1. Terms of reference
1.1.1 This report has been prepared to cover the requirements of the learning and assessment area Principles of Internal Control and Evaluating Accounting Systems at Level 4 of the Association of Accounting Technicians (AAT) Diploma in Accounting qualification. 1.1.2 This report forms an evaluation of the Accounting System of the Inkwell Limited. 1.1.3 The main purpose of the report is:
To evaluate the accounting system and procedures that are currently in place at IWL To identify weaknesses within the system, suggest possible improvements and make recommendations for improvement. To analyse cost
benefit for suggested improvements.
2. Executive summary
3.1.1 This report has been prepared using information provided by AAT case study text and study materials from Home Learning College. 3.1.2 Research for the recommendations has been made using internet. A list of websites used can be found in Appendix 1. 3.1.3 In developing the report support and assistance from my Home Learning College tutor was provided.
4.1. Inkwell Ltd (IWL) was formed seven years ago. IWL is the medium-sized company that supplies a complete range of re-manufactured inkjet and laser toner cartridges that are fully compatible with all major printers. Since its launch IWL has grown steadily and now has revenue of over £16 million. The company employs around 180 full-time employees. 4.2. IWL has adopted the functional structure system with three departments i.e. finance, sales and purchases. The BODs comprised of Managing Director, Sales Director and Finance Director is responsible for all decision-making activities in the company. The management structure chart can be found in Appendix 2. 4.3. The main purpose of accounting function of the IWL is to collect and process information from other departments in order to prepare statutory and management accounts as well as to determine the price of cartridges the company can pay for in order to achieve required profit margin (management accounting). The Finance Department is also responsible for making sure that inventory levels meet IWL’s policy, the company’s credit rating is kept strong, management accounts are prepared every month, orders from suppliers are monitored and supplier payments are arranged for.
4.2 To make an effective use of the accounting systems and procedures in place the finance department has been divided into two main areas of accounting i.e. financial accounting and management accounting (cost accounting). The area of financial accounting has been further sub-divided into the sections of general ledger and inventory, purchase ledger, sales ledger, payroll and personnel database. The chart showing the structure of The Accounts Department is provided in Appendix 3. 4.2.1 Sections within the finance department interact and maintain a relationship with other departments. The information flows to general ledger from the sales ledger, purchase ledger and payroll, personnel section and shops.
The general ledger provides information to the Company Accountant for the purpose of preparing monthly management accounts and approving supplier payments, to The Finance Director for the purpose of preparing financial statements and to the Sales Director for the purpose of costing IWL’s products. The Purchase Ledger section has a direct relationship with the General Ledger and the IWL’s suppliers. The Sales Ledger section maintains a close relationship with the sales department as well as with the General Ledger. The Payroll and Personnel Database section is working closely with shop managers from whom it collects the information to prepare payroll for employees. The department also co-operates with external users such as HMRC in order to comply with statutory requirements. The Costing Section is working closely with The Sales Director.
4.3 The objective of financial statements is to provide information about the financial position, performance and changes in financial position of an enterprise that is useful to a wide range of users such as suppliers, customers, government agencies or financial institutions in making economic decisions, for instance, whether to grant a loan or to give credit to the company. At the financial year end the Finance Director at IWL prepares the following financial statements: 4.3.1 Income Statement: this statement provides information about the financial performance of the company in terms of revenue from sales, costs and expenses incurred to generate the profit. It also provides information about gross and net profit generated for past financial periods.
It is also referred to as the Profit and Loss Account. 4.3.2 Statement of Financial Position: this statement shows the financial position of the company at the end of each financial year. It provides the information about the company’s assets, liabilities and the equity claim of its shareholders. It is also referred to as the Balance Sheet. 4.3.3 The Statement of Cash Flow: this statement provides a link between the Income Statement and Statement of Financial Position as at the year end of the previous and current financial years. Its main purpose is to reconcile liquid funds to profit by providing an analysis of cash inflows and outflows from operating, investing and financing activities.
4.4 A stakeholder is an entity that can be affected by the results of a company in which they are said to be stakeholders, i.e. that in which they have a stake. The critical external stakeholders for IWL have been identified as follows: 4.4.1 The financial institutions- IWL has a strong relationship with its bank. Through producing a series of convincing annual business plans, the company directors have been able to raise sufficient finance to grow IWL into a significant player in the cartridge supplies sector. Without this co-operation it would be much harder to expand the Company to its current position. They are IWL’s stakeholders because they lent money to The Business and they would be affected in case The Company becomes insolvent. 4.4.2 Customers- the IWL has a base of around 120 large trade customers.
