
2. Cash counted 2,015; POS total 2,000. Record it.
Over 15. Cash 2,015 Dr. / Sales 2,000 Cr. / Cash Short and Over 15 Cr.
3. A petty cash fund of 200 has 37 left. Vouchers: postage 60, cleaning 75, coffee for clients 28. Record the replenishment.
Vouchers total 163 = 200 โ 37. Postage 60, Cleaning 75, Entertainment 28 Dr. / Cash 163 Cr.
4. In a small shop, the clerk who receives cheques also posts them to customer accounts. What is the weakness and fix?
No separation of duties: the clerk could keep a cheque and change the customer record to hide it. Give the posting job to another person and have a third person reconcile the bank account.
Common mistakes
- Thinking controls are only about stopping theft. They also catch honest errors and keep records reliable.
- Making a journal entry each time petty cash is spent. Entries are made only when the fund is set up, replenished or changed.
- Treating a cash shortage as zero because it is small. Every difference is recorded in Cash Short and Over.
- Believing an audit proves there is no fraud at all. Auditors give reasonable, not absolute, assurance.