BASIC INTERNAL ACCOUNTING CONTROLS

Although accounting staff persons are typically not directly involved with ensuring appropriate internal accounting controls exist, a basic understanding of small business controls is helpful in carrying out day-to-day duties. This knowledge will also help accounting staff persons better understand why they are asked to perform certain procedures.

This article discusses the following general categories of internal accounting controls:

• Segregation of duties.
• Restricted access.
• Document controls.
• Processing controls.
• Reconciliation controls.

Segregation of Duties
Segregation of duties involves allocating bookkeeping tasks among personnel so that one individual does not have the ability to make an accounting error (either intentionally or unintentionally) and also cover it up.

The principle of segregation of duties implies that the person with physical access to cash or other moveable assets (investments or inventory) should not also be involved with the related recordkeeping. For example, the person opening the mail and depositing customer remittances should not also be responsible for maintaining the accounts receivable subsidiary ledger. In addition, the person responsible for writing checks should not also have responsibility for maintaining the accounts payable subsidiary ledger. Whenever possible, bank accounts should be reconciled by someone with no other cash receipt or disbursement functions.

Unfortunately, the limited number of accounting personnel in most small businesses often makes it difficult to adequately segregate incompatible duties. In this situation, the services of other nonaccounting personnel, such as the receptionist or even the business owner, can sometimes be used in a limited capacity to provide some segregation. Also, a closer involvement in the day-to-day affairs by the small business owner and controller often partially compensates for a lack of segregation of duties.

Restricted Access
Restricted access is a control category closely related to segregation of duties. Not only should bookkeeping duties be segregated whenever possible, but physical access to valuable and moveable assets should be restricted to only authorized personnel.

For example, access to warehouse and other inventory should be restricted to only those people with responsibility for maintaining inventory. In almost all instances, salespersons should not have access to inventory locations. Also, inventory should not be shipped from the warehouse unless accompanied by appropriate shipping documents. In addition, unused checks and petty cash should be kept in a locked filing cabinet in a secured area.

Document Controls
Since source documents initiate the recording of transactions, it is essential that adequate controls exist to ensure that the accounting system captures all source documents. Source document controls principally include using prenumbering documents and accounting for the numerical sequence of those documents.

Common prenumbered source documents include company checks, receiving reports, purchase orders, sales invoices, debit and credit memos, shipping documents, and customer receipts for "over the counter" sales. For retail businesses, a cash register is another basic tool for controlling cash receipt source documents and currency.

Processing Controls
Once documents enter the accounting system, processing controls help ensure that the documents are processed accurately. Common processing controls include:

• Batch controls. Preparing batch control totals of key source docu­ment amounts to ensure the amounts are entered into the accounting system accurately. For example, accounting persons may run an adding machine tape of total remittances received from customers for the day. After entering the remittances into the accounts receivable system, they compare the adding machine tape total to the total generated by the system to ensure all remittances were accurately entered.
• Source document matching. Comparing information on the various source documents to ensure they match. For example, this control might include comparing quantities and part numbers on the receiving reports/packing slips and purchase orders with the vendor invoice, and comparing unit prices on the purchase order with the vendor invoice. For customer shipments, this control might include comparing quantities and part numbers on sales orders and shipping documents with customer invoices, and comparing prices on sales orders and price lists with customer invoices.
• Clerical accuracy of documents. Checking the mathematical accuracy of financial data on key source documents, such as vendor invoices, customer invoices, and time cards. For example, accounting personnel may recalculate the extended prices on invoices by multiplying the quantity by the unit price.
• General ledger account code checking. Checking to ensure that amounts on source documents (such as vendor invoices) were coded with the appropriate general ledger account numbers before entering them into the accounting system.

Processing controls are designed to catch errors before they are posted to the general ledger.

Reconciliation Controls
Reconciliations consist of reconciling selected general ledger control accounts to subsidiary ledgers. Thus, in contrast to processing controls, they are designed to detect errors after transactions have been posted and the general ledger has been run.

Accounting persons commonly reconcile accounts receivable, property and equipment, and accounts payable subsidiary ledgers. Inventory is also commonly reconciled if the company maintains a perpetual inventory subsidiary ledger. Monthly reconciliations of bank accounts are also essential controls over cash balances.

For a more detailed discussion on internal controls, refer to NACPB's Accounting for Small Businesses Guide.