These customers account for 20% of IWL’s revenue. It is imperative to maintain good relationship with customers in order to remain competitive and have high customer satisfaction level. Customers are categorised as stakeholders because the company’s actions can affect their financial position. 4.4.3 Government- The government is interested in businesses as they set out the regulations and need the businesses to do well to keep the economy healthy. Economic policies introduced by The Government through taxation, and the ability of The Government to influence interest rates, impact on the business through prices and costs. The company needs to make sure that it is paying the right amount of tax and VAT and that it complies with all government’s policies and accounting standards.
4.5 IWL is the medium-sized, centralized, manufacturing company operating nationwide. For a small sole trader or partnership type organisation, like off-licence shop, there are likely to be few transactions to process. As a result the basic single entry record system, with detailed cash book, would most likely be used. A simple structure where the owner or partners make all the decisions related to the business would also be adopted. However, the single entry system lacks controls necessary to verify the accuracy of the postings and therefore would not be practical in circumstances where a high volume of business transactions had to be processed. Medium and large sized companies will most likely use more sophisticated, double entry bookkeeping system. Higher amount of transactions would require more people to operate it and therefore the structure would be more sophisticated too, with either divisional or matrix structure adopted. The IWL uses double entry system.
5 Analysis of the Current Accounting System
5.1 The main external regulations the IWL has to comply with has been identified as: 5.1.1 The Company Law- compulsory legislation that governs the formation and registration of limited companies. It sets out the responsibilities of companies, their directors and secretaries and also determines the requirements relating to the preparation of Financial Statements of a company. It is legally binding on all limited companies in UK. In case of any changes in The Company LAW, staff training may be required to ensure compliance which will affect The IWL’s cash flow and availability of resources i.e. staff released for training. 5.1.2 The Pay As You Earn (PAYE) Regulations- this regulation apply when a business organisation employs individuals and sets out the requirements for deducting PAYE income tax and National Insurance Contributions (NIC’s) from payments made to employees. The regulation also stipulates rules for sending PAYE income tax and employees’ NIC’s to HMRC and identify the forms and returns that must be kept and submitted when administering the scheme. Any changes to the regulations i.e. change of the company tax rate or the National Insurance Contribution (NIC) has a direct effect on IWL because these are statutory requirements and The BODs need to make sure the staffs are appropriately trained and that they comply with the regulations. This may require substantial cash outlay as well as additional labour to provide cover for absent staff so these sorts of changes may significantly affect the Company’s finances.
Accounting Standards-these are the regulations and codes of practice which have been developed to try to reduce the number of different interpretations and treatments used by accountants in preparing and presenting the Financial Statements for limited companies. This regulation have a direct impact on the company’s actions, as IWL is a limited company and have to prepare Financial Statements each year. The Finance Director, being ACCA qualified, is applying accounting standards while preparing the financial statements. Changes made to the standards may require the Finance Director to undertake additional training which again will affect the company’s finances and the availability of staff. 5.1.4 The Data Protection Act 1998- the act lays down the principles by which the personal data should be managed by ‘data controllers’. Business organisations that keep personal data in respect of living and identifiable person are data controllers. The IWL has Payroll and Database section in the Accounts Department therefore is obliged to comply with the regulation. Only authorised members of staff are to use IWL’s computers. In case of any changes in the Data Protection Act 1998, the Company may be required to, for example, purchase new safe for keeping the records in safe and secure way or to purchase new database software to meet the requirements of the regulation as well as train staff and review and implement changes in company’s policies.
5.2 Fraud is an intentional act by management or employees in order to obtain an unfair or illegal advantage. The most common causes of fraud in a business can be identified as a lack of operational internal control procedures within the business, lack of internal anti-fraud controls, especially risk management, as well as a lack of internal audit. In order to improve fraud and theft detection, the BODs needs to regularly review company’s fraud policies and procedures to ensure that they effectively reduce risk, improve processes and are in compliance with prevailing laws and regulations. This involves identifying the company’s specific fraud risks and then developing and implementing controls, procedures and operational changes to mitigate those risks. 5.3 The most common types of fraud can be identified as the theft of assets and corruption. The effects of the fraud activities can devastate the company in various ways, for instance, financial loss, external confidence, company morale or increased audit costs.
