An effective internal control structure for inventory includes a company’s plan of organization and all the procedures and actions it takes to:
•Protect its assets against theft and waste.
•Ensure compliance with company policies and federal law.
•Evaluate the performance of all personnel to promote efficient operations.
•Ensure accurate and reliable operating data and accounting reports.
We will look at how these concepts are applied to inventory and we will discuss internal controls more in depth later in the course.
Companies protect their assets by (1) segregating employee duties, (2) assigning specific duties to each employee, (3) rotating employee job assignments, and (4) using mechanical devices.
Segregation of employee duties Segregation of duties requires that someone other than the employee responsible for safeguarding an asset must maintain the accounting records for that asset. Also, employees share responsibility for related transactions so that one employee’s work serves as a check on the work of other employees.
When a company segregates the duties of employees, it minimizes the probability of an employee being able to steal assets and cover up the theft. For example, an employee could not steal inventory from a company and have the theft go undetected unless someone else changes the inventory records to cover the shortage. To change the records, the employee stealing the inventory must also maintain the inventory records or be in collusion with the employee who maintains the inventory records.
Assignment of specific duties to each employee When the responsibility for a particular work function is assigned to one employee, that employee is accountable for specific tasks. Should a problem occur, the company can quickly identify the responsible employee.
Rotation of employee job assignments Some companies rotate job assignments to discourage employees from engaging in long-term schemes to steal from them. Employees realize that if they steal from the company, the next employees assigned to their positions may discover the theft.
Frequently, companies have the policy that all employees must take an annual vacation. This policy also discourages theft because many dishonest schemes collapse when the employee does not attend to the scheme on a daily basis.
Use of mechanical devices Companies use several mechanical devices to help protect their assets. Bar codes scanners make it difficult for employees to steal inventory and alter company documents and records.
Companies should maintain complete and accurate accounting records. Inaccurate or inadequate accounting records serve as an invitation to theft by dishonest employees because theft can be concealed more easily.
One or more business documents support most accounting transactions. These source documents are an integral part of the internal control structure. For optimal control, source documents should be serially numbered.
Since source documents serve as documentation of business transactions, from time to time firms check the validity of these documents. For example, to review a purchase transaction, they check the documents used to record the transaction against the proper accounting records. When the accounting department records a purchase transaction, it should receive copies of the following four documents:
•A purchase requisition is a written request from an employee inside the company to the purchasing department to purchase certain items.
|BRYAN WHOLESALE COMPANY||Date: November20|
Fro: Automotive Supplies Department
|To: Purchasing Department||Suggested supplier: Wilkes Radio Company|
|Please purchase the following items:|
|Description||Item Number||Quantity||Estimated Price|
|Model No. 5868–24393||200||$50perunit|
|Reason for request:||To be filled in by purchasing department:|
|Customer order||Dated ordered November 29|
|Baier Company||Purchase order number N-MS|
•A purchase order is a document sent from the purchasing department to a supplier requesting that merchandise or other items be shipped to the purchaser.
|BRYAN WHOLESALE COMPANY||Date: November 21|
|476 Mason Street||Ship by: December 20|
|Detroit, Michigan 48823|
|To: Wilkes Radio Company||
|2515 West Peachtree Street|
|Atlanta, Georgia 30303|
|Ship to: Above address||FOB terms requested:||Destination|
|Discount terms requested: 2/10, n/30|
|Please send the foil owing item;|
|True-tone stereo radios||Model No. 5868-24393||200||$50||$10,000|
|Ordered by: Jane Knight||Please include order number on all|
|invoice and shipments.|
•An invoice is the statement sent by the supplier to the purchaser requesting payment for the merchandise shipped.
Invoice No. 1574
Date: Dec. 15
WILXES RADIO COMPANY
2515 West Peachtree Street
Atlanta, Georgia 30303
|Customer’s Orders No.||N-14S|
|Sold to: Bryan Wholesale Co.|
|Address: 475 Mason Street|
|Detroit, Michigan 4S823|
|Terms: 2/10, n/30, FOB destination||Date shipped: December 15|
|Shipped by: Nagel Trucking Co.|
|Description||Item Number||Quantity||Price Per Unit||Total Amount|
|Model No. 5868-24393||200||$50||$10,000|
•A receiving report is a document prepared by the receiving department showing the descriptions and quantities of all items received from a supplier in a particular shipment. A copy of the purchase order can serve as a receiving report if the quantity ordered is omitted. Then, because receiving department personnel do not know what quantity to expect, they will count the quantity received more accurately.
These four documents together serve as authorization to pay for merchandise and should be checked against the accounting records. Without these documents, a company might fail to pay a legitimate invoice, pay fictitious invoices, or pay an invoice more than once. Companies can accomplish proper internal control only by periodically checking the source documents of business transactions with the accounting records of those transactions.
Unfortunately, even though a company implements all of these features in its internal control structure, theft may still occur. If employees are dishonest, they can usually figure out a way to steal from a company, thus circumventing even the most effective internal control structure. Therefore, companies should carry adequate casualty insurance on assets.