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Transaction Cycles and Internal Controls

The document discusses various transaction cycles that occur in businesses including purchasing, inventory, sales, payroll, and finance. It describes the typical sequence of events and accounting records affected for each cycle. Maintaining strong internal controls is important for each cycle to protect assets and ensure accurate financial reporting. Key aspects of a good internal control system include adequate separation of duties, proper authorization of transactions, physical control over assets, and independent checks on performance. Strong internal controls provide benefits like more reliable financial information and reduced risk of losses.

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821 views16 pages

Transaction Cycles and Internal Controls

The document discusses various transaction cycles that occur in businesses including purchasing, inventory, sales, payroll, and finance. It describes the typical sequence of events and accounting records affected for each cycle. Maintaining strong internal controls is important for each cycle to protect assets and ensure accurate financial reporting. Key aspects of a good internal control system include adequate separation of duties, proper authorization of transactions, physical control over assets, and independent checks on performance. Strong internal controls provide benefits like more reliable financial information and reduced risk of losses.

Uploaded by

Prey
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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A C T I O N CY CL E S A N D

T RA N S
INTERNAL CO N T R O LS
BY: DR. MEGHA SHAH
MEANING OF TRANSACTION CYCLE
• A transaction cycle is an interlocking set of business transactions.
• Transaction cycles highlight the sequence of events that relate to a particular class of transaction.
• Aim is to determine the nature of the transaction system cycles with respect to the types of transactions,
accounting records affected & personnel involved.

• And also identify the information flow & the need for essential internal controls for each transaction cycle.
• Most business transactions can be aggregated into a relatively small number of transaction cycles related to the
o Sale of goods,
o Payments to suppliers,
o Payments to employees, and
o Payments to lenders.
UNIVERSAL TRANSACTION CYCLE

Purchase&
Inventory
Account
& production
payable
cycletransactions
cycle
SalesNon-current
& Payroll
Finance
accounts assets
Cash & bank balance cycle
Cycle
receivable
PURCHASE & ACCOUNT PAYABLE TRANSACTIONS

A company issues a purchase order to a


 supplier for goods, receives the goods, records an account payable, and pays the supplier.
There are several ancillary activities, such as
the use of petty cash or procurement cards for smaller purchases.
This set of sequential, interrelated activities is known as the purchasing cycle, or expenditure cycle.
Credit & cash purchases are the 2 major transactions classes here.
Internal control objectives for the purchase & accounts payable cycle.
Nature of the purchases & accounts payable cycle.
Transactions in the purchases & accounts payable cycle.
Accounting records affected by the purchases & accounts payable cycle.
Personnel within the purchases & accounts payable cycle.
INVENTORY & PRODUCTION CYCLE
• This cycle for a company is unique, in that it interacts with the purchases, sales & payroll cycles, as well as the
cost of production.

• Because of this interaction, all of the activities associated with it (recording of services, costs of production, wages
& salaries) are of major interest.

• Primary objective of controls in this cycle are to ensure that inventory is protected and production is controlled &
run on a cost-effective basis.
• Internal control objectives for the inventory & production cycle.

• Nature of the inventory & production cycle.


• Transactions in the inventory & production cycle.
• Accounting records affected by the inventory & production cycle.
• Personnel in the inventory & production cycle.
PAYROLL CYCLE

A company records

 the time of its employees,


 verifies hours and overtime worked,
 calculates gross pay,
 deducts taxes and other withholdings, and
 issues paychecks to employees.
 Other related activities include the payment of withheld income taxes to the government, as well as the issuance of
annual form 16 to employees.

 Apart from wages & salaries, they also include – commissions, employee bonuses, employee benefits
 long service leave, annual leave, health insurance payments, super entitlements.
SALES & ACCOUNTS RECEIVABLE CYCLE

A company

 receives an order from a customer,


 examines the order for creditworthiness,
 ships goods or provides services to the customer,
 issues an invoice, and
 collects payment.
FINANCE CYCLE
A company issues debt instruments

 to lenders, followed by
 a series of interest payments and repayments of the debt.
Also, a company

 issues stock to investors, in exchange for periodic dividend payments and


 other payouts if the entity is dissolved.
These clusters of transactions are more diverse than the preceding transaction cycles, but may involve
substantially more money.
Cash & Bank balance

• Cash is used to define money & other negotiable instruments such as cheques, money orders that financial
institutions will accept as deposits. Cash does NOT include
• Accounts receivable,
• post dated cheques
• Because of it’s liquid nature, cash is likely to misuse, misappropriation or theft – therefore it is important to
ensure that organizations have a sound system of internal control to handle cash & cash balances. Internal
control objectives of cash & bank.

• Physical controls
• Working capital controls
Non-current assets
While many non-current assets are large & difficult to remove, others are not, therefore it is important that
strict control be maintained over the entire range of non-current assets.
• Controls over acquisition & recording.
• Controls over the use & security of non-current assets
• Controls over disposals.
IN T E R NA L C ONT RO L
IF…..
• An accounting clerk may have the responsibility of maintaining the
blank cheques in his or her desk, but who else could access them?

• A controller may be the only employee with the accounting software


on his or her computer, but who else could access the software?
IF…
Good internal controls are the procedures that catch fraud or errors.
For the examples previously mentioned,

• a good control would be if the accounting clerk locked the drawer with the blank
cheques and had the only key or

• if the controller used passwords to the computer and software that are only
known to that user.
CONTI..
• To identify segregation of duties issues, organizations might categorize employee responsibilities
related to certain transaction cycles into three categories to help determine weaknesses in internal
controls. In the payroll cycle, for example, who has access to the payroll software, who records the
payroll, and who reviews the payroll? Internal controls should be reviewed more closely if an
employee has responsibilities in two or three categories within the same transaction cycle.

• Many auditing textbooks classify control activities into specific activities which can be helpful to
organizations analyzing their control environment. Arens, elder, and beasley’s auditing and assurance
services identifies five specific activities of a strong control environment:
A GOOD INTERNAL CONTROL SYSTEM

• Adequate separation of duties


• Proper authorization of transaction and activities
• Adequate documents and records
• Physical control over assets and records
• Independent checks on performance
CONTI…

• Implementing a good internal control environment has numerous benefits to an


organization; those with the greatest impact include:

• More reliable and timely financial information will be provided to management and
governance groups.

• The risk of losses due to waste, mismanagement, errors and fraud will be reduced.
• An auditor may be able to reduce the extent of his or her procedures, which leads to time
and cost benefits for both the auditor and the organization.

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