Theft- this is probably the most common method of fraud, usually carried out because staff are presented with opportunities due to lack of physical controls and little or no segregation of duties with individual members of staff being given too much personal control over procedures. Impact of the theft can be fairly easy quantified. If, for example, the manager overstates the hours worked by an employee, these can be easily calculated by multiplying the rate per hour by hours worked. In fact this is stealing the company’s time and subsequently money. There is a high risk of such an activity occurring within IWL shops as the company has no procedure in place for sales, warehouse or administrative staff to sing in or out when they arrive or leave work. This type of fraud often happens without knowledge of the management. 5.3.2 Corruption- this form of fraud usually involves a dishonest member of staff working in collusion with others to commit acts of fraud. The example of such an activity is changing contract terms and conditions after it have been awarded in favour of the supplier. There is a great possibility of this type of fraud occurring in the IWL’s due to lack of internal control procedures for purchasing inventory. This results in loses to the company because, the company is paying more for the product therefore reducing the Company’s revenue.
5.4 The accounting system can support internal control by means of setting the standards and using of control systems. 5.4.1 Standards allow the organisation to define its expectation of how things should be achieved. They allow the management to monitor the performance of the employees. These standards can be based on what the organisation expects from the staff, for example, implementing of company’s procedures. The organisation will generally outline to the staff what it expects in relation to performance levels, like cost of ensuring work is carried out effectively and that the deadlines are met, as well as in relation to the error allowance. Standards should be set in relation to the organisation’s objectives and goals. A tool commonly used for the purpose of measuring performance is that of standard costing. A main feature of standard costing is variance analysis, where differences between budgeted and actual figures are monitored. This allows the organisation to identify where changes may be required. 5.4.2 Use of control in systems is aimed at ensuring that the plans of organisation are being met. Deviations found by the control monitors should be investigated and if they negatively affect organisation then corrective action should be taken. An internal control system includes all the policies and procedures adopted by the organisation to achieve the objectives of: Effective conduct of the business,
Implementation of internal policies and procedures,
Safeguarding the assets of the organisation,
Detecting and preventing incidences of fraud and error,
The accuracy and completeness of the financial records,
The timely preparation of reliable financial information.
Regardless of the size of the organisation the accounting system must be reliable, cost effective and capable of being used effectively by the person(s) operating it. An accounting system of the IWL is a collection of computerized and manual accounting processes, procedures and controls created to collect, record, classify, summarize and interpret financial data for decision making by management. The record keeping systems of IWL meet organisation’s requirements for financial information. The Strengths, Weaknesses, Opportunities and Threads (SWOT) analysis has been prepared to identify those areas of the current accounting system that do not operate satisfactory and can be found in appendix 4. The analysis showed that the work is going through the correct sequence of events and processes and that there is good segregation of duties within the department. However, there are areas where the systems could be improved. These have been identified as better staff training and introduction of audit trail. Better trained staff would become specialised in the area they operate which would enable them to complete tasks more efficiently and effectively and therefore reduce costs. The audit trail would minimise potential for error and would act as a control tool for staff activity.
Weaknesses Identified Within The Accounting System
The weaknesses that rise potential for error and possible exposure to fraud within The Accounting System of the IWL have been identified as insufficient staff training and lack of audit trail procedures. 6.2 Insufficient staff training caused many problems during the last six months period. There was not enough cover in the sales ledger section when the clerk was off sick or on holiday leave which caused accumulation of work that affected other departments as the financial information was not presented in the timely manner. The fact that no one was able to provide cover was evident proof of staff training needs. Another area where problems occurred due to lack of training is that of the payroll and database section. The clerk was provided with only one day in-house training of how to operate payroll software and this resulted in mistakes with the staff salaries calculations. This is the example of error that occurred because of the lack of training.
Some of them have been underpaid what may result in lower staff morale and de-motivate them which will result in worse productivity or alternatively may give a reason to commit fraud. Work could be delegated to different persons what would also act as an anti-fraudulent control because the person providing cover could spot any unauthorised or suspicious activities and report it to the management. It is recommended that all staff should be sent for training in order to become multi skilled. 6.3 Another weakness identified is the lack of internal audit procedures within the accounts department of the IWL. The impact on the organisation may be significant to the company in terms of money and reputation, should the fraud activities took place. Internal audit has proved to be the most successful method of detecting fraud. It would be advantageous to any organisationif its internal audit function were able to advise management on identifying and assessing the risks associated with fraud could review and monitor the internal control procedures in place to minimise the risk of fraud and also actively engage in detection of fraud within the accounts function. Internal controls are also successful as means not only of deterring or preventing fraud, but also of exposing acts of fraud. Many of the causes of fraud can be guarded against and, together with analysis of reports and trends and the investigation of errors and anomalies, fraudulent activities are often expose.
The typical measures introduced in practice to help deter and prevent fraud has been identified as: Educating staff and raising awareness of the possible types of fraud and the likely impact of fraud on the organisation and its stakeholders. Whilst there is a belief that that such education could not only alert staff to types of fraud but could also encourage staff to indulge in fraudulent activities, research shows that money spent on educating staff and promoting staff awareness does in fact deter fraud and in the long run benefits outweigh costs. 6.4.2 Monitoring performance and making sure that accounting procedures are being followed. One member of staff, for instance accounting technician when his review and recommendation process is completed, could be delegated to perform this task with all the discrepancies and suspicious activities reported to the management and appropriate action taken to mitigate risks. 6.5 The company can support individuals who operate accounting systems using training, manuals and written information and help menus. 6.5.1 Training- well trained staffs operate their accountancy systems more effectively than the untrained staffs. A review of the training needs of the company and its accounting staff has been undertaken, these have been identified as follows: General ledger and inventory clerk- appropriate training in the work of the Sales Clerk would relieve pressure from the Sales clerk who has no accounting or credit control qualification and who has a heavy workload during busy periods. 184.108.40.206 Purchase ledger clerk- this member of staff is already familiar with the work of the sales ledger section and an update of skills in this area is worth considering.
The Purchase Ledger clerk is part AAT qualified and expressed an interest in studying for intermediate level 3 exams. 220.127.116.11 Sales ledger clerk and credit controller- this staff member has experience of the purchase ledger having worked as a Purchase Ledger Clerk before joining IWL. Some further training in this area would give a greater degree of flexibility. The clerk has expressed an interest in professional accountancy training and this should be encouraged. 18.104.22.168 Payroll and Personnel Database clerk- this staff member is working on a recently installed system has a heavy workload and is in need of additional training. Further training by a company who sold IWL new system is recommended. The clerk has an accounting qualification but further training should be discussed. 22.214.171.124 Costing technician- this is the only member of staff that has the experience to operate costing system. This member of staff shows reluctance to gain accounting qualification. The issue needs to be resolved to the benefit of the company.
6.5.2 Manuals are files containing documents which provide the user with detailed information relating to procedures and operating activities. An example of the manual is handbook created by the Finance Director of the IWL relating to the IT systems. 6.5.3 Help menus- are aimed at providing assistance to the system user by allowing them to query items relevant to their effective use of the system. It provides the information on how to use
the software in the correct manner. Sage payroll has such a facility in place. 6.5.4 Written information- the example may be company policy handbook issued by the Finance Director. 6.6 Every member of accounting staff is required to comply with statutory and organisational requirements. The types of controls that can be put in place to ensure compliance may include: data security controls and administrative controls. 6.6.1 Data security controls are put in place to ensure that the organisation’s data files are not subject to unauthorised access, change, disclosure to unauthorised persons, loss, damage or destruction.
The IWL has a data security controls in place, however these are not being adhered to properly. It is recommended that staff should be informed about requirements of changing the password regularly and that unauthorised person should not be given access to the company’s computers. 6.6.2 Administrative controls can be categorised as segregation of duties, written policies and procedures and supervision. Due to lack of staff training, it is not possible to segregate and share duties between workers as they are not multi-skilled. This rise a possibility of error occurring as well as fraudulent manipulation of the system. Written policies are in place however, accountability and responsibility for implementing should be clearly defined. Every member should be informed about the consequences in case the procedures are not followed. Supervision of individuals or groups involved in the processing, checking and use of information within the system is essential. It is recommended that the activities of staff should be controlled by either member of the BODs or the Company Accountant. 6.7 The potential areas of fraud arising from lack of control within the accounting system have been identified as inventory control section and the purchase ledger section. Inventory control system would benefit from acquiring the Purchase Order Processing module which would improve the accuracy and reliability of the inventory control and would minimise risk of fraud. The Purchase Ledger section need more supervision as the Purchase Manager seems to be the most unreliable and suspicious person.